MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2005


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

For the transition period from _____________________ to _________________

Commission File Number: (Under the Securities Act of 1933) 33-37977

MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP

(Exact name of registrant as specified in its charter)


MICHIGAN		38-2726166

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


100 PROGRESS PLACE, MIDLAND, MICHIGAN		48640

(Address of principal executive offices)		(Zip Code)


Registrant’s telephone number, including area code:		(989) 839-6000

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

PART I FINANCIAL INFORMATION

Item 1 Consolidated Financial Statements (Unaudited)

MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP

CONSOLIDATED BALANCE SHEETS (UNAUDITED) AS OF

(In Thousands)


	March 31,			December 31,
	2005			2004
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	139,494		$	125,781
Accounts and notes receivable – related parties		42,614			54,368
Accounts receivable		52,228			42,984
Gas inventory		9,421			17,509
Unamortized property taxes		40,949			18,060
Derivative assets		252,610			94,977
Broker margin accounts and prepaid expenses		11,204			13,147

Total current assets		548,520			366,826


PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment		2,468,231			2,466,944
Pipeline		21,432			21,432

Total property, plant and equipment		2,489,663			2,488,376
Accumulated depreciation		(1,078,621	)		(1,062,821	)

Net property, plant and equipment		1,411,042			1,425,555


OTHER ASSETS:
Restricted investment securities held-to-maturity		138,812			139,410
Derivative assets, non-current		94,727			24,337
Deferred financing costs, net of accumulated amortization of $18,781 and $18,498, respectively		6,184			6,467
Prepaid gas costs, spare parts deposit, materials and supplies		17,187			17,782

Total other assets		256,910			187,996


TOTAL ASSETS	$	2,216,472		$	1,980,377


LIABILITIES AND PARTNERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued liabilities – related parties	$	15,110		$	12,772
Accounts payable and accrued liabilities		86,381			69,921
Gas supplier funds on deposit		5,207			19,613
Interest payable		53,604			47,738
Current portion of long-term debt		76,548			76,548

Total current liabilities		236,850			226,592


NON-CURRENT LIABILITIES:
Long-term debt		942,097			942,097
Other		1,442			1,712

Total non-current liabilities		943,539			943,809


COMMITMENTS AND CONTINGENCIES (Note 7)

TOTAL LIABILITIES		1,180,389			1,170,401


PARTNERS’ EQUITY		1,036,083			809,976


TOTAL LIABILITIES AND PARTNERS’ EQUITY	$	2,216,472		$	1,980,377

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

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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP

CONSOLIDATED STATEMENTS OF PARTNERS’ EQUITY (UNAUDITED)

(In Thousands)


	Three Months Ended
	March 31,
	2005									2004
	General Partners			Limited Partners			Total			General Partners			Limited Partners			Total
BALANCE, BEGINNING OF PERIOD	$	693,824		$	116,152		$	809,976		$	684,334		$	114,742		$	799,076

Comprehensive Income:

Net income		181,217			26,928			208,145			9,925			1,475			11,400

Other Comprehensive Income:

Unrealized gain on hedging activities since beginning of period		44,416			6,599			51,015			23,428			3,481			26,909

Reclassification adjustments recognized in net income above		(3,268	)		(485	)		(3,753	)		(5,975	)		(888	)		(6,863	)

Dedesignated cash flow hedges (Note 2)		(25,509	)		(3,791	)		(29,300	)		—			—			—


Total other comprehensive income		15,639			2,323			17,962			17,453			2,593			20,046

Total Comprehensive Income		196,856			29,251			226,107			27,378			4,068			31,446


BALANCE, END OF PERIOD	$	890,680		$	145,403		$	1,036,083		$	711,712		$	118,810		$	830,522

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

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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In Thousands)


	Three Months Ended
	March 31,
	2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	208,145		$	11,400

Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation and amortization		22,395			22,590
Decrease (increase) in accounts receivable		2,510			(8,496	)
Decrease in gas inventory		8,088			10,757
Increase in unamortized property taxes		(22,889	)		(25,809	)
Decrease in broker margin accounts and prepaid expenses		1,943			2,216
Increase in derivative assets		(210,061	)		(6,112	)
Decrease in prepaid gas costs, spare parts deposit, materials and supplies		595			615
Increase in accounts payable and accrued liabilities		18,798			31,448
(Decrease) increase in gas supplier funds on deposit		(14,406	)		4,691
Increase (decrease) in interest payable		5,866			(578	)
(Decrease) increase in other non-current liabilities		(270	)		44


Net cash provided by operating activities		20,714			42,766


CASH FLOWS FROM INVESTING ACTIVITIES:
Plant modifications and purchases of plant equipment		(7,599	)		(2,559	)
Maturity of restricted investment securities held-to-maturity		126,353			114,661
Purchase of restricted investment securities held-to-maturity		(125,755	)		(114,736	)


Net cash used in investing activities		(7,001	)		(2,634	)


NET INCREASE IN CASH AND CASH EQUIVALENTS		13,713			40,132

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		125,781			173,651


CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	139,494		$	213,783

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

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MIDLAND COGENERATION VENTURE LIMITED PARTNERSHIP

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

These consolidated financial statements and condensed notes should be read along with the audited financial statements and notes contained in the Annual Report on Form 10-K for the year ended December 31, 2004 of Midland Cogeneration Venture Limited Partnership (“MCV”). In the opinion of management, the unaudited financial information herein reflects all adjustments (which include only normal recurring adjustments) necessary to assure the fair presentation of financial position, results of operations and cash flows for the periods presented. The consolidated financial statements included the accounts of MCV and its wholly-owned subsidiaries. In 1992, MCV had acquired the outstanding common stock of PVCO Corp., a previously inactive company. MCV and PVCO Corp. then entered into a partnership agreement to form MCV Gas Acquisition General Partnership (“MCV GAGP”) for the purpose of buying and selling natural gas on the spot market and other transactions involving natural gas activities. PVCO Corp. and MCV GAGP were dissolved on January 30, 2004 and July 2, 2004, respectively, due to inactivity. All material transactions and balances among entities, which comprised MCV, had been eliminated in the consolidated financial statements. In addition, the dissolution of these wholly-owned subsidiaries had no impact on the financial position and results of operations of MCV. Interim results may not be indicative of results that may be expected for any other interim period or for 2005 as a whole.

(1)   THE PARTNERSHIP AND ASSOCIATED RISKS

    MCV was organized to construct, own and operate a combined-cycle, gas-fired cogeneration facility (the “Facility”) located in Midland, Michigan. MCV was formed on January 27, 1987, and the Facility began commercial operation in 1990.

    The Facility has a net electrical generating capacity of approximately 1500 MW (including approximately 100 MW of duct burner generation, from five of six duct burners, which are currently unavailable for operational use) and approximately 1.5 million pounds of process steam capacity per hour. MCV has entered into three principal energy sales agreements. MCV has contracted to (i) supply up to 1240 MW of electric capacity and energy (“Contract Capacity”) to Consumers Energy Company (“Consumers”) under the Power Purchase Agreement (“PPA”), for resale to its customers through 2025, (ii) supply electricity and steam to The Dow Chemical Company (“Dow”) through 2008 and 2015, respectively, under the Steam and Electric Power Agreement (“SEPA”) and (iii) supply steam to Dow Corning Corporation (“DCC”) under the Steam Purchase Agreement (“SPA”) through 2011. From time to time, MCV enters into other sales agreements for the sale of excess electric capacity and/or energy available above MCV’s internal use and obligations under the PPA, SEPA and SPA. Results of operations are primarily dependent on successfully operating the Facility at or near contractual capacity levels and on Consumers’ ability to perform its obligations under the PPA. Sales pursuant to the PPA have historically accounted for over 90% of MCV’s revenues.

    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 Michigan Public Service Commission (“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 kilowatt-hour for the available Contract Capacity notwithstanding the “regulatory-out” provision. Consumers and MCV are required to support and defend the terms of the PPA.

