Back to GetFilings.com

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-K

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

For the fiscal year ended December 31, 2002

Commission file number 1-7310

Michigan Consolidated Gas Company, a Michigan corporation, meets the conditions set forth in General Instruction I (1) (a) and (b) of Form 10-K and is, therefore, filing this form with the reduced disclosure format.

MICHIGAN CONSOLIDATED GAS COMPANY
(Exact name of registrant as specified in its charter)

313-965-2430
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

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.                

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 amendments to this Form 10-K. [ X ]

All of the registrant’s 10,300,000 outstanding shares of common stock, par value $1 per share, are indirectly owned by DTE Energy Company.

DOCUMENTS INCORPORATED BY REFERENCE

None

Table of Contents

MICHIGAN CONSOLIDATED GAS COMPANY

ANNUAL REPORT ON FORM 10-K
YEAR ENDED DECEMBER 31, 2002

TABLE OF CONTENTS

Table of Contents

DEFINITIONS

1

Table of Contents

2

Table of Contents

FORWARD-LOOKING STATEMENTS

Certain information presented herein includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve certain risks and uncertainties that may cause actual future results to differ materially from those contemplated, projected, estimated or budgeted in such forward-looking statements. There are many factors that may impact forward-looking statements including, but not limited to, the following:

•		the effects of weather and other natural phenomena on operations and sales to customers;
•		economic climate and growth in the geographic areas where we do business;
•		environmental issues, including changes in the climate, and regulations;
•		implementation of gas Customer Choice programs;
•		implementation of gas utility restructuring in Michigan;
•		employee relations;
•		access to capital markets and capital market conditions and other financing efforts which can be affected by credit agency ratings;
•		the timing and extent of changes in interest rates;
•		the level of borrowings;
•		changes in the cost of natural gas;
•		effects of competition;
•		impact of FERC and MPSC proceedings and regulations;
•		changes in federal or state tax laws and their interpretations, including the code, regulations, rulings, court proceedings and audits;
•		ability to recover costs through rate increases;
•		property insurance;
•		the cost of protecting assets against or damage due to terrorism; and
•		changes in accounting standards and financial reporting regulations.

New factors emerge from time to time. We cannot predict what factors may arise or how such factors may cause our results to differ materially from those contained in any forward-looking statement. Any forward-looking statement speaks only as of the date on which such statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.

3

Table of Contents

PART I

Item 1 & 2. Business & Properties

DESCRIPTION

Michigan Consolidated Gas Company (MichCon or the Company) is a Michigan corporation organized in 1898. MichCon is an indirect, wholly-owned subsidiary of Enterprises, an exempt holding company under the Public Utility Holding Company Act of 1935, successor to MCN Energy. MichCon is a natural gas utility subject to regulation by the MPSC. MichCon is engaged in the purchase, storage, transmission and distribution of natural gas in the state of Michigan. MichCon also has subsidiaries involved in the gathering and transmission of natural gas in northern Michigan. MichCon operates one of the largest natural gas distribution and transmission systems in the United States and the largest in Michigan.

MichCon serves approximately 1.2 million residential, commercial and industrial customers located throughout Michigan. MichCon had approximately $2.4 billion in assets at December 31, 2002 and revenues of approximately $1.3 billion in 2002.

On May 31, 2001, DTE Energy completed the acquisition of MCN Energy. At that time, MCN Energy merged with Enterprises, with Enterprises being the surviving corporation. See Note 3 for a further discussion of the MCN Energy merger.

References in this report to “we”, “us”, and “our” are to MichCon.

A discussion of the services we provide, and the amount and percentage of revenue contributed from such services follows:

•		Gas Sales–Includes the sale and delivery of natural gas primarily to residential and small-volume commercial and industrial customers.
•		End User Transportation–A gas delivery service provided primarily to large-volume commercial and industrial customers. Additionally, the service is provided to residential customers, and small-volume commercial and industrial customers who have elected to participate in our Customer Choice program. End user transportation customers purchase natural gas directly from producers or brokerage companies and utilize our pipeline network to transport the gas to their facilities or homes.

