MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
10-Q, 1998-08-11
ELECTRIC SERVICES
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<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 June 30, 1998


                                       OR


[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934


For the transition period from                to
                               --------------    -----------------------

Commission file number (Under the Securities Act of 1933) 33-37977

                MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
                ------------------------------------------------
             (Exact name of registrant as specified in its charter)


           MICHIGAN                                              38-2726166
           --------                                          -------------------
 State or other jurisdiction of                                (I.R.S. Employer
incorporation or organization)                               Identification No.)


 100 PROGRESS PLACE, MIDLAND, MICHIGAN                              48640
 -------------------------------------                        ------------------
(Address of principal executive offices)                          (Zip Code)


Registrant's telephone number, including area code               (517) 839-6000



Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X  No
                                      ---    ---


<PAGE>   2
                        PART I. FINANCIAL INFORMATION
                         Item 1. Financial Statements
                                      
               MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
                      CONSOLIDATED BALANCE SHEETS AS OF
                                (In Thousands)



<TABLE>
<CAPTION>

                                                                                         
                                                                                         June 30,           December 31,
ASSETS                                                                                    1998                  1997
                                                                                       (Unaudited)
                                                                                      ------------         ---------------
<S>                                                                                   <C>                 <C>
CURRENT ASSETS:
   Cash and cash equivalents                                                           $   229,285          $   222,365
   Restricted cash and cash equivalents                                                     12,541               12,161
   Accounts and notes receivable                                                            97,464               93,674
   Gas inventory                                                                            12,573               12,910
   Unamortized property taxes                                                               28,679               16,097
   Prepaid expenses and other                                                                4,537                4,578
                                                                                       -----------          -----------
     Total current assets                                                                  385,079              361,785
                                                                                       -----------          -----------
                                                                                                            
PROPERTY, PLANT AND EQUIPMENT:                                                                              
   Property, plant and equipment                                                         2,381,454            2,439,651
   Pipeline                                                                                 21,222               21,222
                                                                                       -----------          -----------
     Total property, plant and equipment                                                 2,402,676            2,460,873
                                                                                                            
   Accumulated depreciation                                                               (605,685)            (640,170)
                                                                                       -----------          -----------
     Net property, plant and equipment                                                   1,796,991            1,820,703
                                                                                       -----------          -----------
                                                                                                            
OTHER ASSETS:                                                                                               
   Restricted investment securities held-to-maturity                                       138,486              138,898
   Deferred financing costs, net of accumulated amortization of                                             
        $9,900 and $9,358, respectively                                                      8,677                9,219
   Prepaid gas costs, materials and supplies                                                20,913               20,666
                                                                                       -----------          -----------
     Total other assets                                                                    168,076              168,783
                                                                                       -----------          -----------
                                                                                                                       
                                                                                                            
TOTAL ASSETS                                                                           $ 2,350,146          $ 2,351,271
                                                                                       ===========          ===========
                                                                                                            
LIABILITIES AND PARTNERS' EQUITY                                                                            
CURRENT LIABILITIES:                                                                                        
   Accounts payable and accrued liabilities                                            $    73,825          $    58,942
   Interest payable                                                                         82,899               85,183
   Current portion of long-term debt                                                       102,522              140,950
                                                                                       -----------          -----------
     Total current liabilities                                                             259,246              285,075
                                                                                       -----------          -----------
                                                                                                            
NON-CURRENT LIABILITIES:                                                                                    
   Long-term debt                                                                        1,774,997            1,788,291
   Other                                                                                       820                  684
                                                                                       -----------          -----------
     Total non-current liabilities                                                       1,775,817            1,788,975
                                                                                       -----------          -----------
                                                                                                            
CONTINGENCIES (Note 7)                                                                                      
                                                                                                            
TOTAL LIABILITIES                                                                        2,035,063            2,074,050
                                                                                       -----------          -----------
                                                                                                            
PARTNERS' EQUITY                                                                           315,083              277,221
                                                                                       -----------          -----------
                                                                                                            
TOTAL LIABILITIES AND PARTNERS' EQUITY                                                 $ 2,350,146          $ 2,351,271
                                                                                       ===========          ===========

</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                    Six Months Ended
                                                           June 30,                             June 30,
                                               ---------------------------------    ---------------------------------
                                                    1998              1997              1998               1997
                                               ---------------    --------------    --------------    ---------------
<S>                                           <C>                <C>               <C>               <C>
OPERATING REVENUES:
   Capacity                                    $ 101,474          $ 100,624          $ 201,812          $ 200,993
   Electric                                       48,046             53,311            100,417            108,778
   Steam and other                                 6,425              6,415             13,694             14,785
                                               ---------          ---------          ---------          ---------
                                                                                                        
     Total operating revenues                    155,945            160,350            315,923            324,556
                                               ---------          ---------          ---------          ---------
                                                                                                        
OPERATING EXPENSES:                                                                                     
   Fuel costs                                     59,329             62,923            124,942            132,128
   Depreciation                                   22,954             26,130             49,558             52,337
   Operations                                      3,666              3,849              7,705              8,194
   Maintenance                                     3,211              3,293              5,983              6,205
   Property and single business taxes              6,427              6,981             12,837             13,449
   Administrative, selling and general             2,422              1,992              4,934              4,183
                                               ---------          ---------          ---------          ---------
                                                                                                        
     Total operating expenses                     98,009            105,168            205,959            216,496
                                               ---------          ---------          ---------          ---------
                                                                                                        
OPERATING INCOME                                  57,936             55,182            109,964            108,060
                                               ---------          ---------          ---------          ---------
                                                                                                        
OTHER INCOME (EXPENSE):                                                                                 
   Interest and other income                       5,509              5,222             11,534              9,544
   Interest expense                              (42,227)           (44,503)           (83,636)           (88,076)
                                               ---------          ---------          ---------          ---------
                                                                                                        
     Total other income (expense), net           (36,718)           (39,281)           (72,102)           (78,532)
                                               ---------          ---------          ---------          ---------
                                                                                                        
INCOME BEFORE CUMULATIVE EFFECT OF                                                                      
   ACCOUNTING CHANGE                              21,218             15,901             37,862             29,528
                                                                                                        
Cumulative effect on prior years (to                                                                    
   December 31, 1996) of change in method of                                                            
   accounting for property taxes (Note 3)             --                 --                 --             15,533
                                               ---------          ---------          ---------          ---------
                                                                                                        
NET INCOME                                     $  21,218          $  15,901          $  37,862          $  45,061
                                               =========          =========          =========          =========
</TABLE>

  The accompanying condensed notes are an integral part of these statements.

                                      -2-
<PAGE>   4


                MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
             CONSOLIDATED STATEMENT OF PARTNERS' EQUITY (Unaudited)
                                 (In Thousands)



<TABLE>
<CAPTION>

                                                                                 Six Months Ended
                                                                                  June 30, 1998
                                                            -----------------------------------------------------------
                                                              General                Limited
                                                              Partners               Partners                Total
                                                            -------------          -------------          -------------

<S>                                                         <C>                    <C>                    <C>
       BALANCE, BEGINNING OF PERIOD                          $ 229,992              $  47,229              $  277,221


       Net income                                               32,963                  4,899                  37,862


                                                             ---------              ---------               ---------
       BALANCE, END OF PERIOD                                $ 262,955              $  52,128               $ 315,083
                                                             =========              =========               =========
</TABLE>


   The accompanying condensed notes are an integral part of these statements.

