Back to GetFilings.com
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
Commission file number 333-89725
AES Eastern Energy, L.P.
(Exact name of registrant as specified in its charter)
Delaware 54-1920088
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1001 North 19th Street
Arlington, Virginia 22209
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 703-522-1315
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
(Title of each class)
---------------
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
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ] ___________
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Act).
Yes No X
----- -----
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates computed by reference to the price at which
common equity was last sold, or the average bid and asked price of such common
equity was sold, or the last business day of the registrant's most recently
completed second fiscal quarter: $0
Registrant is a wholly owned subsidiary of The AES Corporation.
Registrant meets the conditions set forth in General Instruction I(1)(a) and
(b)of Form 10-K and is filing this Annual Report on Form 10-K with the reduced
disclosure format authorized by General Instruction I.
DOCUMENTS INCORPORATED BY REFERENCE
None
TABLE OF CONTENTS
Page
PART I
Item 1 Business 2
Item 2 Properties 22
Item 3 Legal Proceedings 23
Item 4 Submission of Matters to a Vote of Security Holders 23
PART II
Item 5 Market for the Registrant's Common Equity and Related
Stockholder Matters 24
Item 6 Selected Financial Data 24
Item 7 Management's Discussion and Analysis of Financial Conditions
and Results of Operation 25
Item 7A Quantitative and Qualitative Disclosures About Market Risks 36
Item 8 Consolidated Financial Statements and Supplementary Data 37
Item 9 Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure 37
PART III
Item 10 Directors and Officers of the Registrants 38
Item 11 Executive Compensation 39
Item 12 Security Ownership of Certain Beneficial Owners And Management 40
Item 13 Certain Relationships and Related Transactions 40
Item 14 Controls and Procedures 40
PART IV
Item 15 Exhibits, Financial Statement Schedules, and Reports on Form 8-K 42
Item 1. Business
(a) General Development of Business
Our company is a Delaware limited partnership. Our company was formed
on December 2, 1998 as an indirect wholly owned subsidiary of The AES
Corporation to take part in the acquisition by subsidiaries of The AES
Corporation of six coal-fired electricity generating stations and related
assets located in the western and west central part of New York State. AES NY,
L.L.C. is the sole general partner of our company and AES NY2, L.L.C. is the
sole limited partner of our company. The AES Corporation owns indirectly all of
the member interests in both AES NY, L.L.C. and AES NY2, L.L.C. The mailing
address of our principal executive offices is 1001 North 19th Street,
Arlington, Virginia 22209, telephone no. (703) 522-1315.
New York State Electric & Gas Corporation and its affiliate NGE
Generation, Inc. (whom we refer to collectively as "NYSEG") sold these six
electricity generating stations and related assets as part of NYSEG's overall
plan to divest itself of its coal-fired electricity generating assets. On May
14, 1999, twelve special purpose business trusts formed by three institutional
investors that are not affiliated with us or with The AES Corporation acquired
from NYSEG and leased to us the assets constituting the Somerset Generating
Station ("Somerset")(formerly known as the Kintigh Generating Station) and the
Cayuga Generating Station ("Cayuga")(formerly known as the Milliken Generating
Station), excluding the real property on which they are located. On that date,
we acquired from NYSEG the real property on which Somerset and Cayuga are
located and two additional coal-fired electricity generating stations, the
Westover Generating Station ("Westover")(formerly known as the Goudey
Generating Station) and the Greenidge Generating Station ("Greenidge")(together
with the real property upon which they are located). We leased a portion of the
real property on which Somerset and Cayuga are located and a selective
catalytic reduction system ("SCR"), which reduces emissions of nitrogen oxides,
that was then being installed at Somerset to the special purpose business
trusts, which subleased them back to us. As part of the transaction, AES
NY3,L.L.C., an indirect wholly owned subsidiary of The AES Corporation that we
do not control, acquired the stock of the Somerset Railroad Corporation, which
owns short line railroad assets used to transport coal to Somerset. Somerset
Railroad entered into a coal hauling agreement with us to transport coal. AES
Creative Resources, L.P., an indirect wholly owned subsidiary of The AES
Corporation that we do not control, acquired the balance of the assets that
were purchased from NYSEG, consisting of two older, coal-fired electricity
generating stations, the Jennison Generating Station and the Hickling
Generating Station.
We operate our electricity generating stations through our wholly
owned subsidiaries. Westover and Greenidge are owned by our wholly owned
subsidiary, AEE2, L.L.C. Our other subsidiaries do not own any of our
electricity generating stations but operate them pursuant to operations and
maintenance agreements with us.
The agreements governing the leases of Somerset and Cayuga and our
working capital credit facility impose severe restrictions on our ability to
make distributions of cash or other assets to our owners and on the ability of
our owners to withdraw cash or other assets from us. These restrictions are
intended to assure that we have paid all of our operating and maintenance
expenses and all of our obligations under our leases and under our working
capital credit facility before any assets are distributed to or withdrawn by
our owners. We may make a distribution to our owners on or within ten business
days after a rent payment date for the Somerset and Cayuga leases so long as
the following conditions are satisfied:
(1) all rent under the leases for Somerset and Cayuga including
deferrable payments, must have been paid to date;
(2) amounts on deposit or deemed on deposit in the rent reserve
account and the additional liquidity account established in connection
with the pass through trust certificates issued to finance the
acquisition of Somerset and Cayuga must be equal to or greater than
the rent reserve account required balance or the additional liquidity
required balance, as applicable;
(3) no lease material default, lease event of default or event of
default under any permitted indebtedness shall have occurred and be
then continuing;
2
(4) no amounts may be outstanding under the working capital credit
facility;
(5) we have no indemnity currently due and payable under specified
provisions of the participation agreements relating to the Somerset
and Cayuga leases or any other operative document or any obligation to
fund the indemnity accounts (as defined in the leases) under the
leases;
(6) the coverage ratios for each of the two semiannual rent payment
periods immediately preceding the rent payment date (based on actual
operating history) must be equal to or greater than the required
coverage ratio and the pro forma coverage ratios for each of the four
semiannual periods immediately succeeding this rent payment date must
be equal to or greater than the required coverage ratio;
(7) with respect to the Somerset Railroad credit facility or any
replacement facility, no event of default shall have occurred and be
then continuing under the facilities and the remaining term of the
Somerset Railroad credit facility or any replacement facility shall
not be less than 30 days.
On February 19, 2002, The AES Corporation announced that it intends to
reposition itself in the electric business by fully contracting or divesting
its merchant generation businesses. The AES Corporation said that it made this
decision to reduce earnings volatility and strengthen its balance sheet. We are
one of AES Corporation's merchant generating businesses. Our business could be
fully contracted if we were to sign one or more long-term power sales
agreements for the output of our electricity generating stations. We stated in
our Annual Report on Form 10-K for the year ended December 31, 2001 that we
were adopting a policy of not commenting on proposed transactions and we
disclaim any obligation to provide information with respect to proposed
transactions until a definitive agreement has been reached.
We wish to caution readers that our business and operations involve
risks and uncertainties, including the following important factors. These
factors should be considered when reviewing our business, financial condition,
results of operations and future prospects, and are relied upon by us in
issuing any forward-looking statements. Such factors could affect our actual
operating results and cause such results to differ materially from those
expressed in any forward-looking statements made by, or on behalf of, us. Some
or all of these factors may apply to our business as currently conducted or as
we intend to conduct it.
o We will be required to make substantial payments under our
leases and other contracts and we may have difficulty responding
to unforeseen requirements.
o We may have difficulty meeting our payment obligations if our
operations are not as successful as we have projected.
o Operation of our electricity generating stations might be
disrupted by: interruptions in fuel supply; disruptions in
electrical transmission; facility shutdown due to breakdowns or
failures of equipment or processes, violations of permit
requirements, operator error or terrorist activity or other
catastrophic events; or labor disputes.
o Our electricity generating stations are not new and will require
careful maintenance if they are to operate efficiently.
o We may have trouble meeting our obligations if our electricity
generating stations are not dispatched nearly continually.
o The perception of the public and government officials in the
markets we serve and in other deregulated markets that
deregulated prices for electric energy are higher than expected
may result in some degree of re-regulation of the markets in
which we sell our electric energy, unforced capacity and
ancillary services. This re-regulation might take the form, for
example, of lowering of caps on wholesale electric energy prices
during periods of peak demand.
3
o The addition of new generating capacity in the New York region
in excess of the amount required to meet increased demand could
result in the reduction of market clearing prices in periods of
peak demand, which would reduce the profitability of our
operations.
o We operate in an industry where there are a limited number of
vendors for supplies which are critical to the operation of our
business. If one of our vendors should have production problems,
a shortage in these commodities could affect our ability to
operate or cause prices to rise for these commodities that may
negatively affect our operating results.
o An increase in the real price of coal may negatively affect our
operating results.
o Our business is extensively regulated and new regulations may
impose requirements that we are unable to meet or that require
us to make additional expenditures.
o We have responsibility for environmental liabilities that
existed prior to our ownership of our electricity generating
stations and we will incur expenses as a result. These expenses
may exceed our estimates.
o We may be subject to significant new restrictions on emissions
which may force us to restrict our operations or incur
significant expenses.
o Under the Asset Purchase Agreement with NYSEG relating to the
acquisition of our electricity generating stations, we have
assumed liabilities of NYSEG that could result in unexpected
expenses and we have given up the right to make claims for
problems we may discover later.
o We are controlled by The AES Corporation and The AES Corporation
may pursue its own interests to the detriment of our creditors
and holders of pass through trust certificates issued to finance
the acquisition of Somerset and Cayuga.
o The AES Corporation is not obligated to provide further funding
to us if we are unable to pay our obligations.
o On November 20, 2002, we signed an agreement with Union Bank of
California, N.A. for a one-year extension to January 2, 2004 of
the secured revolving working capital and letter of credit
facility . Currently, lenders have committed to provide only $15
million of the $35 million secured revolving working capital and
letter of credit facility. We are attempting to obtain
commitments for the remaining $20 million. Our financial
flexibility may be limited if we are unable to obtain these
commitments or substitute sources of credit.
o We expect that two senior members of our management team, Dan
Rothaupt and John Ruggerillo, will devote a portion of their
time to other projects for The AES Corporation.
o In the future we might compete with other electricity generating
stations owned by The AES Corporation.
4
(b) Financial Information About Industry Segments
We operate in only one business segment, electrical generation.
(c) Narrative Description of Business
A diagram of the corporate structure of The AES Corporation as it
relates to our company is included below:
The AES Corporation-------------
| |
AES New York AES Odyssey, L.L.C.
Funding, L.L.C.
|
AES NY Holdings, L.L.C.
|
----------------------------------------------------------------
| | |
| | |
AES NY2, L.L.C. AES NY, L.L.C. AES, NY3,
(Limited Partner) (General Partner) L.L.C.
| | |
| | |
------------------------------------------------- |
| | |
| | |
| | |
AES Eastern AES Creative Somerset
Energy, L.P. Resources, L.P. Railroad
| | Corp.
| |
-------------------------------- ----------------
| | | | |
| | | | |
AES AES AEE 2, AES AES
Somerset, Cayuga, L.L.C. Jennison, Hickling,
L.L.C. L.L.C. | L.L.C. L.L.C.