4

Table of Contents

•		Intermediate Transportation–A gas delivery service provided to producers, brokers and other gas companies that own the natural gas, but are not the ultimate consumers. Intermediate transportation customers utilize our gathering and high-pressure transmission system to transport the gas to storage fields, processing plants, pipeline interconnections or other locations.
•		Other–Includes revenues from providing appliance maintenance, facility development and other energy-related services.

We expect to achieve modest revenue growth through initiatives to expand our gas markets, our residential, commercial and industrial customer base, as well as by continuing to provide energy-related services that capitalize on our expertise, capabilities and efficient systems.

Our operations are not dependent upon a limited number of customers, and the loss of any one or a few customers is not reasonably likely to have a material adverse effect on MichCon.

Our gas sales, end user transportation and intermediate transportation volumes, revenues and net income are impacted by weather. Given the seasonal nature of the business, revenues and net income are concentrated in the first and fourth quarters of the calendar year. By the end of the first quarter, the heating season is largely over, and we typically realize substantially reduced revenues and earnings in the second quarter and losses in the third quarter.

We obtain our natural gas supply from various sources in different geographic areas (the Gulf Coast, the Mid-Continent, Canada and Michigan) under agreements that vary in both pricing and terms. Because of our geographic diversity of supply and our 124 Bcf of storage capacity, we are able to reliably meet our supply requirements.

We have purchase commitments of approximately 140 billion cubic feet (Bcf), or 89% of our normal 2003 gas supply requirement. We have entered into fixed-price contracts for approximately 97 Bcf or 62% of our expected 2003 supply requirements. The balance of the gas supply requirement is expected to be met by purchasing gas at market prices. At December 31, 2002, we owned and operated four natural gas storage fields in Michigan with a working storage capacity of approximately 124 Bcf. These facilities play an important role in providing reliable and cost-effective service to our customers. Generally, we use our storage capacity to supplement our supply during the winter months, replacing the gas in April through October when demand and prices are historically at lower levels. The use of storage capacity also allows us to lower our peak-day entitlements, thereby reducing interstate pipeline charges. Our gas distribution system has a planned maximum daily send-out capacity of 3.0 Bcf, with approximately 56% of the volume coming from underground storage for 2002. Gas costs are recovered through the gas cost recovery (GCR) mechanism.

5

Table of Contents

Following is a listing of our sources of gas supply:

We have long-term firm transportation agreements expiring on various dates through 2011 with ANR Pipeline Company (ANR), Panhandle Eastern Pipeline Company (Panhandle), Viking Gas Transmission Company (Viking) and Great Lakes Gas Transmission Limited Partnership (Great Lakes). The ANR capacity delivers 153.5 MMcf/d of supply sourced from the Gulf Coast, 41.5 MMcf/d sourced from the Midcontinent and 50 MMcf/d from Canada. Viking transports the 50 MMcf/d of Canadian supply to the ANR system for delivery to us. Panhandle transports 2 MMcf/d of Gulf Coast supply from the ANR system for delivery to us and 40 MMcf/Day from the Mid-Continent production area to our system. Additional Canadian supplies of 30 MMcf/d are delivered through firm transport agreements with Great Lakes.

ANR will transport for us up to 245 million cubic feet per day (MMcf/d) of supply through October 2003. Effective in November 2003, 100 MMcf/Day of this capacity is due to expire. We intend to replace this capacity through a competitive bid process among several reliable transport service gas supply providers.

We have supply contracts with independent Michigan producers, which expire on various dates through 2007. Many of these contracts tie prices to spot market indices coupled with transportation rates.

REGULATION

We are subject to the regulatory jurisdiction of the MPSC, which issues orders pertaining to rates, recovery of certain costs, including the costs of regulatory assets, conditions of service, accounting and other operating-related matters. We are subject to the requirements of other regulatory agencies with respect to safety, the environment and health.

In the late 1990’s, the MPSC began an initiative designed to give all of Michigan’s natural gas customers added choices and the opportunity to benefit from lower gas costs resulting from competition. In 1999, the MPSC approved a comprehensive, experimental three-year gas Customer Choice program that allowed an increasing number of customers to purchase natural gas from suppliers other than their local utility. The local utility would continue to transport the natural gas supply to the customers’ facilities, thereby retaining distribution margins. In December 2001, the MPSC issued an order that continues the gas Customer Choice program on a permanent and expanding basis beginning with the conclusion of the three-year temporary program on March 31, 2002. Under the expanded program, which began April 1, 2002, up to approximately 40% of our customers could elect to purchase gas from suppliers other than MichCon. Beginning in April 2003, up to approximately 60% of customers could participate and

6

Table of Contents

beginning April 2004, all 1.2 million of our gas customers could choose to participate. We will continue to transport and deliver the gas to the participating customers’ premises at prices that generate favorable margins.