    The Facility is a qualifying cogeneration facility (“QF”) originally certified by the Federal Energy Regulatory Commission (“FERC”) under the Public Utility Regulatory Policies Act of 1978, as amended (“PURPA”). In order to maintain QF status, certain operating and efficiency standards must be maintained on a calendar-year basis and certain ownership limitations must be met. In the case of a topping-cycle generating plant such as the Facility, the applicable operating standard requires that the portion of total energy output that is put to some useful purpose other than facilitating the production of power (the “Thermal Percentage”) be at least 5%. In addition, the Facility must achieve a PURPA efficiency standard (the sum of the useful power output plus one-half of the useful thermal energy output, divided by the energy input (the “Efficiency Percentage”)) of at least 45%. If the Facility maintains a Thermal Percentage of 15% or higher, the required Efficiency Percentage is reduced to 42.5%. Since 1990, the Facility has achieved the applicable Thermal and Efficiency Percentages. For the three months ended March 31, 2005, the Facility achieved a Thermal Percentage of 24.0% and an Efficiency Percentage of 47.5%. The loss of QF status could, among other things, cause the Facility to lose its

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

    rights under PURPA to sell power to Consumers at Consumers’ “avoided cost” and subject the Facility to additional federal and state regulatory requirements.

    The Facility is wholly dependent upon natural gas for its fuel supply and a substantial portion of the Facility’s operating expenses consist of the costs of natural gas. MCV recognizes that its existing gas contracts are not sufficient to satisfy the anticipated gas needs over the term of the PPA and, as such, no assurance can be given as to the availability or price of natural gas after the expiration of the existing gas contracts. In addition, to the extent that the costs associated with production of electricity rise faster than the energy charge payments, MCV’s financial performance will be negatively affected. The extent of such impact will depend upon the amount of the average energy charge payable under the PPA, which is based upon costs incurred at Consumers’ coal-fired plants and upon the amount of energy scheduled by Consumers for delivery under the PPA. However, given the unpredictability of these factors, the overall economic impact upon MCV of changes in energy charges payable under the PPA and in future fuel costs under new or existing contracts cannot accurately be predicted.

    In 2004, MCV and Consumers entered into a Resource Conservation Agreement (“RCA”) and a Reduced Dispatch Agreement (“RDA”) which, among other things, provides that Consumers will economically dispatch MCV, based upon the market price of natural gas, if certain conditions are met. Such dispatch is expected to reduce electric production from historic levels, as well as decrease gas consumption by MCV. The RCA provides that Consumers has a right of first refusal to purchase, at market prices, the gas conserved under the RCA. The RCA and RDA provide for the sharing of savings realized by not having to generate electricity. The RCA and RDA were approved by the MPSC on January 25, 2005 and MCV and Consumers accepted the terms of the MPSC order. The RCA and RDA became effective January 27, 2005. This MPSC order has been appealed by certain parties. MCV management cannot predict the final outcome of this appeal. While awaiting approval of the RCA and RDA, effective October 23, 2004, MCV and Consumers entered into an interim Dispatch Mitigation program for energy dispatch above 1100 MW up to 1240 MW of Contract Capacity under the PPA. This program, which was structured very similarly to the RCA and RDA, was terminated on January 27, 2005 with the effective date of the RCA/RDA which superceded this interim program.

    At both the state and federal level, efforts continue to restructure the electric industry. 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. At the state level, the MPSC entered a series of orders from June 1997 through February 1998 (collectively the “Restructuring Orders”), mandating that utilities “wheel” third-party power to the utilities’ customers, thus permitting customers to choose their power provider. MCV, as well as others, filed an appeal in the Michigan Court of Appeals to protect against denial of recovery by Consumers of PPA charges. The Michigan Court of Appeals found that the Restructuring Orders do not unequivocally disallow such recovery 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. 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 QFs (like MCV), including the rights to have the PPA charges recovered from customers of the utilities, are not abrogated or diminished, and permits utilities to securitize certain stranded costs, including PPA charges.

    In 1999, the U.S. District Court granted summary judgment to MCV declaring 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 2001, the United States Court of Appeals (“Appellate Court”) vacated the U.S. District Court’s 1999 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 time and the QFs’ (including MCV) claims are premised on speculation about how an order might be interpreted by the MPSC, in the future.