(Somerset) (Cayuga) |
-------------
| |
| |
AES AES
Westover, Greenidge,
L.L.C. L.L.C.
(Westover) (Greenidge)
The AES Corporation
The AES Corporation is a leading global power company committed to
supplying electricity in a socially responsible way. The AES Corporation is a
public company and is subject to the informational requirements of the
Securities Exchange Act of 1934 and, in accordance therewith, files reports,
proxy statements and other information, including financial reports, with the
SEC, which are not incorporated into and do not form a part of this Form 10-K.
5
New York Power Market
The New York Independent System Operator ("NYISO") commenced
operations in November 1999 and consists of the NYISO and the New York State
Reliability Council. The NYISO is a non-profit New York corporation under the
Federal Energy Regulatory Commission's jurisdiction. It is governed by a board
of directors with 10 members and three committees, the management committee,
the operating committee, and the business issues committee, which are composed
of representatives from all market participants, including buyers of power,
sellers of power, consumer groups and transmission owners. The New York State
Reliability Council has the primary responsibility to preserve the reliability
of electricity service on the bulk power system within New York State and sets
the reliability standards to be used by the NYISO. The NYISO operates a
two-settlement system for calculating Location-Based Marginal Prices ("LBMP")
of electric energy. The first settlement system is a financially binding market
for delivery of electric energy on the following day and the second settlement
system is the balancing market for immediate delivery of electric energy. LBMP
is the incremental cost to supply load at a specific location in the grid.
Locational energy price differentials represent the opportunity cost for
transmission between specific locations in the grid.
In July 2001, the Federal Energy Regulatory Commission directed the
NYISO and adjacent power market operators to engage in a 45-day mediation
process to form one regional transmission organization for the northeastern
region. The participants released a business plan on September 17, 2001. On
January 28, 2002 the NYISO and ISO New England(ISO-NE) entered into an
agreement to develop a plan to establish a common market design for a regional
transmission organization. On November 22, 2002, the Boards of Directors for
the ISO-NE and the NYISO withdrew their joint petition to the Federal Energy
Regulatory Commission(FERC) proposing the creation of a Northeast Regional
Transmission Organization for the seven-state northeast region. We cannot
predict if a regional transmission organization will be created or what effect
the creation of such an organization might have on the markets in which we do
business.
On July 31, 2002, FERC issued Standard Market Design Notice of
Proposed Rulemaking. It proposes among other things to establish a single
flexible transmission service, Network Access Service, with a single open
access transmission tariff that applies to all transmission customer-
wholesale, unbundled retail and bundled retail and a standard market design for
wholesale electric markets. On January 13, 2003, FERC announced that it will
issue a white paper on the proposed standard market design in April 2003. FERC
has not set a date for issuance of the standard market design final notice of
proposed rule making. We cannot predict the outcome or actual implementation
date of this final rule proceeding or the effect it will have on the markets in
which we do business.
The New York power market is interconnected with ISO-NE to the
northeast, Hydro Quebec and Ontario Hydro to the north, and PJM
(Pennsylvania-New Jersey-Maryland) Interconnection to the south.
The transmission of electricity between states and between regions
within New York State is constrained by physical limits on transmission
capacity and limits on the amount of electricity that may be imported into a
power pool imposed by power pools to enhance reliability. Therefore, the
generating assets in any given region have a competitive advantage in that
region over generators not in the region. There is an existing natural market
for the unforced capacity and the electric energy of our electricity generating
stations in Western New York, which includes the retail service territories of
NYSEG, Niagara Mohawk Power Corporation and Rochester Gas & Electric
Corporation. The existing transmission infrastructure also permits us to access
neighboring markets. However, our ability to sell electric energy into
neighboring markets is limited by constraints imposed by transmission capacity
limitations and limits on imported electricity imposed by power pools in those
markets for reliability considerations. Until April 30, 2003, our ability to
sell electric energy into neighboring markets is also limited because we have
entered into bilateral contracts for the sale of a substantial portion of our
unforced capacity to load serving entities, i.e., an entity selling electric
energy to consumers of electric energy, including regulated distribution
utilities, municipalities and energy supply companies, in New York.
6
We entered into an arrangement with AES Odyssey, L.L.C. ("Odyssey"), a
direct wholly-owned subsidiary of The AES Corporation, for power marketing
services. This agreement commenced on November 27, 2000 . The initial term of
the agreement was for a term of three years. In March 2002, a new agreement was
reached, for a term of five years through February 28, 2007 pursuant to which
Odyssey provides data management, marketing, scheduling, invoicing and risk
management services for a fee of $300,000 per month. Odyssey acts as agent on
behalf of us in the over-the-counter and NYISO markets.
As agent, Odyssey manages all energy transactions under our name
including (i) preparing confirmations for us and approving confirmations with
counter-parties, (ii) conducting monthly check-outs with counter-parties as
appropriate before the preparation of invoices, (iii) invoicing counter-parties
for the term of the transactions and (iv) otherwise managing and executing the
terms of the transactions in accordance with their provisions.
Odyssey provides data management for us by maintaining databases of
pricing, load, transmission, weather and generation data to aid in analysis to
optimize the value of our assets.
Odyssey maintains a transaction management system to manage day-ahead
commitments with the NYISO and swap and physical values with counter-parties
and to provide daily financial reporting and end of day budget variance,
forward mark-to-market and commercially accepted risk analysis.
New York Wholesale Electric Energy Market. Electric energy generators
may sell electric energy, unforced capacity and ancillary services at the
wholesale level to regulated distribution utilities, municipalities and energy
supply companies. Electric energy generators may also sell electric energy,
unforced capacity and ancillary services in the centralized wholesale market
coordinated by the NYISO. Competition in wholesale and retail markets has led
to unbundling of and distinct markets for electric energy, unforced capacity
and ancillary services.
Electric Energy Markets. Any generator in New York State can sell its
output of electric energy to any wholesale customer statewide including
utilities, municipalities, and energy supply companies. Generators can sell
electric energy under bilateral contracts, with pricing and other provisions
determined by two-party negotiation, or they can bid into either or both of two
centralized settlement systems for electric energy, a market for delivery on
the following day or a market for delivery on an immediate basis, which is
intended primarily to balance actual loads and resources. The system pricing is
based upon market clearing price, which is the price at which sufficient
electric energy is supplied to satisfy all demand for which bids have been
submitted. If a generator's bid is equal to or less than the market clearing
price, the generator will be paid the market clearing price, rather than its
bid price, at the point it supplies electric energy to the system and the
purchaser will pay the market clearing price at the point it receives electric
energy from the system. If a generator's bid exceeds the market clearing price,
the generator will not be dispatched.
In general, we sell the electric energy generated by our electricity
generating stations directly into the NYISO market however, on occasion, we
enter into bilateral sales contracts.
7
Unforced Capacity Market. A market in which electricity generators can
sell commitments of their unforced generating capacity has been established to
ensure there is enough generation capacity available to produce sufficient
electric energy to meet retail demand and ancillary service requirements. Any
load serving entity is required to procure capacity commitments sufficient to
meet its capacity requirements based on its forecasted annual electric energy
requirements at times of maximum usage plus a reserve requirement. Currently,
each load serving entity is required to purchase unforced capacity commitments
equal to approximately 112% of its forecasted annual maximum usage. The load
serving entity can secure these capacity commitments through a bilateral
contract or through unforced capacity auctions. Any capacity commitment which
is not procured locally needs to satisfy the requirement that, as an import, it
does not violate transmission constraints. Starting with the 2001 - 2002 Winter
Capability Period, the NYISO implemented a revised capacity market design in
the New York control area that employs unforced capacity as the measure of the
capacity of a generator rather than the old measure of installed capacity.
Unforced capacity factors in the probability that a generator will be available
to serve load. Unforced capacity is the demonstrated maximum output of a
generator(installed capacity) with a formula applied that takes into account a
generator's forced outage rate over a defined period of time.
Suppliers of unforced capacity are not required to supply the
associated electric energy to the load serving entity with whom they have a
contract to provide unforced capacity. For reliability reasons, the NYISO
requires that electricity generators that sell unforced capacity into New York
must make their electric energy available in the event of a system emergency.
This prevents generators from entering into firm contracts to sell electric
energy into one market and unforced capacity into another. If the unforced
capacity supplier's offer in the electric energy market for delivery on the
following day is not accepted, the unforced capacity supplier, for the next
day, will be free either to offer to sell its electric energy in the market for
delivery on an immediate basis or to sell electric energy to any customer,
including out-of-state customers.
AES NY, L.L.C. and NYSEG entered into a New York Transition Agreement,
dated as of August 3, 1998, to ease the transition of NYSEG's native load
customers' installed capacity requirements. Under this agreement, NYSEG agreed
to purchase, and AES NY, L.L.C. agreed to sell, installed capacity in the
amount of 1,424MW (which is the aggregate capacity of all of the generating
assets included in the assets acquired from NYSEG) for the term of the
agreement. AES NY, L.L.C. assigned this agreement to us insofar as it related
to our electricity generating stations. The parties performance under the
agreement commenced on May 14, 1999 and terminated on April 30, 2001. Since
this agreement terminated, we have entered into bilateral contracts with a
number of parties for the substantial portion of our unforced capacity through
April 30, 2003.
Ancillary Services Market. The NYISO will procure various ancillary
services required for reliability from generators as needed. Services to be
procured on a market basis include operating reserves and regulation and
frequency support. Generators will be compensated for other services, including
voltage support and black start capability, on a cost basis.
OTC Swap Market. A fairly liquid over-the-counter swap market has
developed in several of the NYISO Zones, (1) West or Zone A, (2) East or Zone
G, and (3) New York City or Zone J. A zone is a defined portion of the New York
electric system that encompasses a set of load and generation buses. Each zone
has an associated zonal price that is calculated as a weighted average price.
Currently New York State is divided into eleven zones, corresponding to ten
major transmission interfaces that can become congested. The swaps settle
against the Day Ahead LBMP for Zone A. Our plant prices are highly correlated
to the Zone A price and the swaps are highly effective products for managing
our price risk.
Transmission System Market. Transmission lines in New York are
controlled by the NYISO. Transmission access is available to all market
participants on a comparable and non-discriminatory basis. A party transmitting
electric energy through or out of New York State pays the NYISO a transmission
service charge to cover the revenue requirements of the transmission owner.
Electric energy sold under
8
a bilateral contract is subject to a congestion charge. The congestion charge
reflects the differences between the LBMP at the source and destination on the
transmission system. Parties can hedge their exposure to congestion charges
through transmission congestion contracts which are auctioned biannually.