Under the December 2001 MPSC order, we returned to a GCR mechanism in January 2002 upon termination of the temporary Gas Sales Program. The GCR permits us to pass the cost of natural gas to our customers. Under the Gas Sales Program, the MPSC suspended the GCR mechanism and our sales rates included a gas commodity component that was fixed at $2.95 per thousand cubic feet (Mcf). Under this program, we incurred commodity price risk associated with our ability to secure gas supplies at prices less than $2.95 per Mcf. Beginning in January 2002, our gas sales rates include a gas commodity component designed to recover our actual gas costs.

In November 2002, the MPSC requested Michigan gas and electric utilities to justify why their retail rates should not be lowered due to potential personal property tax reductions. We have responded and await further MPSC action.

For additional information regarding our regulatory environment, see Note 5 - Regulatory Matters.

PROPERTIES

We own distribution, transmission and storage properties and facilities that are all located in the state of Michigan.

At December 31, 2002, our distribution system included 17,774 miles of distribution mains, 1,136,863 service lines and 1,241,516 active meters. We own 2,581 miles of transmission lines that deliver natural gas to the distribution districts and interconnect our storage fields with the sources of supply and the market areas. We own properties relating to four underground natural gas storage fields with an aggregate working gas storage capacity of approximately 124 Bcf.

Substantially all of our property is subject to the lien of our Indenture of Mortgage and Deed of Trust under which our First Mortgage Bonds are issued. Some properties are being fully utilized, and new properties are being added to meet the expansion requirements of existing areas. Our capital investments for 2002 totaled $90 million, which compares with $111 million in 2001 and $118 million in 2000.

Our subsidiaries own a 67-mile gathering pipeline that transports natural gas and natural gas liquids from reserves in east-central Michigan to natural gas processing plants in northern Michigan and 134 miles of gathering lines and a 2,400 horsepower compressor station located in northern Michigan. Other MichCon subsidiaries have a 46% interest in a partnership that owns lateral lines related to the 67-mile gathering pipeline and an 83% interest in an additional 32-miles of gathering pipelines in northern Michigan. We lease a portion of our pipeline system to the Vector Pipeline Partnership through a capital lease arrangement (Note 10).

STRATEGY & COMPETITION

We generate approximately 95% of our revenues from providing gas sales, and end user and intermediate transportation services. We continue to take steps to become the preferred provider of natural gas and high-value energy services within Michigan in order to achieve competitive financial results. We expect modest growth and to control costs in order to provide customers high-quality service at competitive prices. To accomplish this, we continue to position ourselves to respond to changes in regulation and

7

Table of Contents

increased competition by reducing our cost of operations, maintaining a safe and reliable system for customers, and focusing on meeting the needs of the marketplace.

Competition in the gas sales market primarily involves other natural gas providers, and alternative fuels such as electricity, propane and, to a lesser degree, oil and wood.

Other natural gas providers — As previously discussed, we are operating under the gas Customer Choice program that allows our customers to purchase natural gas from other suppliers. As a result of MichCon returning to a GCR mechanism in January 2002, we do not profit from selling gas. We continue to transport and deliver gas to customers who choose to purchase gas from other suppliers thereby retaining favorable margins.

Alternative fuels — Natural gas continues to be the preferred space and water-heating fuel for Michigan residences and businesses. Developers in our service territories select natural gas in new construction because of the convenience, cleanliness and relative price advantage compared to propane, fuel oil and other alternative fuels.

The primary focus of competition in the end user transportation market is cost and reliability. Some large commercial and industrial customers have the ability to switch to alternative fuel sources such as coal, electricity, oil and steam. If these customers were to choose an alternative fuel source, they would not have a need for our end user transportation service. In addition, some of these customers could bypass our pipeline system and have their gas delivered directly from an interstate pipeline. However, price differentials must be sufficient to offset the costs, risks and loss of service flexibility associated with fuel switching or bypass. Since 1988, only one MichCon industrial customer has bypassed our distribution system. We compete against alternative fuel sources by providing competitive pricing and reliable service, supported by our extensive storage capacity.