                                      -3-
<PAGE>   5
                MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
                CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
                                 (In Thousands)


<TABLE>
<CAPTION>

                                                                                            Six Months Ended
                                                                                                June 30,
                                                                                  --------------------------------------
                                                                                        1998                 1997
                                                                                  -----------------    -----------------
<S>                                                                                 <C>                 <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income                                                                        $  37,862           $  45,061
                                                                                    
   Adjustments to reconcile net income to net cash provided  by                     
     operating activities                                                           
                                                                                    
   Depreciation and amortization                                                        50,100              52,908
   Cumulative effect of change in accounting principle                                      --             (15,533)
   Increase in accounts and notes receivable                                            (3,790)             (1,607)
   Decrease in gas inventory                                                               337               3,372
   Increase in unamortized property taxes                                              (12,582)            (12,781)
   Decrease (increase) in prepaid expenses and other                                        41              (2,582)
   Increase in prepaid gas costs, materials and supplies                                  (247)            (15,325)
   Increase in accounts payable and accrued liabilities                                 14,883               7,853
   Decrease in interest payable                                                         (2,284)             (1,282)
   Increase in other non-current liabilities                                               136                 142
                                                                                     ---------           ---------
                                                                                    
     Net cash provided by operating activities                                          84,456              60,226
                                                                                     ---------           ---------
                                                                                    
CASH FLOWS FROM INVESTING ACTIVITIES:                                               
   Plant modifications and purchases of plant and equipment                            (25,846)            (20,646)
                                                                                     ---------           ---------
                                                                                    
     Net cash used in investing activities                                             (25,846)            (20,646)
                                                                                     ---------           ---------
                                                                                    
CASH FLOWS FROM FINANCING ACTIVITIES:                                               
   Repayment of financing obligation                                                   (51,722)            (29,040)
   Decrease in restricted non-current cash and cash equivalents                             --               3,044
   Maturity of restricted investment securities held-to-maturity                       145,093                  --
   Purchase of restricted investment securities held-to-maturity                      (144,681)                 --
                                                                                     ---------           ---------
                                                                                    
     Net cash used in financing activities                                             (51,310)            (25,996)
                                                                                     ---------           ---------
                                                                                    
NET INCEASE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH - CURRENT                 
                                                                                         7,300              13,584
                                                                                    
CASH, CASH EQUIVALENTS AND RESTRICTED CASH - CURRENT, AT BEGINNING                  
   OF PERIOD                                                                           234,526             224,000
                                                                                    
                                                                                     ---------           ---------
CASH, CASH EQUIVALENTS AND RESTRICTED CASH - CURRENT, AT END OF                     
   PERIOD                                                                            $ 241,826           $ 237,584
                                                                                     =========           =========

</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, 1997 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 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 ("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 six months ended June 30, 1998, the
     Facility achieved a Thermal Percentage of 17.6% and a PURPA Efficiency
     Percentage of 45.5%. 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 1998. MCV meets the ownership
     limitations of PURPA.




                                      -5-
<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 it can meet the
     requirement of continuing assurances in 1998 for the succeeding five-year
     period. 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.

     At both the state and federal level, efforts continue on restructuring the
     electric industry. In Michigan, the Michigan Public Service Commission
     ("MPSC") has entered a final order permitting customers to choose their
     power provider over a four-year phase-in period beginning in 1998. Similar
     efforts, in the form of proposed legislation, exist at the federal level.
     Two issues generally involved in these restructuring efforts which could
     impact MCV the most are stranded assets or transition cost recovery for
     utilities and contract (PPA) sanctity. Over 90% of MCV's revenues come from
     sales pursuant to the PPA. To date, these restructuring efforts have not
     negatively impacted MCV, but if the final order of the MPSC is construed so
     as to deny stranded cost recovery of above-market PPA costs, and such order
     is not reversed on appeal, MCV cashflows may be negatively impacted
     especially in the period after 2007. MCV, as well as others, has filed an
     appeal of the MPSC restructuring orders in the Michigan Court of Appeals
     and a complaint in the U.S. District Court for the Western District of
     Michigan challenging the restructuring orders. MCV continues to monitor and
     participate in these matters, as appropriate and to evaluate potential
     impacts on both cashflows and recoverability of the carrying value of
     property, plant and equipment. MCV management cannot, at this time, predict
     the impact or outcome of these matters.


(2)  SIGNIFICANT ACCOUNTING POLICIES

     Fair Value of Financial Instruments

     The carrying amounts of cash, cash equivalents and short-term investments
     approximate fair value because of the short maturity of these instruments.
     MCV's short-term investments, which are made up of investment securities
     held-to-maturity, as of June 30, 1998 and December 31, 1997, have original
     maturity dates of less than one year. 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

     An amended service agreement (the "amended Service Agreement") was entered
     into between MCV and ABB Power Generation ("ABB Power"), under which ABB
     Power provides hot gas path parts for MCV's twelve gas turbines through the
     sixth series of major gas turbine generator ("GTG") inspections, which are
     expected to be completed by year 2008. The payments due to ABB Power under
     this amended 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 amended Service
     Agreement.

     To manage this currency exchange rate risk and hedge against adverse
     currency fluctuations impacting the payments under this amended 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 



                                      -6-
<PAGE>   8

                MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
         CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)


     Standards ("SFAS") 52 "Foreign Currency Translation," since they hedge the
     identifiable foreign currency commitment of the amended 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 major renewal costs when incurred. As of June 30,
     1998, MCV had forward purchase contracts involving Swiss francs in the
     notional amount of $5.0 million, with a deferred $39,000 loss, recorded in
     prepaid expenses and other. On December 29, 1997, MCV closed out the
     forward purchase contracts involving Swiss francs in the notional amount of
     $10.0 million, resulting in a deferred $.2 million gain, recorded in
     current liabilities.

     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, recorded in prepaid expenses and other, was $2.2 million and $1.6
     million as of June 30, 1998 and December 31, 1997, respectively. MCV's
     deferred gains and losses on future and option contracts, recorded in
     current liabilities, 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. MCV had net open futures and options contracts of .3 Bcf with a
     deferred loss of $.1 million as of both June 30, 1998 and December 31,
     1997. In addition, MCV recorded approximately $.2 million in net deferred
     losses on contracts closed prior to June 30, 1998, related to July-October
     1998 purchase commitments, and had approximately $.6 million in net
     deferred gains on contracts closed prior to December 31, 1997, related to
     January and February 1998 purchase commitments.

     Interest Rate Swap Hedges

     To manage the effects of interest rate volatility on interest income while
     maximizing return on permitted investments, MCV established an interest
     rate hedging program. The notional amounts of the hedges are tied directly
     to MCV's anticipated cash investments, without physically exchanging the
     underlying notional amounts. These agreements will maximize the yield on
     MCV's investments and minimize the impact of fluctuating interest rates.

     In December 1997, MCV entered into an interest rate swap hedge in the
     notional amount of $20 million, with the period of performance from April
     1, 1998 through December 1, 2002. Cash was deposited with the broker at the
     time the interest rate swap was initiated. The change in market value of
     this contract requires adjustment of the margin account balance. The margin
     balance recorded in prepaid expenses and other, was $200,000 and $25,000,
     as of June 30, 1998 and December 31, 1997, respectively. The difference
     between the amounts received and paid under the interest rate swap
     transaction is accrued and recorded as an adjustment to the interest income
     over the life of the hedged agreement. As of June 30, 1998, MCV had an
     immaterial loss under this interest rate swap hedge.

     Depreciation

     Effective January 1, 1998, MCV prospectively revised its useful lives of
     the gas turbines and certain related capital spares, to more closely
     reflect the economic useful lives of these assets. These assets are
     serviced and maintained by ABB Power under the amended Service Agreement,
     which will extend through the sixth series of major GTG inspections, with
     expected coverage through year 2008. The effect of this change in
     accounting estimate will result in a decrease to operating expenses of
     approximately $8.9 million for the year ending December 31, 1998.


                                      -7-
<PAGE>   9
                MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
         CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)



     New Accounting Standard

     In June 1998, the Financial Accounting Standards Board issued Statement of
     Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
     Instruments and Hedging Activities". This statement establishes accounting
     and reporting standards requiring that every derivative instrument be
     recorded in the balance sheet as either an asset or liability measured at
     its fair value. The statement requires that changes in the derivative's
     fair value be recognized currently in earnings unless specific hedge
     accounting criteria are met. Special accounting for qualifying hedges in
     some cases allows a derivative's gains and losses to offset related results
     on the hedged item in the income statement or permits recognition of the
     hedge results in other comprehensive income. SFAS No. 133 is effective for
     fiscal years beginning after June 15, 1999. MCV is currently studying the
     impact of SFAS No. 133, but at this time, does not expect the application
     of this standard to materially affect its financial position or results of
     operations.


(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
     six months ended June 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, CASH EQUIVALENTS AND INVESTMENT SECURITIES 
     HELD-TO-MATURITY

     Current and non-current restricted cash and cash equivalents and investment
     securities held-to-maturity consist of the following as of (in thousands):


<TABLE>
<CAPTION>

                                                                             June 30,              December 31,
                                                                               1998                    1997
                                                                          ---------------         ---------------
<S>                                                                      <C>                     <C>
       Current:
       Funds restricted for plant modifications                           $       12,541          $       12,161
                                                                          ==============          ==============

       Non-current:
       Funds restricted for rental payments pursuant to the Overall
         Lease Transaction                                                $      137,664          $      138,242

       Funds restricted for management non-qualified plans                           822                     656
                                                                          --------------          --------------

       Total                                                              $      138,486          $      138,898
                                                                          ==============          ==============
</TABLE>



                                      -8-
<PAGE>   10
                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>

                                                                             June 30,              December 31,
                                                                               1998                    1997
                                                                          ---------------         ---------------
<S>                                                                      <C>                     <C>
       Accounts payable
         Related parties                                                  $        26,521         $        15,382
         Trade creditors                                                           20,052                  28,531
       Property and single business taxes                                          25,485                  12,379
       Other                                                                        1,767                   2,650
                                                                          ---------------         ---------------

       Total                                                              $        73,825         $        58,942
                                                                          ===============         ===============
</TABLE>


(6)  LONG-TERM DEBT

     Long-term debt consists of the following as of (in thousands):

<TABLE>
<CAPTION>

                                                                             June 30,              December 31,
                                                                               1998                    1997
                                                                          ---------------         ---------------
<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                                                          $     1,877,519          $    1,929,241

       Less current portion                                                      (102,522)               (140,950)
                                                                          ---------------         ---------------

       Total long-term debt                                               $     1,774,997          $    1,788,291
                                                                          ===============         ===============
</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 six months ended June 30, 1998 and 1997 were $83.0 million and $87.5
     million, respectively. Interest and fees paid for the six months ended June
     30, 1998 and 1997 were $85.3 million and $88.7 million, respectively.


(7)  CONTINGENCIES

     PPA - "Regulatory Out" Provision

     Under the "regulatory out" provision of the PPA, Consumers may, under
     certain conditions, be relieved of paying capacity and/or 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 


                                      -9-
<PAGE>   11
                MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
         CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)




     to MCV below an average rate of 3.77 cents per kWh for available contract
     capacity as a result of a regulatory disallowance.

         PPA - Jurisdictional Allocation
         On February 23, 1995, the 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) (the "Jurisdictional Issue"). 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 in accordance with the MPSC order which
         was upheld by the Michigan Court of Appeals. 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 since MCV's application to
         appeal was denied by the Michigan Supreme Court in January 1998. Based
         on this decision, Consumers notified MCV that it would continue
         withholding the fixed energy charges on the Jurisdictional Issue
         (currently averaging approximately $35,000 per month in 1998). MCV
         released to Consumers 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
         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 through 1997 Reconciliation and/or 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"). 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 believes
         these rulings are erroneous and petitioned the Michigan Supreme Court
         to review the off-peak cap issue in the 1993 Reconciliation and 1994
         Plan Cases. During 1998, the Michigan Supreme Court denied MCV's
         petition for review of the 1993 Reconciliation and 1994 Plan Cases,
         thus, these cases are now final. Other PSCR Plan and/or Reconciliation
         Cases for the years 1996 and 1997 are pending before the MPSC which
         involve this same issue. Consumers escrowed approximately $2.8 million
         for 1996 and $1.0 million for the period 1994 and 1995 of fixed energy
         charges payable to MCV based upon the MPSC rulings. MCV has not
         recognized any of these amounts related to the off-peak cap issue as
         operating revenues.

         PPA - Additional 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 proposed
         approving one-hundred percent jurisdictional cost recovery of an
         additional 325 MW of capacity purchased from MCV. Cost recovery
         approval for the 325 MW of MCV Contract Capacity was in addition to the
         915 MW already approved (subject to the Jurisdictional Issue) by the
         MPSC. In November 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 Case. In the 1996 PSCR Plan Case, 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. As a result of the approval of the
         325 



                                      -10-

<PAGE>   12

                MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
         CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)



         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
         $1.4 million for the first six months of 1998 and $2.8 million for the
         year 1997, for energy delivered above the off-peak cap, 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, the 1996 PSCR Plan Case, subsequent PSCR proceedings,
         or appeals, if any.

         PPA - 1998 PSCR Rate Freeze
         On January 14, 1998, the MPSC issued a ruling suspending Consumers
         annual PSCR Plan and Reconciliation Cases and set a PSCR "rate freeze"
         effective January 1, 1998. This PSCR rate freeze is subject to a final
         adjustment in Consumers' 1997 PSCR Reconciliation Case, which is in
         progress. This case will determine the level at which Consumers' PSCR
         rates will be frozen during the period 1998 through 2001. Beginning
         with the payment of the March 1998 invoice, Consumers began paying MCV
         fixed energy payments based upon MCV's availability up to 915 MW and on
         deliveries above 915 MW, rather than the higher level established in
         the PSCR rate freeze. MCV disputes Consumer's contention that
         availability based payments occur only up to 915 MW and is continuing
         to discuss this issue with Consumers. MCV has recognized the fixed
         energy payment based on availability up to the caps in the 915 MW
         Settlement Order and on deliveries above 915 MW as operating revenues.
         At this time, MCV Management cannot predict the outcome of this issue.