Regions. New York State has regional transmission constraints which
divide the state's power market into distinct regions. The most significant
transmission constraints impede the transmission of electricity going west to
east. As a result, the most significant regional differences in the power
market are between the western and eastern regions. The eastern region includes
the service areas of the Long Island Power Authority, Key Span Energy
Corporation, Consolidated Edison Company of New York, Inc., Orange & Rockland
Utilities, Inc. and Central Hudson Gas & Electric Corporation. The western
region includes service areas of Niagara Mohawk Power Corporation, Rochester
Gas & Electric Corporation, the New York Power Authority and most of NYSEG.
The western region is dominated by low cost nuclear, coal and hydro
facilities which, together with non-utility generators that must be permitted
to run under their power purchase agreements with local utilities, form 83% of
installed capacity. The eastern region has a predominance of facilities which
are economically viable only at periods of peak demand, which form 80% of its
installed capacity. Even though the western region has only 40% of the New York
power market's generation capacity, power normally flows from the west into the
east. The flow of power from the lower priced western region to the higher
priced eastern region is limited to approximately 5,000MW by transmission
limits and reliability considerations. When this limit is reached, higher cost
units in the New York City area are directed to run even when lower cost units
in the western region are available.
9
Interconnection. Western and central New York are relatively
unattractive markets for the transmission of imported power due to the low
generation costs of existing facilities and low on-peak electric energy prices
relative to the area's adjacent markets, ISO New England, PJM (Pennsylvania-New
Jersey-Maryland) Interconnection and eastern New York. The existing
transmission infrastructure permits us to access these neighboring markets,
subject to constraints imposed by capacity limitations and reliability
considerations and subject to our obligation to offer to sell our electric
energy in the New York market for the delivery of electric energy on the
following day to the extent that we have sold our unforced capacity to a load
serving entity in New York in accordance with the rules of the NYISO.
Fuel Supply
Our electricity generating stations are located in close proximity to
important coal producers. In addition, both Somerset and Cayuga are equipped
with flue gas desulfurization("FGD") systems that allow the plants to burn less
expensive medium- and high-sulfur coal while staying within sulfur dioxide
("SO2") emission regulation requirements.
Coal mines in the Pittsburgh Seam coal formation near our electricity
generating stations include some of the lowest cost coal supply sources
producing at volume. Although more expensive low-sulfur coals are available for
units without FGD systems, the high sulfur content of the coals from the
Pittsburgh Seam have historically made coal-fired generating stations equipped
with FGD systems the primary market for Pittsburgh Seam producers. Since both
Somerset and Cayuga have installed FGD systems and are capable of burning
higher sulfur coals, we expect to maintain a fuel cost advantage over
competitors without FGD systems.
The Electricity Generating Stations
We believe that our two principal coal-fired electricity generating
stations, Somerset and Cayuga, are among the lowest variable cost facilities in
the New York power market. We expect them to be fully dispatched when available
in the deregulated and competitive New York power market. As a means of further
enhancing the competitive position of our electricity generating stations in
the New York power market, we expect to use expertise of The AES Corporation as
a major operator of coal-fired facilities on a worldwide basis. We also intend
to make appropriate investments of capital to maintain our electricity
generating stations. Somerset, Cayuga, Westover and Greenidge have an aggregate
net generating capacity of 1,268MW.
The Somerset Generating Station
Somerset is the largest and newest of our electricity generating
stations and is located northeast of Niagara Falls, alongside the southern
shore of Lake Ontario near Barker, New York. There is a single operating unit,
which began generating electricity in 1984. The maximum net generating capacity
of Somerset is 675MW.
Somerset is believed to be among the lowest variable cost facilities
in the New York power market. It can be run economically even at times of
minimum demand for electric energy. Somerset also is capable of burning low
cost medium- and high-sulfur coal as a result of being equipped with a FGD
system and a selective catalytic reduction ("SCR") system. When Somerset is not
being dispatched at maximum load, its periodic load can be varied to meet both
system load demand and provide transmission system support and the plant can
provide both operating reserves that are available immediately or on ten
minutes notice. The plant is also equipped with Automatic Generation Controls
enabling it to provide regulation and frequency support.
The Cayuga Generating Station
Cayuga is located alongside the east shore of Cayuga Lake, near the
town of Lansing, New York. There are two operating units at Cayuga, Unit 1 and
Unit 2, which began generating electricity in 1955 and 1958, respectively. The
maximum aggregate net generating capacity of the two units is 306MW. Cayuga
Unit 1
10
currently has a net generating capacity of 150MW. Unit 2 currently has a net
generating capacity of 156MW.
Cayuga is believed to be among the lowest variable cost facilities in
the New York power market. It can be run economically even at times of minimum
demand for electric energy. Cayuga also is capable of burning low cost medium
and high-sulfur coal as a result of being equipped with a FGD system. When
Cayuga is not being dispatched at maximum load, its periodic load can be varied
to meet both system load demand and provide transmission system support, and
the plant can provide both operating reserves that are available immediately or
on ten minutes notice. The plant is also equipped with Automatic Generation
Controls enabling it to provide regulation and frequency support. During 2001,
we installed a SCR system on Unit 1, which became operational on June 7, 2001.
Westover Generating Station
Westover is located alongside the Susquehanna River near Johnson City,
New York, and began generating electricity in the early 1900's. Units 1 through
6 have been retired and physically removed. Westover presently consists of two
units, Unit 7 and Unit 8, with a combined maximum net generating capacity of
126MW.
Westover is capable of providing both operating reserves that are
available immediately or on ten minutes notice. The station is equipped with
Automatic Generation Controls, which connect it to the NYISO power control
center and enable it to provide regulation, frequency support, and when
directed by the NYISO, voltage support.
Greenidge Generating Station
Greenidge is located on the west shore of Seneca Lake adjacent to the
village of Dresden, New York, and began generating electricity in 1938. Units 1
and 2 have been retired and physically removed. Greenidge presently consists of
two units, Unit 3 and Unit 4, with a combined maximum net generating capacity
of 161MW.
Greenidge is capable of providing both operating reserves available
immediately and on ten minutes notice. The station is equipped with Automatic
Generating Controls, which connect it to the NYISO power control center and
enable it to provide regulation, frequency support, and, when directed by the
NYISO, voltage support.
Regulation
Energy Regulatory Matters
General
We and our ownership and operation of our electricity generating
stations are regulated under numerous federal, state and local statutes and
regulations. Among other aspects of electric generation, these statutes and
regulations govern the rates that we may charge for the output of our
electricity generating stations, establish in certain instances the operating
parameters of our electricity generating stations, and define standards for
ownership of our electricity generating stations. While there exists interest
at both the federal and state level to deregulate certain aspects of the
electric generation industry, we currently remain subject to extensive
regulation.
11
Federal Energy Regulation
Federal Power Act. Under the Federal Power Act, the Federal Energy
Regulatory Commission possesses exclusive rate-making jurisdiction over
wholesale sales of electricity and transmission in interstate commerce. FERC
regulates the owners of facilities used for the wholesale sale of electricity
and transmission in interstate commerce as "public utilities" under the Federal
Power Act.
Pursuant to the Federal Power Act, all public utilities subject to
FERC's jurisdiction are required to obtain FERC's acceptance of their rate
schedules in connection with the wholesale sale of electricity.
Our rate schedule was approved by FERC as a market-based rate schedule
and, accordingly, FERC granted us waivers of the principal accounting,
record-keeping and reporting requirements that otherwise are imposed on
utilities with a cost-based rate schedule.
Public Utility Holding Company Act. The Public Utility Holding Company
Act ("PUHCA") provides that any corporation, partnership or other entity or
organized group that owns, controls or holds power to vote 10% or more of the
outstanding voting securities of a "public utility company" or a company that
is a "holding company" of a public utility company is subject to regulation
under PUHCA, unless an exemption is established or an order is issued by the
SEC declaring it not to be a holding company. Registered holding companies
under PUHCA are required to limit their utility operations to a single
integrated utility system and to divest any other operations not functionally
related to the operation of the utility system. In addition, a public utility
company that is a subsidiary of a registered holding company under PUHCA is
subject to financial and organizational regulation, including approval by the
SEC of certain of its financing transactions. However, under the Energy Policy
Act of 1992, a company engaged exclusively in the business of owning and/or
operating a facility used for the generation of electric energy exclusively for
sale at wholesale may be exempted from PUHCA regulation as an "exempt wholesale
generator." On February 5, 1999, we received exempt wholesale generator status
from FERC for our ownership and operation of generation and associated
facilities. If, after having received this status, there is a "material change"
in facts that might affect our continued eligibility for exempt wholesale
generator status, within 60 days of this material change, we must (a) file a
written explanation of why the material change does not affect our exempt
wholesale generator status, (b) file a new application for exempt wholesale
generator status or (c) notify FERC that we no longer wish to maintain exempt
wholesale generator status. However, if we should lose exempt wholesale
generator status, then we would either have to restructure ourselves or risk
subjecting ourselves and our affiliates to PUHCA regulation.
State Regulation. In New York State, legislation has significantly
deregulated the rate setting aspects of the industry. However, significant
risks remain, including, but not limited to, the potential that the state
deregulation initiatives could be reversed or nullified. We obtained
authorization from the New York State Public Service Commission for the
issuance of the pass through trust certificates and the incurrence of debt
pursuant to the terminated working capital credit facility with Union Bank of
California, N.A. In April 2001, we have received approval of our current
working capital facility.
Lease Transactions Filings and Approvals. As conditions to completion
of the lease transactions relating to Somerset and Cayuga, we and the
appropriate financial participants in the lease transactions were required to
obtain certain approvals from FERC. We obtained all of our approvals, including
authorization to sell wholesale electric energy under our market-based rate
schedule and related waivers and blanket authorization. We believe that the
special purpose business trusts have obtained all energy-related approvals
required to be obtained by them. The special purpose business trusts have been
included in the approval by FERC of the transfer of jurisdictional facilities
and the acquisition and leaseback of FERC-jurisdictional facilities, and FERC
has granted a disclaimer of jurisdiction over each of the institutional
investors and the special purpose business trusts and the trustees of those
trusts as public utilities under Part II or III of the Federal Power Act. The
special purpose business trusts have received determinations from FERC that
they are exempt wholesale generators. The special purpose business trusts
12
obtained a no-action letter from the SEC staff that no enforcement action would
be recommended against them under PUHCA if they proceeded with the lease
transactions prior to obtaining exempt wholesale generation determinations from
FERC.
13
Environmental Regulatory Matters
General
As is typical for electric generators, our electricity generating
stations are required to comply with federal, state and local environmental
regulations relating to the safety and health of personnel and the public,
including
o the identification, generation, storage, handling,
transportation, disposal, record-keeping, labeling, reporting of
and emergency response in connection with hazardous and toxic
materials associated with our electricity generating stations;
o limits on noise emissions from our electricity generating
stations;
o safety and health standards, practices and procedures applicable
to the operation of our electricity generating stations; and
o environmental protection requirements, including standards and
limitations relating to the discharge of air and water
pollutants.
Failure to comply with any of these statutes or regulations could have
material adverse effects on us, including the imposition of criminal or civil
liability by regulatory agencies or civil fines and liability to private
parties, and the required expenditure of funds to bring our electricity
generating stations into compliance. In addition, pursuant to the Asset
Purchase Agreement with NYSEG, we (as assignee of AES NY, L.L.C.) have, with a
few exceptions, agreed to indemnify NYSEG against the consequences of NYSEG's
handling, storage or emission of hazardous and toxic materials on any of the
sites of our electricity generating stations and the Lockwood off-site ash
disposal site and for NYSEG's past non-compliance, if any, with environmental
requirements.
It is likely that the stringency of environmental regulations
affecting us and our operations will increase in the future. In the meantime,
we will monitor potential regulatory developments that may impact our
operations and we will participate in rulemaking proceedings applicable to our
operations when we consider it advisable to do so. We do not expect any
proposed regulations to have a material adverse effect on our operations or our
financial condition.
On February 14, 2002, the Bush Administration issued its
multi-pollutant proposal called "Clear Skies". This proposal would regulate the
emission of SO2, NOx and mercury. We have not determined the effect of the
Clear Skies or any other pending regulation or legislation.
Expenditures. Compliance with environmental standards will continue to
be reflected in our capital expenditures and operating costs. Based on the
current status of regulatory requirements, other than the expenditures for the
SCRs at Somerset and Cayuga including the construction of new landfill space to
manage ash from Somerset's SCR system operations, expenditures for possible
installation of a SCR system on Cayuga Unit 2 and the U.S. Department of Energy
Power Plant Improvement project on Greenidge Unit 4 and the Westover Overfire
Air Project, we do not anticipate that any capital expenditures or operating
expenses associated with our compliance with current laws and regulations will
have a material effect on our operations or our financial condition. See "Air
Emissions--Nitrogen Oxides."
Air Emissions
The federal Clean Air Act and many state laws, including the laws of
the State of New York, require significant reductions in utility Sulfur Dioxide
and Nitrogen Oxides ("NOx") emissions that result from burning fossil fuels in
order to reduce acid rain and ground-level ozone (smog).
Sulfur Dioxide (SO2). SO2 emissions are regulated under Title IV of
the federal Clean Air Act Amendments and by the New York Acid Deposition
Control Act. One of the primary goals of Title IV of the Amendments was to
reduce SO2 emissions
14
by 10 million tons from 1980 levels. The SO2 emission reduction requirements
generally apply to almost all fossil-fuel fired electric generating units
producing electricity for sale. Power plants subject to Title IV are required
to obtain acid rain permits, to hold sufficient emission allowances to cover
their SO2 emissions, and to comply with various monitoring and record-keeping
requirements. The federal SO2 requirements were implemented in two
phases--Phase I applies to the 110 plants listed in section 404 of the Act and
Phase II generally affects all other fossil-fuel fired electric generating
plants selling over 25MW to the electricity distribution grid. Phase I of the
federal Clean Air Act Amendments SO2 program went into effect January 1, 1995,
with Cayuga Unit 1 and Unit 2 and Greenidge Unit 4 falling under the program.
Phase II went into effect January 1, 2000 and affects all the units.
FGD systems are operated at both Somerset and Cayuga to reduce total
SO2 emissions from these plants to quantities substantially below the Title IV
SO2 "allowance" allocations for the units at these plants. An allowance is a
freely transferable right to emit one ton of a substance, in this case, SO2.
The excess allowances are accumulated and can either be used for our other
electricity generating stations or sold to provide liquidity to us. We may sell
SO2 allowances rather than save them for Phase II of Title IV of the federal
Clean Air Act Amendments. During Phase II, we may need to purchase SO2
allowances to cover SO2 emissions for Greenidge and Westover. Market prices for
SO2 allowances currently range from about $140 to $160 per ton. We were self
sufficient with respect to SO2 allowances in 2001, however we had a shortfall
of approximately 6,000 SO2 allowances in 2002. The majority of the SO2
allowance shortfall was covered with allowances purchased from the electricity
generating stations owned by our affiliate , AES Creative Resources, L.P.
(ACR), which are on long-term cold standby. The allowances were purchased at
quoted market prices.
On October 14, 1999, New York Governor Pataki announced a new
initiative which directs the New York State Department of Environmental
Conservation ("NYSDEC")to issue regulations requiring electric generators to
reduce SO2 emissions by another 50% below Phase II standards. The NYSDEC issued
final regulations in March 2003. The final regulations call for the new SO2
reduction regulations to be phased in starting on January 1, 2005 with
implementation completed by January 1, 2008. If adopted, the final regulations
will require further SO2 reductions at our electric generating stations and may
necessitate that either additional SO2 emission controls be installed, lower
sulfur coal be utilized, operations of our non-reheat units be reduced or
surplus SO2 allowances be purchased. We are not currently in a position to
quantify the potential costs of complying with the proposed regulations;
however, the costs of compliance could be substantial. The final regulations
are set to be voted upon by the New York State Environmental Board on March 26,
2003.
In addition, we received an information request letter dated October
12, 1999 from the New York Attorney General which sought detailed operating and
maintenance history for Westover and Greenidge. On January 13, 2000, we
received a subpoena from the NYSDEC seeking similar operating and maintenance
history for all four of our electricity generating stations. We have provided
materials responding to the requests from the Attorney General and the NYSDEC.
This information was sought in connection with the Attorney General's and the
NYSDEC's investigations of several electric generation stations in New York
which are suspected of undertaking modifications in the past (from as far back
as 1977) without undergoing an air permitting review.
On April 14, 2000, we received a request for information pursuant to
Section 114 of the Clean Air Act from the United States Environmental
Protection Agency ("EPA") seeking detailed operating and maintenance history
data for Cayuga and Somerset. EPA has commenced an industry-wide investigation
of coal-fired electric power generators to determine compliance with
environmental requirements under the Clean Air Act associated with repairs,
maintenance, modifications and operational changes made to coal-fired
facilities over the years. The EPA's focus is on whether the changes were
subject to new source review or new source performance standards, and whether
best available control technology was or should have been used. We have
provided the requested documentation.
15
By letter dated May 25, 2000, the NYSDEC issued a Notice of Violation
(NOV) to NYSEG for violations of the Clean Air Act and the Environmental
Conservation Law at Greenidge and Westover related to NYSEG's alleged failure
to obtain an air permitting review for repairs and improvements made during the
1980s and 1990s, which was prior to the acquisition of the electricity
generating stations by us. Pursuant to the Asset Purchase Agreement relating to
the acquisition of the electricity generating stations from NYSEG, we agreed to
assume responsibility for environmental liabilities that arose while NYSEG
owned the electricity generating stations. On September 12, 2000, we agreed
with NYSEG that we will assume the defense of and responsibility for the NOV,
subject to a reservation of our right to assert applicable exceptions to our
contractual undertaking to assume preexisting environmental liabilities.
We are currently in negotiation with both the EPA and NYSDEC. If our
current proposal is rejected, the EPA and the NYSDEC could issue a notice or
notices of violation (NOV) to us for violations of the Clean Air Act and the
Environmental Conservation Law. If the Attorney General, the DEC or the EPA
does file an enforcement action against our Somerset, Cayuga, Westover, or
Greenidge Plants, then penalties may be imposed and further emission reductions
might be necessary at these Plants which could require us to make substantial
expenditures. We are unable to estimate the effect of such a NOV on our
financial condition or results of future operations.
We voluntarily disclosed to the NYDEC in January 2003 that Cayuga had
inadvertently burned synfuel (coal with a latex binder applied), which it is
not permitted to burn. Cayuga had entered into an agreement with a supplier to
purchase coal. It received approximately one 9000-ton train per month from
April 24, 2001 to December 27, 2002. In January 2003, we became aware that the
product we were receiving was synfuel. We have suspended all shipments from
that supplier until a resolution is reached. We have reviewed the emission and
operation data which showed there was no adverse effect to air quality
attributable to burning the material and the plant's emmissions were in
compliance with applicable permit emissions limits. We are unable to predict
any potential actions or fines the NYSDEC may require, if any.
Nitrogen Oxides (NOx). New York State and the other states in the
Mid-Atlantic and Northeast region are classified as the Ozone Transport Region
in the federal Clean Air Act, which designates the Ozone Transport Region as
not being in compliance with the ozone National Ambient Air Quality Standard.
The states in the Ozone Transport Region have agreed to implement a three-phase
process to reduce NOx emissions in the region in order to comply with the
federal Clean Air Act Title I requirements for ozone non-compliance areas.
NYSEG complied with Phase I through operational modifications to reduce NOx
emissions, reduction of electric output from selected generating units to
reduce emissions to cap levels, and installation of NOx reduction equipment on
selected generating units.
The Phase I regulations require facilities in New York State to
implement NOx control requirements based on reasonably available control
technology ("RACT"). Somerset, Cayuga, Greenidge and Westover operate under a
common averaging plan, whereby the stations that emit well below the
system-wide limit reduce the overall average for electricity generating
stations that emit in excess of the system-wide limit known as a RACT Rate.
Implementation of the Phase II emission rules commenced on May 1,
1999. The Phase II NOx regulations set forth a NOx allowance allocation program
which gives us 6,292 NOx emission allowances annually through 2002. Each
allowance authorizes us to emit one ton of NOx during the ozone season (May 1
to September 30), beginning in 1999.
Implementation of the Phase III emission rules will commences on May
1, 2003. The Phase III NOx regulations set forth a NOx allowance allocation
program which gives us 2,516 NOx emission allowances for 2003.
To comply with the stricter emissions regulations beginning in 1999,
we installed a SCR system at Somerset which became operational in June 1999.
During 2001, we installed a SCR system on Unit 1 of Cayuga, which became
operational on June 7, 2001.
16
Somerset generated excess allowances in 2002, 2001 and 2000. Cayuga
generated excess allowances on Unit 1 during the 2002 and 2001 ozone seasons.
We expect that Somerset and Cayuga will accumulate excess allowances during the
2003 ozone season at a lower rate due to the reduced allocation of allowances
under Phase III of the NOx reduction program. Our compliance strategy involves
potential installation of additional NOx control technology at our electricity
generating stations, reduced operations of our non-reheat units during the
ozone season, reducing emission rates and/or the selling/buying or trading of
NOx allowances. This includes trades between our electricity generating
stations as needed to offset NOx emissions. During 2002 and 2001, we were a net
seller of NOx allowances.
New York Governor Pataki's October 14, 1999 initiative also directs
the NYSDEC to issue regulations requiring electric generators to impose
stringent NOx reduction requirements during the seven months not covered by the
summertime ozone season. The NYSDEC issued final regulations in March 2003. The
final regulations call for implementation the new NOx regulations to be in
effect starting on October 1, 2004. The final regulations are set to be voted
upon by the New York State Enviromental Board on March 26, 2003. If adopted,
the final regulations have the potential to require further NOx emission
reductions at our electricity generating stations and may necessitate the
installation of additional NOx emission controls be installed, operations of
our non-reheat units be reduced or surplus New York State NOx allowances be
purchased. We are not currently in a position to quantify the potential costs
of complying with the NOx requirements of the proposed regulations; however,
the costs of compliance could be substantial.
The capital cost of the Somerset SCR was $31 million. We expect that
the system will operate for 20 years. We will need to replace the catalyst
approximately every three years at an estimated cost of approximately $4.5
million in 1999 dollars. The capital cost of the Cayuga SCR on Unit 1 was $11.2
million and it was operational on June 7, 2001. We expect that the system will
operate for 20 years. We will need to replace the catalyst approximately every
four years at an estimated cost of approximately $325,000 in 2001 dollars.
Our electricity generating stations have generally achieved continuous
compliance with the current NOx reduction requirements with the exceptions
noted below.
A one-time violation of the facility-wide NOx emission cap in May
1998. We believe that, under the Asset Purchase Agreement with NYSEG, any
penalty assessed for that exceedence would be the responsibility of NGE
Generation, Inc.
We voluntarily disclosed to the NYSDEC and EPA on November 27, 2002
that NOx exceedances appear to have occurred on October 30 and 31 and November
1-8 and 10 of 2002. The exceedances were discovered through an audit by plant
personnel of the electricity generating stations' NOx RACT tracking system. The
plants have taken all reasonable, good faith efforts to assess and correct the
exceedances. Immediately upon discovery of the calculation error, the SCR at
Somerset was activated to reduce NOx emissions. Emission data indicates that
the system had already returned to a compliant operation by the time the error
was discovered. The EPA has decided to defer to the NYSDEC for review of the
self-disclosure letter and technical issues. We are unable to predict any
potential actions or fines the NYSDEC may require, if any.
On October 16, 2001, Greenidge was awarded a Federal Clean Coal Grant
that, if accepted, will fund 50% of the capital costs for backend technology
and 30% of the operations and maintenance costs for a test and demonstration
period. This technology will include a single bed, in-duct Selective Catalytic
Reduction (SCR) unit in combination with low-NOX combustion technology, on
Greenidge Unit 4 firing on coal and biomass. It will also include a Circulating
Dry Scrubber (CDS) for SO2, mercury and acid gas removal. Greenidge's share of
the project's costs will be approximately $9.8 million. Greenidge has submitted
a written request to the Department of Energy, which administers the Clean Coal
program, for a 12 to 18 month delay in starting the grant. This request was
made in light of the current difficult electricity and credit markets and the
uncertain state regulatory environment. Westover is also in the process of
installing overfire air to control NOx.
17
Particulates and Opacity. Each of our electricity generating stations
is currently in compliance with particulate emission limits.
Each of our electricity generating stations is required to meet an
opacity limit. In the past, several of the plants exceeded these limits. This
was a common problem at coal-fired electricity generating stations, and the
NYSDEC has initiated an enforcement action against several utilities, including
NYSEG. Potential fines and required actions cannot be divulged to the public
until a final settlement is reached. Nevertheless, we expect that any consent
order will likely require continued operation at the current level of opacity
compliance that has been achieved over the past year.
In January 2000, we received a draft consent order from the NYSDEC
that alleges violations of the opacity emission limitations in the air permits
for Cayuga, Westover, and Greenidge occurring since our electricity generating
stations were purchased from NYSEG. The draft consent order would require us to
prepare an opacity compliance plan and would impose penalties for opacity
violations occurring after May 14, 1999, the date of the acquisition. We expect
to enter a final consent order with the NYSDEC in 2003. AES NY, L.L.C. also
received notice from NYSEG that NYSEG has received a draft consent order from
the NYSDEC seeking penalties primarily for opacity violations occurring prior
to May 14, 1999. In the notice, NYSEG asserts that it will seek indemnification
from AES NY, L.L.C. for any penalties, attorney fees, and related costs that it
incurs in connection with the consent order. We and AES NY, L.L.C. have denied
liability for the pre-closing violations and intend to vigorously defend this
claim if NYSEG pursues litigation or arbitration.
Mercury. In 2000, the EPA determined that regulation of mercury
emissions from the nation's coal-fired power plants is necessary. The
regulations will be developed over the coming years, with a final rule
scheduled to be promulgated in December 2004, and compliance under the new rule
expected for December 2007. At this point we cannot determine what the costs
would be to comply with mercury control regulations.
Carbon Dioxide (CO2). Environmental concerns related to the impacts of
greenhouse gases (e.g., carbon dioxide, "CO2") led to the adoption in 1992 of
the United Nations-sponsored Framework Convention, which was ratified by over
150 countries, including the United States. In 1993, President Clinton
committed the United States to limit CO2 and other climate-altering gas
emissions to their 1990 levels by the year 2000. However, it became apparent
that this goal was unlikely to be met by most industrialized nations. The Kyoto
Conference was called in December 1997 to expedite a global climate treaty
supported by the United States. If adopted by the participating nations, any
legally binding global climate treaty will have significant economic
consequences for all U.S. industries, including the electricity generating
industry.
The Bush Administration has indicated that the United States will not
implement the Kyoto Protocol. On February 14, 2002, President Bush announced
his Global Climate Change Initiative which calls on U.S. industry to commit to
voluntary greenhouse gas emission reductions and directs the U.S. Department of
Energy to implement an improved verifiability system for the existing voluntary
emission reductions registry and to develop transferable credits for verifiable
reductions.
Water Issues
The federal Clean Water Act prohibits the discharge of any
pollutant (including heat), except in compliance with a discharge permit issued
by the states or the federal Environmental Protection Agency for a term of no
more than five years. There is potential uncertainty with permitting issues in
the future, but much of the uncertainty on these issues is industry-wide
because of new regulatory requirements for cooling water discharges under the
National Pollutant Discharge Elimination System program. In April 2002, the EPA
proposed to establish location, design, construction and capacity standards for
cooling water intake structures at existing power plants. The EPA is developing
these regulations under the terms of an Amended Consent Decree in Riverkeeper,
Inc vs. Whitman, US District Court, Southern
18
District of New York. It has been repeated that the issuance of the final for
existing facilities has been extended by six months to February 16, 2004. These
new rules will impose new compliance requirements, with potentially significant
costs, on operating plants across the nation. Cost items include various
environmental and engineering studies, and potential capital and maintenance
costs. We have not determined the effects of these regulations on our financial
condition.
Our electricity generating stations and their ash disposal sites have
been designed and are operated to comply with strict water and wastewater
compliance standards. Groundwater protection measures include coal pile liners
at all stations, lined active ash disposal sites, no active fly ash settling
ponds, and a network of groundwater monitoring wells. New York State has not
only technology-based effluent limitations for surface water discharges, but is
one of the first states in the nation to impose more restrictive limits on
wastewater discharges to ensure that very protective water quality-based
standards are maintained. Our electricity generating stations have numerous
wastewater treatment facilities in order to ensure compliance with these
restrictive discharge limits. In addition, Somerset normally operates in a zero
process wastewater discharge mode, reusing wastewater for various plant
processes. Similarly, the ash disposal sites must comply with both technology
and water quality-based discharge limits. Where necessary, lime treatment is
employed to remove metals from ash site wastewater prior to discharge.
Hazardous Material and Wastes
The electric utility industry typically uses and/or generates in its
operations a range of potentially hazardous products and by-products. We have
identified a number of site remediation issues at our electricity generating
stations. Under the terms of the Asset Purchase Agreement with NYSEG, NYSEG
retained pre-closing off-site environmental liabilities associated with our
electricity generating stations (other than liabilities arising from the Weber
and Lockwood ash disposal sites), but we assumed responsibility for
contamination at our electricity generating stations and at the Lockwood ash
disposal site.
We have budgeted $9.8 million for the cost for environmental
liabilities at our electricity generating stations (excluding closure and
post-closure costs for the Weber and Lockwood ash disposal sites), based on
estimates of environmental consultants retained by NYSEG and The AES
Corporation. We have budgeted approximately $6 million for closure and
post-closure (monitoring and maintenance) expenses for the Lockwood ash
disposal site, based solely on amounts previously budgeted for these activities
by NYSEG. AES Creative Resources, L.P.("ACR") assumed responsibility for the
Weber ash disposal site. Our subsidiary, AEE2, L.L.C., has contributed one-half
of the closure costs for the Weber ash disposal site based on the amount of ash
disposed at the site from Westover and Greenidge, which are owned by AEE2,
L.L.C., compared to the amount disposed from the Hickling Generating
Station("Hickling") and the Jennison Generating Station("Jennison"), which were
acquired by ACR.
In October 1999, ACR entered into a consent order with the NYSDEC to
resolve alleged violations of the water quality standards in the groundwater
downgradient of the Weber ash disposal site. The consent order included a
suspended $5,000 civil penalty and a requirement to submit a work plan to
initiate closure of the landfill by October 8, 2000. The consent order also
called for a site investigation, which was conducted and indicated that there
is a possibility that some groundwater remediation at the site may be required.
Further compliance with this order included a Closure Investigation Report
which was submitted to the NYSDEC in the spring of 2000, and a Closure Plan
which was submitted to the NYSDEC in January 2001. The Closure Plan was
implemented in December 2001 when capping of the site was completed. AEE2,
L.L.C. contributed one-half of the costs to close the landfill, which were
approximately $2 million, and it will contribute additional costs for long-term
groundwater monitoring. Nevertheless, if a groundwater remediation is required,
AEE2, L.L.C. may be responsible for a portion of such costs.
We expect to develop a new area, Area 3, of the on-site landfill
located at Somerset to contain ammonia-contaminated fly ash produced during
operation of the SCR system and stabilized sludge produced during simultaneous
operation of the FGD
19
system. As designed, Area 3 will comply with modern landfill design and
performance standards. On April 26, 1999, the New York State Board on Electric
Generation Siting and the Environment approved the plan to use Area 3, subject
to approval by the NYSDEC of more detailed design submissions. The NYSDEC has
defined non-ammoniated waste material to contain less than 0.5 parts per
million of ammonia. Most of the fly ash generated during operation of the SCR
at Somerset qualifies as non-ammoniated. The NYSDEC approved disposal of
non-ammoniated waste material generated during the operation of the SCR system
in an existing area of the landfill, Area 1. We are working with the NYSDEC to
complete an approved design for the Area 3 expansion. The existing Cayuga
on-site landfill currently complies with modern landfill design and performance
standards and will receive any ammonia-contaminated fly ash or ammoniated
sludge produced during operation of the SCR system on Unit 1.
The Somerset landfill is under the jurisdiction of the Public Service
Commission. NYSEG's original compliance filing with the Public Service
Commission in 1983 provided that the landfill would be constructed in a 200
acre section of the site, which NYSEG divided into three areas (Areas 1, 2, and
3). The landfill was designed to comply with the then-existing solid waste
landfill standards of the NYSDEC. Each area was to receive a separate landfill
unit lined with a low permeability material, usually clay. However, the first
17-acre section of Area 1 of the landfill was lined with compacted soil only.
Only Area 1 was used by NYSEG. The Area 1 landfill has been expanded seven
times during the years since 1983. When a portion of Area 1 reaches the maximum
allowable elevation (130 feet), it is "capped" by adding compacted soil and
planting ground cover. The entire process is meant to be self-implementing,
with little input from the Public Service Commission unless there is a problem
or a change in design or operation.
In the period since the original approval of the Somerset landfill,
the NYSDEC has modified its solid waste landfill regulations extensively. As a
result of these changes, these regulations currently allow construction or
expansion of landfills only with low permeability liners and sophisticated
leachate collection systems, and impose higher standards for capping and
closing solid waste facilities.
Natural groundwater conditions present at the Somerset site make it
very difficult to distinguish between landfill leachate and naturally occurring
substances in the groundwater. Substances that are typically considered
indicators of leachate infiltration into groundwater from ash monofill
operations, namely sulfates, iron and manganese, are also naturally occurring
in the groundwater around and beneath Area 1. NYSEG commissioned independent
consultants to perform groundwater testing using sophisticated geochemical
fingerprinting techniques, which distinguish the major ions of a water sample.
NYSEG's consultants have shown, to the satisfaction of the Public Service
Commission, that there has been no material release of leachate from Area 1
into the groundwater.
In April 1999, the NYSDEC and the Public Service Commission negotiated
a Memorandum of Understanding that clarifies their respective roles with
respect to the regulation of the Somerset landfill. According to the Memorandum
of Understanding, the Public Service Commission's decisions will continue to
control all aspects of Areas 1 and 2 of the landfill, but the Public Service
Commission must defer to current and future NYSDEC regulations, standards and
policies with respect to the development, use and closure of Area 3. The
Memorandum of Understanding was approved by the New York State Board on
Electric Generation Siting and the Environment and was incorporated as part of
the April 26, 1999 amendment to the Certificate of Environmental Compatibility
for Somerset that we received in connection with installation of the SCR.
Factors which could cause actual costs of disposal in Areas 1, 2 and 3
to vary include, but are not limited to, adoption of more stringent solid waste
landfill regulations by the NYSDEC, the discovery of groundwater contamination
from Area 1, and escalation of the costs of landfill development.
Exceedences of state groundwater standards at Cayuga were reported in
the vicinity of the coal pile area, the coal pile runoff pond, and the ash
disposal site. In 1997, a new liner was installed under the coal pile, which
brought Cayuga within state groundwater standards.
20
In an area adjacent to the Lockwood ash disposal site, our
environmental consultant reported that approximately 500 to 700 drums of
abrasives were disposed in the early 1970s and covered with ash. We have
budgeted $520,000 to conduct a site investigation and remove the drums. In
addition, groundwater sampling in this area and around the Lockwood ash
disposal site indicates that some monitoring wells have parameters which exceed
state regulatory limits. As noted above, we have budgeted $6 million in closure
and post-closure (monitoring and maintenance) costs for the Lockwood ash
disposal site.
In 2000, the EPA confirmed that ash disposed of in landfills should be
regulated as non-hazardous waste. Nevertheless, the EPA determined that
additional solid waste regulations will be developed for coal ash disposal in
landfills and surface impoundments. At this point, we cannot determine whether
such new regulations will have an impact on our ash disposal practices.
These projected environmental cost estimates are not a guarantee that
additional environmental liabilities will not be incurred, and it is possible
that the actual costs could be significantly higher. In addition, it is
possible that previously unknown environmental conditions will be discovered in
the future.
Noise
The Certificate of Environmental Compatibility that was issued to
NYSEG in 1978 for the development and operation of Somerset contains a number
of requirements for mitigating environmental impacts from the facility,
including noise impacts. Among the noise requirements was an obligation to
obtain noise easements from neighboring landowners or, as subsequently approved
by the Public Service Commission, to purchase their property in a buffer zone
where noncompliance with noise standards was expected to occur. Subsequent
analyses predicted that these exceedences would occur only in connection with
ash disposal operations when Area 2 of the Somerset landfill was constructed.
Prior to the acquisition of our electricity generating stations, NYSEG had
purchased neighboring properties for a combined cost totaling approximately
$1.5 million and had a standing offer to purchase the remainder. We obtained an
appraisal of the remaining properties which places their aggregate value at
approximately $3.1 million in 1999 dollars. We have not budgeted any amount for
the acquisition of these properties.
The Public Service Commission has also required that a noise
mitigation plan be developed and submitted for Public Service Commission
approval at least one year prior to commencement of Area 2 development.
The Public Service Commission could require additional noise control
measures at that time. We do not expect that the noise compliance costs we may
incur, including as a result of taking over the land purchase program, will be
material.
People
As of December 2002, we employed 288 people who operate our
electricity generating stations. The International Brotherhood of Electrical
Workers (the "IBEW") represents hourly labor at Somerset, Cayuga, Westover and
Greenidge. The IBEW represents approximately 240 workers. We have negotiated
collective bargaining agreements with respect to each electricity generating
station, on an individual electricity generating station basis. This gives us
continuing labor harmony and encourages the adoption of The AES Corporation's
culture by emphasizing individual businesses with responsibility and ownership
of local issues. We believe that relations with the people employed at our
electricity generating stations are satisfactory.
21
Item 2. Properties
The following table shows the material properties which we or our
subsidiaries own or lease. See "Business--The Electricity Generating Stations"
for more information about these properties.
Electricity
Generating Station Location Capacity Owned or Leased Expiration of
Lease
- ------------------ ---------------- ---------- --------------- -------------------
Somerset Barker, NY 675MW Leased* February 13, 2033
Cayuga Lansing, NY 306MW Leased* November 13, 2027
Westover Johnson City, NY 126MW Owned Not Applicable
Greenidge Dresden, NY 161MW Owned Not Applicable
- ---------
* We own all of the land on which Somerset and Cayuga are located and we
lease the portion on which the facilities of those stations are located to
the special purpose business trusts that own those facilities. We lease
the facilities of those stations and sublease the land on which they are
located from the special purpose business trusts.
Item 3. Legal Proceedings
We received an information request letter dated October 12, 1999 from
the New York Attorney General which sought detailed operating and maintenance
history for Westover and Greenidge. On January 13, 2000, we received a subpoena
from the NYSDEC seeking similar operating and maintenance history for all four
of our electricity generating stations. We have provided materials responding
to the requests from the Attorney General and the Department of Environmental
Conservation. This information was sought in connection with the Attorney
General's and the Department of Environmental Conservation's investigations of
several electricity generating stations in New York which are suspected of
undertaking modifications in the past (from as far back as 1977) without
undergoing an air permitting review.
On April 14, 2000, we received a request for information pursuant to
Section 114 of the Clean Air Act from the EPA seeking detailed operating and
maintenance history data for Cayuga and Somerset. The EPA has commenced an
industry-wide investigation of coal-fired electric power generators to
determine compliance with environmental requirements under the Clean Air Act
associated with repairs, maintenance, modifications and operational changes
made to coal-fired facilities over the years. The EPA's focus is on whether the
changes were subject to new source review or new source performance standards,
and whether best available control technology was or should have been used. We
have provided the requested documentation.
By letter dated May 25, 2000, the NYSDEC issued a Notice of Violation
(NOV) to NYSEG for violations of the Clean Air Act and the Environmental
Conservation Law at Greenidge and Westover related to NYSEG's alleged failure
to obtain an air permitting review for repairs and improvements made during the
1980s and 1990s, which was prior to the acquisition of the electricity
generating stations by us. Pursuant to the Asset Purchase Agreement relating to
the acquisition of the electricity generating stations from NYSEG, we agreed to
assume responsibility for environmental liabilities that arose while NYSEG
owned the electricity generating stations. On September 12, 2000, we agreed
with NYSEG that we will assume the defense of and responsibility for the NOV,
subject to a reservation of our right to assert applicable exceptions to our
contractual undertaking to assume preexisting environmental liabilities. The
financial and operational effect of this NOV is still being discussed with the
NYSDEC.
22
We are currently in negotiation with the both EPA and NYSDEC. If our
current proposal is rejected, the EPA and the NYSDEC could issue a notice or
notices of violation (NOV) to us for violations of the Clean Air Act and the
New York Environmental Conservation Law. If the Attorney General, the DEC or
the EPA does file an enforcement action against our Somerset, Cayuga, Westover,
or Greenidge Plants, then penalties may be imposed and further emission
reductions might be necessary at these Plants which could require us to make
substantial expenditures. We are unable to estimate the effect of such a NOV on
our financial condition or results of future operations.
In January 2000, we received a draft consent order from the NYSDEC
that alleges violations of the opacity emission limitations in the air permits
for Cayuga, Westover, and Greenidge occurring since we acquired our electricity
generating stations from NYSEG. The draft consent order would require us to
prepare an opacity compliance plan and would impose penalties for opacity
violations occurring after May 14, 1999, the date of the acquisition. We expect
to enter a final consent order with the NYSDEC in 2003. AES NY, L.L.C. also
received notice from NYSEG that NYSEG has received a draft consent order from
the NYSDEC seeking penalties primarily for opacity violations occurring prior
to May 14, 1999. In the notice, NYSEG asserts that it will seek indemnification
from AES NY, L.L.C. for any penalties, attorney fees, and related costs that it
incurs in connection with the consent order. We and AES NY, L.L.C. have denied
liability for the pre-closing violations and intend to vigorously defend this
claim if NYSEG pursues litigation or arbitration.
On March 30, 2001, Pozament Corp. filed a Summons and Complaint to be
served on AES Westover, LLC., wherein it seeks to recover damages for breach of
contract. The plaintiff alleges that it had an exclusive agreement with
Westover to remove all of its coal flyash. We believe that the contract in
question is unenforceable and void and intend to vigorously defend this claim.
We feel that any award or settlement in this case would not materially affect
our financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
23
PART II
Item 5. Market for our Company's Common Equity and Related Stockholder Matters
All outstanding equity interests in our company are owned indirectly
by The AES Corporation.
Item 6. Selected Financial Data
As of December 31, 2002 2001 2000 1999
- ----------------------------------------- -------- -------- --------- --------
Balance Sheet Data (in millions)
Total assets $1,126 $1,194 $1,185 $1,133
Long term liabilities $ 688 $ 699 $ 678 $ 692
Partners' capital $ 382 $ 433 $ 441 $ 378
- ----------------------------------------------------------------------------------------
For the period ending December 31, 2002 2001 2000 1999
- ----------------------------------------- -------- -------- ---------- ---------
Statement of Income Data (in millions)
Operating revenue $ 363 $ 378 $ 388 $ 185
Operating income $ 114 $ 106 $ 151 $ 57
Net income $ 59 $ 52 $ 98 $ 24
SELECTED QUARTERLY FINANCIAL DATA
The following table summarizes the quarterly consolidated statements of
income (in thousands):
First Second Third Fourth
Quarter Quarter Quarter Quarter
-------- -------- -------- ----------
YEAR ENDED DECEMBER 31, 2002:
Operating revenue $84,520 $ 89,382 $ 85,788 $103,324
Operating income 25,700 31,718 18,755 38,035
Net income 11,854 17,917 3,279 25,580
YEAR ENDED DECEMBER 31, 2001:
Operating revenue $111,405 $ 69,681 $ 88,657 $108,605
Operating income 49,391 12,294 25,083 19,671
Net income 35,455 (1,406) 11,822 5,994
YEAR ENDED DECEMBER 31, 2000:
Operating revenue $ 80,096 $ 89,613 $ 97,219 $120,638
Operating income 27,183 30,745 35,403 57,958
Net income 12,115 15,903 24,552 45,667
PERIOD FROM MAY 14, 1999 (INCEPTION)
TO DECEMBER 31, 1999:
Operating revenue N/A $ 17,225 $103,618 $ 63,725
Operating income N/A 3,141 43,628 10,269
Net income N/A 578 27,730 (3,893)
24
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
The information in this Management's Discussion and Analysis should be
read in conjunction with the accompanying consolidated financial statements,
the related Notes to the Financial Statements and the selected financial data.
Forward looking statements in this Management's Discussion and Analysis are
qualified by the cautionary statement in the Forward Looking Statements section
of the Management's Discussion and Analysis.
All four of our electricity generating stations operate as merchant
plants, which means that we will sell their output in power pool spot market
transactions or in transactions negotiated from time to time directly with
another party rather than selling the output under a long-term power sales
contract. As merchant plants, our electricity generating stations generally
will be dispatched, that is, they will supply electricity, whenever the market
price of electricity exceeds their variable cost of generating electricity. Our
energy revenue will be directly affected by the price of electricity, which is
usually highest during the summer and winter peak seasons.
On February 19, 2002, The AES Corporation announced that it intends to
reposition itself in the electric business by fully contracting or divesting
its merchant generation businesses. The AES Corporation stated that it made
this decision to reduce earnings volatility and strengthen its balance sheet.
We are one of the merchant generating businesses. Our business could be fully
contracted if we were to sign one or more long-term power sales agreements for
the output of our electricity generating stations. We stated in our Annual
Report on Form 10-K for the year ended December 31, 2001 that we were adopting
a policy of not commenting on proposed transactions and we disclaim any
obligation to provide information with respect to proposed transactions until a
definitive agreement has been reached.
The economics of any electric power facility are primarily a function
of the price of electricity, the quantity of electricity which is purchased and
the level of operating expenses. The greater the percentage of time a unit is
dispatched, the greater the revenues associated with that unit.
The markets for wholesale electric energy, unforced capacity and
ancillary services in the New York power market were largely deregulated in
November 1999. In a competitive market where the order in which electricity
generating plants are dispatched will be based on bids for the sale of electric
energy by the generating assets in the region, we expect that the lower
marginal cost facilities will bid lower prices and therefore those facilities
will be dispatched more often than higher marginal cost facilities.
We believe that our electricity generating stations are among the
lowest variable cost facilities in the New York power market. We also believe
that our electricity generating stations are among the most efficient coal
units in the region. We expect that our electricity generating stations will
almost always be dispatched. The efficiency of our electricity generating
stations provides several important advantages: a relatively stable pricing
structure, the ability to benefit from energy price spikes in the market and
relatively little risk that our electricity generating stations will be idle
while other generating stations are directed to run.
Our electricity generating stations have historically been available
to run a high percentage of the time due to the regulated utility-grade nature
of their design and construction. In 2002, 2001 and 2000, the stations had a
weighted average (based on capacity) equivalent availability factor of 96%, 96%
and 94%, respectively (excluding the outage at Cayuga from April to June 2001).
Based upon the historical experience of The AES Corporation, we believe that we
can maintain or improve the availability of our electricity generating
stations.
We believe that we will also have opportunities to derive revenue from
sales of unforced capacity and ancillary services. Under the terms of the New
York Transition Agreement with NYSEG, NYSEG purchased all of our 1,268MW of
installed capacity at a price of $68 per MW-day from May 14, 1999 through April
30, 2001. During the term of the New York Transition Agreement, the rules of
the NYISO system required us to offer to sell our electric energy in the New
York market for delivery of electric energy on the following day. Since
termination of the New York Transition Agreement with NYSEG on April 30, 2001,
we are
25
permitted to sell unforced capacity through bilateral contracts or through
unforced capacity auctions or into other markets. See "Business--New York Power
Market."
NYSEG has brought a proceeding to obtain a refund of real estate taxes
it paid in connection with Somerset while NYSEG owned it. NYSEG had little
incentive to contest the tax valuation of its electricity generating stations
while it owned them because the real property taxes it paid were included among
the expenses it was permitted to recover through regulated electricity rates
and were therefore passed along to its customers. We have identified real
estate taxes as a potential area for cost savings.
If NYSEG is successful in obtaining substantial refunds of prior real
estate taxes, our potential savings may be to some extent nullified because the
local governments may be forced to raise real estate tax rates to bring
revenues into balance with expenditures. It is too early to tell what impact,
if any, this will have on our financial condition and results of operations.
Critical Accounting Policies
General
We prepare our consolidated financial statements in accordance with
accounting principles generally accepted in the United States of America. As
such, we are required to make certain estimates, judgments and assumptions that
we believe are reasonable based upon the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the periods presented. The significant accounting policies
which we believe are most critical to understanding and evaluating our reported
financial results include the following: Revenue Recognition; Property, Plant
and Equipment, Contingencies and Derivatives.
Revenue Recognition
Revenues from the sale of electricity are recorded based upon output
delivered and rates specified under contract terms. Revenues generated from the
hedging of future sales using commodity forwards, swaps and options are
recorded based on settlement accounting with the net amount received recognized
as revenue. Revenues for ancillary and other services are recorded when the
services are rendered. The Transmission Congestion Contract is not deemed to be
a hedge based on the definitions in SFAS 133. Therefore, this contract is
marked to market at the end of every period. The mark-to-market value is
computed based on a regression of historical eastern and western locational
prices. This regression is used with forecasted eastern and western locational
prices to calculate the forward congestion for the remainder of the contract
term. This accounting treatment contributes to the income statement volatility
of this contract.
Property, Plant and Equipment
Electric generation assets that existed at the date of acquisition
(see Note 3) were recorded at fair market value. Somerset and Cayuga, which
represent $650 million of the electric generation assets, are subject to a
leasing arrangement accounted for as a financing (see Note 6). Additions or
improvements thereafter are recorded at cost. Depreciation is computed using
the straight-line method over the 34-year and 28.5-year lease terms for
Somerset and Cayuga, respectively, and over the estimated useful lives for the
other fixed assets, which range from 7 to 35 years. A significant overabundance
of supply and a sustained, significant decline in market prices to below our
variable cost could cause a decrease in the estimated useful lives of our
electric generation assets. If the useful life of any of our property, plant
and equipment is changed, the new life would be based on engineering studies
and expected usage. The estimated average remaining useful life of our
property, plant and equipment is approximately 23 years. If the estimated
average remaining life of our property, plant and equipment were to decrease
by five years, annual depreciation would increase by $7.7 million. Maintenance
and repairs are charged to expenses as incurred.
Contingencies
We accrue for loss contingencies when the amount of the loss is
probable and estimable. We are subject to various environmental regulations,
and we are involved in certain legal proceedings. If our actual environmental
and/or legal obligations are
26
materially different from our estimates, the recognition of the actual amounts
may have a material impact on our operating results and financial condition.
Derivatives
On January 1, 2001, we adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which, as amended, established
new accounting and reporting standards for derivative instruments and hedging
activities. SFAS 133 requires that all derivatives (including derivatives
embedded in other contracts) be recorded as either assets or liabilities at
fair value on the balance sheet. Changes in the derivative's fair value are to
be recognized in earnings in the period of change, unless hedge accounting
criteria are met. Hedge accounting allows the derivative's gains or losses in
fair value to offset the related results of the hedged item. We utilize
derivative financial instruments to manage commodity price risk. Although the
majority of our derivative instruments qualify for hedge accounting, the
adoption of SFAS No. 133 may result in more variation to our results of
operations from changes in commodity prices. We have chosen to use the
hypothetical derivative methodology for testing whether our hedges meet the
criteria to qualify for hedge accounting treatment. A historical regression is
performed between the plants, delivery points into the NYISO and the NYISO zones
in which the hedges are settled. Comparing the results of the historical
regression and the actual changes in the market value of the hedges determines
if the hedges qualify for hedge accounting criteria treatment. For the years
ended December 31, 2002, 2001 and 2000 we recognized income of $8.9 million, a
loss of $29.5 million and income of $24.9 million, respectively, pursuant to
SFAS No. 133 related to derivatives which did not qualify for hedge accounting.
See Note 7 to the consolidated financial statements for a more complete
discussion of the accounting for derivatives under SFAS No. 133.
Results of Operations
---------------------
(Amounts in Millions)
% %
For the Year Ended December 31, 2002 2001 Change 2000 Change
------ ------ ------- ------ -------
Energy Revenue $310.6 $345.4 (10.1) $322.7 7.0
Capacity Revenue 36.6 26.8 36.6 31.6 (15.2)
Transmission Congestion Contract 8.9 - - 24.9 -
Other 6.9 6.2 11.3 8.5 (27.1)
Energy revenues for the year ended December 31, 2002 were $310.6
million, compared to $345.4 million for the year ended December 31, 2001, a
decrease of 10.1%. The decrease in energy revenues is primarily due to lower
market prices and lower demand. Market prices for peak and offpeak electricity
were 12.2% and 6.5% lower than for the year ended December 31, 2001. Demand for
peak and offpeak electricity was 3.2% and 1.7% lower than the year ended
December 31, 2001. Energy revenues for the year ended December 31, 2001 were
$345.4 million, compared to $322.7 million for the year ended December 31,
2000, an increase of 7.0%. The increase in energy revenues from 2000 to 2001 is
primarily due to higher market prices in the first half of the year and higher
operating levels during that time. These were offset by a major maintenance
outage at Cayuga of approximately 45 days for Unit 1 in 2001.
Capacity revenues for the year ended December 31, 2002 were $36.6
million, compared to $26.8 million for the year ended December 31, 2001, an
increase of 36.6%. The increase in capacity revenue is primarily due to higher
prices for capacity sales on the open market for the summer capacity period
(June - October) offset by the expiration of a long-term capacity contract in
April 2001. Capacity sales on the open market for the winter capacity period
(November-May) were at lower rates. Capacity revenues for the year ended
December 31, 2001 were $26.8 million, compared to $31.6 million for the year
the December 31, 2000, a decrease of 15.2%. The decrease in capacity revenue
from 2000 to 2001 is primarily due to the expiration of a long-term capacity
purchase agreement with NYSEG in April 2001. Capacity sales on the open market
for the winter capacity period (November-May) were at lower rates.
The Transmission Congestion Contract is essentially a swap between the
congestion component of the locational prices posted by the NYISO in western
New York and the more populated areas in eastern New York. The Transmission
Congestion Contract became effective on November 1, 2000 and terminates on
October 1, 2004. We entered into this agreement because
27
it provided a reasonable settlement for resolving a FERC dispute between us and
Niagara Mohawk Power Corporation. This contract is not deemed to be a hedge
based on the definitions in SFAS 133. Therefore, this contract is marked to
market at the end of every period. The mark-to-market value is computed based
on a regression of historical eastern and western locational prices. This
regression is used with forecasted eastern and western locational prices to
calculate the forward congestion for the remainder of the contract term. This
accounting treatment contributes to the income statement volatility of this
contract.
Operating Expenses
- -------------------- % %
For the Year Ended December 31, 2002 2001 Change 2000 Change
------ ------ ------- ------ ------
Fuel expense $137.2 $135.6 1.2 $131.7 3.0
Depreciation and amortization 35.5 33.6 5.7 31.7 6.0
Operations and maintenance 17.0 19.6 (13.3) 16.8 16.7
General and administrative 59.1 53.7 10.0 56.1 (4.3)
Transmission Congestion Contract - 29.5 - - -
Fuel Expense for the year ended December 31, 2002 was $137.2 million,
compared to $135.6 million for the year ended December 31, 2001, an increase of
1.2%. The increase in fuel expenses is primarily due to higher coal prices
offset by lower operating levels due to lower demand. Fuel expense for the
year ended December 31, 2001 was $135.6 million, compared to $131.7 million for
the year ended December 31, 2000, an increase of 3.0%. The increase in fuel
expenses is primarily due to higher operating levels in the first half of the
year, which necessitated greater coal usage and greater coal purchases on the
spot market.
Depreciation and amortization expense for the year ended December 31,
2002 was $35.5 million, compared to $33.6 million for the year ended December
31, 2001, an increase of 5.7%. This increase is primarily due to a full year's
depreciation of the SCR system to reduce NOx emissions at Cayuga which was
operational June 7, 2001. Depreciation and amortization expense for the year
ended December 31, 2001 was $33.6 million, compared to $31.7 million for the
year ended December 31, 2000, an increase of 6.0%. This increase is primarily
due to a half year's depreciation of the SCR system to reduce NOx emissions at
Cayuga which was operational June 7, 2001.
Operations and maintenance expense for the year ended December 31,
2002 was $17.0 million, compared to $19.6 million for the year ended December
31, 2001, a decrease of 13.3%. This decrease is primarily due to maintenance
expenses incurred during a scheduled outage at Cayuga in the second quarter of
2001, which are not annually recurring expenses. Operations and maintenance
expense for the year ended December 31, 2001 was $19.6 million, compared to
$16.8 million for the December 31, 2000, an increase of 16.7%. This increase is
primarily due maintenance expenses incurred during a scheduled outage at Cayuga
in the second quarter of 2001.
General and administrative expense for the year ended December 31,
2002 was $59.1 million, compared to $53.7 million for the year ended December
31, 2001, an increase of 10.0%. This increase is primarily due to significant
increases in property taxes and property and medical insurance which were
partially offset by reversal of accruals for potential environmental
liabilities which were resolved at a lower cost than estimated. General and
administrative expense for the year ended December 31, 2001 was $53.7 million,
compared to $56.1 million for the year December 31, 2000, a decrease of 4.3%.
28
The Transmission Congestion Contract is essentially a swap between the
congestion component of the locational prices posted by the NYISO in western
New York and the more populated areas in eastern New York. The Transmission
Congestion Contract became effective on November 1, 2000 and terminates on
October 1, 2004. We entered into this agreement because it provided a
reasonable settlement for resolving a FERC dispute between us and Niagara
Mohawk Power Corporation. This contract is not deemed to be a hedge based on
the definitions in SFAS 133. Therefore, this contract is marked to market at
the end of every period. The mark-to-market value is computed based on a
regression of historical eastern and western locational prices. This regression
is used with forecasted eastern and western locational prices to calculate the
forward congestion for the remainder of the contract term. This accounting
treatment contributes to the income statement volatility of this contract.
Other Expenses
- -------------------- % %
For the Year Ended December 31, 2002 2001 Change 2000 Change
------ ------ ------- ------ ------
Interest expense $57.7 $58.4 (1.2) $57.3 1.9
Interest Income 2.1 3.9 (46.2) 4.3 (9.3)
Other Income/Expenses for the year ended December 31, 2002 were net
expenses of $55.5 million, compared to net expenses of $54.5 million for the
year ended December 31, 2001, an increase of 1.8%. This increase is primarily
due to lower interest income offset by lower interest expense. Other
Income/Expenses for the year ended December 31, 2001 were net expenses of $54.6
million, compared to net expenses of $53.0 million for the year ended December
31, 2000, a decrease of 2.8%. This decrease is primarily due to lower interest
rates and higher interest expense.
Liquidity and Capital Resources
The leases for Somerset and Cayuga require that we make fixed
semiannual payments of rent on each January 2 and July 2 during the terms of
the leases commencing on January 2, 2000 in amounts calculated to be sufficient
(1) to pay principal and interest when due on the secured lease obligation
notes issued by the special purpose business trusts that own and lease to us
Somerset and Cayuga and (2) to pay the economic return of the institutional
investors that formed the special purpose business trusts. Our minimum rent
obligation under the leases is $57.6 million for 2003, $63.5 million for 2004,
$59.5 million for 2005, $61.6 million for 2006, $62.5 for 2007 and a total of
$1,252.1 million for the years thereafter. For purposes of the minimum rent
obligations described in the preceding sentence, we treated the semiannual rent
payments that are due on January 2 of each year as though they would be paid in
the preceding year. You can find information concerning our minimum rental
obligations that treats rent payments as obligations for the years in which
they are due in note 6 of our audited financial statements which are included
in this Annual Report on Form 10-K. Through July 2, 2020 and so long as no
lease event of default exists, we may defer payment of rent obligations under
each lease in excess of the amount required to pay principal and interest on
the secured lease obligation notes until after the final scheduled payment date
of the secured lease obligation notes. As of December 31, 2002, we have not
deferred any portion of our lease obligations. In addition, we are required to
maintain a rent reserve account equal to the maximum semiannual payment with
respect to the sum of basic rent (other than deferrable basic rent) and fixed
charges expected to become due on any one basic rent payment date in the
immediately succeeding three-year period. At December 31, 2002 and 2001, the
amounts deposited in the rent reserve account were $31.7 million for each year.
We will also be obligated to make payments under the coal hauling
agreement with Somerset Railroad in an amount sufficient, when added to funds
available from other sources, to enable Somerset Railroad to pay, when due, all
of its operating expenses and other expenses, including interest on and
principal of outstanding indebtedness. On August 14, 2000, Somerset Railroad
entered into a $26 million credit facility with Fortis Capital Corp. which
replaced in its entirety a credit facility for the same amount previously
provided to Somerset Railroad by an affiliate of CIBC World Markets. The credit
facility provided by Fortis Capital Corp. consists of a 14-year term note
(maturing on May 6, 2014), with principal and interest payments due quarterly.
As a result of these obligations, we must dedicate a substantial
portion of our cash flow from operations to payments of rent under the leases,
payments under our working capital
29
facility and payments under the coal hauling agreement with Somerset Railroad,
which in turn allow Somerset Railroad to pay principal and interest under its
credit facility with Fortis Capital Corp. The principal payments for the $26
million credit facility are $1.9 million per year.
We incurred approximately $7.1 million, $17.1 million and $20.8
million in capital expenditures with regard to our assets for the years ended
December 31, 2002, 2001 and 2000, respectively. These amounts include
approximately $11.2 million for a SCR system to reduce NOx emissions at Cayuga
which was operational June 7, 2001. We will make capital expenditures
thereafter according to the maintenance program for our electricity generating
stations. In addition to capital requirements associated with the ownership and
operation of our electricity generating stations, we will have significant
fixed charge obligations in the future, principally with respect to the leases.
Compliance with environmental standards will continue to be reflected
in our capital expenditures and operating costs. Based on the current status of
regulatory requirements and, other than the expenditures for the SCRs at
Somerset and Cayuga, including the construction of new landfill space to manage
ash from Somerset's SCR system operations, and expenditures for possible
installation of a SCR system on Cayuga Unit 2, the U.S. Department of Energy
Power Plant Improvement project on Greenridge Unit 4 and the Westover Overfire
Air Project, we do not anticipate that any capital expenditures or operating
expenses associated with our compliance with current laws and regulations will
have a material effect on our results of operations or our financial condition.
See "Business--Regulation--Environmental Regulatory Matters."
Our net working capital at December 31, 2002, 2001 and 2000 was $96.5
million, $80.1 million and $84.2 million, respectively. During 2000, we made
one borrowing under a Credit Suisse First Boston working capital credit
facility. The borrowing was from July 18, 2000 to July 25, 2000 in the amount
of $8 million and bore interest at the rate of 8.375% per annum. At March 9,
2001, our $20 million Credit Suisse First Boston working capital credit
facility was terminated. In April 2001, we entered into a $35 million secured
revolving working capital and letter of credit facility with Union Bank of
California, N.A. This facility had a term of approximately twenty-one months.
We can borrow up to $35 million for working capital purposes under this
facility. In addition, we can have letters of credit issued under this facility
up to $25 million, provided that the total amount of working capital borrowings
and letters of credit issuances may not exceed the $35 million limit on the
entire facility. Through November 20, 2002, we made three borrowings under this
facility. The first borrowing was for $7 million on July 13, 2001 at an
interest rate of 8.125% and was repaid in full on July 31, 2001. The second
borrowing was for $8.5 million on January 11, 2002 at an interest rate of
6.125% and was repaid in full on February 28, 2002. The third borrowing was for
$14.0 million on July 9, 2002, at an interest rate of 6.125% and was repaid in
full in two installments: $7.2 million on July 31, 2002 and $6.8 million on
August 28, 2002.
On November 20, 2002, we signed an agreement with Union Bank of
California, N.A. for a one-year extension of our current facility. Currently,
lenders have committed to provide only $15 million of the $35 million secured
revolving working capital and letter of credit facility. We are attempting to
obtain commitments for the remaining $20 million. Our financial flexibility may
be limited if we are unable to obtain these commitments or substitute other
sources of credit. Under this agreement, we borrowed $9.7 million on January
10, 2003 at an interest rate of 5.75%. The $9.7 million was repaid in full on
January 28, 2003. At the date of filing our 2002 annual report on Form 10-K, of
the $15 million committed, we have letters of credit of $7.5 million written
which have been provided as additional margin to counterparties.
As we attempt to obtain the remaining commitments on our current
facility, The AES Corporation on January 6, 2003 authorized us to provide
letters of credit t