Our extensive transmission pipeline system has enabled us to develop a 500 to 600 Bcf annual market for transportation services for Michigan gas producers, marketers, distribution companies and other pipeline companies. We operate in a pivotal geographic location with links to major interstate pipelines that reach markets elsewhere in the Midwest, the eastern United States and eastern Canada. Michigan gas production has also increased significantly over the past several years, resulting in a growing demand by gas producers and brokers for intermediate transportation services.

ENVIRONMENTAL MATTERS

We are subject to extensive environmental regulation. Additional costs may result as the effects of various chemicals on the environment are studied and governmental regulations are developed and implemented. We expect to continue recovering environmental costs related to utility operations through rates charged to our customers. Greater details on environmental issues are provided in the following Notes to the Consolidated Financial Statements:

Prior to the construction of major natural gas pipelines, gas for heating and other uses was manufactured from processes involving coal, coke or oil. We own, or previously owned, 16 such former manufactured gas plant (MGP) sites. Investigations have revealed contamination related to the by-products of gas manufacturing at each site. We are remediating eight of the former MGP sites and are conducting more

8

Table of Contents

extensive investigations at three of the sites. We have received Michigan Department of Environmental Quality (MDEQ) closure of one site and a determination that we are not a responsible party for two other sites. While we cannot make any assurances, we believe that a cost deferral and rate recovery mechanism approved by the MPSC will prevent these costs from having a material adverse impact on our results of operations.

RISK FACTORS

There are various risks associated with the operations of our business. To provide a framework to understand our operating environment, we are providing a brief explanation of the more significant risks associated with our business. Although we have tried to identify and discuss key risk factors, others could emerge in the future. Each of the following risks could affect our performance.

Weather – Weather significantly affects our operations. Deviations from normal cold weather conditions affect our earnings and cash flow. Mild temperatures can result in decreased utilization of our assets, lowering income and cash flow.

Regional and national economic conditions – Our business follows the economic cycles of the customers we serve. Should national or regional economic conditions decline, reduced volumes of gas we supply will result in decreased earnings and cash flow.

Environmental laws and liability – We are subject to numerous environmental regulations. Compliance with these regulations can significantly increase capital spending and operating expenses. These laws and regulations require us to seek a variety of environmental licenses, permits, inspections, and other regulatory approvals. The regulatory environment is subject to significant change, and therefore we cannot predict future issues.

Additionally, we may become a responsible party for environmental clean up at sites identified by a regulatory body. We cannot predict with certainty the amount and timing of future expenditures related to environmental matters because of the difficulty of estimating clean up costs. There is also uncertainty in quantifying liabilities under environmental laws that impose joint and several liability on all potentially responsible parties.

Rate regulation – We operate in a regulated industry. Our rates are set by the MPSC and cannot be increased without their authorization. We may be impacted by new regulations or interpretations by the MPSC or other regulatory bodies. New legislation, regulations or interpretations could change how our business operates, impact our ability to recover costs through rate increases or may require us to incur additional expenses.

Competition – Deregulation and restructuring in the gas industry, including the customer choice program, could result in increased competition and unrecovered costs that could affect the financial condition, results of operations or cash flows of our regulated business.

Supply and price of raw materials – Our access to natural gas supplies is critical to ensure reliability of service for our regulated gas customers.

Labor relations – Unions represent a majority of our employees. A union choosing to strike as a negotiating tactic could have an impact on our business.

9

Table of Contents

Access to capital markets and interest rates – Our ability to access capital markets is important to operate our business. Heightened concerns about the energy industry, the level of borrowing by other energy companies and the market as a whole could limit our access to capital markets. Changes in interest rates could increase our borrowing costs.

Property tax reform – We are one of the largest payers of property taxes in the state of Michigan. Should the legislature change how schools are financed, we could face increased property taxes on our Michigan facilities.