         PPA - Other Issues
         In 1997, Consumers informed MCV of several other potential payment
         issues it may pursue, pursuant to the "regulatory out" and other
         provisions 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). Consumers has estimated that the
         financial impact of these issues for 1996 would decrease MCV's
         operating revenues by an estimated $2.5 million. In addition, Consumers
         notified MCV that it does not believe that MCV can use the
         approximately 15 MW of generating capacity and energy attributable to
         the back pressure turbine, which was placed into service in July 1997,
         towards available Contract Capacity or electric deliveries under the
         PPA. Consumers has also indicated that they may take a similar position
         on the incremental energy and capacity resulting from MCV's
         installation of 11NM upgrade packages on the GTGs. MCV has recognized
         amounts related to the above issues as operating revenues, except for
         revenues associated with the band width (currently averaging
         approximately $7,000 per month in 1998). MCV Management continues to
         review Consumers positions on the above issues and cannot predict the
         outcome of these issues.

     GTG Equipment Problems

     In 1996, several of the GTGs experienced severe cracking in the hot gas
     casings, which in some cases caused extensive damage to the turbine blades
     and vanes. MCV and ABB Power have identified and modified each of the GTGs
     to eliminate the problems and have implemented a program of hot gas path
     inspections for all GTGs, which are currently being performed every 2,000
     hours. MCV and ABB Power continue to address reliability issues to
     alleviate future outages, and MCV believes that with the modifications that
     have been made to date there should be no significant future impacts on
     plant availability or efficiency, although no assurance can be given that
     additional equipment problems will not occur.

     The cost of casing replacements and modifications is covered by ABB Power
     (with the exception of insurable events) pursuant to the amended Service
     Agreement, under which ABB Power is providing hot gas path parts for MCV's
     twelve gas turbines through the sixth series of major GTG inspections which
     are expected to be completed by year end 2008.

     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 



                                      -11-
<PAGE>   13
                MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
         CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)

     the second quarter of 1999. Failure to maintain insurance, subject to
     certain exceptions, not currently applicable, is an Event of Default under
     the Overall Lease Transaction.







                                     -12-
<PAGE>   14
                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 June
     30, 1998, and the nature and amount of related party transactions or
     agreements that existed with the Partners or affiliates as of June 30, 1998
     and 1997, and for each of the six month periods ended June 30, (in
     thousands).


<TABLE>
<CAPTION>
 Equity Partner, Type of Partner and   Equity
       Nature of Related Party         Interest   Interest    Related Party Transactions and Agreements             1998       1997
- ------------------------------------------------------------------------------------------------------------------------------------
<S>                                   <C>        <C>     <C>                                                  <C>         <C>
CMS Midland, Inc.                      $154,390   49.0%   Power purchase agreement                             $294,587    $301,532
  General Partner; wholly-owned                           Purchases under gas transportation agreements           4,791       4,817
  subsidiary of Consumers Energy                          Purchases under spot gas agreements                       487       2,499
  Company (formerly Consumers                             Purchases under gas supply agreements                   3,231       4,635
  Power Company)                                          Gas storage agreement                                   1,282       1,282
                                                          Land lease/easement agreements                            300         300
                                                          Accounts receivable                                    49,406      50,118
                                                          Accounts payable                                       13,596      11,101
                                                          Gas exchanges                                             832       1,268

The Dow Chemical Company                 36,618    7.5    Steam and electric power agreement                     20,630      23,024
  Limited Partner                                         Steam purchase agreement - Dow Corning Corp             
                                                          (affiliate)                                             1,700       1,700
                                                          Purchases under demineralized water supply              
                                                          agreement                                               3,297       3,816
                                                          Accounts receivable                                     2,407       1,706
                                                          Accounts payable                                          527       1,343
                                                          Standby and backup fees                                   350         403

Source Midland Limited Partnership       51,697   18.1    SMLP - Under Ownership of MCNIC Power Company
  ("SMLP") General Partner; wholly-                       Purchases under spot gas agreements                     4,035         563
  owned limited partnership of MCN                        Purchases under gas supply agreements                   5,735       1,597
  Energy Group Inc. (1)                                   Accounts payable                                        1,761       1,469
                                                          Partner cash withdrawal (including accrued             
                                                          interest) (2)                                          14,036          --

                                                          SMLP - Under Ownership of Pan Energy Corp
                                                          Purchases under gas transportation agreements              --       4,648
                                                          Purchases under spot gas agreements                        --         911

Coastal Midland, Inc. ("Coastal")        31,018   10.9    Purchases under gas transportation agreements           6,742       6,849
  General Partner; wholly-owned                           Purchases under spot gas agreement                      7,159       1,687
  subsidiary of The Coastal                               Purchases under gas supply agreement                    1,428       2,306
  Corporation                                             Gas agency agreement                                      728         742
                                                          Deferred reservation charges under gas purchase         
                                                          agreement                                               4,925       3,940
                                                          Accounts receivable                                     1,961           -
                                                          Accounts payable                                        3,587       3,305
                                                          Gas exchanges                                           4,111         149
                                                          Partner cash withdrawal (including accrued             
                                                          interest) (2)                                          19,520       7,149

MEI Limited Partnership ("MEI") (3)                       MEI - Under Ownership of Coastal and SMLP 
  A General and Limited Partner;                          See related party activity listed under Coastal 
  50% interest owned by Coastal                           Midland, Inc. and Source Midland Limited Partnership
  Midland, Inc. and 50% interest                            
  owned by SMLP                                           MEI - Under Ownership of ASEA Brown Boveri, Inc.
      General Partnership Interest       25,850    9.1    Gas turbine maintenance and spare parts agreement      23,377      16,093
      Limited Partnership Interest        2,585     .9    Accounts payable                                           --       2,291
                                                          Partner cash withdrawal (including accrued                 
                                                          interest) (2)                                              --       4,398

Micogen Limited Partnership              12,924    4.5    MLP - Under Ownership of The Coastal Corporation 
   ("MLP") Limited Partner; owned-                        See related party activity listed under Coastal 
   by a subsidiary of The Coastal                         Midland Inc.
   Corporation (4)                                        
                                                          MLP - Under Ownership of Fluor Corporation
                                                          Partner cash withdrawal (including accrued                 
                                                          interest) (2)                                              --       3,062

C-E Midland Energy, Inc. ("C-E") (5)         --   --      C-E  - Under Ownership of ASEA Brown Boveri, Inc.
  Interest in MCV acquired by MEI                         Service Agreement                                       1,252       1,248
  Limited Partnership                                     Accounts Payable                                           --         137

Alanna Corporation                        1 (6)   .00001  Note receivable                                             1           1
  Limited Partner; wholly-owned
  subsidiary of Alanna Holdings
  Corporation
</TABLE>

                                      -13-
<PAGE>   15

                MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
         CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Continued)




         Footnotes to Partners' Equity and Related Party Transactions

         (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 June 30, 1998 and for
              the six month period ended June 30, 1998; and as of June 30, 1997
              and for the period May 16, 1997 to June 30, 1997. The SMLP amounts
              listed Under Ownership of PanEnergy Corp. are for the period
              January 1, 1997 to May 15, 1997.
         (2)  Letters of credit have been issued and recorded as notes
              receivables from various equity partners, pursuant to the
              Participation Agreement. In the case of SMLP, the amount includes
              their share of the cash available to MEI Limited Partnership
              ("MEI"). In the case of Coastal Midland, Inc. ("Coastal"), the
              amount includes their share of cash available of MEI and Micogen
              Limited Partnership ("MLP").
         (3)  On June 16, 1998, Coastal and SMLP, each acquired a 50% interest
              in MEI. All MEI related party activity under the ownership of
              Coastal and SMLP is shown under the equity partners, Coastal and
              SMLP. All MEI related party activity under the ownership of ASEA
              Brown Boveri, Inc. is for the period January 1, 1998 to June 16,
              1998, and as of June 30, 1997 and for the six month period ended
              June 30, 1997.
         (4)  On April 30, 1998 Coastal and an affiliate of The Coastal
              Corporation acquired all of the partnership interests in MLP from
              Fluor Corporation ("Fluor"). All MLP related party activity under
              the ownership of The Coastal Corporation is shown under the equity
              partner, Coastal, which is also wholly-owned by The Coastal
              Corporation. The MLP amount listed Under Ownership of Fluor is as
              of June 30, 1997.
         (5)  C-E Midland Energy, Inc.'s limited partnership interest was
              acquired by MEI, which was subsequently acquired by Coastal and
              SMLP. All C-E related party activity under the ownership of ASEA
              Brown Boveri, Inc. is for the period January 1, 1998 to June 16,
              1998, and for the six month period ended June 30, 1997.
         (6)  Alanna's capital stock is pledged to secure MCV's obligation under
              the lease and other overall lease transaction documents.



                                      -14-
<PAGE>   16



       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, 1997 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                  Six Months Ended
                                                                    June 30,                           June 30,
                                                         -------------------------------     ------------------------------
                                                             1998              1997             1998              1997
                                                         --------------    -------------    --------------    -------------
<S>                                                       <C>              <C>               <C>              <C>
Operating Revenues                                         $   155,945      $   160,350       $   315,923      $   324,556

Capacity Revenue                                           $   101,474      $   100,624       $   201,812      $   200,993
   PPA Contract Capacity (MW)                                    1,240            1,240             1,240            1,240
   PPA Availability                                               99.3%            98.5%             99.3%            98.9%

Electric Revenue                                           $    48,046      $    53,311       $   100,417      $   108,778
   PPA Delivery as a Percentage of Contract Capacity              78.5%            90.6%             83.6%            91.0%
   PPA and SEPA Electric Deliveries (MWh)                    2,271,031        2,589,375         4,780,680        5,169,111
   Average PPA Variable Energy Rate ($/MWh)                $     16.90      $     16.73       $     16.93      $     16.83
   Average PPA Fixed Energy Rate ($/MWh)                   $      3.70      $      3.90              3.80             4.00

Steam Revenue                                              $     2,607      $     2,597       $     6,059      $     7,150
   Steam Deliveries (Mlbs)                                   1,257,167        1,289,976         2,928,118        3,000,438

Other Revenue                                              $     3,818      $     3,818       $     7,635      $     7,635

</TABLE>



Comparison of the Three Months ended June 30, 1998 and 1997

Overview

For the second quarter of 1998, MCV recorded net income of $21.2 million as
compared to net income of $15.9 million for the second quarter of 1997. The
increase in second quarter 1998 earnings is the result of lower interest expense
on MCV's financing obligation and lower depreciation expense due to revising the
useful lives of the gas turbine parts.



                                      -15-
<PAGE>   17

Operating Revenues

For the second quarter of 1998, MCV's operating revenues decreased $4.4 million
from the second quarter of 1997. This decrease was due primarily to lower
electric deliveries under the PPA with Consumers, resulting from Consumers
change to economic dispatch of the facility (See Part 1, Item 2, MD&A, "Outlook
- - Operating Outlook"). This decline in electric revenue is largely offset by a
decline in fuel costs also associated with the decrease in dispatch. In
addition, capacity revenue increased due to higher availability of the operating
equipment during the second quarter of 1998 versus 1997.

Operating Expenses

For the second quarter of 1998, MCV's operating expenses were $98.0 million,
which includes $59.3 million of fuel costs. During this period, MCV purchased
approximately 21.2 billion cubic feet ("bcf") of natural gas, of which 1.4 bcf
was used for transportation fuel and as a net change to gas in storage. During
this same period, MCV consumed 20.6 bcf of natural gas, of which .8 bcf of this
total was gas provided by Dow. The average commodity cost of fuel for the second
quarter of 1998 was $2.42 per million British thermal units ("MMBtu"). For the
second quarter of 1997, MCV's operating expenses were $105.2 million, which
includes $62.9 million of fuel costs. During this period, MCV purchased
approximately 26.4 bcf of natural gas, of which 4.0 bcf was used for
transportation fuel and as a net change to gas in storage. During this same
period, MCV consumed 23.3 bcf of natural gas, of which .8 bcf of this total was
gas provided by Dow. The average commodity cost of fuel for the second quarter
of 1997 was $2.34 per MMBtu. Fuel costs for the second quarter of 1998 compared
to 1997 decreased $3.6 million. This decrease was primarily due to lower gas
usage resulting from a lower electric dispatch by Consumers. This decrease was
partially offset by a higher 1998 average cost of gas due to an increase in spot
gas market prices.

For the second quarter of 1998, operating expenses, other than fuel costs,
decreased by $3.6 million from the second quarter of 1997, primarily due to
lower depreciation expense, resulting from a revision to the useful lives of the
gas turbines and certain related capital spares to more closely reflect the
economic useful lives of these assets. Other expenses incurred in these periods
were considered normal expenditures to achieve the recorded operating revenues.

Other Income (Expense)

The decrease in interest expense in the second quarter of 1998 from the second
quarter of 1997 is due to a lower principal balance on MCV's financing
obligation.

Comparison of the Six Months ended June 30, 1998 and 1997

Overview

For the first six months of 1998, MCV recorded net income of $37.9 million as
compared to net income of $45.1 million for the first six months of 1997. The
decrease in 1998 earnings is the result of the 1997 change in method of
accounting for property taxes (the cumulative effect on prior years of this
change increased earnings for the first quarter of 1997 by $15.5 million). This
decrease was partially offset by lower interest expense on MCV's financing
obligation, lower depreciation expense and the accrual of an interest refund
from Great Lakes Gas Transmission Company.

Operating Revenues

For the first six months of 1998, MCV's operating revenues decreased $8.6
million from the first six months of 1997. This decrease was due primarily to
lower electric deliveries under the PPA with Consumers, resulting from Consumers
change to economic dispatch of the facility (See Part 1, Item 2, MD&A, "Outlook
- - Operating Outlook"). Electric and steam revenues generated under the Steam and
Electricity Purchase Agreement with Dow also decreased due to the gas tolling
credit. 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. These declines in revenue are largely offset
by a decline in fuel costs.



                                      -16-
<PAGE>   18

Operating Expenses

For the first six months of 1998, MCV's operating expenses were $206.0 million,
which includes $124.9 million of fuel costs. During this period, MCV purchased
approximately 44.2 bcf of natural gas, of which 1.8 bcf was used for
transportation fuel and as a net change to gas in storage. During this same
period, MCV consumed 44.0 bcf, of which 1.6 bcf of this total was gas provided
by Dow. The average commodity cost of fuel for the first six months of 1998 was
$2.41 per MMBtu. For the first six months of 1997, MCV's operating expenses were
$216.5 million, which includes $132.1 million of fuel costs. During this period,
MCV purchased approximately 47.1 bcf of natural gas, of which .9 bcf was used
for transportation fuel and as a net change to gas in storage. During this same
period, MCV consumed 47.0 bcf, of which .8 bcf of this total was gas provided by
Dow. The average commodity cost of fuel for the first six months of 1997 was
$2.40 per MMBtu. Fuel costs for the first six months of 1998 compared to 1997
decreased $7.2 million. This decrease was primarily due to lower gas usage
resulting from a lower overall electric dispatch from Consumers, and Dow's
election to provide its own gas to generate part of its take of steam and
electricity.

For the first six months of 1998, operating expenses other than fuel costs
decreased $3.3 million from the first six months of 1997. This decrease is
primarily due to lower depreciation expense, resulting from a revision to the
useful lives of the gas turbines and certain related capital spares to more
closely reflect the economic useful lives of these assets. 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 six months of 1998
compared to 1997 reflects the accrual of an interest income refund due from
Great Lakes Gas Transmission Company, pursuant to a Federal Appeals Court
decision made in January, 1998. The decrease in interest expense in the first
six months of 1998 from the first six months of 1997 is due to a lower principal
balance on MCV's financing obligation.

Cumulative Effect of Accounting Change

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 on prior years of this
change increased earnings for the six months ended June 30, 1997 by
approximately $15.5 million.

Liquidity and Financial Resources

During the first six months of 1998 and 1997, net cash generated by MCV's
operations was $84.5 million and $60.2 million, respectively. The primary use of
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 seventeen years. In January 1998 and 1997, MCV paid the basic
rent requirements of $136.9 million and $117.7 million, respectively, as
required under the Overall Lease Transaction.

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 June 30, 1998, the
borrowing base was $45.3 million. The Working Capital Facility term currently
extends to August 31, 1999. MCV did not utilize the Working Capital Facility
during the first six months of 1998, except for letters of credit associated
with normal 


                                      -17-
<PAGE>   19
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.

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 June 30, 1998, there was $287.1 million (which includes $69.0
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 the
final outcome of the MPSC Restructuring Orders (see Part I, Item 2, MD&A,
"Outlook - Michigan Electric Industry Restructuring Proceedings") and challenges
thereto, governmental policies, legislation and other regulatory actions
(including those of the Michigan Legislature, 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, capacity
payments made by Consumers 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 99.3% for the
first six months of 1998, 98.9% in 1997 and 96.4% in 1996. 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%.

On March 13, 1998, MCV received notice from Consumers that it would begin
dispatching the Facility by scheduling energy deliveries on an economic basis
relative to the cost of other energy resources, instead of at the higher
dispatch levels experienced over the past several years. MCV consequently
expects both electric operating revenues and operating costs to decline.
However, MCV Management does not expect this change to have a material impact on
MCV's financial position or results of operations.

GTG Equipment Problems. In 1996, several of the gas turbine generators "GTGs"
experienced severe cracking in the hot gas casings, which in some cases caused
extensive damage to the turbine blades and vanes. MCV and ABB Power have
identified and modified each of the GTGs to eliminate the problems and have
implemented a program of hot gas path inspections for all GTGs, which are
currently being performed every 2,000 hours. MCV and ABB Power continue to
address reliability issues to alleviate future outages, and MCV believes that
with the 



                                     -18-
<PAGE>   20

modifications that have been made to date there should be no significant future
impacts on plant availability or efficiency, although no assurance can be given
that additional equipment problems will not occur.

The cost of casing replacements and modifications is covered by ABB Power (with
the exception of insurable events) pursuant to the amended Service Agreement,
under which ABB Power is providing hot gas path parts for MCV's twelve gas
turbines through the sixth series of major GTG inspections which are expected to
be completed by year end 2008.

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 1999. 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 June 1998, 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 - 1997, has risen by $0.21 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 two
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 capacity
and/or 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 - Jurisdictional Allocation. 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) (the "Jurisdictional Issue"). 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 in accordance with the MPSC order which was
      upheld by the Michigan Court of Appeals. 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




                                      -19-
<PAGE>   21

      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 since MCV's application to appeal was denied by the Michigan
      Supremem Court in January 1998. Based on this decision, Consumers notified
      MCV that it would continue withholding the fixed energy charges on the
      Jurisdictional Issue (currently averaging approximately $35,000 per month
      in 1998). MCV released to Consumers 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 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 through 1997 Reconciliation and/or 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"). 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 believes these rulings are erroneous and
      petitioned the Michigan Supreme Court to review the off-peak cap issue in
      the 1993 Reconciliation and 1994 Plan Cases. During 1998, the Michigan
      Supreme Court denied MCV's petition for review of the 1993 Reconciliation
      and 1994 Plan Cases, thus, these cases are now final. Other PSCR Plan
      and/or Reconciliation Cases for the years 1996 and 1997 are pending before
      the MPSC which involve this same issue. Consumers escrowed approximately
      $2.8 million for 1996 and $1.0 million for 1994 and 1995 of fixed energy
      charges payable to MCV based upon the MPSC rulings. MCV has not recognized
      any of these amounts related to the off-peak cap issue as operating
      revenues.

      PPA - Additional 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
      proposed approving one-hundred percent jurisdictional cost recovery of an
      additional 325 MW of capacity purchased from MCV. Cost recovery approval
      for the 325 MW of MCV Contract Capacity was in addition to the 915 MW
      already approved (subject to the Jurisdictional Issue) by the MPSC. In
      November 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
      Case. In the 1996 PSCR Plan Case, 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. 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 $1.4 million for the first six months of 1998 and
      $2.8 million for the year 1997, for energy delivered above the off-peak
      cap, 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, the 1996 PSCR Plan Case, subsequent PSCR
      proceedings, or appeals, if any.

      PPA - Other Issues. In 1997, Consumers informed MCV of several other
      potential payment issues it may pursue, pursuant to the "regulatory out"
      and other provisions 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). Consumers has estimated that the financial impact
      of these issues for 1996 would decrease MCV's operating revenues by an
      estimated $2.5 million. In addition, Consumers notified MCV that it does
      not believe that MCV can use the approximately 15 MW of generating
      capacity and energy attributable to the back pressure turbine, which was
      placed into service in July 1997, towards available Contract Capacity or
      electric deliveries under the PPA. Consumers has also indicated that they
      may take a similar position on the incremental energy and capacity
      resulting from MCV's installation of 11NM upgrade 



                                      -20-
<PAGE>   22

      packages on the GTGs. MCV has recognized amounts related to the above
      issues as operating revenues, except for revenues associated with the band
      width (currently averaging approximately $7,000 per month in 1998). MCV
      Management continues to review Consumers positions on the above issues and
      cannot predict the outcome of these issues.

Michigan Electric Industry Restructuring Proceedings. On December 20, 1996, the
MPSC issued an order on its own motion to consider the restructuring of the
electric industry in Michigan. After public hearings and contested case hearings
the MPSC issued its initial order on June 5, 1997, intermediate orders in
related dockets on October 29, 1997, its final order on January 14, 1998, and a
clarification order on February 11, 1998 (collectively the "Restructuring
Orders"). While the Restructuring Orders are not entirely clear, they generally
provide for a transition to a competitive regime whereby electric retail
customers will be able to chose their power supplier and pay negotiated or
market-based rates for such power supply. The MPSC ordered a phased-in program
(from 1998 through 2001) for this competitive regime known as "direct access"
whereby all customers (industrial, commercial and residential) would be eligible
to select the power supplier of their choice. The MPSC also addressed many
transition issues including reliability, stranded cost (or transition cost)
recovery, rates, and other issues. The two issues involved in this restructuring
which could impact MCV the most are contract sanctity and stranded cost
recovery. On the issue of contract sanctity, the Restructuring Orders indicate
that it was not the intent of the MPSC to take any action that would affect the
contractual rights of QFs, including MCV. On the issue of stranded cost
recovery, the Restructuring Orders allow recovery by utilities (including
Consumers) of stranded costs including capacity charges previously approved by
the MPSC in power contracts incurred during the regulated era that will be above
market prices during the new competitive regime. However, it appears that
stranded cost recovery of above-market capacity charges in power purchase
contracts (i.e., MCV's PPA) may be limited to the period 1998 through 2007
(MCV's PPA expires in 2025). The Restructuring Orders do not specifically
address the issue of stranded cost recovery after 2007. In addition, the
Restructuring Orders permitted Consumers to elect to suspend the PSCR process
and freeze its PSCR rate factor through which charges under the PPA are
recovered from retail customers. The MPSC has suspended the annual PSCR (Plan
and Reconciliation Case) process indefinitely, and froze Consumers PSCR rate
factor, at Consumers' request. The suspension of the PSCR process and the PSCR
"rate freeze" was effective January 1, 1998. This PCSR rate freeze is subject to
the final outcome of Consumers' 1997 PSCR Reconciliation Case which is in
progress. This case will determine the level at which Consumers' PSCR rates will
be frozen during the period 1998 through 2001.

In the restructuring cases before the MPSC, MCV has advocated, among other
things, full recovery of PPA charges (capacity and energy) for the life of the
PPA. MCV, as well as others, has filed an appeal of the MPSC Restructuring
Orders in the Michigan Court of Appeals and a complaint in the U.S. District
Court for the Western District of Michigan challenging the Restructuring Orders.
MCV's complaint seeks, among other things, a declaration that the Restructuring
Orders are preempted by PURPA to the extent that they fail to provide for
assured retail rate recovery of payments made by Consumers to MCV pursuant to
PURPA and an injunction barring enforcement of the Restructuring Orders to the
extent they are preempted by PURPA. MCV is a party in the 1997 PSCR
Reconciliation Case. The Michigan legislature has also begun the process to
consider electric industry restructuring and deregulation. While restructuring
could have a material impact on MCV, MCV Management cannot, at this time,
predict the impact or the outcome of these administrative, judicial and
legislative 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. Appeals of Order No. 888 are pending before the United States Court
of Appeals for the Second Circuit. 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 proceedings.



                                      -21-
<PAGE>   23

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 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
the years 1995 through 1997 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. Dow and
DCC steam purchases for the first six months of 1998 averaged 674,216 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.

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 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 1997, MCV achieved an
Efficiency Percentage of 45.7% and a Thermal Percentage of 16.0%. In the first
six months of 1998 MCV achieved an Efficiency Percentage of 45.5% and a Thermal
Percentage of 17.6%.

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).

Year 2000 Computer Issues. MCV utilizes certain software and related
technologies throughout the Facility which will be affected by the year 2000
date change. Modifications to computer software systems to process year 2000
date transactions and receipt of vendor confirmations that their software is
year 2000 compliant began in 1997. MCV expects that all new software
installations or other modifications to its computer systems will be completed
by 2000. Anticipated spending for modifications will be expensed as incurred,
while the costs for new software will be capitalized and amortized over the
software's useful life. At this time, MCV does not expect that the cost of these
modifications or software will have a material effect on its financial position,
liquidity or results of operations.



                                      -22-
<PAGE>   24

See Part I, Item 1, "Financial Statements and Supplementary Data -- Notes 1 and
7 to the Condensed Notes to Unaudited Consolidated Financial Statements" for a
further discussion of associated risks and contingencies.














                                      -23-

<PAGE>   25


                           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 Recovery
Reconciliation Proceeding" ("Reconciliation Case"). The MPSC believes it has the
authority to suspend the PSCR plan and reconciliation process. 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/or energy charges payable to MCV
and/or to receive refunds of capacity and/or 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, among other things, 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 



                                      -24-
<PAGE>   26

time each day and recovery of energy payments based on coal proxy prices (the
formula in the PPA). However, instead of capacity and fixed 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 1993 and
subsequent years. Opponents to the Revised Settlement Proposal, filed appeals of
the Settlement Order with the Michigan Court of Appeals. On March 19, 1996, the
Court of Appeals issued a decision which affirmed the Settlement Order. The
Appellants unsuccessfully sought further judicial review and the 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, Consumers' cost recovery
relating to purchases from MCV is reviewed in the annual PSCR Plan and
Reconciliation Cases.

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
this 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 to
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 increase the amount escrowed each month to reflect its
calculation of fixed energy charge payments allocated to non-jurisdictional
customers in accordance with the MPSC Order which was upheld by the Michigan
Court of Appeals. In addition, Consumers requested a refund from MCV of $1.9
million plus interest, for the calendar years 1993 and 1994 and the first eight
months of 1995. On November 21, 1995, MCV responded to Consumers indicating that
MCV would, pursuant to the PPA, refund the appropriate funds, if any, and
determine the appropriate 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 since MCV's application to appeal was denied by the
Michigan Supreme Court in January 1998. Based on this decision, Consumers
notified MCV that it would continue withholding the fixed energy charges on the
Jurisdictional Issue (currently averaging approximately $35,000 per month in
1998). 



                                      -25-
<PAGE>   27

MCV released to Consumers 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 Jurisdictional Issue. MCV
has not recognized any of these amounts related to the Jurisdictional Issue as
operating revenues.

The MPSC ruled in the 1993 Reconciliation Case that Consumers could not recover
from its retail customers fixed energy charges payable to MCV for energy
delivered above the off-peak cap of 732 MW (the "off-peak cap issue"). Consumers
and MCV appealed the MPSC February 23, 1995 Order to the Michigan Court of
Appeals and on November 1, 1996, the Michigan Court of Appeals affirmed the
MPSC's decision. 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 of
this case. On January 30, 1998, the Michigan Supreme Court denied MCV's petition
for review, thus, the case is now final.

In addition, as part of its order in Consumers' 1994 PSCR Plan proceedings, the
MPSC, on August 18, 1994, ruled that for 1994 Consumers would not be permitted
to recover fixed energy costs for energy associated with the off-peak cap issue.
MCV believed the MPSC order on this issue was erroneous and filed an appeal of
the MPSC decision. The Michigan Court of Appeals affirmed the MPSC. MCV
petitioned the Michigan Supreme Court to review this case, but the court
declined the petition and the issue is now final. Other PSCR Plan and
Reconciliation Cases for the years 1996 and 1997 are pending before the MPSC.
Consumers has escrowed approximately $2.8 million in 1996 and $1.0 million for
the years 1994 and 1995 of fixed energy charges payable to MCV based on the MPSC
ruling.

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
related to three cases: Case No. U-10685, Consumers' electric general rate case;
Case No. U-10787, Consumers' request for approval of a special competitive
services tariff (Rate SCS); and Case No. U-10754, Consumers' application for
approval of revised depreciation rates for electric and common utility plant.
MCV was a party to the consolidated proceeding. The settlement agreement
proposed approving one-hundred percent jurisdictional cost recovery of an
additional 325 MW of capacity purchased from MCV. Cost recovery approval for the
325 MW of MCV Contract Capacity was in addition to the 915 MW already approved
(subject to the Jurisdictional Issue) by the MPSC with recovery from Consumers
retail customers to begin January 1, 1996. The initial average capacity charge
recovered would be 2.86 cents per kWh escalating to 3.62 cents per kWh in 2004
and thereafter. On September 22, 1995, MCV filed a position statement not
objecting to the 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 Case. In the 1996 PSCR Plan Case, 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. 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 proceeding paragraph and Consumers has paid to MCV approximately $1.4
million for the first six months of 1998 and $2.8 million for the year 1997, for
energy delivered above the off-peak cap, 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, the 1996 PSCR Plan Case,
subsequent PSCR proceedings, or appeals, if any.

Michigan Electric Industry Restructuring Proceedings

On December 20, 1996, the MPSC issued an order on its own motion to consider the
restructuring of the electric industry in Michigan. After public hearings and
contested case hearings the MPSC issued its initial order on June 5, 1997,
intermediate orders in related dockets on October 29, 1997, its final order on
January 14, 1998, and a 



                                      -26-
<PAGE>   28

clarification order on February 11, 1998 (collectively the "Restructuring
Orders"). While the Restructuring Orders are not entirely clear, they generally
provide for a transition to a competitive regime whereby electric retail
customers will be able to chose their power supplier and pay negotiated or
market-based rates for such power supply. The MPSC ordered a phased-in program
(from 1998 through 2001) for this competitive regime known as "direct access"
whereby all customers (industrial, commercial and residential) would be eligible
to select the power supplier of their choice. The MPSC also addressed many
transition issues including reliability, stranded cost (or transition cost)
recovery, rates, and other issues. The two issues involved in this restructuring
which could impact MCV the most are contract sanctity and stranded cost
recovery. On the issue of contract sanctity, the Restructuring Orders indicate
that it was not the intent of the MPSC to take any action that would affect the
contractual rights of QFs, including MCV. On the issue of stranded cost
recovery, the Restructuring Orders allow recovery by utilities (including
Consumers) of stranded costs including capacity charges previously approved by
the MPSC in power contracts incurred during the regulated era that will be above
market prices during the new competitive regime. However, it appears that
stranded cost recovery of above-market capacity charges in power purchase
contracts (i.e., MCV's PPA) may be limited to the period 1998 through 2007
(MCV's PPA expires in 2025). The Restructuring Orders do not specifically
address the issue of stranded cost recovery after 2007. In addition, the
Restructuring Orders permitted Consumers to elect to suspend the PSCR process
and freeze its PSCR rate factor through which charges under the PPA are
recovered from retail customers. The MPSC has suspended the annual PSCR (Plan
and Reconciliation Case) process indefinitely and froze Consumers PSCR rate
factor, at Consumers' request. The suspension of the PSCR process and the PSCR
"rate freeze" was effective January 1, 1998. This PSCR rate freeze is subject to
the final outcome of Consumers' 1997 PSCR Reconciliation Case which is in
progress. This case will determine the level at which Consumers' PSCR rates will
be frozen during the period 1998 through 2001.

In the restructuring cases before the MPSC, MCV has advocated, among other
things, full recovery of PPA charges (capacity and energy) for the life of the
PPA. MCV, as well as others, has filed an appeal of the MPSC Restructuring
Orders in the Michigan Court of Appeals and a complaint in the U.S. District
Court for the Western District of Michigan challenging the Restructuring Orders.
MCV's complaint seeks, among other things, a declaration that the Restructuring
Orders are preempted by PURPA to the extent that they fail to provide for
assured retail rate recovery of payments made by Consumers to MCV pursuant to
PURPA and an injunction barring enforcement of the Restructuring Orders to the
extent they are preempted by PURPA. MCV is a party in the 1997 PSCR
Reconciliation Case. The Michigan legislature has also begun the process to
consider electric industry restructuring and deregulation. While restructuring
could have a material impact on MCV, MCV Management cannot, at this time,
predict the impact or the outcome of these administrative, judicial and
legislative 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. Appeals of Order No. 888 are pending
before the United States Court of Appeals for the Second Circuit. 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 proceedings.

Property Tax Appeal

In 1997, MCV filed a property tax appeal contesting the assessed value of MCV's
property for 1997 taxes, which is pending before the Michigan Tax Tribunal. MCV
also filed an appeal for 1998 taxes. MCV Management cannot predict the outcome
of these proceedings.



                                      -27-
<PAGE>   29


                    Item 6. Exhibits and Reports on Form 8-K


a.)  List of Exhibits

     (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.












                                      -28-
<PAGE>   30


                                   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:  August 11, 1998                  /s/ James M. Kevra
        ------------------             ---------------------------------------
                                                      James M. Kevra
                                       President and Chief Executive Officer




Dated:  August 11, 1998                  /s/ James M. Rajewski
        ------------------             ---------------------------------------
                                                    James M. Rajewski
                                             Vice President and Controller
                                             (Principal Accounting Officer)







                                      -29-


<PAGE>   31




                                Exhibit Index
                                -------------


<TABLE>
<CAPTION>
Exhibit No.             Description
- ----------              -----------
<S>                     <S>
   27                   Financial Data Schedule


</TABLE>


<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 JUNE 30, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
       
<S>                             <C>
<PERIOD-TYPE>                   6-MOS
<FISCAL-YEAR-END>                          DEC-31-1998
<PERIOD-START>                             JAN-01-1998
<PERIOD-END>                               JUN-30-1998
<CASH>                                         241,826
<SECURITIES>                                   138,486
<RECEIVABLES>                                   97,464
<ALLOWANCES>                                         0
<INVENTORY>                                     12,573
<CURRENT-ASSETS>                               385,079
<PP&E>                                       2,402,676
<DEPRECIATION>                                 605,685
<TOTAL-ASSETS>                               2,350,146
<CURRENT-LIABILITIES>                          259,246
<BONDS>                                      1,774,997
                                0
                                          0
<COMMON>                                             0
<OTHER-SE>                                     315,083
<TOTAL-LIABILITY-AND-EQUITY>                 2,350,146
<SALES>                                              0
<TOTAL-REVENUES>                               315,923
<CGS>                                                0
<TOTAL-COSTS>                                  205,959
<OTHER-EXPENSES>                                     0
<LOSS-PROVISION>                                     0
<INTEREST-EXPENSE>                              83,636
<INCOME-PRETAX>                                      0
<INCOME-TAX>                                         0
<INCOME-CONTINUING>                                  0
<DISCONTINUED>                                       0
<EXTRAORDINARY>                                      0
<CHANGES>                                            0
<NET-INCOME>                                    37,862
<EPS-PRIMARY>                                        0
<EPS-DILUTED>                                        0
        

</TABLE>


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