<PAGE> 1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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>
September 30,
1998 December 31,
ASSETS (Unaudited) 1997
- ------ -------------- ----------------
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 125,622 $ 222,365
Restricted cash and cash equivalents 12,541 12,161
Accounts and notes receivable 97,711 93,674
Gas inventory 12,786 12,910
Unamortized property taxes 22,152 16,097
Prepaid expenses and other 4,219 4,578
------------- ---------------
Total current assets 275,031 361,785
------------- ---------------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment 2,381,934 2,439,651
Pipeline 21,222 21,222
------------- ---------------
Total property, plant and equipment 2,403,156 2,460,873
Accumulated depreciation (623,640) (640,170)
------------- ---------------
Net property, plant and equipment 1,779,516 1,820,703
------------- ---------------
OTHER ASSETS:
Restricted investment securities held-to-maturity 142,180 138,898
Deferred financing costs, net of accumulated amortization of
$10,155 and $9,358, respectively 8,422 9,219
Prepaid gas costs, materials and supplies 20,595 20,666
------------- ---------------
Total other assets 171,197 168,783
------------- ---------------
TOTAL ASSETS $ 2,225,744 $ 2,351,271
============= ===============
LIABILITIES AND PARTNERS' EQUITY
- --------------------------------
CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 60,729 $ 58,942
Interest payable 39,053 85,183
Current portion of long-term debt 64,331 140,950
------------- ---------------
Total current liabilities 164,113 285,075
------------- ---------------
NON-CURRENT LIABILITIES:
Long-term debt 1,723,960 1,788,291
Other 850 684
------------- ---------------
Total non-current liabilities 1,724,810 1,788,975
------------- ---------------
CONTINGENCIES (Note 7)
TOTAL LIABILITIES 1,888,923 2,074,050
------------- ---------------
PARTNERS' EQUITY 336,821 277,221
------------- ---------------
TOTAL LIABILITIES AND PARTNERS' EQUITY $ 2,225,744 $ 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 Nine Months Ended
September 30, September 30,
-------------------------------- ---------------------------------
1998 1997 1998 1997
-------------- ------------- ------------- ---------------
OPERATING REVENUES:
<S> <C> <C> <C> <C>
Capacity $ 102,677 $ 102,147 $ 304,489 $ 303,140
Electric 47,005 54,546 147,422 163,324
Steam and other 6,322 6,063 20,016 20,848
-------------- ------------- ------------- --------------
Total operating revenues 156,004 162,756 471,927 487,312
-------------- ------------- ------------- --------------
OPERATING EXPENSES:
Fuel costs 60,739 66,868 185,681 198,996
Depreciation 23,807 26,207 73,365 78,544
Operations 3,574 3,876 11,279 12,070
Maintenance 3,070 3,542 9,053 9,747
Property and single business taxes 6,439 5,885 19,276 19,334
Administrative, selling and general 1,898 1,867 6,832 6,050
-------------- ------------- ------------- --------------
Total operating expenses 99,527 108,245 305,486 324,741
-------------- ------------- ------------- --------------
OPERATING INCOME 56,477 54,511 166,441 162,571
-------------- ------------- ------------- --------------
OTHER INCOME (EXPENSE):
Interest and other income 4,627 4,807 16,161 14,351
Interest expense (39,366) (42,473) (123,002) (130,549)
-------------- ------------- ------------- --------------
Total other income (expense), net (34,739) (37,666) (106,841) (116,198)
-------------- ------------- ------------- --------------
INCOME BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE 21,738 16,845 59,600 46,373
Cumulative effect on prior years (to
December 31, 1996) of change in method of
accounting for property taxes (Note 3) -- -- -- 15,533
-------------- ------------- ------------- --------------
NET INCOME $ 21,738 $ 16,845 $ 59,600 $ 61,906
============== ============= ============= ==============
</TABLE>
The accompanying condensed notes are an integral part of these statements.
-2-
<PAGE> 4
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENT OF PARTNERS' EQUITY (Unaudited)
(In Thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30, 1998
----------------------------------------------------------
General Limited
Partners Partners Total
------------ ------------ ------------
<S> <C> <C> <C>
BALANCE, BEGINNING OF PERIOD $ 229,992 $ 47,229 $ 277,221
Net income 51,889 7,711 59,600
------------ ------------ ------------
BALANCE, END OF PERIOD $ 281,881 $ 54,940 $ 336,821
============ ============ ============
</TABLE>
The accompanying condensed notes are an integral part of these statements.
-3-
<PAGE> 5
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In Thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
---------------------------------
1998 1997
------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net income $ 59,600 $ 61,906
Adjustments to reconcile net income to net cash provided by
operating activities
Depreciation and amortization 74,162 79,390
Cumulative effect of change in accounting principle -- (15,533)
Increase in accounts and notes receivable (4,037) (15,576)
Decrease in gas inventory 124 1,288
Increase in unamortized property taxes (6,055) (6,976)
Decrease (increase) in prepaid expenses and other 359 (2,469)
Decrease (increase) in prepaid gas costs, materials and supplies 71 (14,991)
Increase in accounts payable and accrued liabilities 1,787 2,965
Decrease in interest payable (46,130) (46,520)
Increase in other non-current liabilities 166 149
----------- -----------
Net cash provided by operating activities 80,047 43,633
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Plant modifications and purchases of plant and equipment (32,178) (29,256)
----------- -----------
Net cash used in investing activities (32,178) (29,256)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of financing obligation (140,950) (78,574)
Decrease in restricted non-current cash and cash equivalents -- 665
Maturity of restricted investment securities held-to-maturity 269,113 --
Purchase of restricted investment securities held-to-maturity (272,395) --
----------- -----------
Net cash used in financing activities (144,232) (77,909)
----------- -----------
NET DECEASE IN CASH, CASH EQUIVALENTS AND
RESTRICTED CASH-CURRENT (96,363) (63,532)
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 $ 138,163 $ 160,468
=========== ===========
</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 nine months ended September 30, 1998, the
Facility achieved a Thermal Percentage of 16.7% 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.
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<PAGE> 7
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The Facility is wholly dependent upon natural gas for its fuel supply and a
substantial portion of the Facility's operating expenses consist of the
costs of natural gas. MCV recognizes that its existing gas contracts are
not sufficient to satisfy the anticipated gas needs over the term of the
PPA and, as such, no assurance can be given as to the availability or price
of natural gas after the expiration of the existing gas contracts.
Commencing in 1998, MCV must provide at Consumers request, continuing
annual assurances of such capability for each succeeding five-year period.
If MCV is unable to provide these continuing assurances, Consumers is
entitled to withhold in a separate escrow fund a portion of capacity
charges until these assurances are provided. MCV believes 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 September 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 end 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 September
30, 1998, MCV had forward purchase contracts involving Swiss francs in the
notional amount of $10.0 million, with a deferred $1.0 million gain,
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
options 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
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 futures
or options 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 million and $1.6
million as of September 30, 1998 and December 31, 1997, respectively. MCV's
deferred gains and losses on futures and options 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. As of September 30, 1998, MCV had net open futures and options
contracts of 1.8 Bcf with a deferred gain of $.1 million. As of December
31, 1997, MCV had net open futures and options contracts of .3 Bcf with a
deferred loss of $.1 million. In addition, MCV recorded an immaterial gain
on contracts closed prior to September 30, 1998, related to 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 $177,000 and $25,000,
as of September 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 September 30, 1998, MCV
had a $22,000 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
-7-
<PAGE> 9
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
inspections, with expected coverage through 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.
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
nine months ended September 30, 1997, by approximately $15.5 million. The
pro forma effect on 1997 and prior years' consolidated net income,
including all interim periods, of retroactively recording property taxes as
if the new method of accounting had been in effect for all periods
presented is not material.
(4) RESTRICTED CASH, 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>
September 30, December 31,
1998 1997
-------------- --------------
Current:
<S> <C> <C>
Funds restricted for plant modifications $ 12,541 $ 12,161
============== ==============
Non-current:
Funds restricted for rental payments pursuant to the Overall
Lease Transaction $ 141,329 $ 138,242
Funds restricted for management non-qualified plans 851 656
-------------- --------------
Total $ 142,180 $ 138,898
============== ==============
</TABLE>
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<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>
September 30, December 31,
1998 1997
-------------- --------------
Accounts payable
<S> <C> <C>
Related parties $ 21,004 $ 15,382
Trade creditors 24,852 28,531
Property and single business taxes 12,016 12,379
Other 2,857 2,650
-------------- --------------
Total $ 60,729 $ 58,942
============== ==============
</TABLE>
(6) LONG-TERM DEBT
Long-term debt consists of the following as of (in thousands):
<TABLE>
<CAPTION>
September 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 $ 1,788,291 $ 1,929,241
Less current portion (64,331) (140,950)
-------------- --------------
Total long-term debt $ 1,723,960 $ 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 nine months ended September 30, 1998 and 1997 were $122.1 million and
$129.7 million, respectively. Interest and fees paid for the nine months
ended September 30, 1998 and 1997 were $168.3 million and $176.2 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 power supply
cost recovery ("PSCR") reconciliation proceeding for 1993, "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 nine 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 became final in January 1998 when the Michigan
Supreme Court denied MCV's application for an appeal. Based on this
decision, Consumers notified MCV that it would continue withholding the
fixed energy charges on the Jurisdictional Issue (currently averaging
approximately $39,000 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 the years 1993 and 1994 to the Michigan Court of Appeals,
and the Michigan Court of Appeals affirmed the MPSC's decisions. The
Michigan Supreme Court denied MCV's petition for review of this issue,
thus, this issue is now final. 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 MW Settlement Order, Consumers notified MCV in February 1997, that
it would cease escrowing for the off-peak cap issue. Consumers released
to MCV the 1996 escrowed funds of approximately $2.8 million discussed
in the preceding paragraph and Consumers has paid to MCV approximately
$2.0 million for the first nine months of 1998 and $2.8 million for the
year 1997, for energy
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<PAGE> 12
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
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 and Consumers have
continued to negotiate a settlement of the above issues. At this time,
MCV Management cannot predict the outcome of these negotiations or
issues.
PPA - Sale and Assignment
On October 2, 1998, Consumers initiated a process for the solicitation
of bids to acquire Consumers' rights to the 1240 MW of Contract
Capacity and associated energy under the PPA ("PPA Sale and
Assignment"). The PPA Sale and Assignment is being offered in one 1240
MW block or two 620 MW blocks for the period from an effective date in
1999 through either September 2007 or March 2025. Consumers has
reserved the right, in its sole discretion, to terminate the bidding
process or to reject all bids. The PPA prohibits a party from
transferring or otherwise alienating the agreement without the prior
written consent of the other party, which consent shall not be
unreasonably withheld. At this time, MCV Management is currently
evaluating this proposed sale and assignment, however, it cannot
predict the outcome or potential ramifications of this issue.
-11-
<PAGE> 13
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(8) PARTNERS' EQUITY AND RELATED PARTY TRANSACTIONS
The following table summarizes the nature and amount of each of MCV's
Partner's equity interest, interest in profits and losses of MCV at
September 30, 1998, and the nature and amount of related party transactions
or agreements that existed with the Partners or affiliates as of September
30, 1998 and 1997, and for each of the nine month periods ended September
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>
CMS Midland, Inc. $165,042 49.0% Power purchase agreement $439,827 $454,721
General Partner; wholly-owned Purchases under gas transportation agreements 7,221 7,270
subsidiary of Consumers Energy Purchases under spot gas agreements 487 4,720
Company (formerly Consumers Purchases under gas supply agreements 6,543 7,768
Power Company) Gas storage agreement 1,922 1,922
Land lease/easement agreements 450 450
Accounts receivable 49,176 50,043
Accounts payable 15,871 14,192
Gas exchanges 1,148 1,268
The Dow Chemical Company 38,249 7.5 Steam and electric power agreement 30,918 32,587
Limited Partner Steam purchase agreement - Dow Corning Corp 2,353 2,294
(affiliate)
Purchases under demineralized water supply
agreement 4,723 5,540
Accounts receivable 1,822 1,633
Accounts payable 521 1,230
Standby and backup fees 572 605
Source Midland Limited Partnership 55,637 18.1 SMLP - Under Ownership of MCNIC Power Company
("SMLP") General Partner; wholly- ---------------------------------------------
owned limited partnership of MCN Purchases under spot gas agreements 5,832 578
Energy Group Inc.(1) Purchases under gas supply agreements 9,621 5,384
Accounts payable 1,794 1,284
Partner cash withdrawal (including accrued 14,286 11,753
interest)(2)
SMLP - Under Ownership of Pan Energy Corp
-----------------------------------------
Purchases under gas transportation agreements -- 4,648
Purchases under spot gas agreements -- 911
Coastal Midland, Inc. ("Coastal") 33,382 10.9 Purchases under gas transportation agreements 10,112 10,237
General Partner; wholly-owned Purchases under spot gas agreement 9,691 4,445
subsidiary of The Coastal Purchases under gas supply agreement 2,875 3,255
Corporation Gas agency agreement 1,137 1,121
Deferred reservation charges under gas purchase 4,925 3,940
agreement
Accounts receivable 79 891
Accounts payable 2,818 4,490
Gas exchanges 4,998 1,411
Partner cash withdrawal (including accrued 19,741 7,246
interest) (2)
MEI - Under Ownership of Coastal and SMLP
MEI Limited Partnership ("MEI")(3) -----------------------------------------
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 27,820 9.1 Gas turbine maintenance and spare parts agreement 23,377 23,503
Limited Partnership Interest 2,781 .9 Accounts payable -- 1,545
Micogen Limited Partnership 13,909 4.5 MLP - Under Ownership of The Coastal Corporation
("MLP") Limited Partner; ------------------------------------------------
owned by subsidiaries of See related party activity listed under Coastal
The Coastal Corporation(4) Midland Inc.
MLP - Under Ownership of Fluor Corporation
------------------------------------------
Partner cash withdrawal (including accrued -- 3,102
interest)(2)
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 1,538
Limited Partnership
Alanna Corporation 1(6) .00001 Note receivable 1 1
Limited Partner; wholly-owned
subsidiary of Alanna Holdings
Corporation
</TABLE>
-12-
<PAGE> 14
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 September 30, 1998 and
for the nine month period ended September 30, 1998; and as of
September 30, 1997 and for the period May 16, 1997 to September
30, 1997. The SMLP amounts listed Under Ownership of PanEnergy
Corp. are for the period January 1, 1997 to May 15, 1997.
(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 September 30, 1997 and for the nine month period
ended September 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.
(5) C-E Midland Energy, Inc.'s ("C-E") 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 nine month period ended September 30, 1997.
(6) Alanna's capital stock is pledged to secure MCV's obligation under
the lease and other overall lease transaction documents.
-13-
<PAGE> 15
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 Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
1998 1997 1998 1997
-------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Operating Revenues $ 156,004 $ 162,756 $ 471,927 $ 487,312
Capacity Revenue $ 102,677 $ 102,147 $ 304,489 $ 303,140
PPA Contract Capacity (MW) 1,240 1,240 1,240 1,240
PPA Availability 99.4% 98.9% 99.3% 98.9%
Electric Revenue $ 47,005 $ 54,546 $ 147,422 $ 163,324
PPA Delivery as a Percentage of Contract Capacity 76.3% 91.2% 81.1% 91.0%
PPA and SEPA Electric Deliveries (MWh) 2,247,027 2,641,101 7,027,697 7,810,213
Average PPA Variable Energy Rate ($/MWh) $ 16.63 $ 16.87 $ 16.83 $ 16.84
Average PPA Fixed Energy Rate ($/MWh) $ 3.70 $ 3.91 $ 3.76 $ 3.97
Steam Revenue $ 2,504 $ 2,245 $ 8,563 $ 9,395
Steam Deliveries (Mlbs) 1,199,045 1,163,636 4,127,163 4,164,074
Other Revenue $ 3,818 $ 3,818 $ 11,453 $ 11,453
</TABLE>
Comparison of the Three Months ended September 30, 1998 and 1997
Overview
For the third quarter of 1998, MCV recorded net income of $21.7 million as
compared to net income of $16.8 million for the third quarter of 1997. The
increase in third 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 turbines and certain related capital spares to more
closely reflect the economic useful lives of these assets.
-14-
<PAGE> 16
Operating Revenues
For the third quarter of 1998, MCV's operating revenues decreased $6.8 million
from the third 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.
Operating Expenses
For the third quarter of 1998, MCV's operating expenses were $99.5 million,
which includes $60.7 million of fuel costs. During this period, MCV purchased
approximately 20.3 billion cubic feet ("bcf") of natural gas, of which .7 bcf
was used for transportation fuel and as a net change to gas in storage. During
this same period, MCV consumed 20.4 bcf of natural gas, of which .7 bcf of this
total was gas provided by Dow. The average commodity cost of fuel for the third
quarter of 1998 was $2.53 per million British thermal units ("MMBtu"). For the
third quarter of 1997, MCV's operating expenses were $108.2 million, which
includes $66.9 million of fuel costs. During this period, MCV purchased
approximately 24.6 bcf of natural gas, of which 1.5 bcf was used for
transportation fuel and as a net change to gas in storage. During this same
period, MCV consumed 23.9 bcf of natural gas, of which .8 bcf of this total was
gas provided by Dow. The average commodity cost of fuel for the third quarter of
1997 was $2.43 per MMBtu. Fuel costs for the third quarter of 1998 compared to
1997 decreased $6.2 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
long-term gas prices.
For the third quarter of 1998, operating expenses, other than fuel costs,
decreased by $2.6 million from the third 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 third quarter of 1998 from the third
quarter of 1997 is due to a lower principal balance on MCV's financing
obligation.
Comparison of the Nine Months ended September 30, 1998 and 1997
Overview
For the first nine months of 1998, MCV recorded net income of $59.6 million as
compared to net income of $61.9 million for the first nine 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 an interest refund from Great Lakes
Gas Transmission Company.
Operating Revenues
For the first nine months of 1998, MCV's operating revenues decreased $15.4
million from the first nine 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.
-15-
<PAGE> 17
Operating Expenses
For the first nine months of 1998, MCV's operating expenses were $305.5 million,
which includes $185.7 million of fuel costs. During this period, MCV purchased
approximately 64.4 bcf of natural gas, of which 2.4 bcf was used for
transportation fuel and as a net change to gas in storage. During this same
period, MCV consumed 62.0 bcf, of which 2.4 bcf of this total was gas provided
by Dow. The average commodity cost of fuel for the first nine months of 1998 was
$2.45 per MMBtu. For the first nine months of 1997, MCV's operating expenses
were $324.7 million, which includes $199.0 million of fuel costs. During this
period, MCV purchased approximately 71.7 bcf of natural gas, of which 2.4 bcf
was used for transportation fuel and as a net change to gas in storage. During
this same period, MCV consumed 70.9 bcf, of which 1.6 bcf of this total was gas
provided by Dow. The average commodity cost of fuel for the first nine months of
1997 was $2.41 per MMBtu. Fuel costs for the first nine months of 1998 compared
to 1997 decreased $13.3 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. This decrease was partially offset by a higher 1998 average cost of
gas due to an increase in long-term gas prices.
For the first nine months of 1998, operating expenses other than fuel costs
decreased $6.0 million from the first nine 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 nine months of 1998
compared to 1997 reflects the an interest income refund 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 nine months of 1998
from the first nine 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 of prior years of this
change increased earnings for the nine months ended September 30, 1997 by
approximately $15.5 million.
Liquidity and Financial Resources
During the first nine months of 1998 and 1997, net cash generated by MCV's
operations was $80.0 million and $43.6 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. During 1998 and 1997, MCV paid the basic rent
requirements of $309.0 million and $254.6 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 September 30, 1998,
the borrowing base was $45.2 million. The Working Capital Facility term
currently extends to August 31, 1999. MCV did not utilize the Working Capital
Facility during the first nine months of 1998, except for letters of credit
associated with normal
-16-
<PAGE> 18
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 September 30, 1998, there was $291.6 million (which includes
$69.8 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, Congress, 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 other factors such as, weather conditions, pricing and
transportation of commodities, environmental legislation/regulation, year 2000
compliance issues and inflation, among other important factors. In October 1998,
Consumers announced that it is offering for sale and assignment its rights under
the PPA. MCV's business and profitability may also be materially affected by the
results of any such sale or assignment of the PPA. All such factors are
difficult to predict, contain uncertainties which may materially affect actual
results, and are largely 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 nine 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
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<PAGE> 19
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.
Natural Gas. The Facility is wholly dependent upon natural gas for its fuel
supply and a substantial portion of the Facility's operating expenses consist of
the costs of natural gas. While MCV continues to pursue the acquisition of fuel
supply beyond the year 2002, MCV recognizes that its existing gas contracts are
not sufficient to satisfy the anticipated gas needs over the term of the PPA
and, as such, no assurance can be given as to the availability or price of
natural gas after the expiration of the existing gas contracts.
Energy Rates and Cost of Production. Under the PPA, energy charges are based on
the costs associated with fuel inventory, operations and maintenance, and
administrative and general expenses associated with certain of Consumers' coal
plants. However, MCV's costs of producing electricity are tied, in large part,
to the cost of natural gas. To the extent that the costs associated with
production of electricity with natural gas rise faster than the energy charge
payments, which are based largely on Consumers' coal plant operation and
maintenance costs, MCV's financial performance would be negatively affected. For
the period April 1990 through September 1998, the energy charge (fixed and
variable) paid to MCV has declined by .27 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
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
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<PAGE> 20
non-appealable order disallowing these recoveries is entered. The
Michigan Court of Appeals decision involving the Jurisdictional Issue
became final in January 1998 when the Michigan Supreme Court denied MCV's
application for an appeal. Based on this decision, Consumers notified MCV
that it would continue withholding the fixed energy charges on the
Jurisdictional Issue (currently averaging approximately $39,000 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 the years 1993 and
1994 to the Michigan Court of Appeals, and the Michigan Court of Appeals
affirmed the MPSC's decisions. The Michigan Supreme Court denied MCV's
petition for review of this issue, thus, this issue is now final.
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 $2.0 million for the first nine 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 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 and Consumers have
continued to negotiate a settlement of the above issues. At this time, MCV
Management cannot predict the outcome of these negotiations or issues.
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PPA - Sale and Assignment. On October 2, 1998, Consumers initiated a
process for the solicitation of bids to acquire Consumers' rights to the
1240 MW of Contract Capacity and associated energy under the PPA ("PPA
Sale and Assignment"). The PPA Sale and Assignment is being offered in one
1240 MW block or two 620 MW blocks for the period from an effective date
in 1999 through either September 2007 or March 2025. Consumers has
reserved the right, in its sole discretion, to terminate the bidding
process or to reject all bids. The PPA prohibits a party from transferring
or otherwise alienating the agreement without the prior written consent of
the other party, which consent shall not be unreasonably withheld. At this
time, MCV Management is currently evaluating this proposed sale and
assignment, however, it cannot predict the outcome or potential
ramifications of this issue.
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
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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.
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 nine months of 1998 averaged 630,005 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
nine months of 1998 MCV achieved an Efficiency Percentage of 45.5% and a Thermal
Percentage of 16.7%.
The loss of QF status could, among other things, cause the Facility to lose its
right under PURPA to sell power to Consumers at Consumers' "avoided cost" and
subject the Facility to additional federal and state regulatory requirements,
including the 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).
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Year 2000
Risks of MCV's Year 2000 Issues. MCV utilizes information technologies and
non-information technologies (collectively "Systems") in the Facility, some of
which may be affected by the year 2000 ("Y2K") date change. If uncorrected, the
Y2K date change could cause, among other things, MCV to incur failures and
outages of the Facility's generating equipment, the equipment operating systems
and business systems. In particular, if MCV's critical systems, i.e., GTGs,
steam turbines and the control system, are adversely affected, these negative
conditions could result in a failure to keep the GTG's running and inhibit MCV's
ability to produce electricity and steam.
Because of the integrated nature of MCV's business with third party suppliers,
customers and other vendors (collectively "associates") MCV may also be affected
by Y2K compliance complications of these associates. MCV's key associates
include vendors supplying MCV's plant control system, natural gas vendors,
Consumers as a transmission provider and certain financial institutions. Y2K
compliance complications of these associates could adversely impact MCV's
ability to transmit power and cause difficulties in obtaining natural gas to
fuel the Facility, among other things.
MCV expects that all new equipment software and hardware installations or other
modifications to its Systems will be completed prior to 2000. However, there can
be no guarantee that these costs, plans or time estimates will be achieved, and
adverse implications of Y2K non-compliance will not occur. Specific factors that
may cause such adverse results include, but are not limited to, the availability
of personnel trained in this area, the ability to locate and correct all
relevant computer code and the Y2K readiness of MCV's associates.
State of Readiness. In 1997, MCV staff developed a Y2K plan to address the
Systems. The MCV's Y2K plan addresses the Y2K issues in four phases: (1) the
awareness phase, completed in April 1998, brought the Y2K issues to the
attention of all employees; (2) the assessment phase, completed in September
1998, which identified, inventoried and prioritized all Systems; (3) the
renovation phase, expected to be completed by the end of August 1999, which
consists of converting and replacing Systems or components and applications in
Systems which are business critical and non Y2K compliant. Currently, MCV is
concentrating on configuration of new equipment and software supporting the
plant control system, GTG vibration monitoring replacements and natural gas
metering and regulating equipment; and (4) the validation and testing phase,
scheduled to be completed by October 1999, which is being done simultaneously
with the renovation phase.
MCV's work to date indicates that the GTGs appear to have no Y2K problems and
could be operated in a manual mode, if necessary. The main steam turbines also
appear to have no Y2K problems. Testing results to date on the plant control
system have been positive, but validation is incomplete at this time.
In late 1997, MCV began contacting key associates to determine their
organizations' Y2K state of preparedness and is continuing to follow up based on
each entity's Y2K target completion dates.
Contingency Plans. MCV is currently in the process of developing contingency
plans and procedures which include alternative operating plans for the most
reasonably likely worst-case scenarios, including associates in such plans where
appropriate. These plans and procedures will outline alternate methods of
operations (manual or otherwise) and all resources required, including staffing
needs where necessary. These contingency plans and procedures are targeted for
completion by the end of the first quarter of 1999.
Costs. Anticipated spending to make the Systems Y2K compliant will be expensed
as incurred, except costs for new software which will be capitalized and
amortized over the software's useful life. At this time, MCV estimates the
aggregate expenditures, for Y2K compliance and new software, to be $300,000.
This estimate does not include any estimated costs that may be incurred by MCV
as a result of the failure of any associate to become Y2K compliant or costs to
implement any contingency plans.
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.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
MPSC and Other Proceedings Relating to Capacity and Energy Charges
Background. Michigan law requires Consumers to file on an annual basis a "Power
Supply Cost Recovery Plan" (the "PSCR Plan") describing, among other things, the
anticipated sources of electric power to be purchased during the upcoming year.
The PSCR Plan must be filed at least three months before the beginning of the
12-month period covered by the plan. If the MPSC fails to allow or disallow the
costs of purchased power in the PSCR Plan by the beginning of the year covered
thereby, Consumers may adjust its rates to recover such costs, as proposed by
Consumers, until the MPSC acts. Actual costs are reconciled with the costs
billed to customers in a subsequent filing (made by March 31 of the year
subsequent to the plan year) known as the "Power Supply Cost 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
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<PAGE> 25
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 became final in January 1998 when the Michigan Supreme Court denied MCV's
application for an appeal. Based on this decision, Consumers notified MCV that
it would continue withholding the fixed energy charges on the Jurisdictional
Issue (currently averaging approximately $39,000 per month in 1998). MCV
released
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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.
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 $2.0
million for the first nine 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 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
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<PAGE> 27
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.
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<PAGE> 28
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.
-27-
<PAGE> 29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MIDLAND COGENERATION VENTURE
LIMITED PARTNERSHIP
-------------------------------------------
(Registrant)
Dated: November 9, 1998 /s/ James M. Kevra
------------------- -------------------------------------------
James M. Kevra
President and Chief Executive Officer
Dated: November 9, 1998 /s/ James M. Rajewski
------------------- -------------------------------------------
James M. Rajewski
Vice President and Controller
(Principal Accounting Officer)
-28-
<PAGE> 30
Index to Exhibits
Ex-27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENT OF OPERATIONS OF THE
MIDLAND COGENERATION VENTURE FOR THE QUARTER ENDED SEPTEMBER 30, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIALS STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 138,163
<SECURITIES> 142,180
<RECEIVABLES> 97,711
<ALLOWANCES> 0
<INVENTORY> 12,786
<CURRENT-ASSETS> 275,031
<PP&E> 2,403,156
<DEPRECIATION> 623,640
<TOTAL-ASSETS> 2,225,744
<CURRENT-LIABILITIES> 164,113
<BONDS> 1,723,960
0
0
<COMMON> 0
<OTHER-SE> 336,821
<TOTAL-LIABILITY-AND-EQUITY> 2,225,744
<SALES> 0
<TOTAL-REVENUES> 471,927
<CGS> 0
<TOTAL-COSTS> 305,486
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 123,002
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 59,600
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