Credit ratings – Increased scrutiny of the energy industry and regulatory changes could result in credit agencies reexamining our credit rating. A change in our rating could restrict our ability to access capital markets at attractive rates and increase our borrowing costs.

Property insurance – While we seek to adequately insure our property, catastrophic damage as a result of acts of God, terrorism, war or a combination of significant unforeseen items occurring at one time could impact our operations and economic losses might not be covered in full by insurance.

Terrorism – Damage to downstream infrastructure or our own assets by terrorist groups would impact our operations. We may be required to increase security or assist other energy companies if terrorists were to strike their energy facilities.

EMPLOYEES

We had 2,246 employees at December 31, 2002, of which 1,508 were represented by unions.

Item 3. Legal Proceedings

We are involved in certain legal (including commercial matters), administrative and environmental proceedings before various courts, arbitration panels and governmental agencies concerning claims arising in the ordinary course of business. These proceedings include contract disputes, environmental reviews and investigations, and pending judicial matters. We cannot predict the final disposition of such proceedings. We regularly review legal matters and record provisions for claims that are considered probable of loss. The resolution of pending proceedings is not expected to have a material effect on our financial statements in the period they are resolved. For additional discussion on legal matters, see the following Notes to the Consolidated Financial Statements:

10

Table of Contents

Item 4. Submission of Matters to a Vote of Security Holders

Omitted per general instruction I (2) (c) of Form 10-K for wholly owned subsidiaries (reduced disclosure format).

PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

All of the 10,300,000 issued and outstanding shares of common stock of MichCon, par value $1 per share, are indirectly owned by DTE Energy, and constitute 100% of the voting securities of MichCon. Therefore, no market exists for our common stock.

We did not pay cash dividends in 2002. We paid cash dividends on our common stock of $75 million in 2001 and $100 million in 2000.

Item 6. Selected Financial Data

Omitted per general instruction I (2) (a) of Form 10-K for wholly owned subsidiaries (reduced disclosure format).

11

Table of Contents

Item 7. Management’s Narrative Analysis of Results of Operations

The Results of Operations discussion for MichCon is presented in accordance with General Instruction I (2) (a) of Form 10-K for wholly owned subsidiaries (reduced disclosure format).

Certain losses reflected in the accompanying consolidated financial statements have been eliminated at DTE Energy as a result of purchase accounting adjustments.

We had earnings of $20.3 million in 2002, compared to losses of $41.1 million in 2001. As subsequently discussed, the comparison was impacted by $103.4 million ($67.2 million net of taxes) of merger and restructuring charges recorded in 2001. Excluding merger and restructuring costs, 2001 earnings were $26.1 million, a decline of $86.1 million from 2000 results reflecting lower gross margins and higher operating costs.

Operating revenues increased $94.9 million in 2002 and increased $73.3 million in 2001. As subsequently discussed, operating revenues reflect the operations of our Gas Sales Program and the impact of weather, which was warmer than normal in 2002 and 2001. Our three-year Gas Sales Program is part of its Regulatory Reform Plan (Note 5) which ended in December 2001.

12

Table of Contents

Gas sales and end user transportation revenues in total increased $92.2 million in 2002 and $81.4 million in 2001. Revenues in 2002 reflect an increase in the gas commodity component of sales rates. During 2001 we operated under the Gas Sales Program in which the gas commodity component of our sales rates was fixed at $2.95 per thousand cubic feet (Mcf). In January 2002, the Gas Sales Program ended and we returned to a gas cost recovery mechanism (GCR) that allows for the recovery of reasonably and prudently incurred gas costs. Our sales rates included a gas commodity component of $3.62 per Mcf for January 2002 and $4.38 per Mcf for the remainder of 2002 compared to $2.95 per Mcf in 2001 and 2000. Revenues in 2002 were adversely affected by a $26.5 million accrual for the possible disallowance of gas cost in the 2002 GCR reconciliation case. See Note 17. Higher revenues in 2001 reflect more customers choosing to purchase their gas from us rather than other gas suppliers. There were approximately 190,000 customers participating in the gas Customer Choice program in 2002, compared to approximately 30,000 customers in 2001. Higher gas sales in 2001 were impacted by sales to off system customers allowed under the Gas Sales Program. Revenues were also impacted by weather that was warmer than normal.

