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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission file number (Under the Securities Act of 1933) 33-37977
MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
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(Exact name of registrant as specified in its charter)
MICHIGAN 38-2726166
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 PROGRESS PLACE, MIDLAND, MICHIGAN 48640
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (989) 839-6000
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Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
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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. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12B-2 of the Act).
Yes No X
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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
TABLE OF CONTENTS
PART I Page
Item 1. Business.........................................................................1
A. General......................................................................1
B. The Partners.................................................................1
C. The Facility.................................................................2
D. Major Issues Facing MCV......................................................2
E. Contracts....................................................................3
F. Employees...................................................................12
G. Regulation..................................................................12
H. Environmental Matters.......................................................16
I. Overall Lease Transaction...................................................18
Item 2. Properties......................................................................21
Item 3. Legal Proceedings...............................................................21
Item 4. Submission of Matters to a Vote of Security Holders.............................21
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...........22
Item 6. Selected Financial Data.........................................................22
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.................................................................22
Item 7A. Quantitative and Qualitative Disclosures about Market Risk......................30
Item 8. Financial Statements and Supplementary Data.....................................32
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure....................................................................32
PART III
Item 10. Directors and Executive Officers of the Registrant..............................33
Item 11. Executive Compensation..........................................................35
Item 12. Security Ownership of Certain Beneficial Owners and Management..................38
Item 13. Certain Relationships and Related Transactions..................................38
Item 14. Controls and Procedures.........................................................39
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.................40
Signatures ..........................................................................F-24
Certifications ..........................................................................F-25
PART I
Item 1. BUSINESS
A. General
In January 1987, Midland Cogeneration Venture Limited Partnership ("MCV")
was formed as a limited partnership to convert a portion of an uncompleted
Consumers Energy Company ("Consumers") nuclear power plant into a natural
gas-fired, combined-cycle, cogeneration facility located in Midland
County, Michigan (the "Facility"). The Facility commenced commercial
operation in 1990 (the "Commercial Operation Date") and is capable of
generating approximately 1500 megawatts ("MW") of electricity and
approximately 1.5 million pounds of process steam per hour. The Facility
is dependent upon natural gas for its fuel supply.
The Facility is a cogeneration facility, meaning that it sequentially
produces electricity and useful thermal energy through an integrated
system using a single fuel source. The Facility has been certified by the
Federal Energy Regulatory Commission ("FERC") as a qualifying cogeneration
facility ("QF") under the Public Utility Regulatory Policies Act of 1978,
as amended ("PURPA"). As a QF, the Facility is exempt from various
provisions of the Federal Power Act, as amended (the "FPA"), the Public
Utility Holding Company Act of 1935, as amended (the "1935 Act"), certain
state laws regarding rate, financial and organizational regulation, and is
entitled to sell electric capacity and related energy to a public utility
(such as Consumers) at such utility's incremental cost of alternative
electric energy, otherwise known as "avoided cost." A utility's
"incremental cost of alternative electric energy" means, with respect to
electric energy purchased from a QF, the cost to the electric utility of
the electric energy (determined, at the option of the QF, at either the
time of delivery or at the time the obligation is incurred) which, but for
the purchase from such QF, such utility would generate or purchase from
another source.
MCV has entered into three principal energy sales agreements. The first is
a Power Purchase Agreement (the "PPA"), providing for the sale to
Consumers of electric capacity and related energy from the Facility for a
term of 35 years commencing on the Commercial Operation Date. Under the
terms of the PPA, MCV will supply up to 1240 MW of electric capacity and
related energy to Consumers for resale to its customers. The second is a
Steam and Electric Power Agreement (the "SEPA"), providing for the sale to
The Dow Chemical Company ("Dow") of steam and electricity produced by the
Facility for terms of 25 years and 15 years, respectively, commencing on
the Commercial Operation Date. The third is a Steam Purchase Agreement
(the "SPA") effective in 1996, providing for the sale of steam produced by
the Facility to Dow Corning Corporation ("DCC") for a term of 15 years.
From time to time, MCV enters into other sales agreements for the sale of
excess capacity and/or energy available above MCV's internal use and
obligations MCV has to Consumers, Dow and DCC.
B. The Partners
The current general partners of MCV are CMS Midland, Inc. ("CMS Midland"),
a wholly-owned subsidiary of Consumers and El Paso Midland, Inc. ("El Paso
Midland"), Source Midland Limited Partnership ("SMLP") and MEI Limited
Partnership ("MEI"), which is a general and limited partner, all of which
are indirect wholly-owned subsidiaries of El Paso Corporation ("El Paso").
MCV's other limited partners are Dow, Micogen Limited Partnership
("Micogen"), owned by subsidiaries of El Paso, and Alanna Corporation
("Alanna"), a wholly-owned subsidiary of Alanna Holdings Corporation
("Alanna Holding"). The capital stock of Alanna Holding is owned by Dow,
CMS Energy Corporation ("CMS Energy"), an affiliate of Consumers, and El
Paso CNG Company, an affiliate of El Paso. The general partners and
limited partners of MCV are referred to herein as the "Partners." The
ownership interests of the Partners are shown in "Security Ownership of
Certain Beneficial Owners and Management."
-1-
C. The Facility
MCV's principal business is the operation of the Facility and the sale of
electric capacity and related energy (principally to Consumers) and steam
(to Dow and DCC) produced at the Facility. The Facility is located on an
approximately 1200-acre site that is leased from Consumers (the "Site").
The Facility consists of the following:
- 12 gas turbine generators ("GTGs");
- 12 heat recovery steam generators ("HRSGs") which create steam using
heat from the GTG exhaust;
- A steam turbine (the "Unit 1 Steam Turbine") capable of producing
electricity from steam generated by the HRSGs;
- A second steam turbine (the "Unit 2 Steam Turbine") which serves as
a backup to the Unit 1 Steam Turbine;
- A back-pressure steam turbine;
- Pollution control assets;
- A 25-mile gas pipeline connecting interstate and intrastate gas
pipeline systems to the Facility;
- Pipelines to deliver steam to Dow and DCC; and
- Various associated equipment and improvements.
The Facility was originally designed to have a net electrical generating
capacity of approximately 1370 MW and to produce approximately 1.5 million
pounds per hour of process steam under design ambient conditions.
Electricity is produced by the 12 GTGs, and the steam is produced by the
12 HRSGs using the heat from the GTG exhaust. The Unit 1 Steam Turbine is
designed to produce electricity using the steam generated by the HRSGs and
process steam that is provided to Dow and DCC. Subsequent improvements to
the Facility have increased the net electrical generating capacity to
approximately 1500 MW. MCV purchases demineralized water from Dow.
Electricity is sold by MCV to Consumers and other parties through an
interconnect and to Dow through dedicated transmission lines.
D. Major Issues Facing MCV
MCV faces several major issues crucial to its future success. These
issues, briefly summarized here, are discussed more fully in the sections
cross referenced below:
Electric Industry Restructuring. At both the state and federal level,
efforts continue to restructure the electric industry. In 1997 and 1998,
the Michigan Public Service Commission ("MPSC") entered a series of
orders, permitting customers to choose their power provider over a
four-year phase-in period which started in 1999 ("Restructuring Orders")
(these orders are further described in "Regulation - Michigan Electric
Industry Restructuring Proceedings"). In addition, Michigan enacted
restructuring legislation in June 2000. A significant issue to MCV is the
potential for future regulatory denial of recovery by Consumers from its
customers of above market PPA costs Consumers pays MCV. Over 90% of MCV's
revenues come from sales pursuant to the PPA. To date, restructuring has
not negatively impacted MCV, but if restructuring results in denying
Consumers' recovery of above-market PPA costs, MCV's cash flows may be
negatively impacted, especially after 2007. (See "Regulation - Michigan
Electric Industry Restructuring Proceedings and Federal Electric Industry
Restructuring", Managements Discussion and Analysis of Financial Condition
and Results of Operations ("MD&A") - Outlook - Michigan Electric Industry
Restructuring Proceedings and Federal Electric
-2-
Industry Restructuring", and Notes to Consolidated Financial Statements,
Note 1, "The Partnership and Associated Risks".)
Energy Rate and Cost of Production. Since January 1992, MCV has
experienced an overall reduction in the energy charges it is paid for
electricity under the PPA, primarily due to declining coal costs at
Consumers' generating plants. In addition, MCV's costs associated with
production of electricity have continued to rise. These circumstances have
negatively affected MCV's cash flow. While MCV has the majority of its
expected natural gas needs under contract for the next several years,
sustained periods of high market gas prices could adversely affect MCV's
earnings and cash flow. (See "Regulation -- MPSC and Other Proceedings
Relating to Capacity and Energy Charges", "Overall Lease Transaction", and
MD&A -- Liquidity and Financial Resources" and "Contracts - Gas Supply
Agreements".) In addition, MCV has credit exposure to suppliers who have
entered into fixed price natural gas contracts with MCV. To the extent
that the aforementioned suppliers fail to deliver natural gas under their
fixed price contracts and the cost to replace such gas is in excess of the
contract rate, MCV could experience higher natural gas prices in the
future. (See "Contracts - Credit Support Requirements for MCV's Gas
Arrangements.")
E. Contracts
MCV's material contracts are the PPA, which provides for the sale to
Consumers of electric capacity and related energy; the SEPA, which
provides for the sale of steam and electricity to Dow; the SPA, which
provides for the sale of steam to DCC; gas supply, storage and
transportation contracts with a number of companies; an agreement covering
gas turbine inspection services and spare parts with Alstom Power Inc.
("Alstom"); and an agreement covering steam turbine inspection services
and parts with General Electric Company ("GE"). On December 31, 2002, MCV
entered into an agreement covering gas turbine inspection services and
spare parts with General Electric International, Inc. ("GEII"). This
agreement will replace the similar agreement with Alstom. MCV's interests
in all the foregoing contracts, except the SPA, have been assigned to the
Owner Trustees, which in turn subassigned such contracts to MCV and
granted a security interest in such contracts to the Note Trustees. (See
"Overall Lease Transaction.") The following is intended to summarize
briefly certain provisions of such contracts and is qualified in its
entirety by reference thereto.
Power Purchase Agreement
Under the PPA, Consumers contracted to purchase specified amounts (the
"Contract Capacity") of the Facility's electric capacity until March 15,
2025 and thereafter subject to yearly extensions that are automatic in the
absence of a termination notice from either party. Contract Capacity is
1240 MW/hour.
In allocating the available electrical output of the Facility, MCV must
first satisfy Dow's requirements under the SEPA before supplying power to
Consumers.
Consumers has the right of first refusal to purchase any available
electric capacity and related energy produced by the Facility in excess of
Contract Capacity if MCV is willing to sell the same for a period of six
months or longer. MCV is entitled to sell excess electric capacity and
related energy to other electric utilities, and Consumers is required, if
requested by such utilities or MCV, to transmit electrical energy for them
subject to certain conditions.
Capacity charges are payable for available Contract Capacity, whether or
not electricity is dispatched. The capacity charges for on-peak and
off-peak power average 4.15 cents per available kilowatt hour ("kWh");
however, until September 15, 2007, the capacity charge may be reduced by
Consumers to a level of no less than an average of 3.77 cents per kWh.
Energy charges are based on costs incurred by Consumers at certain of its
coal-fired plants (i.e., those coal plants wholly or partially owned by
Consumers having a net demonstrated capacity of at least 100 MW, available
for generating electrical energy for not less than 5500 hours during the
most recent year and having a capacity factor of at least 40% when
connected to Consumers' system and generating electrical energy).
-3-
Fixed Energy Charges. Like the capacity charges, fixed energy
charges are payable for available kWhs of Contract Capacity. Fixed
energy charges are adjusted each year based on a fuel inventory
charge, administrative and general expenses and one-half of
operation and maintenance expenses (excluding fuel) incurred at
these plants during either the immediately preceding calendar year
or the calendar year preceding that year depending on when the
adjustment is being made. In 1995, an arbitrator ruled that, under
the PPA, Consumers had the right to withhold that portion of fixed
energy charges payable on the basis of energy available but not
delivered since it was not permitted by the MPSC to collect such
charges from its electric customers. (See "Regulation -- MPSC and
Other Proceedings Relating to Capacity and Energy Charges.")
Variable Energy Charges. Variable energy charges are payable for
energy actually delivered. Variable energy charges are determined
monthly and are equal to one-half of operation and maintenance
expenses incurred at these plants, as calculated annually, and the
actual cost of coal burned at these plants as determined monthly
based on a rolling twelve-month average (with a two-month lag) and
converted to an overall cost per kWh.
The PPA permits Consumers, under certain conditions, to reduce the
capacity and energy charges payable to MCV and/or to receive refunds of
capacity and energy charges paid to MCV if the MPSC does not permit
Consumers to recover from its customers the capacity and energy charges
specified in the PPA (the "regulatory-out" provision). Until September 15,
2007, however, the capacity charge may not be reduced below an average
capacity rate of 3.77 cents per kWh for the available Contract Capacity
notwithstanding the "regulatory-out" provision. Consumers and MCV are
required to support and defend the terms of the PPA. (See "Regulation --
MPSC and Other Proceedings Relating to Capacity and Energy Charges.")
Under the PPA, MCV must provide assurances that it has adequate gas
supplies under contract to generate at least 60% of the maximum annual
output of Contract Capacity. Commencing in 1998 and each year thereafter,
MCV must provide at Consumers' request continuing annual assurances of
such capability for each succeeding five-year period. MCV believes it has
adequate gas supplies under contract to satisfy its PPA fuel assurance
requirements. If MCV is unable to provide these continuing assurances,
Consumers is entitled to withhold in a separate escrow fund a portion of
capacity charges until these assurances are provided. The portion of such
capacity charges is a function of the percentage of unmet fuel needs and
an increasing factor based on the number of consecutive months that
capacity charges have been withheld. Assuming a 3.77 cents per kWh
capacity charge, the maximum capacity charges, which could be withheld and
escrowed under this provision, are as follows:
Maximum Possible
Consecutive Months That Reduction in
MCV Fails to Provide Capacity Charge
Adequate Continuing Assurance (cents/kWh)
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1-12........................................ .1885
13-24....................................... .5655
25-36....................................... 1.5080
37 and thereafter........................... 2.6390
The PPA does not make any provision for the use of escrowed funds, except
that the PPA provides that interest earned, if any, on the escrowed funds
is to be divided equally between MCV and Consumers. After withholding
capacity charges for 48 months without fuel assurances being provided,
Consumers may terminate the PPA. In the event of termination, MCV must pay
an early termination charge.
If any party is rendered unable by force majeure to carry out its
obligations under the PPA, these obligations are suspended during the
period of force majeure. Force majeure includes all natural calamities;
war; curtailments, orders, regulations or restrictions imposed by
governmental authority; and all other causes beyond the reasonable control
of the affected party, but specifically does not include shortages of fuel
and supplies (unless caused by calamity or unusual world events applicable
to other major industrial users as well as MCV), mechanical breakdowns,
labor strikes or explosions or fires (unless caused by criminal acts).
-4-
Consumers schedules all deliveries of electricity from the Facility to its
system and is obligated to do so in a manner consistent with the safe and
prudent operation of the Facility. Consumers currently dispatches the
Facility by scheduling energy deliveries on an economic basis relative to
the cost of other energy resources. Beginning in July 2000, in response to
the rapidly escalating cost of natural gas, MCV entered into transactions
with Consumers whereby Consumers agreed to reduce the dispatch level of
the Facility. In the event of reduced dispatch, MCV agreed to share the
savings realized by not having to generate electricity. MCV anticipates
using the same or similar transactions in the future to mitigate the
impact of high market gas prices, if circumstances warrant such use.
As long as the annual availability of Contract Capacity equals or exceeds
75% of Contract Capacity, Consumers must purchase sufficient electrical
energy from the Facility to achieve at least a 60% capacity factor on an
annual basis. This purchase obligation decreases, based on a prescribed
formula, if annual availability falls below 75% of Contract Capacity.
Annual PPA availability has exceeded 98% since 1997.
Consumers must purchase a specified minimum amount of electrical energy at
all times, except during emergencies on its system. MCV determines a
minimum level of generation designed to assure that the Facility operates
in a stable manner and that MCV meets its obligations to supply steam and
electricity to Dow, but MCV cannot specify a minimum generating level,
which exceeds 350 MW. Outages, other than forced outages, are to be
scheduled to accommodate Consumers' requirements to the extent MCV deems
practicable.
MCV is obligated to have the Facility inspected at least once each year by
a consulting engineer selected by it from a list of engineering firms
approved by Consumers. The annual inspection includes, at a minimum, all
equipment, structures, operating procedures and maintenance practices
necessary for the generation and delivery of energy to Consumers. Upon
completion of an annual inspection, the consulting engineer must promptly
issue a written report. Any recommendations in this report regarding
equipment, structure and maintenance practices, which have been approved
by MCV's management, must be implemented within a specified period of
time. In its April 2002 report, Cummins & Barnard, Inc., the consulting
engineer, found no specific issues that MCV should take under advisement
or act upon. With regard to the most recent inspection, MCV expects to
receive the report by the end of April 2003 and does not anticipate any
substantial problems or requirements for plant modifications.
In 1997, Consumers informed MCV of several other potential payment issues
it would pursue, pursuant to the "regulatory out" and other provisions of
the PPA. These issues related to Consumers' special contract customers,
pricing of the energy delivered during off-peak ramp hours (when MCV
adjusts its output to match Consumers' dispatch) and energy delivered in
the band width (energy delivered above dispatch, within certain limits).
In addition, Consumers notified MCV that it did not believe that MCV could
use the approximately 15 MW of generating capacity and energy attributable
to the back pressure turbine, which was placed into service in July 1997,
towards available Contract Capacity or electric deliveries under the PPA.
Consumers had also indicated that they would take a similar position on
the incremental energy and capacity resulting from MCV's installation of
11NM upgrade packages on the GTGs (collectively the "Disputed Issues").
MCV and Consumers entered into a settlement agreement ("Settlement
Agreement"), effective January 1, 1999, which resolves (for the various
time periods specified in the Settlement Agreement) all of the previously
Disputed Issues under the PPA and includes definitive obligations for
Consumers to make energy payments calculated in accordance with the PPA,
irrespective of any MPSC or the reviewing courts decision which may affect
those issues or payments. The Settlement Agreement also provides that, not
withstanding modifications to the Facility increasing its capacity, in
billing Consumers for capacity charges (at the rates set forth in the PPA)
availability would be capped at 98.5% of the 1240 MW ("98.5% cap") on a
calendar-year basis for the term of the PPA irrespective of any MPSC or
the reviewing courts decision, which may affect this issue or payment.
Provided, however, that if Consumers transfers (subject to MCV's prior
consent) its rights of up to 1240 MW of capacity and associated energy
under the PPA to a third party for an extended period of time, the 98.5%
cap will not apply except that the 98.5% cap is, in any event, reinstated
on September 15, 2007. Notwithstanding the Settlement Agreement, after
September 15, 2007, an issue could exist as to whether or not Consumers
can exercise the "regulatory out" provision to reduce capacity payments to
MCV based upon the "availability caps" of 88.7% of the 1240 MW (both on
and off peak) of
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contract capacity as provided for in the 915 MW Settlement and the 325
MW Settlement (See "Regulation - MPSC and Other Proceedings Relating to
Capacity and Energy Changes). The Settlement Agreement is not expected
to materially affect MCV's earnings and cash flows.
MCV currently delivers its electric power to purchasers through
transmission lines owned and operated by Trans-Elect, Inc.
("Trans-Elect"). Such lines were previously owned by Consumers. MCV and
Consumers previously entered into the Facilities Agreement which provides
for transmission service of excess capacity and energy available at the
Facility. The sale of the transmission facilities to Trans-Elect does not
change, in any respect, the contractual relationship and obligations of
Consumers under the Facilities Agreement. Trans-Elect is serving as
Consumers' agent to perform Consumers' obligations under the Facilities
Agreement.
Steam and Electric Power Agreement; Related Dow Agreements
SEPA. Pursuant to the SEPA, Dow has agreed to purchase steam from the
Facility for an initial term of 25 years from the Commercial Operation
Date and to purchase electricity from the Facility for 15 years (any
electricity to be purchased thereafter at Dow's option, although MCV
remains obligated to make certain amounts of electricity available for an
additional 10 years). The SEPA is subject to automatic extensions for up
to 10 additional years after its 25-year term in the absence of a
three-year notice of termination from either party.
In any year, MCV is not obligated to deliver more than 691,900 pounds of
steam per hour and 60 MW of electricity on an annual average basis except
as Dow may increase its entitlement as discussed below. Dow has agreed to
take as much steam as is necessary for the Facility to retain its QF
status under the FERC regulations in effect on November 1, 1986 (which
regulations have not been revised in relevant part in any material
respect). However, Dow's obligation with respect to minimum annual steam
purchases is an average of 440,000 pounds per hour (less amounts supplied
by certain standby facilities owned by Dow and less 50% of amounts
purchased by any other steam customers of MCV) and is binding only for the
initial 25-year term of the SEPA. During 2002, MCV sold an average of
508,981 pounds of steam and 61 MW of electricity per hour to Dow.
Dow may increase its steam or electricity entitlement to 110% of the steam
or electricity delivered in the previous 12-month period, plus any steam
or electricity required by any addition to or modification of the Dow
plant, provided that any increase above an annual average of 1,000,000
pounds of steam per hour or 75 MW of electricity requires MCV's consent.
MCV, however, may be required, on an instantaneous basis, to deliver steam
at a rate of up to 135% of the maximum annual average hourly quantity of
steam or to deliver power at a rate up to 20 MW greater than the
applicable annual average. In 1997, Dow increased its electric entitlement
to 67.75 MW/hr; no such increase has since been requested. In 1994, MCV
and Dow amended the SEPA to provide that Dow would install a steam line to
the Dow Corporate Center to deliver MCV-generated steam for heating and
air conditioning purposes.
Under the SEPA, there is a base charge for steam and electricity which is
subject to adjustment each quarter based on changes in MCV's fuel costs,
producer price for capital equipment and certain compensation per hour
indices. Dow also has the option under the SEPA and subsequent amendments,
to provide the gas necessary to generate Dow's take of steam and
electricity ("toll"). Under the provisions of the SEPA, Dow receives a
billing credit of 5/8 of its steam and electric charges in exchange for
Dow purchasing the natural gas for MCV.
In order to assure reliable steam for the Dow plant, Dow owns and
maintains standby facilities, which are not part of the Facility (the
"Standby Facilities"). The SEPA amendment also provided that Dow would
retire certain of the Standby Facilities located on the MCV site and
reduce the annual standby fees payable to Dow to $350,000 per year. This
fee is subject to the same indexing adjustments each quarter as the base
steam charge. In addition, the fee charged by Dow for each use of the
Standby Facilities, necessitated when MCV fails to deliver steam under the
SEPA is $150,000.
The terms of the SEPA provide that Dow may terminate the SEPA if one or
more "contract outages" occur for a cumulative period greater than 60
hours in the first year after the Commercial Operation Date, 40 hours in
the second year and 24 hours in any subsequent year, provided that a
single outage of more than 24
-6-
consecutive hours but less than 72 consecutive hours will not give rise to
a right of termination unless another such contract outage has occurred
within the previous 60 months.
A "contract outage" generally occurs when MCV fails to deliver minimum
operation steam (i.e., an hourly flow rate of at least 75% of the then
current rate), or fails to meet pressure specifications after having
failed to deliver steam for 15 consecutive minutes, or fails to meet
pressure and quantity specifications after having failed to deliver steam
for seven consecutive days, except in each case as a result of scheduled
maintenance outages, outages forced at Dow's request or resulting from
Dow's failure to provide demineralized water or waste water treatment
services or outages caused by an event of force majeure lasting no more
than two years. Steam provided to Dow from the Standby Facilities is
treated as steam delivered by MCV for this purpose. For such a contract
outage to occur, more than ten of the Facility's GTGs would have to be out
of service at the same time that Dow's Standby Facilities are unavailable.
The SEPA and various backup agreements among MCV, Consumers and Dow
contain various provisions designed to assure a continuous supply of steam
and electricity to Dow in the event the SEPA is terminated.
Dow Facilities and Demineralized Water. Dow owns the electrical
transmission lines, which carry electricity from the Facility to the Dow
plant. Dow also owns certain steam and demineralized water lines which are
used in the operation of the Facility, and which have been leased by Dow
to MCV. Dow has contracted to provide MCV sufficient demineralized water
to meet the Facility's requirements until 30 months after MCV's obligation
to supply steam to Dow ceases.
Steam Purchase Agreement
In 1995, MCV entered into the SPA with DCC which provides that MCV
construct, own and operate a steam line and appurtenant equipment to serve
steam to DCC's Midland plant. DCC has agreed to purchase steam from MCV
for an initial term of fifteen years with automatic year-to-year renewals
thereafter. MCV expects to supply steam at the rate of up to 180,000
pounds per hour with a minimum of 90,000 pounds per hour. The steam MCV
provides DCC must meet operational and content specifications. The
provision of steam to DCC is subject to Dow's first preference to the
steam under the SEPA. MCV began supplying steam to DCC in July 1996. The
parties have certain termination rights after the declared in service date
but may be subject to penalties or damages for such termination.
Gas Supply Arrangements
MCV has a portfolio of long term natural gas purchase contracts (contracts
that provide for gas purchases for a term of greater than one year),
having remaining terms of 1 to 11 years, with U.S. and Canadian suppliers
for an annual average maximum supply of natural gas for 2003 of 209,089
MMBtu/day. As of January 1, 2003, no single gas contract accounts for more
than 14.2% of MCV's portfolio, though, El Paso and its subsidiaries now
account for 36.0% of MCV's portfolio. Gas contracts with U.S. suppliers
provide for a 2003 annual average purchase of 128,363 MMBtu/day, while gas
contracts with Canadian suppliers provide for the purchase of 80,726
MMBtu/day. In addition to purchasing natural gas under long term
contracts, MCV also purchases gas under short term ("spot") agreements for
a term of less than one year. During 2002, MCV's gas purchases were
supplied 73% from long term gas contracts and 27% from spot gas contracts.
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MCV Gas Under Contract
Annual Average For Each Year
Maximum Daily Quantity (MMBtu/Day)
YEAR FIXED PRICE INDEXED PRICE FLOATING PRICE TOTAL
---------------------- ---------------------- ---------------------- ---------------------- -----------------
2003 60,863 118,226 30,000 209,089
2004 67,923 110,638 49,000 227,561
2005 80,000 61,695 96,836 238,531
2006 74,164 59,156 105,345 238,665
2007 54,329 16,000 141,367 211,696
2008 46,000 7,500 122,000 175,500
2009 36,000 7,500 120,329 163,829
2010 36,000 7,500 94,151 137,651
2011 36,000 4,863 47,000 87,863
2012 32,667 2,667 43,500 78,833
2013 -- -- 3,395 3,395
The pricing for the above contracted volumes are defined as follows:
Fixed Price Individual contracts utilize either
a fixed price through life of contract or
a fixed price with fixed escalator.
Indexed Price Individual contracts utilize either
a fixed price with an escalator tied to
the energy index based on Consumers'
charges under the PPA or an amount based
on a combination of a fixed with
escalator and fixed with energy
escalator.
Floating Price A price tied to (1) the Henry Hub gas
Mercantile contract on the New York Exchange for
the month gas is purchased or (2) the
Alberta, Canada price as published is
the Canadian Gas Price Reporter.
Current U.S. Long Term Gas Contracts. The U.S. long term gas contracts
provide for either a "dedication of reserves" or a corporate "warranty of
deliverability." Under a dedication of reserves, specific reserves are
dedicated to fulfill the supplier's obligations and under a corporate
warranty, reserves are not dedicated but generally MCV is indemnified for
the cost of purchasing supplies elsewhere if the gas is not delivered as
warranted.
Most of the U.S. long term gas contracts contain "take-or-pay" provisions
obligating MCV to purchase at least a specified percentage (generally 75%
to 100%) of the minimum daily quantity ("MDQ") to which MCV is entitled
under the contract, unless such failure is due to force majeure, failure
of the gas to meet quality standards or, in some cases, failure of the
supplier to deliver the quantity nominated by MCV. If, over the course of
a contract year, MCV has a take deficiency, it must make a deficiency
payment that is based, in most cases, on the product of the take
deficiency and either all or some percentage of the contract price. In
addition, under some of the U.S. long term gas contracts, the producer may
terminate the contract if, for reasons other than force majeure, MCV fails
to purchase a specified percentage of the MDQ (generally between 50 and
100%) within a specified period (generally 120 days). Some U.S. long term
gas contracts allow a "make-up period" ranging from one to five years to
make up the deficiency.
Most U.S. long term gas contracts provide that MCV has the right to
terminate upon 20 days' written notice if the supplier, for any reason
other than force majeure, fails to provide a specific percentage of the
requested volumes of gas for a period of at least 120 consecutive days.
MCV may terminate two other U.S. long term
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gas contracts upon 30 days' written notice if the producer, for any
reason, including force majeure, fails to deliver 500 Mcf/day for a period
of four consecutive months.
In addition, MCV previously had two long term gas contracts with
affiliates of the Enron Corporation ("Enron"), which filed bankruptcy
petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code
in December of 2001. The Bankruptcy Court rejected one of the Enron
contracts in 2002 and due to the uncertain nature of the future viability
of this contract, MCV expensed $8.2 million of unamortized prepaid gas
costs associated with this contract in December 2001. MCV has filed a
claim in the Bankruptcy court to recover its loss on the rejected Enron
contract. MCV Management cannot predict the outcome of MCV's claim in the
Enron case at this time. The second of the Enron contracts was purchased
by an affiliate of El Paso and continues in full effect.
Current Canadian Long Term Gas Contracts. All Canadian long term gas
contracts ("Canadian contracts") warrant the delivery of quantities
requested by MCV up to the MDQ, subject to force majeure, and in one case,
a 2% tolerance is allowed. Subject to MCV's obligation to mitigate,
Canadian suppliers have agreed to indemnify MCV for the Facility's
replacement gas costs, excluding indirect or consequential damages or loss
of profit, for any breach of this supply warranty. One producer may be
relieved of its supply warranty under certain circumstances if its ratio
of remaining reserves to annual production is less than ten.
Prices under most of the Canadian contracts are based on reference prices
indexed to Consumers' energy charges under the PPA, subject in some
instances to floor prices below which the reference price cannot fall, and
are denominated in U.S. dollars. All the Canadian contracts provide for
deliveries at the international border near Emerson, Manitoba.
In addition to an amount per MMBtu based on the quantity of gas actually
delivered (the "Commodity Charge"), under most of the Canadian contracts
MCV is required to pay a monthly charge whether or not MCV buys any
natural gas (the "Demand Charge") to each Canadian supplier. This Demand
Charge covers the transportation charges incurred by the Canadian
suppliers to have transportation capacity for the MDQ available to the
U.S.-Canada border. To the extent that MCV takes less than 100% of the MDQ
from its Canadian contracts, gas costs per unit taken by MCV increase
because Demand Charges are being paid for the quantity of gas not being
taken. Two contracts provide discounts to the Commodity Charge where
monthly takes are in excess of 85% of MDQ.
The Canadian contracts establish minimum annual takes under the contracts
that range from 75% to 100% of the stated MDQ. Generally, under the
contracts that require less than 100% takes, MCV is contractually required
to make a deficiency payment, which could range from a partial percentage
to a full percentage of the Commodity Charge multiplied by the deficiency
take; however, some contracts provide MCV the opportunity to reduce such
deficiency payment by taking gas in excess of the MDQ during the following
year. Generally, under the contracts that require 100% daily takes, MCV is
required to pay the supplier for any unexcused deficiencies, which amount
is calculated as the sum of (i) the daily deficiency multiplied by the
positive price differential between market and contract prices and (ii)
the Demand Charge accessed by transporter.
Under most of the Canadian contracts, if a Canadian supplier under
delivers to MCV in any month, subject to certain force majeure provisions,
the contract price is reduced by a proportionate share of the Canadian and
U.S. transporters' Demand Charges. Further, if a Canadian supplier fails,
for reasons other than force majeure, to deliver 90% of quantities
requested up to the MDQ over any 120 consecutive day period then, in most
cases following a cure period, MCV can reduce the MDQ or, under certain
circumstances, terminate the agreement. If the MDQ is reduced, MCV can
request the Canadian supplier to assign to it, to the extent permitted,
the quantity of firm transportation capacity on Canadian transporters that
corresponds to the reduction in MDQ. One of the Canadian suppliers may
terminate its contract if MCV fails to take specified percentages of the
MDQ.
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Gas Transportation and Storage Arrangements
The location of the Facility permits gas to be transported over a number
of U.S. interstate pipelines. MCV has signed long term transportation
contracts with four of these pipelines: ANR Pipeline Company ("ANR"); CMS
Panhandle Eastern Pipe Line Company ("Panhandle"); CMS Trunkline Gas
Company ("Trunkline"); and Great Lakes Gas Transmission Company ("Great
Lakes"). ANR and Great Lakes are affiliates of El Paso. CMS Energy, the
parent company of Consumers currently owns Panhandle and Trunkline (See
paragraph below). In addition, certain of the gas suppliers arrange with
pipelines for the gathering and transportation of gas from their supply
sources to the interconnection points with the major interstate pipelines
with which MCV has contracts.
On December 22, 2002, CMS Energy announced that it had reached a
definitive agreement to sell Panhandle and Trunkline to Southern Union
Pipeline. The sale is subject to the customary closing conditions by the
Federal Trade Commission and by appropriate state regulators. No change in
rates or service, under MCV's contracts with these companies, are expected
as a result of this sale.
MCV originally entered into long term transportation arrangements with two
connecting pipelines which link the Facility and its own pipeline to these
interstate pipelines: Michigan Gas Storage Company (a subsidiary of
Consumers) and Consumers. In November 2002, Consumers combined the
operations of Michigan Gas Storage Company and Consumers. As a result of
this combination, MCV's service is now provided under one agreement. No
change in rates or service has occurred under the consolidation of these
service agreements. Michigan gas produced by suppliers is currently
transported to Consumers' pipeline system by the supplier under contracts
the suppliers have with MichCon Gathering Company (previously Michigan
Consolidated Gas Company) ("MichCon"), on the MichCon pipeline system in
northern Michigan.
The remaining terms of MCV's agreements with the U.S. transporters range
from less than 1 to 22 years. The transportation rates of ANR, Panhandle,
Trunkline and Great Lakes are subject to FERC regulation.
The suppliers under the Canadian contracts are themselves responsible for
arranging transportation within Canada, and are responsible for paying the
transportation rates charged by the Canadian transporters, which are then,
in most cases, reimbursed by MCV. All suppliers have been allocated firm
transportation capacity on the relevant pipelines. Great Lakes transports
Canadian gas from the U.S.-Canada border to Michigan.
MCV has also entered into a gas storage agreement with Consumers for the
underground storage of eight billion cubic feet of gas in exchange for
delivery to Consumers of 1.75% of the gas placed in storage (for fuel) and
the payment by MCV to Consumers of an annual storage service charge of
32.04 cents per Dth times the eight billion cubic feet of storage service
provided. Consumers is obligated to provide deliveries from storage up to
a rate of 120,000 Mcf/day, subject to certain restrictions relating to
levels of storage gas maintained in inventory by MCV. This storage
capability allows MCV to meet fluctuating daily operating requirements and
to take advantage of opportunities to make spot purchases during periods
of the year when gas prices are favorable.
Credit Support Requirements for MCV's Gas Arrangements
Many of MCV's gas supply contracts have credit support requirements that
can be triggered by changes in the financial condition of MCV or the gas
supplier, price changes in the forward gas market or the quantity of gas
purchases. As of December 31, 2002, MCV was supplying no credit support in
the form of cash or letters of credit for any gas supply agreements. MCV
was holding on December 31, 2002, a letter of credit for $9 million from a
gas supplier as collateral support for one of MCV's long term gas
agreements.
A number of MCV's gas supply agreements have parent guarantees that are
supplied by the corporate parents of the entity that is a party to the MCV
gas contract. The MCV Partners guarantee none of MCV's gas supply
agreements.
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MCV hedges gas with NYMEX contracts that have both initial and variation
margin requirements. As of December 31, 2002, MCV held 3,453 NYMEX
contracts and had provided $13.3 million in margin requirements to support
the acquisition of the aforementioned NYMEX contracts.
In addition, MCV also has credit support requirements in connection with
its gas transportation contracts. The present tariff provisions in MCV's
gas transportation contracts provide that credit support can be required
based on the credit worthiness of the holder of the contract. As of
December 31, 2002, MCV had not been required to provide any credit support
for its gas transportation contracts.
Gas Turbine Service Agreement
Under a service agreement between MCV and Alstom, as amended, (the
"Service Agreement"), Alstom sold MCV spare parts for the GTGs and
provides qualified service personnel and supporting staff to assist MCV to
perform scheduled inspections on the GTGs, and to repair the GTGs at MCV's
request. The Service Agreement, commenced on January 1, 1990, and will
expire upon the earlier of the completion of the sixth series of major GTG
inspections or December 31, 2009. Alstom does not assure any level of
performance by the GTGs in the Service Agreement but warrants all repairs
made by it pursuant to the Service Agreement.
Under the Service Agreement MCV must pay a monthly inspection fee which is
adjusted based upon various wage level indices, is payable on the basis of
operating hours as they occur over the same period, and may be increased
under certain events of force majeure or change of laws. In addition, MCV
pays maintenance and repair fees equal to material and other direct costs,
amounts payable to subcontractors, and Alstom's out-of-pocket costs, plus
15% except in the case of fees relating to certain service engineers,
supervisors and specialists where the maintenance fee shall be equal to
the Alstom rate. Alstom warrants that all repairs performed and all spare
parts supplied by it will be free of defects for one year from the date of
completion or date of use, respectively.
The Service Agreement terminates (i) if either Alstom or MCV fails to
perform the duties outlined under the Service Agreement, at the option of
the other party; or (ii) at MCV's option, if MCV is unable to operate the
Facility for 60 consecutive days due to force majeure. Upon cessation of
the force majeure, the Service Agreement may be reinstated by either party
upon 60 days' notice, together with a remobilization fee. Upon termination
of the Service Agreement (except for nonperformance by Alstom), MCV must
pay a cancellation payment.
MCV and Alstom amended the Service Agreement effective December 31, 1993
under which Alstom provides hot gas path parts for MCV's twelve gas
turbines through the fourth series of major GTG inspections, which were
completed in 2002. In January 1998, MCV and Alstom amended the length of
the Service Agreement to extend through the sixth series of major GTG
inspections, which are expected to be completed by year-end 2008, for a
lump sum fixed price covering the entire term of the amended Service
Agreement of $266.5 million (in 1993 dollars, which is adjusted based on
exchange rates and Swiss inflation indices), payable on the basis of
operating hours as they occur over the same period. The amendment is
severable and may be terminated separately from the Service Agreement. If
the Service Agreement is terminated, MCV must pay a cancellation payment
of $5.0 million.
MCV has signed a new maintenance service and parts agreement with GEII,
effective December 31, 2002 ("GEII Agreement"). GEII will provide
maintenance services and hot gas path parts for MCV's twelve GTG's under
terms and conditions similar to the MCV/Alstom Service Agreement, as
described above. The GEII Agreement will cover four rounds of major GTG
inspections, which are expected to be completed by the year 2015, at a
savings to MCV as compared to the Service Agreement with Alstom. The GEII
Agreement is expected to replace the current Alstom Service Agreement
during the first half of 2004, but in no event later than January 1, 2005.
The GEII Agreement can be terminated by either party for cause or
convenience. Should termination for convenience occur, a buy out amount
will be paid by the terminating party with payments ranging from
approximately $19.0 million to $.9 million, based upon the number of
operating hours utilized since commencement of the GEII Agreement.
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Steam Turbine Service Agreement
MCV has entered into a nine year Steam Turbine Maintenance Agreement with
GE effective January 1, 1995, which is designed to improve unit
reliability, increase availability and minimize unanticipated maintenance
costs. MCV is to make monthly payments over the life of the contract
totaling $13.0 million (in 1995 dollars).
Gas Turbine Generator Compressor Blade Agreement
MCV has entered into an agreement with MTS Machinery Tools & Services AG
("MTS"), effective January 18, 2002. Under this agreement MTS will design,
manufacture and install new design compressor blades for MCV's GTG's,
which is expected to increase the overall electrical capacity and
efficiency of each GTG. MCV has agreed to purchase one set of such blades
and has the option to purchase an additional eleven sets which would be
installed during the fifth series of major GTG inspections, which are
expected to be completed by the third quarter of 2006. The cost of this
project to upgrade all twelve GTG's, including the purchase of spare
parts, is approximately $32.7 million (in 2001 dollars), payable based
upon performance milestones. The first set of new compressor blades is
expected to be installed in the second quarter of 2003, for approximately
$4.2 million.
F. Employees
As of February 28, 2003, MCV had 131 employees. Fifty-three of MCV's
employees are members of the Utility Workers Union of America, AFL-CIO
Local 564 (the "Union"), and are subject to the terms of a collective
bargaining agreement between MCV and the Union. MCV and the Union signed a
new agreement effective March 1, 1999. It is a five year contract with a
wage reopener in each of the last two years. The Union did not exercise
the wage reopener in either of the last two years. MCV believes that its
relationship with its employees is good.
G. Regulation
Introduction
MCV and the Facility are not subject to most state and federal public
utility laws and regulations. The following is a discussion of the
principal regulatory proceedings and issues which could have an impact on
MCV and/or the Facility.
QF Certification
In order to be a QF under PURPA and to maintain this status, not more than
50% of the "equity interest" in a facility may be owned by electric
utilities or their affiliates. In addition, certain operating and
efficiency standards must be maintained on a calendar-year basis. In the
case of a topping-cycle generating plant such as the Facility, the
applicable operating standard requires that the portion of total energy
output that is put to some useful purpose other than facilitating the
production of power (the "Thermal Percentage") be at least 5%. In
addition, the plant must achieve and maintain an average PURPA efficiency
standard (the sum of the useful power output plus one-half of the useful
thermal energy output, divided by the energy input) of at least 45% (the
"Efficiency Percentage"). However, if the plant maintains a Thermal
Percentage of 15% or higher, the required Efficiency Percentage is reduced
to 42.5%. Since 1990, the required Thermal and Efficiency Percentages have
been achieved. During 2002, a Thermal Percentage of 18.6% and an
Efficiency Percentage of 47.0% were achieved.
The Facility's QF certification by FERC became effective when portions of
the Facility were first synchronized to Consumers' system in June 1989. As
the operator of a QF, MCV (and the Facility) are exempt from various
provisions of the FPA and the 1935 Act and from certain state laws and
regulations respecting rate, financial and organizational regulation of
public utilities. On January 31 and March 1, 1990, FERC recertified the
Facility as a QF in the context of an ownership structure in which MCV
owns the Facility and in the context of a leveraged lease transaction in
which the Facility is owned by owner trustees on behalf of institutional
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investors. In 1997, 1998, 2000 and 2001, MCV filed Notices of
Self-Recertification with the FERC to reflect changes in the configuration
and equipment of the Facility, and changes in MCV Partnership ownership
(which changes did not result in a change in the percentage of utility
ownership). (See "MD&A -- Outlook -- Maintaining QF Status".)
MPSC and Other Proceedings Relating to Capacity and Energy Charges
Background. The PPA contains a "regulatory out" provision which permits
Consumers, under certain conditions, to reduce the capacity and/or energy
charges payable to MCV and/or to receive refunds of capacity and/or energy
charges paid to MCV under the PPA if the MPSC does not permit Consumers to
recover from its customers the capacity and energy charges specified in
the PPA. Until September 15, 2007, however, the PPA further provides that
Consumers may not reduce the average capacity charge below 3.77 cents per
kWh notwithstanding the MPSC's failure to approve either the amount of
capacity Consumers has agreed to purchase from MCV under the PPA or the
capacity charge specified in the PPA for such purchase.
Energy charges payable by Consumers under the PPA are separate and
distinct from the capacity charge in that no 17-1/2 year protection
against the exercise of the "regulatory out" provision for energy charges
is provided for in the PPA. Although prior approval of energy charges is
not required or provided for under Michigan law, the MPSC has asserted the
authority to disallow Consumers' recovery of a portion of such energy
charges paid to MCV. Any disallowance by the MPSC of Consumers' ability to
pass energy charges through to its customers could, pursuant to the
"regulatory out" provision of the PPA, result in a reduction or refund of
the fixed and variable portions of the energy charge under the PPA.
MPSC and Other Proceedings. In September 1987, in order to obtain a 17-1/2
year rate protection provided under Michigan law, known as Act 81, MCV
requested MPSC approval of the capacity rate provided for in the PPA.
During the pendency of this matter, Consumers, MPSC staff and others
negotiated a revised settlement proposal, which was submitted to the MPSC
for approval ("Revised Settlement Proposal").
In a 1993 order ("915 MW Settlement"), the MPSC approved with
modifications the Revised Settlement Proposal. Generally, the 915 MW
Settlement approved cost recovery of Consumers from its rate payers of 915
MW of MCV capacity subject to certain "availability caps" associated with
on-peak and off-peak periods of time each day (beginning on September 16,
2007, the "availability caps" are 88.7% of 915 MW both on and off peak)
and recovery of energy payments based on coal proxy prices (the formula in
the PPA). However, instead of capacity and fixed energy payments being
based on "availability" as provided in the PPA, the 915 MW Settlement
provided for recovery of such payments on an energy "delivered" basis. The
MPSC did not order that the PPA be modified to conform with the cost
recovery approved in the 915 MW Settlement. However, the MPSC found that
since the capacity charges approved for recovery under the Revised
Settlement Proposal would not be reflected in the PPA, approval for the
purposes of Act 81 could not be extended to those capacity charges. The
MPSC did indicate in its order, however, that its 915 MW Settlement would
be implemented for rate-making purposes in 1993 and subsequent years.
Opponents to the Revised Settlement Proposal unsuccessfully filed appeals
of the 915 MW Settlement which is now final.
In connection with a dispute between MCV and Consumers regarding the
payment of certain fixed energy charges which stemmed from the Revised
Settlement Proposal, on December 10, 1993, Consumers made a written
irrevocable offer of relief ("Offer of Relief") to MCV. The Offer of
Relief was for the purpose of facilitating the sale of Senior Secured
Lease Obligation Bonds, issued in connection with the financing of the
Overall Lease Transaction (See "Overall Lease Transaction") and held by
Consumers. Pursuant to the Offer of Relief, which was rendered final and
irrevocable on December 28, 1993, Consumers committed to pay MCV the fixed
energy charges on all energy delivered by MCV from the block of Contract
Capacity above 915 MW. Consumers did not commit to pay MCV for fixed
energy charges on energy delivered above the "caps" established in the 915
MW Settlement up to 915 MW. This unilateral commitment, which became
effective as of January 1, 1993, to pay fixed energy charges on delivered
energy from the block of Contract Capacity above 915 MW will expire on
September 15, 2007.
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In 1993, Consumers exercised its rights under the PPA to obtain a
determination through arbitration proceedings of whether Consumers could
exercise the "regulatory out" provision of the PPA in view of Consumers'
acceptance of the 915 MW Settlement. In a Final Order issued in 1995, the
arbitrator ruled that Consumers may withhold the fixed energy charges for
available but undelivered energy, as well as for energy delivered between
the "caps" contained in the 915 MW Settlement and 915 MW.
In 1995, Consumers and the MPSC staff asked the MPSC to approve a
settlement agreement ("325 MW Settlement") which proposed approving
recovery by Consumers from its ratepayers of an additional 325 MW of
capacity purchased from MCV beginning January 1, 1996 through the term of
the PPA. The costs recovered for this 325 MW of MCV Contract Capacity was
essentially the same as the 915 MW Settlement already approved by the MPSC
after a phase in of the capacity rate between 1996 and 2004 including the
same "availability caps" as the 915 MW Settlement. On November 14, 1996,
the MPSC approved, with modifications not material to MCV, the 325 MW
Settlement effective January 1, 1996 ("325 MW Settlement"). The 325 MW
Settlement is now final.
In 1997, Consumers informed MCV of several other potential payment issues
it would pursue, pursuant to the "regulatory out" and other provisions of
the PPA. These issues related to Consumers' special contract customers,
pricing of the energy delivered during off-peak ramp hours (when MCV
adjusts its output to match Consumers' dispatch) and energy delivered in
the band width (energy delivered above dispatch, within certain limits).
In addition, Consumers notified MCV that it did not believe that MCV could
use the approximately 15 MW of generating capacity and energy attributable
to the back pressure turbine, which was placed into service in July 1997,
towards available Contract Capacity or electric deliveries under the PPA.
Consumers had also indicated that they would take a similar position on
the incremental energy and capacity resulting from MCV's installation of
11NM upgrade packages on the GTGs (collectively the "Disputed Issues").
MCV and Consumers entered into a settlement agreement ("Settlement
Agreement"), effective January 1, 1999, which resolves (for the various
time periods specified in the Settlement Agreement) all of the previously
Disputed Issues under the PPA and includes definitive obligations for
Consumers to make energy payments calculated in accordance with the PPA,
irrespective of any MPSC or the reviewing courts decision which may affect
those issues or payments. The Settlement Agreement also provides that, not
withstanding modifications to the Facility increasing its capacity, in
billing Consumers for capacity charges (at the rates set forth in the PPA)
availability would be capped at 98.5% of the 1240 MW ("98.5% cap") on a
calendar-year basis for the term of the PPA irrespective of any MPSC or
the reviewing courts decision, which may affect this issue or payment.
Provided, however, that if Consumers transfers (subject to MCV's prior
consent) its rights of up to 1240 MW of capacity and associated energy
under the PPA to a third party for an extended period of time, the 98.5%
cap will not apply except that the 98.5% cap is, in any event, reinstated
on September 15, 2007. Notwithstanding the Settlement Agreement, after
September 15, 2007, an issue could exist as to whether or not Consumers
can exercise the "regulatory out" provision to reduce capacity payments to
MCV based upon the "availability caps" of 88.7% of the 1240 MW (both on
and off peak) of contract capacity as provided for in the 915 MW
Settlement and the 325 MW Settlement. The Settlement Agreement is not
expected to materially affect MCV's earnings and cash flows.
Michigan Electric Industry Restructuring Proceedings
The MPSC issued orders in 1997 and 1998 (collectively the "Restructuring
Orders"). The Restructuring Orders provide for a transition to a
competitive regime whereby electric retail customers would be able to
choose their power supplier and pay negotiated or market-based rates for
such power supply. The Restructuring Orders also mandated that utilities
"wheel" third-party power to the utilities' customers. An issue involved
in restructuring, which could significantly impact MCV, is stranded cost
recovery. The Restructuring Orders allow recovery by utilities (including
Consumers) of stranded costs, which include capacity charges from QFs,
including MCV, previously approved by the MPSC, incurred during the
regulated era that will be above market prices during the new competitive
regime. However, it appears that stranded cost recovery of above-market
capacity charges in power purchase contracts (i.e., MCV's PPA) is limited
to customers who chose an alternative power supplier and are only paid for
the period 1998 through 2007 (MCV's PPA expires in 2025). Customers who
chose to remain power supply customers of Consumers will continue to pay
capacity charges as
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part of rates charged by Consumers, subject to MPSC rate regulation. The
Restructuring Orders do not otherwise specifically address the recovery of
PPA capacity charges after 2007.
MCV, as well as others, filed appeals in state and federal courts
challenging the Restructuring Orders. The Michigan Court of Appeals found
that the Restructuring Orders do not unequivocally disallow recovery of
PPA charges (capacity and energy) by Consumers and, therefore, MCV's
issues were not ripe for appellate review and no actual controversy
regarding recovery of costs could occur until 2008, at the earliest. This
order is now final. In June 1999, the Michigan Supreme Court issued an
opinion in an MPSC "retail wheeling" experiment case holding, among other
things, that the MPSC lacks the statutory authority to mandate that
utilities transmit power of third parties to the utilities' customers
("Michigan Supreme Court Order"). While the Michigan Supreme Court Order
was not directed at the Restructuring Orders, the MPSC has effectively
applied it to them by entering an order on August 17, 1999, making retail
wheeling under the Restructuring Orders voluntary on the part of the
utilities. In September 1999, Consumers filed a statement with the MPSC
stating that it intends to begin voluntarily implementing the
Restructuring Orders. In June 2000, the State of Michigan enacted
legislation which, among other things, states that the Restructuring
Orders (being voluntarily implemented by Consumers) are in compliance with
the legislation and enforceable by the MPSC. The legislation provides that
the rights of parties to existing contracts between utilities (like
Consumers) and QF's (like MCV), including the rights to have the PPA
charges recovered from customers of the utilities, are not abrogated or
diminished, and permitted utilities to securitize certain stranded
(transition) costs including PPA charges.
In MCV's federal court challenge to the Restructuring Orders, the U.S.
District Court granted summary judgment to MCV declaring, among other
things, that the Restructuring Orders are preempted by federal law to the
extent they prohibit Consumers from recovering from its customers any
charge for avoided costs (or "stranded costs") to be paid to MCV under
PURPA pursuant to the PPA. In June 2001, the United States Court of
Appeals ("Appellate Court") vacated the U.S. District Court's summary
judgment and ordered the case dismissed based upon a finding that no
actual case or controversy existed for adjudication between the parties.
The Appellate Court determined that the parties' dispute is hypothetical
at this point in time and the QFs' (including MCV) claims are premised on
speculation about how an order might be interpreted in the year 2007 or
beyond by a future MPSC.
Federal Electric Industry Restructuring
FERC has jurisdiction over wholesale energy sales and is moving towards
"market" based pricing of electricity as opposed to traditional cost-based
pricing. In April 1996, FERC issued Order No. 888 requiring all utilities
FERC regulates to file uniform transmission tariffs providing for, among
other things, non-discriminatory "open access" to all wholesale buyers and
sellers, including the transmission owner, on terms and conditions
established by FERC. Order No. 888 also requires utilities to
"functionally unbundle" transmission and separate transmission personnel
from those responsible for marketing generation. In December 1999, FERC
issued a final rule, Order No. 2000, designed to encourage all owners and
operators of interstate electric transmission lines to join regional
transmission organizations. In July 2001, FERC issued a Notice of Proposed
Rulemaking to establish a standard market design ("SMD") in order to
remedy remaining undue discrimination in transmission and wholesale energy
markets. The SMD requires all FERC jurisdictional transmission providers
to transfer control of their transmission facilities to an independent
transmission provider. The independent transmission provider will provide
transmission service under a standardized tariff and administer market
based wholesale energy markets for day-ahead and real-time sales. The SMD
proposal has drawn strong criticism from certain State regulators in the
Pacific northwest and southeast, which are asking Congress to block the
proposal. This criticism has had the effect of delaying issuance of a
final SMD rule. In addition, apart from the SMD proceeding, the Midwest
Independent System Operator ("Midwest ISO") has committed to FERC to
implement in December 2003 a day-ahead and real-time energy market similar
to that proposed in the SMD proceeding. The Midwest ISO provides
transmission service in most parts of the Midwest, including Michigan. The
SMD could impact MCV in selling electricity in the wholesale market. MCV
Management cannot predict the impact on MCV or the outcome of these
proceedings.
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Other Regulatory Issues
MCV has been granted a permanent exemption from the Power Plant and
Industrial Fuel Use Act of 1978, as amended, relating to the use of
natural gas as its primary energy source. This exemption permits MCV to
consume gas without restriction as to hours of operation or the capacity
of the Facility to consume an alternate fuel.
The Canadian long term gas contracts require permits from both Canadian
and U.S. authorities. All of the suppliers have received approval from
Canadian provincial authorities to lift and remove sufficient gas volumes
to meet MCV's current contract requirements and from the National Energy
Board ("NEB") to export these volumes. The U.S. long term gas contracts
are not subject to regulatory approvals.
H. Environmental Matters
MCV has obtained all material federal, state and local environmental
permits necessary to construct and operate the Facility. MCV believes that
the Facility complies in all material respects with all applicable
federal, state and local environmental regulations and laws. There is no
litigation or, to the knowledge of MCV, any administrative proceeding or
investigation pending or threatened with respect to environmental issues
at the Facility. It is possible that applicable environmental laws and
regulations may change, making compliance more costly, time consuming and
difficult. Any such changes, however, are likely to apply to similarly
situated power plants and not only to the Facility.
Water Quality. MCV's National Pollutant Discharge Elimination System
permit was reissued in August 1999 for the period of October 1, 1999 to
October 1, 2003. Application for renewal will be submitted to the State of
Michigan no later than April 1, 2003. On four instances in 2002, MCV
exceeded its daily maximum discharge limits into the cooling pond. On June
11, August 19 and September 17, 2002, the daily maximum limit for oil and
grease were exceeded from the oily waste treatment system. On August 18,
2002 the daily maximum discharge limit for total suspended solids was
exceeded. The cause of the exceedances were investigated and identified;
and corrective action taken to eliminate the potential for reoccurrence.
The Michigan Department of Environmental Quality ("MDEQ") has taken no
action nor is it expected that they will.
Air Quality. MCV's Renewable Operating Permit was issued June 4, 1999 with
an expiration date of June 4, 2004. This permit details the applicable
requirements, which apply to all the emission unit/process groups at MCV
and did not apply more stringent limits on the site than was already in
the Permit to Install.
In September 1998, the United States Environmental Protection Agency
("EPA") announced three rulemaking actions to address interstate and
regional transport of ground level ozone, namely the NOXSIP Call Final
Rule ("SIP Call Rule"), Proposed Federal Implementation Plan ("FIP Plan")
and the proposed Section 126 Rule. The SIP Call Rule requires 22 states
(including Michigan) to submit state implementation plans ("SIPs") which
address the regional transport of ground level ozone through reductions in
nitrogen oxide ("NOX") emissions from combustion sources, including gas
turbines. States were to submit plans to meet certain overall reduction
percentages established in the SIP Call Rule by September 30, 1999, with
emission reduction measures in place by May 1, 2003 and overall compliance
by September 30, 2007. The SIP Call Rule's initial compliance date has
since been extended to May 31, 2004. The FIP Plan includes the same NOX
reduction requirements and modified time tables contained in the SIP Call
Rule. The FIP Plan provides that it would be implemented in any state
which fails to submit an approvable NOX SIP or otherwise fails to require
applicable NOX emission reduction requirements to be in place. The Section
126 Rule deals with petitions filed by northeastern states under Clean Air
Act Section 126, against sources in "upwind" states in the Midwest,
including Michigan. Public hearings were held and comments and
industry-based appeals have been filed on all three of these rulemaking
actions. In May 1999, the United States Court of Appeals for the D.C.
Circuit remanded EPA's "8-hour" ozone measurement standard, set forth in
the SIP Call Rule, as being unconstitutional. It left intact, the EPA's "1
hour" standard. On January 18, 2000, the EPA issued its "Finding of
Significant Contribution and Rulemaking on Section 126 Petitions for the
Purposes of Reducing Interstate Ozone Transport" ("Section 126
Rulemaking"). In the Section 126 Rulemaking, the EPA made findings that a
number of large electric generating units ("EGUs") named in the petitions
emit in violation of the Clean Air
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Act prohibition against significantly contributing to nonattainment or
maintenance problems in the petitioning States. The Section 126 Rulemaking
also finalizes the Federal NOX Budget Trading Program as the control
remedy for sources affected by the rule. The Section 126 Rulemaking was
effective February 17, 2000, but a subsequent ruling by the D.C. Circuit
Court of Appeals on May 15, 2001, remanded to the EPA that portion of the
rule which applied to cogeneration units. The EPA is expected to provide
its response to the remand in the second quarter of 2003. MCV is
identified in the Section 126 Rulemaking as a large EGU subject to NOX
emissions averaging of .15 lb/MMBtu during the ozone season (May through
September). MCV nevertheless believes it will be able to meet the
standards in the Section 126 Rulemaking.
On December 4, 2002, Michigan's revised NOx rule package, addressing the
requirements of EPA's Nox SIP call, became effective. This rule was
included in a revision to Michigan's SIP. A public hearing on that SIP
revision was held on January 22, 2003 with no adverse comments submitted.
The State of Michigan has advised that the SIP revision will be submitted
to the EPA for approval during the second quarter of 2003. The EPA has
indicated that the revision is approvable and formal approval is expected
within six months of receipt by the EPA. Upon approval of the SIP
revision, EPA will halt the FIP Plan and Section 126 Rule processes. MCV
has determined it can meet the requirements specified by the State of
Michigan in this SIP revision.
Dow Operations. Portions of the Site were previously owned by Dow. At one
time, Dow had a brine pond, a portion of which was on the Site. In
addition, brine pipelines previously crossed the Site, some of which were
capped and abandoned in place. One brine well was used by Dow on the Site.
Dow brine pipeline spills off the Site are listed on Michigan's "List of
Sites of Environmental Contamination" established under Michigan
Environmental Response Act ("MERA"). The principal contaminant of concern
at the pipeline spill locations is brine. The Site also may have been used
for the testing of explosives during the 1950s or the 1960s.
The Dow Plant, immediately across the Tittabawassee River from the Site,
is on Michigan's "List of Sites of Environmental Contamination"
established under MERA. The principal contaminants of concern at the Dow
Plant are dioxins believed to have originated from chemical product
manufacturing.
While it is possible that MCV or Consumers could incur liability under the
Comprehensive Environmental Response, Compensation, and Liability Act of
1980 or MERA for Site conditions from previous Dow activities, MCV does
not know of any conditions on the Site that MCV believes require cleanup.
In any event, to the extent that such liability could be shown to be due
to Dow's activities, MCV or Consumers would seek contribution from Dow for
any costs incurred in connection with Dow's activities.
Environmental Indemnity Agreements. CMS Energy has executed environmental
indemnity agreements in favor of the Senior Bond Trustee, the Subordinated
Bond Trustee, the Tax-Exempt Trustee (all as defined in "Overall Lease
Transaction"), MCV and the holders, from time to time, of the Bonds.
Pursuant to these indemnity agreements, CMS Energy has agreed to indemnify
these parties and certain related parties against all expense, damage and
liability incurred by them, which is caused by certain classes of
environmental matters to the extent these occurred at the Site before June
15, 1990 (with certain exceptions). These matters include (i) the presence
of any environmentally hazardous materials at the Site, (ii) any
environmentally hazardous activity at the Site and (iii) any event which
is a violation of environmental laws affecting the Site (including
amendments and supplements to such laws whenever enacted except, in the
case of such enactments after June 15, 1990, to the extent they would
require installation or modification of equipment). CMS Energy has entered
into a similar environmental indemnity agreement for the benefit of the
Owner Trustee (in its individual and trust capacities), the Owner
Participants (as defined in "Overall Lease Transaction") and certain
related parties. In the agreement in favor of MCV, payments by CMS Energy
are subject to a deductible of $20,000 per occurrence and $240,000 in the
aggregate. The agreement in favor of MCV terminates when all the Senior
Bonds (as defined in "Overall Lease Transaction") have been paid in full
and all the holders of the Bonds (as defined in "Overall Lease
Transaction") have been paid all amounts owed under the general indemnity
in the Participation Agreements, except that such indemnity shall not
terminate with respect to certain rights arising prior to such final
payment.
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MCV has also executed an environmental indemnification agreement in favor
of CMS Energy under which it has agreed to indemnify CMS Energy in
connection with (i) any violation of the environmental laws by MCV with
respect to the Site after June 5, 1988, (ii) the release or disposal of
any hazardous materials at, on or to the Site after June 5, 1988 (unless
caused by CMS Energy or resulting from hazardous materials at or on the
Site prior to June 5, 1988), and (iii) any hazardous activities at the
Site after June 5, 1988, provided that CMS Energy may satisfy these
obligations only from amounts that are otherwise available for
distribution to Partners under the Participation Agreements.
I. Overall Lease Transaction
General
Permanent financing for the Facility has been provided through five
separate but contemporaneous sale and leaseback transactions (the "Overall
Lease Transaction"), pursuant to which MCV sold undivided interests in all
of the fixed assets comprising the Facility to the Owner Trustee under
five separate owner trusts (the "Owner Trusts") established for the
benefit of certain institutional investors ("Owner Participants"). U.S.
Bank National Association (formerly known as State Street Bank and Trust
Company) serves as Owner Trustee under each of the Owner Trusts (in each
such capacity, an "Owner Trustee" and, collectively, the "Owner
Trustees"). Each Owner Trustee leases its undivided interest in the
Facility to MCV under one of five separate leases, each having a 25-year
base term (the "Basic Lease Term") commencing in 1990. The Overall Lease
Transaction was closed in two phases. The first closing (involving
pollution control and certain related assets) occurred on March 16, 1990,
(the "First Closing" or the "First Closing Date") and the second closing
(involving the remainder of the Facility) occurred on June 16, 1990 (the
"Second Closing" or the "Second Closing Date").
Each purchase of an undivided interest in the Facility by an Owner Trustee
and the lease of such undivided interest back to MCV constitutes a
separate transaction (each, a "Lease Transaction"). The undivided
interests are in varying "undivided interest percentages" ranging from
approximately 4.4% to 75.5%. Each Lease Transaction was effected through
separate, but substantially identical, documents relating to a particular
undivided interest, including a Trust Agreement pursuant to which the
Owner Participant established the Owner Trust with the Owner Trustee and
authorized the Owner Trustee to hold title to its undivided interest on
its behalf and lease the same to MCV (each a "Trust Agreement"), a
Participation Agreement pursuant to which MCV, the Owner Participant, the
Owner Trustee and the various other parties to such Lease Transaction
agreed to the terms and conditions thereof (each, a "Participation
Agreement"), a Lease Agreement pursuant to which the Owner Trustee leases
the undivided interest to MCV (each, a "Lease") and two separate Trust
Indentures pursuant to which the Owner Trustee issued Senior Notes (as
defined in this Section I, "Overall Lease Transaction -- The Lease
Funding") (each, a "Senior Note Indenture") and Subordinated Notes (as
defined in this Section I, "Overall Lease Transaction -- The Lease
Funding") (each, a "Subordinated Note Indenture" and, together with the
Senior Note Indentures, the "Note Indentures"). The Bank of New York
(formerly known as United States Trust Company) and Wachovia Bank National
Association (formerly known as First Union National Bank) are note
trustees under the Senior Note Indenture and the Subordinated Note
Indenture, respectively (the "Note Trustees"). There is, however, a single
Collateral Agency and Intercreditor Agreement (the "Intercreditor
Agreement"), executed by the Owner Trustees, MCV, the Note Trustees, the
Working Capital Lender (as defined below) and U.S. Bank National
Association as collateral Agent (the "Collateral Agent"), which provides
for the creation and maintenance of certain reserves, the deposit of all
revenues generated by the operation of the Facility, the payment of
operating expenses, and the distribution of remaining revenues according
to the priorities set forth therein to or for the account of the Working
Capital Lender, the Note Trustees, the Owner Trustees, MCV and the
affiliates of certain Partners. MCV has arranged for a $50 million working
capital line (the "Working Capital Facility") with Bank of Montreal (the
"Working Capital Lender"), which expires August 29, 2003. As security for
its obligation to repay advances made under the Working Capital Facility,
MCV has granted to the Working Capital Lender a first priority security
interest in certain receivables earned by MCV through the sale of
electricity, electric generating capacity, natural gas, or steam to third
parties, including Dow, Consumers and DCC (the "Earned Receivables") and
in MCV's natural gas inventory (the "Natural Gas Inventory"). Payments due
under the Working Capital Facility are direct obligations of MCV and will
in general have a priority in payment over payments under the Leases (and
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thus on the Notes, as defined in this Section "Overall Lease Transaction
-- The Lease Funding," and the Bonds).
Pursuant to separate Tax Indemnification Agreements between MCV and the
Owner Participants (the "Tax Indemnification Agreements"), MCV has agreed
to indemnify the Owner Participants against certain adverse federal income
tax consequences.
Statement of Financial Accounting Standards ("SFAS") No. 98, which applies
to sale and leaseback transactions entered into after June 30, 1988,
specifies the accounting required by generally accepted accounting
principles for a seller-lessee's sale and simultaneous leaseback
transaction involving real estate, including real estate with equipment.
In accordance with SFAS No. 98, the Overall Lease Transaction must be
accounted for as a financing obligation and not a sale, since MCV has the
option to purchase the undivided interests in the Facility at the end of
the Basic Lease Term, which expires on July 23, 2015, and has other forms
of continuing involvement with the Facility throughout the Basic Lease
Term.
The Lease obligation is recorded as long term debt, at the present value
of future minimum Lease payments. There was no change to property, plant
and equipment, on the Consolidated Balance Sheet, as the transaction was
accounted for as a financing arrangement for financial reporting purposes.
Certain Lease transaction expenses of MCV are recorded as deferred
financing costs and amortized using the interest method over the term of
the Lease. On an ongoing basis, the monthly accrual for the semi-annual
Lease payments is divided between interest and principal components using
the effective interest method. On June 15, 2000, MCV closed on the sale of
$200 million of Tax-Exempt Bonds, the proceeds of which were used on July
24, 2000 to refund a like amount of previously issued Tax-Exempt Bonds.
This refinancing activity reduced the amount of interest expense.
The Lease Funding
Each Owner Trustee has financed the purchase of its undivided interest in
the Facility through a combination of equity invested by its related Owner
Participant ($556,320,000 in the aggregate) and debt incurred through the
issuance of nonrecourse notes by the Owner Trustee under the related Note
Indentures, consisting of senior secured notes ($1,200,000,000 in the
aggregate) (the "Senior Notes") and subordinated secured notes
($567,180,000 in the aggregate) (the "Subordinated Notes," and together
with the Senior Notes, the "Notes"). In order to facilitate the sale of
this debt (other than the debt evidenced by the Subordinated Notes pledged
to secure the Tax-Exempt Bonds) (as defined below), two funding
corporations have been established. Midland Funding Corporation I was
established for the purpose of issuing various series of senior bonds (the
"Senior Bonds"), each series secured by a pledge of the corresponding
series of Senior Notes issued by the five Owner Trustees. Midland Funding
Corporation II was established for the purpose of issuing various series
of subordinated bonds (the "Subordinated Bonds" and, together with the
Senior Bonds, the "Bonds"), each series secured by a pledge of the
corresponding series of the Subordinated Notes issued by the five Owner
Trustees. These pledged Subordinated Notes are secured proportionally with
the Subordinated Notes pledged to secure the Tax-Exempt Bonds issued by
the Tax-Exempt Issuer (as defined below). The use of the funding
corporations facilitated the sale of debt by permitting the offer and sale
of three series of Senior Bonds and two series of Subordinated Bonds, each
secured equally and ratably by the corresponding series of Notes issued by
each of the five Owner Trusts, thus eliminating the need to offer a
greater number of separate series of Notes to the investor. In addition,
the use of a corporate obligor facilitates compliance with certain
investment laws by certain institutional purchasers of the Senior and
Subordinated Bonds. The aggregate principal amount, maturity date,
interest rate, redemption provisions and other material terms of each
series of the Bonds are identical to those of the Notes pledged as
security therefore. As of February 28, 2003, there remains outstanding
approximately $556.3 million of equity invested by the Owner Participants
and $567.2 million of Subordinated Bonds. The remaining balance of the
Senior Bonds was retired in July 2002.
The Economic Development Corporation of the County of Midland (the
"Tax-Exempt Issuer") has issued certain series of tax-exempt bonds (the
"Tax-Exempt Bonds"), which are issued under and secured by a tax-exempt
collateral trust indenture. The proceeds from the issuance and sale of the
Tax-Exempt Bonds were used to finance certain pollution control assets
constituting a portion of the Facility. Each series of
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Tax-Exempt Bonds is secured solely by a corresponding series of
Subordinated Notes issued by the Owner Trustees, which are secured by a
junior security interest in the undivided interests of the Owner Trustees
in the Facility and certain of their rights under and to the related
Leases, including rents thereunder and the Lease Collateral, including
(subject to the rights of the Working Capital Lender, which include a
prior security interest in certain of MCV's receivables and natural gas
inventory securing the Working Capital Facility) the revenues and other
payments received thereunder. On June 15, 2000, MCV refinanced the
Tax-Exempt Bonds. The Subordinated Notes securing the Tax-Exempt Bonds and
the Subordinated Notes issued by the Owner Trustees to secure the
Subordinated Bonds are secured by junior security interests in a shared
collateral pool.
Security and Sources of Payment
The sole sources of payment for the Senior Bonds and Subordinated Bonds
were certain pledged Senior Notes and pledged Subordinated Notes,
respectively, issued by each of the five Owner Trustees and pledged under
the Senior Bond Indenture and Subordinated Bond Indenture, respectively.
The pledged Senior Notes and pledged Subordinated Notes of each Owner
Trustee are nonrecourse obligations of such Owner Trustee payable solely
from the rental payments made by MCV under its related Lease and the other
security therefor. The Senior Notes were secured by a senior security
interest in such Owner Trustee's undivided interest in the Facility and
certain of its rights under and to the related Lease, including rents and
the Lease collateral, including (subject to the rights of the Working
Capital Lender) the revenues and other payments received thereunder. The
Pledged Subordinated Notes are secured on a proportional basis with the
Subordinated Notes pledged to secure the Tax-Exempt Bonds, by a junior
lien on and security interest in such collateral. Such lien, security
interest and assignment were subordinated to the senior lien, security
interest and assignment securing the Senior Notes issued by such Owner
Trustee (and pledged to secure the Senior Bonds).
Additional Senior Notes may be issued (i) to refinance the Senior Notes,
in whole but not in part, and (ii) to pay certain costs of modifying the
Facility. Additional Subordinated Notes may be issued (i) to refinance any
series of Subordinated Notes, and (ii) to pay certain costs of modifying
the Facility. Any additional Senior and Subordinated Notes will rank
proportionally with all Senior and Subordinated Notes, respectively, then
outstanding. The aggregate principal amount of Senior and Subordinated
Bonds that may be issued is unlimited, provided that at no time may the
aggregate principal amount of Senior and Subordinated Bonds exceed the
aggregate principal amount of Senior and Subordinated Notes, respectively,
then outstanding. The future issuance of additional Senior and
Subordinated Bonds (other than for refinancing purposes) would create
additional claims against the security for the Note Indentures and the
amounts available to repay amounts in respect of the Bonds currently
outstanding in the event of foreclosure.
The rental payments under the Leases are established to provide funds
sufficient to service the debt issued by the Owner Trustees and to provide
the Owner Participants with a return on their equity investment. MCV is
unconditionally obligated to make rental payments under the Leases in
amounts sufficient to provide for scheduled payments of the principal of,
premium, if any, and interest on the Notes, which amounts, in turn, are
equal to scheduled payments of principal of, premium, if any, and interest
on the Bonds. MCV has pledged to each Owner Trustee an undivided interest
percentage of all revenues to be derived from the operation of the
Facility, together with its rights with respect to the PPA, the SEPA, and
various other contracts of MCV relating to the Facility (the "Lease
Collateral") to secure its rental obligations under the Leases. Neither
the Bonds nor the Notes are direct obligations of, or guaranteed by, MCV
nor do any Partners of MCV have any liability under the terms of the
Notes, the Bonds or the Leases. Neither the Partners nor the Partner
affiliates have any obligations under the Leases, and the obligations of
MCV under the Leases and the other documents related to the Overall Lease
Transaction are nonrecourse to the Partners and the Partner affiliates.
Any default or foreclosure with respect to the undivided interest of an
Owner Trustee relates solely to such undivided interest. There is no
cross-collateralization among Owner Trustees and the Subordinated Bond
trustee as holder of the pledged Subordinated Notes. The Leases, however,
contain identical events of default including an event of default related
to a failure by MCV to pay principal of or interest on any indebtedness
for borrowed money or other financing obligations (including lease
obligations) with respect to an amount greater than $10 million.
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Pursuant to the Intercreditor Agreement, a reserve account has been
created for the benefit of the holders of the Notes, which had been
initially funded with $90 million in cash (the "Reserve Account"). The
Intercreditor Agreement sets forth circumstances under which amounts in
the Reserve Account will be adjusted to equal the greater (for so long as
the Senior Bonds are outstanding) or the lesser (after the Senior Bonds
have been paid in full) of $137 million or the debt portion of basic rent
under the Leases payable on the next succeeding basic rent payment date,
and limited circumstances under which no more than $10 million contained
therein may be withdrawn therefrom to provide working capital. As of
December 31, 2002, MCV had funds of $136.6 million in the Reserve Account.
Excess funds in the Reserve Account are periodically transferred to MCV.
Item 2. PROPERTIES
MCV leases the Facility from the Owner Trustees pursuant to the Leases. For a
description of the Facility, see "The Facility." For a description of the
financing arrangements in connection with the lease of the Facility to MCV,
including a description of the liens on the Facility, see "Overall Lease
Transaction."
The Facility is located on the Site, previously the location of Consumers'
abandoned Midland Nuclear Generating Plant in Midland County, Michigan. The Site
contains approximately 1,200 acres, including an 880-acre cooling pond. By a
lease dated as of December 29, 1987, Consumers, as fee simple owner, leased the
land on which the Facility is located to MCV, CMS Midland and MDC (the "Original
Lease"), which was amended and restated in its entirety in 1988. By five
separate instruments, each dated as of June 1, 1990, Consumers and MCV created
undivided interests in the amended Original Lease and amended and restated the
lease to reflect the creation of such interests (the Original Lease as so
amended and restated is referred to as the "Ground Lease"). In connection with
the Overall Lease Transaction, MCV assigned to each Owner Trustee an undivided
interest in the Ground Lease equal to such Owner Trustee's undivided interest
percentage. Each Owner Trustee in turn subleased its undivided interest back to
MCV pursuant to separate subleases of the Site.
In addition to leasing the Site, the Ground Lease assigns to MCV appurtenant
easement rights for a gas pipeline in Midland and Isabella Counties, Michigan
and easements in the City of Midland for a railroad spur track and a water
pipeline. The Ground Lease terminates on December 31, 2035, with two renewal
terms of five years each and with additional renewal terms of two years each.
The annual rental under each of the Ground Leases is equal to the undivided
interest percentage of $600,000 per annum through the two five-year renewal
terms; thereafter, it is fair market rental. The Ground Leases are fully net
leases.
Item 3. LEGAL PROCEEDINGS
In 1997, MCV filed a property tax appeal against the City of Midland at the
Michigan Tax Tribunal contesting MCV's 1997 property taxes. Subsequently, MCV
filed appeals contesting its property taxes for tax years 1998 through 2003 at
the Michigan Tax Tribunal. A trial was held for tax years 1997 - 2000 and for
the appeals for tax years 2001-2003 are being held in abeyance pending the
resolution of the aforesaid trial. MCV is seeking a reduction of its annual
property taxes on the basis that the City of Midland has over assessed the
property's taxable value for ad valorem property tax purposes. MCV Management
cannot predict the outcome of these proceedings.
Other than as discussed in "Regulation" there are no other pending legal
proceedings to which MCV is a party and to which any of its property is subject,
that are material in relation to the consolidated financial statements.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Not applicable.
Item 6. SELECTED FINANCIAL DATA
The following table sets forth certain selected financial data of MCV. The
selected operating and financial position data as of December 31, 2002, 2001,
2000, 1999 and 1998 and for each of the five years ended December 31, 2002 have
been derived from MCV's audited financial statements. This information should be
read in conjunction with "Managements Discussion &Analysis" and the financial
statements and notes thereto included elsewhere herein.
(Dollars in Thousands)
2002 2001 2000 1999 1998
------------- ------------- ------------- ------------- -------------
STATEMENT OF OPERATIONS DATA:
Operating Revenues $ 596,819 $ 610,813 $ 604,547 $ 617,352 $ 627,054
Operating Income 188,124 157,835 212,813 215,884 222,461
Cumulative Effect of Change in Method of
Accounting for Derivative Option Contracts
(to April 1, 2002) (1) 58,131 -- -- -- --
Net Income 132,027 48,264 90,121 80,069 80,327
BALANCE SHEET DATA: (2)
Total Assets 2,098,073 2,117,047 2,274,956 2,299,212 2,286,506
Capitalization
Partners' Equity 734,310 551,712 527,738 437,617 357,548
Long term Debt, Excluding Current
Maturities 1,153,221 1,243,060 1,429,233 1,584,865 1,723,960
(1) Effective April 1, 2002, the FASB issued guidance regarding natural gas
commodity contracts that combine an option component and a forward
component. This guidance requires either that the entire contract be
accounted for as a derivative or the components of the contract be
separated into two discrete contracts. As of April 1, 2002, MCV had nine
long term gas contracts that each contain both an option and forward
component. As such, they are no longer accounted for under the normal
purchases and sales exception and MCV began mark-to-market accounting of
these nine contracts through earnings. Based on the natural gas prices, at
the beginning of April 2002, MCV recorded a $58.1 million gain for the
cumulative effect of this accounting change. Subsequent gains and losses
were recorded as operating costs.
(2) Balance sheet data consists of the balances at December 31.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS ("MD&A")
Results of Operations
Overview
For the year ended December 31, 2002, MCV recorded net income of $132.0 million,
which includes the April 1, 2002 change in method of accounting for long term
gas derivative option contracts. Certain natural gas contracts that contain
optionality are now being marked-to-market through earnings, as required by SFAS
No. 133. The cumulative effect of this accounting change as of April 1, 2002
increased earnings by approximately $58.1 million and additional quarterly
mark-to-market adjustments as of December 31, 2002 resulted in an additional net
earnings increase of $21.9 million. MCV's recorded net income, without the
effects of the accounting change of $80.0
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million, was $52.1 million as compared to net income of $48.3 million for the
year 2001. The earnings increase for the year 2002 compared to 2001, was
primarily due to lower fuel usage and two 2001 one-time charges. In December
2001, MCV expensed $8.2 million in relating to the prepayment of gas costs under
a long term contract with an affiliate of Enron Corporation, which was
subsequently terminated. Also in 2001, MCV expensed $6.7 million in development
costs. Other factors contributing to the earnings increase were lower interest
expense on MCV's financing arrangements and higher electric rates under the PPA,
partially offset by higher natural gas prices under MCV's long term gas
contracts, lower interest income on MCV's invested cash reserves and lower
revenues from energy sales outside of the PPA.
For the year ended December 31, 2001, MCV recorded net income of $48.3 million,
a decrease of $41.8 million as compared to 2000 net income of $90.1 million. Two
one-time items contributed to the decrease in 2001 earnings. A provision of $8.2
million was made relating to the prepayment of gas costs under a long term
contract with an affiliate of Enron Corporation. Also in 2001, MCV expensed $6.7
million in development costs associated with the potential plant expansion
previously under consideration. Other factors contributing to the earnings
decrease for 2001 compared to 2000 were higher fuel costs resulting from higher
natural gas prices in the long term gas contracts and the short-term market,
lower operating margins resulting from a higher electric dispatch under the PPA
with Consumers and lower interest income on MCV's invested cash reserves. This
earnings decrease was partially offset by lower interest expense on MCV's
financing arrangements.
Operating Revenues
The following represents significant operating revenue statistics for the years
ended December 31 (dollars in thousands except average rates):
2002 2001 2000
----------- ----------- ------------
Operating Revenues $ 596,819 $ 610,813 $ 604,547
Capacity Revenue $ 404,713 $ 409,633 $ 410,938
PPA Contract Capacity (MW) 1,240 1,240 1,240
Billed PPA Availability 98.5% 98.5% 98.5%
Electric Revenue $ 177,569 $ 184,707 $ 177,989
PPA Delivery as Percentage of Contract Capacity (1) 70.9% 75.0% 72.1%
PPA, SEPA and Other Electric Deliveries (MWh) 8,275,229 8,811,950 8,535,548
Average PPA Variable Energy Rate ($ / MWh) $ 15.94 $ 15.62 $ 15.68
Average PPA Fixed Energy Rate ($ / MWh) $ 3.89 $ 3.75 $ 3.57
Steam Revenue $ 14,537 $ 16,473 $ 15,620
Steam Deliveries (Mlbs) 5,455,050 5,693,240 5,869,454
(1) Beginning in July 2000, in response to the rapidly escalating cost of
natural gas, MCV entered into transactions with Consumers whereby
Consumers agreed to reduce the dispatch level of the Facility. In the
event of reduced dispatch, MCV agreed to share the savings realized by
not having to generate the electricity.
For the year ended December 31, 2002, MCV's operating revenues decreased $14.0
million from 2001. This decrease is due primarily to a lower electric dispatch
under the PPA with Consumers, lower capacity and energy revenues under summer
electric option agreements with Consumers and other third parties, and lower
energy rates under the SEPA, due to Dow's election to cease tolling of gas. This
decrease was partially offset by an increase in the electric energy rates under
the PPA.
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For the year ended December 31, 2001, MCV's operating revenues increased $6.3
million from 2000. This increase is due primarily to an increase in the electric
dispatch under the PPA with Consumers and due to higher energy rates under the
PPA and SEPA with Dow. This increase was slightly offset by lower capacity
payments under the PPA due to fewer billing days in 2001 and lower third party
energy sales.
Operating Expenses
For the year ended December 31, 2002, MCV's operating expenses were $408.7
million, which includes $255.1 million of fuel costs, including a $21.9 million
mark-to-market net gain on the natural gas contracts which contain optionality.
During this period, MCV purchased approximately 74.6 Bcf of natural gas, and a
net 2.3 Bcf was used for transportation fuel and as a net change to gas in
storage. During this same period, MCV consumed 74.3 Bcf of which 2.0 Bcf of this
total was gas provided by Dow. The average commodity cost of fuel for the year
2002 was $3.23 per MMBtu, which includes the effects of the disposition of
excess gas supplies not required for generation. For the year ended December 31,
2001, MCV's operating expenses were $453.0 million, which includes $288.2
million of fuel costs. During this period, MCV purchased approximately 84.0 Bcf
of natural gas, and a net 4.9 Bcf was injected into storage and used for
transportation fuel. During this same period, MCV consumed 79.1 Bcf. The average
commodity cost of fuel for the year 2001 was $2.94 per MMBtu, which includes the
effects of the disposition of excess gas supplies not required for generation.
Fuel costs for the year 2002 compared to 2001 decreased by $11.2 million,
excluding the $21.9 million mark-to-market net gain. This fuel cost decrease was
primarily due to a lower natural gas usage resulting from a reduction in the
electric dispatch under the PPA and from Dow's election to toll gas; and lower
costs associated with the electric dispatch reduction transaction entered into
with Consumers. Also contributing to this decrease was a 2001 one-time expense
for an $8.2 million provision made relating to the prepayment of gas costs under
a long term contract with an affiliate of Enron. Partially offsetting this
decrease are higher natural gas prices under MCV's long term gas contracts.
For the year ended December 31, 2001, MCV's operating expenses increased $61.3
million from the year 2000, which included a $56.1 million increase in