    Two significant issues that could affect MCV’s future financial performance are the price of natural gas and Consumers’ ability/obligation to pay PPA charges. Natural gas prices have historically been volatile and

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

    presently there is no consensus among forecasters on the price or range of future prices of natural gas. Even with an approved RCA and RDA, if gas prices continue at present levels or increase, the economics of operating the Facility may be adversely affected. Consumers’ ability/obligation to pay PPA charges may be affected by an MPSC order denying Consumers recovery from ratepayers. This issue is likely to be addressed in the timeframe of 2007 or beyond. MCV continues to monitor and participate in these matters as appropriate, and to evaluate potential impacts on both cash flows and recoverability of the carrying value of property, plant and equipment. MCV management cannot, at this time, predict the impact or outcome of these matters.

(2)   RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS

    Fair Value of Financial Instruments

    The carrying amounts of cash, cash equivalents and short-term investments approximate fair value because of the short maturity of these instruments. MCV’s short-term investments, which are made up of investment securities held-to-maturity, as of March 31, 2005 and December 31, 2004, have original maturity dates of approximately one year or less. The unique nature of the negotiated financing obligation discussed in Note 6 makes it unnecessary to estimate the fair value of the lessor group (“Owner Participants”) underlying debt and equity instruments supporting such financing obligation, since Statement of Financial Accounting Standards (“SFAS”) No. 107, “Disclosures about Fair Value of Financial Instruments” does not require fair value accounting for the lease obligation.

    Accounting for Derivative Instruments and Hedging Activities

    Effective January 1, 2001, MCV adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” which was issued in June 1998 and then amended by SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities – Deferral of the Effective Date of SFAS No. 133,” SFAS No. 138 “Accounting for Certain Derivative Instruments and Certain Hedging Activities – An amendment of FASB Statement No. 133” and SFAS No. 149 “Amendment of Statement 133 on Derivative Instruments and Hedging Activity (collectively referred to as “SFAS No. 133”). SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in a derivative’s fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges in some cases allows a derivative’s gains and losses to offset related results on the hedged item in the income statement or permits recognition of the hedge results in other comprehensive income, and requires that a company formally document, designate and assess the effectiveness of transactions that receive hedge accounting.

    Electric Sales Agreements

    MCV believes that its electric sales agreements currently do not qualify as derivatives under SFAS No. 133, due to the lack of an active energy market (as defined by SFAS No. 133) in the State of Michigan and the transportation cost to deliver the power under the contracts to the closest active energy market at the Cinergy hub in Ohio and as such does not record the fair value of these contracts on its balance sheet. If an active energy market emerges, MCV intends to apply the normal purchase, normal sales exception under SFAS No. 133 to its electric sales agreements, to the extent such exception is applicable.

    Natural Gas Supply Contracts

    MCV management believes that its long-term natural gas contracts, except for those which contain volume optionality and the long term gas contracts under the RCA/RDA, qualify under SFAS No. 133 for the normal purchases and normal sales exception. Therefore, these contracts are currently not recognized at fair value on the balance sheet.

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

Mark-to-Market Activity

MCV holds certain long-term gas contracts that do not qualify for the normal purchases and sales exception, under SFAS No. 133, because (1) these gas contracts contain volume optionality and/or (2) are gas contracts associated with the implementation of the RCA/RDA in January 2005. With the implementation of the RCA/RDA, MCV determined that additional gas contracts no longer qualified under the normal purchases and sales exception, because the contracted gas will not be consumed for electric production. Therefore, both the contracts with volume optionality and the contracts affected by the RCA/RDA, are being accounted for as derivatives, which do not qualify for hedge accounting treatment. In addition, the financial hedges associated with the long-term gas contracts now under the RCA/RDA were previously recognized as cash flow hedges in other comprehensive income and were dedesignated as hedges in the first quarter of 2005 and marked-to-market through earnings since the previously hedged long-term gas contracts no longer qualify for the normal purchase and sales exception. MCV expects future earnings volatility on all of these contracts as changes in the mark-to-market recognition are recorded in earnings on a quarterly basis.

The cumulative mark-to-market gain through March 31, 2005 of $264.9 million is recorded as a current and non-current derivative asset on the balance sheet, as detailed below. These assets will reverse over the remaining life of these contracts. For the three months ended March 31, 2005, MCV recorded in “Fuel costs” a gain of $209.3 million for the net mark-to-market adjustment associated with these contracts. In addition, as of March 31, 2005 and December 31, 2004, MCV recorded “Derivative assets” in Current Assets in the amount of $170.2 million and $31.4 million, respectively, and for the same periods recorded “Derivative assets, non-current” in Other Assets in the amount of $94.7 million and $24.3 million, respectively, representing the mark-to-market value on these long-term natural gas contracts.

Natural Gas Supply Futures and Options Which Qualify for Hedge Accounting

To manage market risks associated with the volatility of natural gas prices, MCV maintains a gas hedging program. MCV enters into natural gas futures contracts, option contracts, and over the counter swap transactions (“OTC swaps”) in order to hedge against unfavorable changes in the market price of natural gas in future months when gas is expected to be needed. These financial instruments are being utilized principally to secure anticipated natural gas requirements necessary for projected electric and steam sales, and to lock in sales prices of natural gas previously obtained in order to optimize MCV’s existing gas supply, storage and transportation arrangements.

These financial instruments are derivatives under SFAS No. 133 and the contracts that are utilized to secure the anticipated natural gas requirements necessary for projected electric and steam sales qualify as cash flow hedges under SFAS No. 133, since they hedge the price risk associated with the cost of natural gas. MCV also engages in cost mitigation activities to offset the fixed charges MCV incurs in operating the Facility. These cost mitigation activities include the use of futures and options contracts to purchase and/or sell natural gas to maximize the use of the transportation and storage contracts when it is determined that they will not be needed for Facility operation. Although these cost mitigation activities do serve to offset the fixed monthly charges, these cost mitigation activities are not considered a normal course of business for MCV and do not qualify as hedges under SFAS No. 133. Therefore, the resulting mark-to-market gains and losses from cost mitigation activities are flowed through MCV’s earnings.

Cash is deposited with a broker in a margin account at the time futures or options contracts are initiated. The change in market value of these contracts requires adjustment of the margin account balances. The margin account balance as of March 31, 2005 and December 31, 2004 was recorded as a current asset in “Broker margin accounts and prepaid expenses,” in the amount of $7.2 million and $1.4 million, respectively.

For the three months ended March 31, 2005, MCV has recognized in other comprehensive income, an unrealized gain of $18.0 million on the gas futures contracts and OTC swaps, which are hedges of forecasted purchases for plant use of market priced gas. This resulted in a net $83.7 million gain in other comprehensive income as of March 31, 2005. This balance represents natural gas futures, options and OTC swaps with maturities ranging from April 2005 to December 2009, of which $20.3 million of this gain is expected to be

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

    reclassified into earnings within the next twelve months. MCV also has recorded, as of March 31, 2005, an $82.4 million current derivative asset in “Derivative assets,” representing the mark-to-market gain on natural gas futures for anticipated projected electric and steam sales accounted for as hedges. In addition, for the three months ended March 31, 2005, MCV has recorded a net $10.8 million gain in earnings from hedging activities related to MCV natural gas requirements for Facility operations.

    For the three months ended March 31, 2004, MCV recognized an unrealized $20.0 million increase in other comprehensive income on the futures contracts, which are hedges of forecasted purchases for plant use of market priced gas, which resulted in a net $51.3 million gain in other comprehensive income as of March 31, 2004. For the three months ended March 31, 2004, MCV had recorded a net $5.2 million gain in earnings from hedging activities related to MCV natural gas requirements for Facility operations and a net $1.0 million gain in earnings from cost mitigation activities.

(3)   RESTRICTED INVESTMENT SECURITIES HELD-TO-MATURITY

    Non-current restricted investment securities held-to-maturity have carrying amounts that approximate fair value because of the short maturity of these instruments and consist of the following as of (in thousands):


	March 31,		December 31,
	2005		2004
Funds restricted for rental payments pursuant to the Overall
Lease Transaction	$	137,369	$	138,150

Funds restricted for management non-qualified plans		1,443		1,260


Total	$	138,812	$	139,410

(4) ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities consist of the following as of (in thousands):


	March 31,		December 31,
	2005		2004
Accounts Payable – Related Parties	$	15,110	$	12,772


Accounts Payable – Non-related
Trade creditors	$	50,634	$	53,476
Property and single business taxes		30,464		11,833
Other		5,283		4,612


Total Accounts Payable – Non-related	$	86,381	$	69,921

(5) GAS SUPPLIER FUNDS ON DEPOSIT

Pursuant to individual gas contract terms with counterparties, deposit amounts or letters of credit may be required by one party to the other based upon the net amount of exposure. The net amount of exposure will vary with changes in market prices, credit provisions and various other factors. Collateral paid or received will be posted by one party to the other based on the net amount of the exposure. Interest is earned on funds on deposit. As of March 31, 2005, MCV is supplying credit support to a gas supplier in the form of a letter of credit in the amount of $2.4 million. As of March 31, 2005, MCV is holding $5.2 million of cash on deposit from one of MCV’s brokers. In addition as of March 31, 2005, MCV is also holding letters of credit totaling $281.6 million from four gas suppliers, of which $250.6 million is a letter of credit from El Paso Corporation (“El Paso”), a related party.

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		Page
PART I	FINANCIAL INFORMATION

Item 1.	Consolidated Financial Statements (Unaudited)		2

	Consolidated Balance Sheets		2

	Consolidated Statements of Operations		3

	Consolidated Statements of Partners’ Equity		4

	Consolidated Statements of Cash Flows		5

	Condensed Notes to Unaudited Consolidated Financial Statements		6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)		15

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		21

Item 4.	Controls and Procedures		22

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings		24

Item 6.	Exhibits		25

Signatures			26

Certifications			27
302 Certification of Chief Executive Officer
302 Certification of Chief Financial Officer
906 Certification of Chief Executive Officer
906 Certification of Chief Financial Officer


	Three Months Ended
	March 31,
	2005			2004
OPERATING REVENUES:
Capacity	$	99,522		$	100,660
Electric		44,510			54,229
Steam		6,027			5,618


Total operating revenues		150,059			160,507


OPERATING EXPENSES:
Fuel costs (Note 2)		(119,924	)		81,835
Depreciation		22,112			22,267
Operations		4,376			4,757
Maintenance		2,236			3,654
Property and single business taxes		7,337			7,163
Administrative, selling and general		2,800			2,890


Total operating expenses		(81,063	)		122,566


OPERATING INCOME		231,122			37,941


OTHER INCOME (EXPENSE):
Interest and other income		2,136			1,167
Interest expense		(25,113	)		(27,708	)


Total other income (expense), net		(22,977	)		(26,541	)


NET INCOME	$	208,145		$	11,400

Table of Contents

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(1)	THE PARTNERSHIP AND ASSOCIATED RISKS

	MCV was organized to construct, own and operate a combined-cycle, gas-fired cogeneration facility (the “Facility”) located in Midland, Michigan. MCV was formed on January 27, 1987, and the Facility began commercial operation in 1990.

	The Facility has a net electrical generating capacity of approximately 1500 MW (including approximately 100 MW of duct burner generation, from five of six duct burners, which are currently unavailable for operational use) and approximately 1.5 million pounds of process steam capacity per hour. MCV has entered into three principal energy sales agreements. MCV has contracted to (i) supply up to 1240 MW of electric capacity and energy (“Contract Capacity”) to Consumers Energy Company (“Consumers”) under the Power Purchase Agreement (“PPA”), for resale to its customers through 2025, (ii) supply electricity and steam to The Dow Chemical Company (“Dow”) through 2008 and 2015, respectively, under the Steam and Electric Power Agreement (“SEPA”) and (iii) supply steam to Dow Corning Corporation (“DCC”) under the Steam Purchase Agreement (“SPA”) through 2011. From time to time, MCV enters into other sales agreements for the sale of excess electric capacity and/or energy available above MCV’s internal use and obligations under the PPA, SEPA and SPA. Results of operations are primarily dependent on successfully operating the Facility at or near contractual capacity levels and on Consumers’ ability to perform its obligations under the PPA. Sales pursuant to the PPA have historically accounted for over 90% of MCV’s revenues.

	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 Michigan Public Service Commission (“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 kilowatt-hour for the available Contract Capacity notwithstanding the “regulatory-out” provision. Consumers and MCV are required to support and defend the terms of the PPA.

	The Facility is a qualifying cogeneration facility (“QF”) originally certified by the Federal Energy Regulatory Commission (“FERC”) under the Public Utility Regulatory Policies Act of 1978, as amended (“PURPA”). In order to maintain QF status, certain operating and efficiency standards must be maintained on a calendar-year basis and certain ownership limitations must be met. In the case of a topping-cycle generating plant such as the Facility, the applicable operating standard requires that the portion of total energy output that is put to some useful purpose other than facilitating the production of power (the “Thermal Percentage”) be at least 5%. In addition, the Facility must achieve a PURPA efficiency standard (the sum of the useful power output plus one-half of the useful thermal energy output, divided by the energy input (the “Efficiency Percentage”)) of at least 45%. If the Facility maintains a Thermal Percentage of 15% or higher, the required Efficiency Percentage is reduced to 42.5%. Since 1990, the Facility has achieved the applicable Thermal and Efficiency Percentages. For the three months ended March 31, 2005, the Facility achieved a Thermal Percentage of 24.0% and an Efficiency Percentage of 47.5%. The loss of QF status could, among other things, cause the Facility to lose its

	rights under PURPA to sell power to Consumers at Consumers’ “avoided cost” and subject the Facility to additional federal and state regulatory requirements.

	The Facility is wholly dependent upon natural gas for its fuel supply and a substantial portion of the Facility’s operating expenses consist of the costs of natural gas. MCV recognizes that its existing gas contracts are not sufficient to satisfy the anticipated gas needs over the term of the PPA and, as such, no assurance can be given as to the availability or price of natural gas after the expiration of the existing gas contracts. In addition, to the extent that the costs associated with production of electricity rise faster than the energy charge payments, MCV’s financial performance will be negatively affected. The extent of such impact will depend upon the amount of the average energy charge payable under the PPA, which is based upon costs incurred at Consumers’ coal-fired plants and upon the amount of energy scheduled by Consumers for delivery under the PPA. However, given the unpredictability of these factors, the overall economic impact upon MCV of changes in energy charges payable under the PPA and in future fuel costs under new or existing contracts cannot accurately be predicted.

	In 2004, MCV and Consumers entered into a Resource Conservation Agreement (“RCA”) and a Reduced Dispatch Agreement (“RDA”) which, among other things, provides that Consumers will economically dispatch MCV, based upon the market price of natural gas, if certain conditions are met. Such dispatch is expected to reduce electric production from historic levels, as well as decrease gas consumption by MCV. The RCA provides that Consumers has a right of first refusal to purchase, at market prices, the gas conserved under the RCA. The RCA and RDA provide for the sharing of savings realized by not having to generate electricity. The RCA and RDA were approved by the MPSC on January 25, 2005 and MCV and Consumers accepted the terms of the MPSC order. The RCA and RDA became effective January 27, 2005. This MPSC order has been appealed by certain parties. MCV management cannot predict the final outcome of this appeal. While awaiting approval of the RCA and RDA, effective October 23, 2004, MCV and Consumers entered into an interim Dispatch Mitigation program for energy dispatch above 1100 MW up to 1240 MW of Contract Capacity under the PPA. This program, which was structured very similarly to the RCA and RDA, was terminated on January 27, 2005 with the effective date of the RCA/RDA which superceded this interim program.

	At both the state and federal level, efforts continue to restructure the electric industry. 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. At the state level, the MPSC entered a series of orders from June 1997 through February 1998 (collectively the “Restructuring Orders”), mandating that utilities “wheel” third-party power to the utilities’ customers, thus permitting customers to choose their power provider. MCV, as well as others, filed an appeal in the Michigan Court of Appeals to protect against denial of recovery by Consumers of PPA charges. The Michigan Court of Appeals found that the Restructuring Orders do not unequivocally disallow such recovery 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. 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 QFs (like MCV), including the rights to have the PPA charges recovered from customers of the utilities, are not abrogated or diminished, and permits utilities to securitize certain stranded costs, including PPA charges.

	In 1999, the U.S. District Court granted summary judgment to MCV declaring 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 2001, the United States Court of Appeals (“Appellate Court”) vacated the U.S. District Court’s 1999 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 time and the QFs’ (including MCV) claims are premised on speculation about how an order might be interpreted by the MPSC, in the future.

	Two significant issues that could affect MCV’s future financial performance are the price of natural gas and Consumers’ ability/obligation to pay PPA charges. Natural gas prices have historically been volatile and

	presently there is no consensus among forecasters on the price or range of future prices of natural gas. Even with an approved RCA and RDA, if gas prices continue at present levels or increase, the economics of operating the Facility may be adversely affected. Consumers’ ability/obligation to pay PPA charges may be affected by an MPSC order denying Consumers recovery from ratepayers. This issue is likely to be addressed in the timeframe of 2007 or beyond. MCV continues to monitor and participate in these matters as appropriate, and to evaluate potential impacts on both cash flows and recoverability of the carrying value of property, plant and equipment. MCV management cannot, at this time, predict the impact or outcome of these matters.

(2)	RISK MANAGEMENT ACTIVITIES AND DERIVATIVE TRANSACTIONS

	Fair Value of Financial Instruments

	The carrying amounts of cash, cash equivalents and short-term investments approximate fair value because of the short maturity of these instruments. MCV’s short-term investments, which are made up of investment securities held-to-maturity, as of March 31, 2005 and December 31, 2004, have original maturity dates of approximately one year or less. The unique nature of the negotiated financing obligation discussed in Note 6 makes it unnecessary to estimate the fair value of the lessor group (“Owner Participants”) underlying debt and equity instruments supporting such financing obligation, since Statement of Financial Accounting Standards (“SFAS”) No. 107, “Disclosures about Fair Value of Financial Instruments” does not require fair value accounting for the lease obligation.

	Accounting for Derivative Instruments and Hedging Activities

	Effective January 1, 2001, MCV adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” which was issued in June 1998 and then amended by SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities – Deferral of the Effective Date of SFAS No. 133,” SFAS No. 138 “Accounting for Certain Derivative Instruments and Certain Hedging Activities – An amendment of FASB Statement No. 133” and SFAS No. 149 “Amendment of Statement 133 on Derivative Instruments and Hedging Activity (collectively referred to as “SFAS No. 133”). SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in a derivative’s fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges in some cases allows a derivative’s gains and losses to offset related results on the hedged item in the income statement or permits recognition of the hedge results in other comprehensive income, and requires that a company formally document, designate and assess the effectiveness of transactions that receive hedge accounting.

	Electric Sales Agreements

	MCV believes that its electric sales agreements currently do not qualify as derivatives under SFAS No. 133, due to the lack of an active energy market (as defined by SFAS No. 133) in the State of Michigan and the transportation cost to deliver the power under the contracts to the closest active energy market at the Cinergy hub in Ohio and as such does not record the fair value of these contracts on its balance sheet. If an active energy market emerges, MCV intends to apply the normal purchase, normal sales exception under SFAS No. 133 to its electric sales agreements, to the extent such exception is applicable.

	Natural Gas Supply Contracts

	MCV management believes that its long-term natural gas contracts, except for those which contain volume optionality and the long term gas contracts under the RCA/RDA, qualify under SFAS No. 133 for the normal purchases and normal sales exception. Therefore, these contracts are currently not recognized at fair value on the balance sheet.

(5)	GAS SUPPLIER FUNDS ON DEPOSIT

	Pursuant to individual gas contract terms with counterparties, deposit amounts or letters of credit may be required by one party to the other based upon the net amount of exposure. The net amount of exposure will vary with changes in market prices, credit provisions and various other factors. Collateral paid or received will be posted by one party to the other based on the net amount of the exposure. Interest is earned on funds on deposit. As of March 31, 2005, MCV is supplying credit support to a gas supplier in the form of a letter of credit in the amount of $2.4 million. As of March 31, 2005, MCV is holding $5.2 million of cash on deposit from one of MCV’s brokers. In addition as of March 31, 2005, MCV is also holding letters of credit totaling $281.6 million from four gas suppliers, of which $250.6 million is a letter of credit from El Paso Corporation (“El Paso”), a related party.