End user transportation volumes and revenues also reflect deliveries associated with a varying number of customers participating in the Customer Choice program. Customers participating in this program purchase gas from other suppliers, while we continue to deliver the gas to their premises.

Upon returning to the GCR mechanism in January 2002, we have no commodity price risk associated with our prudently incurred gas costs. Accordingly, no margin was earned from selling gas in 2002. Margins generated from providing end user transportation services were not affected by the return to a GCR.

13

Table of Contents

Intermediate transportation revenues increased $2.8 million in 2002 and decreased $6.9 million in 2001, whereas intermediate transportation deliveries decreased 73.0 Bcf in 2002 and decreased 33.8 Bcf in 2001. A significant portion of the volume decrease was due to weather, slightly offset by a volume increase attributable to customers who pay a fixed fee for intermediate transportation capacity regardless of actual usage. Although volumes associated with these fixed-fee customers may vary, the related revenues are not affected.

Cost of gas is affected by variations in sales volumes, cost of purchased gas and related transportation costs, and the effects of any permanent liquidation of inventory gas. Cost of gas sold increased $91.5 million in 2002 and $156.2 million in 2001 primarily due to prices paid for gas supply and the impact in 2001 of a reduction in inventory gas. The average cost of gas sold increased $1.05 per Mcf (32%) and increased $0.49 per Mcf (17%) for 2002 and 2001, respectively. We recorded the benefits of a 19.6 Bcf inventory liquidation in 2001. The inventory liquidation was priced at $0.38 per Mcf compared to an average gas purchase rate in 2001 of $3.61 per Mcf. The effect of the inventory liquidation lowered cost of gas for 2001 by $63.2 million.

Operation and maintenance expenses decreased $20.4 million in 2002 and increased $44.5 million in 2001. The 2002 decrease was due primarily to lower accruals for injuries and damages and costs allocated from DTE Energy corporate for corporate support services, partially offset by higher uncollectible accounts expense. The 2001 increase is due to costs allocated from DTE Energy corporate for corporate support services, higher employee medical costs and accruals for injuries and damages.

Depreciation, depletion and amortization decreased $6.0 million in 2002 and increased $9.1 million in 2001. The 2001 increase was impacted by an adjustment of $8 million recorded in settlement in an MPSC proceeding that required a MichCon subsidiary to record additional depreciation expense.

Taxes other than income decreased $4.9 million in 2002 and decreased $5.0 million in 2001. The improvement is attributed to lower Michigan Single Business Taxes. The comparisons also reflect an adjustment in property tax expense resulting from a change in method of calculating the taxable value of personal property subject to taxation by local taxing jurisdictions.

Merger and restructuring charges were not incurred in 2002 and increased $99.4 million in 2001. Merger costs associated with the DTE Energy acquisition of MCN Energy consist primarily of system integration, relocation, legal, accounting and consulting costs (Notes 3 and 4). Restructuring charges consist of charges associated with a work force reduction plan.

Property write-down and contract loss totaled $47.8 million in 2002 due to a $33.2 million loss from the planned sale of our former headquarters and a $14.6 million charge related to the termination of a contract for computer services.

Other income and deductions decreased $9.4 million in 2002 and increased $1.0 million in 2001. The variance is primarily due to a $9.3 million loss in 2001 from our 33% to 50% interests in a series of partnerships that own a residential community on the Detroit riverfront (Harbortown). Partially offsetting the decrease for the 2002 period were higher interest costs. The 2001 increase in interest income of $6.4 million results from leasing a portion of our pipeline system to the Vector Pipeline Partnership through a capital lease arrangement that began in December 2000 (Note 10).

14

Table of Contents

Income taxes increased $38.2 million in 2002 and decreased $81.2 million in 2001 (Note 6). Income tax comparisons were affected by variations in pre-tax earnings and tax adjustments recorded upon filing our tax returns.

CAPITAL RESOURCES AND LIQUIDITY

Operating Activities

Net cash from operating activities decreased $13.9 million in 2002 due to higher working capital requirements, partially offset by higher net income, after adjusting for noncash items (depreciation, depletion and amortization, property write-down and contract losses and deferred taxes). The higher working capital requirements primarily reflect a significant increase in gas inventories due to management’s decision to utilize storage gas during 2001 that resulted in a gas inventory decrement during the 2001 calendar year. Net cash from operating activities decreased $168.9 million in 2001 due to lower net income, after adjusting for noncash items, partially offset by lower working capital requirements.

Investing Activities

Net cash used for investing activities decreased $18.3 million in 2002 and $19.2 million in 2001, respectively, reflecting declines in capital expenditures.

Financing Activities

Net cash related to financing activities increased $7.4 million in 2002 and increased $138.0 million in 2001. The 2002 increase reflects a $200 million capital contribution by our parent company which was offset by the repayment of short-term borrowings. The 2001 increase reflects the issuance of long-term debt which was offset by a $75 million dividend payment.

In February 2003, MichCon issued $200 million of 5.7% senior notes, due in 2033. The proceeds were used for debt redemption.

15

Table of Contents

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Commodity Price Risk

Prior to the reinstatement of the GCR mechanism in January 2002, our primary market risk arose from fluctuations in natural gas prices. We managed such natural gas price risk by entering into fixed-price contracts for a large portion of our expected supply requirements. If we did not enter into these fixed-price supply contracts, our exposure to such risk would have been substantially higher. See Note 11 – Financial and Other Derivative Instruments.”

Interest Rate Risk

We currently have market risk from fluctuations in interest rates. We manage interest rate risk through the use of various derivative instruments and limit the use of such instruments to hedging activities. If we did not use derivative instruments, our exposure to such risk would be higher. We are subject to interest rate risk in connection with the issuance of fixed- and variable-rate debt. In order to manage interest costs, we use interest rate swap agreements to exchange fixed- and variable-rate interest payment obligations over the life of the agreements without exchange of the underlying principal amounts. Our exposure to interest rate risk arises primarily from changes in U.S. Treasury rates, commercial paper rates and London Inter-Bank Offered Rates (LIBOR).

At December 31, 2002 and 2001, we had interest rate swap agreements with notional principal amounts totaling $40 million and $80 million and a weighted average remaining life of 2.4 and 1.9 years, respectively. The notional principal amounts are used solely to calculate amounts to be paid or received under the interest rate swap agreements and approximate the principal amount of the underlying debt being hedged.

A sensitivity analysis model was used to calculate the fair values of our debt and interest rate swaps, utilizing applicable forward interest rates in effect at December 31, 2002. The sensitivity analysis involved increasing and decreasing the forward rates by a hypothetical 10% and calculating the resulting change in the fair values or cash flows of the interest rate sensitive instruments.

The results of the sensitivity model calculations follow:

16

Table of Contents

Credit Risk

We sell gas to numerous companies operating in the steel, automotive, energy and retail industries. During 2002 and 2001, a number of customers have filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code, including certain Enron Corporation affiliates. We regularly review contingent matters relating to purchase and sale contracts and record provisions for amounts considered probable of loss. We believe our previously accrued amounts are adequate for probable losses. The final resolution of these matters is not expected to have a material effect on our financial statements in the period they are resolved.

17

Table of Contents

Item 8. Financial Statements and Supplementary Data

18

Table of Contents

INDEPENDENT AUDITORS’ REPORT

To the Board of Directors and Shareholder of
Michigan Consolidated Gas Company

We have audited the consolidated statement of financial position of Michigan Consolidated Gas Company and subsidiaries (the “Company”) as of December 31, 2002 and 2001 and the related consolidated statements of operations, cash flows, and retained earnings for each of the three years in the period ended December 31, 2002. Our audits also included the consolidated financial statement schedule listed in the Index at Item 15. These financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Michigan Consolidated Gas Company and subsidiaries at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
 

/s/ DELOITTE & TOUCHE LLP

Detroit, Michigan
February 11, 2003 (March 12, 2003 as to Note 17)

19

Table of Contents

MICHIGAN CONSOLIDATED GAS COMPANY
CONSOLIDATED STATEMENT OF OPERATIONS

See Notes to Consolidated Financial Statements.

20

Table of Contents

MICHIGAN CONSOLIDATED GAS COMPANY
CONSOLIDATED STATEMENT OF FINANCIAL POSITION

See Notes to Consolidated Financial Statements.

21

Table of Contents

MICHIGAN CONSOLIDATED GAS COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS