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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998, OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________ TO ___________
COMMISSION FILE NUMBER 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)
MICHIGAN 38-0478040
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
500 GRISWOLD STREET, DETROIT, MICHIGAN 48226
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
313-965-2430
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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 AMENDMENTS TO
THIS FORM 10-K. X
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ALL OF THE REGISTRANT'S 10,300,000 OUTSTANDING SHARES OF COMMON STOCK, PAR
VALUE $1 PER SHARE, ARE INDIRECTLY OWNED BY MCN ENERGY GROUP INC.
DOCUMENTS INCORPORATED BY REFERENCE: NONE
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GLOSSARY
Antrim Gas........................ Natural gas produced from shallow wells in
the Devonian (Antrim) shale formations.
End User Transportation........... A gas delivery service provided to
large-volume commercial and industrial
customers who purchase natural gas directly
from producers or brokerage companies.
FERC.............................. Federal Energy Regulatory Commission; a
federal agency that determines the rates and
regulations of interstate pipelines.
Gas Storage....................... The process of injecting, storing and
withdrawing natural gas from a depleted
underground natural gas field or salt cavern.
GCR............................... Gas Cost Recovery; a process, in effect
through 1998, by which MichCon, through
annual gas cost proceedings before the
Michigan Public Service Commission, was
allowed to recover its reasonable and prudent
cost of gas sold.
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.
MCN............................... MCN Energy Group Inc. and its subsidiaries.
MichCon........................... Michigan Consolidated Gas Company; an
indirect wholly-owned natural gas
distribution and intrastate transmission
subsidiary of MCN.
MichCon Pipeline.................. MichCon Pipeline Co., a wholly-owned
subsidiary of MichCon that engages in
pipeline projects through its subsidiaries.
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GLOSSARY
(concluded)
MPSC.............................. Michigan Public Service Commission; the
regulator of intrastate aspects of the
natural gas industry within the State of
Michigan.
Normal Weather.................... The average daily temperature within
MichCon's service area during a recent
30-year period.
Spot Market....................... The buying and selling of natural gas on a
short-term basis, typically month to month.
Units of Measurement:
Bcf............................... Billion cubic feet of gas.
Mcf............................... Thousand cubic feet of gas.
MMcf.............................. Million cubic feet of natural gas.
/d................................ Added to various units of measure to denote
units per day.
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TABLE OF CONTENTS
CONTENTS PAGE
-------- NUMBER
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Part I
Item 1. Business....................................................................... 1
Item 2. Properties .................................................................... 8
Item 3. Legal Proceedings.............................................................. 9
Item 4. Submission of Matters to a Vote of Security Holders............................ 10
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters........................................................................ 10
Item 6. Selected Financial Data........................................................ 11
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations .................................................................... 12
Item 7A. Quantitative and Qualitative Disclosures About Market Risk .................... 23
Item 8. Financial Statements and Supplementary Data.................................... 24
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure .................................................................... 49
Part III
Item 10. Directors and Executive Officers of the Registrant............................. 49
Item 11. Executive Compensation......................................................... 49
Item 12. Security Ownership of Certain Beneficial Owners and Management................. 49
Item 13. Certain Relationships and Related Transactions................................. 49
Part IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8- K............... 49
Signatures................................................................................. 52
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FORWARD-LOOKING STATEMENTS
This Form 10-K 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. Factors that may impact forward-looking
statements include, but are not limited to, the following: (i) the effects of
weather and other natural phenomenon; (ii) increased competition from other
energy suppliers as well as alternative forms of energy; (iii) the capital
intensive nature of MichCon's business; (iv) economic climate and growth in the
geographic areas in which MichCon does business; (v) the uncertainty of gas
reserve estimates; (vi) the timing and extent of changes in commodity prices for
natural gas, electricity and crude oil; (vii) conditions of capital markets and
equity markets; (viii) the timing, nature and impact of Year 2000 activities;
and (ix) the effects of changes in governmental policies and regulatory actions,
including income taxes, environmental compliance and authorized rates.
ITEM 1. BUSINESS
MichCon, or the Company, is a Michigan corporation that was organized in
1898 and, with its predecessors, has been in business for 150 years. MichCon is
a natural gas utility primarily engaged in the distribution and transmission 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's non-regulated
operations are not material.
On December 31, 1998, MichCon and its subsidiaries employed 2,724 persons.
Slightly less than half of MichCon's labor force is covered by five collective
bargaining agreements. In June 1998, MichCon successfully negotiated and signed
three 3-year collective bargaining agreements. The remaining two agreements will
expire December 2000.
RESULTS OF OPERATIONS
MichCon's earnings for 1998 were $77.0 million, a decrease of $2.0 million
from 1997. Results for 1998 include an unusual charge which reduced earnings by
$11.2 million, net of taxes and minority interest, relating to a write-down of
certain gas gathering properties, owned by Saginaw Bay Pipeline Company, a
wholly-owned subsidiary of MichCon Pipeline. A new gas reserve analysis was
performed in 1998 to determine the impact of the diversion of certain untreated
gas away from the gathering system. This analysis revealed that projected cash
flows from the gathering system were not sufficient to cover the system's
carrying value. Therefore, an impairment loss was recorded representing the
amount by which the carry value of the system exceeded its estimated fair value.
Excluding this unusual charge, MichCon had 1998 earnings of $88.2 million,
an improvement of $9.2 million over 1997. Earnings comparisons were impacted by
variations in weather and cost-saving initiatives resulting in significantly
lower operating costs. The cost-saving initiatives allowed MichCon to continue
its record of solid financial performance.
GAS SALES & TRANSPORTATION
MichCon serves 1.2 million customers in the Detroit, Grand Rapids, Ann
Arbor, Traverse City and Muskegon metropolitan areas and in various other
communities throughout the State of Michigan. The following services are
provided by MichCon:
Gas Sales - Includes the sale and delivery of natural gas to residential and
small-volume commercial customers.
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End User Transportation - Through this service, large-volume commercial and
industrial customers that purchase natural gas directly from producers or
brokerage companies utilize the Company's network to transport the gas to their
facilities.
Intermediate Transportation - Provides transportation service through the
Company's gathering and high pressure transmission system to producers, brokers
and other local distribution companies that own the natural gas, but are not the
ultimate consumer.
1998 1997 1996
-------- -------- --------
REVENUE (in millions of dollars)
Gas Sales ......................... $ 823.8 $1,062.8 $1,085.8
End User Transportation ........... 82.0 84.5 82.2
Intermediate Transportation ....... 63.2 55.2 48.6
-------- -------- --------
Total Sales and Transportation .. 969.0 1,202.5 1,216.6
Other ............................. 64.7 51.2 42.2
-------- -------- --------
Total Operating Revenues ........ $1,033.7 $1,253.7 $1,258.8
======== ======== ========
MARKETS (Bcf)
Gas Sales ......................... 168.9 205.8 217.7
End User Transportation ........... 140.1 145.0 146.7
Intermediate Transportation ....... 537.5 586.4 527.5
-------- -------- --------
Total Sales and Transportation .. 846.5 937.2 891.9
======== ======== ========
EFFECT OF WEATHER: MichCon's gas sales and end user transportation volumes,
revenues and net income are impacted by weather. Given the seasonal nature of
the business, revenues and net income tend to be higher in the first and fourth
quarters of the calendar year.
Effect of Weather on Gas Markets and Earnings
1998 1997 1996
-------- -------- -------
Percentage Colder (Warmer) Than Normal .... (19.3)% 0.8% 5.4%
Increase (Decrease) From Normal in:
Gas Markets (in Bcf) .................... (40.3) 0.6 10.9
Net Income (in Millions) ................ $(35.3) $ 0.5 $ 9.9
GAS SALES: Revenues decreased $239.0 million in 1998 due primarily to
weather, which was 20.1% warmer in 1998 compared to 1997, and a reduction in gas
sales rates resulting from lower gas costs. This market represents approximately
20% of total deliveries and produced approximately 64% of MichCon's gross profit
margin. The average margin per Mcf from gas sales was improved significantly to
$2.16 in 1998 from $2.07 in 1997.
Competition in the gas sales market comes primarily from alternative fuels
such as electricity, propane and, to a lesser degree, oil and wood, and other
natural gas providers in a few areas. Natural gas continues to be the preferred
fuel for Michigan residences and businesses. Nearly every residential and
commercial developer in MichCon's service territories selects natural gas in new
construction because of the convenience, cleanliness and price advantage of
natural gas compared to propane, fuel oil and other alternative fuels. Service
and price are the primary factors affecting this market.
MichCon continues to take steps to become the preferred provider of natural
gas and high-value energy services within Michigan and to achieve competitive
financial results. To accomplish this, MichCon will increase penetration of
existing markets by focusing on meeting the needs of customers and the
marketplace, will continue efforts to reduce cost of gas and operating costs,
and will take advantage of profitable opportunities to expand to new geographic
areas.
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The challenges and opportunities resulting from increased competition in the
natural gas industry have been a catalyst for MPSC action in the development of
major reforms in utility regulation aimed at giving all customers added choices
and greater price certainty. The overall package of regulatory changes
associated with the gas industry restructuring is expected to generate
additional revenue and cost savings opportunities. MichCon is positioning itself
to respond to changes in regulation and increased competition by reducing its
cost of operations while maintaining a safe and reliable system for customers.
See "Regulation and Rates" on page 6 for a discussion regarding Regulatory
Reform.
MichCon's Market Expansion Program is intended to spur demand for natural
gas in areas currently not served. The program primarily targets residential and
small-volume commercial markets. By financing the cost of main extensions, this
program makes it easier for users of higher-cost fuels, such as propane and fuel
oil, to switch to natural gas for space heat and other applications. This
program accounted for over 12,000 of the nearly 93,000 new customers added
during the past four years. In 1998, three new areas of Michigan were served by
MichCon, bringing the total number of new areas added since the program's
inception in 1984 to 140.
Cost of gas sold per Mcf for 1998 was $2.71, a decrease of $.40 (13%) from
1997. MichCon continued to retain a significant cost advantage over competing
fuels. Cost of gas sold per Mcf for 1997 increased from 1996 by $.19 (7%).
END USER TRANSPORTATION: Deliveries decreased slightly to 140.1 Bcf in 1998
due to warmer weather. In 1998, this market accounted for approximately 17% of
total gas deliveries and produced approximately 14% of MichCon's gross profit
margin.
At December 31, 1998, MichCon had end user transportation agreements
representing annual volumes of 154 Bcf. Approximately 53% of these volumes are
under contracts that extend to 2000 or beyond and include the majority of the
large, and most price-sensitive, customers. Contracts for the remaining volumes
are typically one-year contracts that expire at various times during 1999 and
relate to a large number of low-volume users with relatively low price
sensitivity.
Through technical and financial assistance, industrial and commercial
customers have been encouraged to increase their use of natural gas. The natural
gas-fueled power generation market accounted for approximately 31 Bcf of gas
deliveries in both 1998 and 1997. Gas engine driven technologies, along with
industrial process and heating, ventilation and air conditioning (HVAC)
conversion applications in certain businesses, also provide significant
opportunities for conversion to natural gas-powered equipment. The efficiencies
and price competitiveness of natural gas can significantly reduce operating
costs for customers, generally offsetting in a relatively short period of time
the typically higher initial cost of gas-burning equipment.
MichCon continues to be successful in converting customers' facilities to
natural gas from alternative fuels and in retaining those customers after
conversion. Also, it has not experienced any significant fuel switching by its
customers in recent years. In 1998, approximately 23 Bcf of MichCon's
transportation deliveries were to customers who substituted natural gas for
coal.
The primary focus of competition in this market is cost. Some large
commercial and industrial customers have the capacity to switch to alternative
fuel sources such as coal, electricity, oil and steam. In addition, some of
these customers could bypass MichCon's distribution system and obtain gas
directly from an interstate pipeline company. However, cost differentials must
be sufficient to offset the costs, risks and loss of service flexibility
associated with fuel switching or bypass. During 1998, none of MichCon's
industrial customers bypassed its distribution system. MichCon competes against
alternative fuel sources by providing competitive pricing and reliable supply
through the use of the Company's extensive storage capacity and multiple supply
sources. Almost all significant customers who could bypass MichCon are under
long-term transportation contracts.
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The MPSC has approved a direct access program for the state's two largest
electric utilities, which began in mid-1998, and allows large electric users to
directly purchase lower priced electricity. The program is not expected to
materially impact the competitiveness of natural gas.
INTERMEDIATE TRANSPORTATION: This service accounts for approximately 63% of
total gas deliveries, however, due to the lower costs and therefore rates
applicable to this service, it represents only 11% of MichCon's gross profit
margin. The decrease in intermediate transportation deliveries in 1998 reflects
lower off-system demand caused by the warmer weather and lower volumes
transported for fixed-fee customers. Although transported volumes for fixed-fee
customers may fluctuate, revenues from such customers are not affected.
In 1998, through efficient use of transmission and storage assets as well as
upstream supply, MichCon sold significant short-term services resulting in
increased revenues from 1997. MichCon's extensive transmission pipeline system
has enabled it to increase the volumes transported for Michigan gas producers,
marketers, distribution companies and other pipelines. MichCon operates 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 Antrim gas production has increased significantly over the past several
years, resulting in a growing demand by gas producers and brokers for
intermediate transportation services.
In 1997, in order to meet the increased demand, MichCon expanded the
transportation capacity of its northern Michigan gathering system. In December
1997, MichCon Pipeline purchased Thunder Bay Pipeline for approximately $13
million. During 1998, 175 Bcf was transported on this system, of which Thunder
Bay contributed 31.7 Bcf.
In January 1997, MichCon placed into service a $91 million, 59-mile loop of
its existing Milford-to-Belle River Pipeline. This new loop has improved the
overall reliability and efficiency of MichCon's gas storage and transmission
system by mitigating the risk associated with the disruption of the existing
pipeline or other facilities used to supply gas to MichCon's customers. In
addition, the pipeline provides significant off-system transportation
opportunities as discussed below.
MichCon is in an excellent position to increase revenues through providing
transportation of new supplies of western Canadian gas, coming into the Chicago
area beginning in December 1998, to third-party pipelines serving growing
markets in eastern Canada and the northeast United States. In December 1997,
MichCon entered into a long-term facility lease of its Milford-to-Belle River
Pipeline to the Vector Pipeline to effectuate transportation of Chicago supplies
to Dawn, Ontario, a significant Canadian natural gas market hub. An affiliate of
MichCon owns a 25% interest in Vector. Currently, Vector is contemplating
completing its proposed project in two phases. Phase One would be the
construction of approximately 19 miles of 42" pipeline by November 1, 1999 from
MichCon's Belle River Mills Compressor station to Dawn, Ontario. The remainder
of Vector is scheduled to be completed in October 2000. MichCon is reviewing the
possibility of providing transportation service to Vector for Phase One services
to be delivered at Vector's proposed Belle River receipt point. The bridging
service would commence on November 1, 1999 and terminate in October 31, 2000
when Phase Two of the Vector project is completed. Additional opportunities for
transportation services are being pursued which will further maximize the use of
MichCon's transmission infrastructure.
MichCon is negotiating with Washington 10 Storage Corporation to provide
transportation services to and from the storage field in southeastern Michigan
which is expected to be in service by mid-1999. In addition, MichCon has
identified firm, long-term capacity, available in late 1999, between its
southern interconnections with ANR Pipeline Company (ANR) at Willow Run and
Consumers Energy at Northville to various interconnections at the U.S./Canadian
border near the St. Clair River. MichCon is soliciting offers for this capacity
in the first quarter of 1999. MichCon also is investigating other firm and
interruptible transportation services for incremental revenue opportunities.
ENERGY ASSISTANCE PROGRAMS
Energy assistance programs funded by the federal government and the State of
Michigan, including the Home Heating Credit for low-income customers and the
Family Independence Agency's State Emergency Relief Program,
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remain critical to MichCon's ability to control its uncollectible gas account
expenses. MichCon has historically obtained favorable regulatory treatment of
its uncollectible gas account costs, including those related to these energy
assistance programs.
MichCon receives a significant amount of its heating assistance funding
through the Federal Low-Income Home Energy Assistance Program (LIHEAP) which
funds the State of Michigan's Home Heating Credit program. In 1998 Congress
provided $1.1 billion for LIHEAP funding for the 1998 fiscal year and
supplemented it with a $300 million emergency fund that could be tapped only
upon order of the President. Michigan received $54 million of the total $1.1
billion that was released in 1998. MichCon received $13.4 million through this
program in 1998. Home Heating Credits assisted 73,000 MichCon customers in 1998.
Congress voted to continue LIHEAP for federal fiscal years 1999 and 2000. For
federal fiscal year 1999, which began October 1, 1998, Congress maintained
LIHEAP funding at $1.1 billion and again authorized a $300 million emergency
fund. In addition, Congress appropriated $1.1 billion for federal Fiscal Year
2000 which is subject to revision during budget deliberations.
Gas Supply
MichCon obtains its natural gas supply from various sources in different
geographic areas (the Gulf Coast, the Midcontinent, Canada, and Michigan) under
agreements that vary in both pricing and terms. Looking forward to MichCon's
Regulatory Reform Plan, in 1998 MichCon issued and signed new base supply
contracts with its suppliers, ensuring price stability and supply reliability
(See "Regulation and Rates" on page 6 for a discussion regarding MichCon's
plan). This geographic diversity of supply ensures that MichCon will be able to
meet the requirements of its existing and future customers with reliable
supplies of natural gas at a known cost, free from the potentially severe swings
of a volatile gas market. Whereas prior to 1999 under GCR regulation gas supply
costs were a non-profit passthrough of prudently incurred costs. Beginning
January 1, 1999, MichCon has the ability to take full advantage of its assets
and expertise to generate profits from gas supply operations. By fixing the gas
cost component of MichCon's sales rates at $2.95/Mcf for three years, customers
benefit from greater price certainty while MichCon can take advantage of
opportunities to secure lower priced gas supplies. MichCon has secured 100% of
its 1999 warmer than normal weather requirements and approximately 90% of its
2000 and 2001 similar requirements at prices that help ensure profit
contributions from gas supply operations.
Gas Supply Purchases(Bcf)
1998 1997 1996
------- ------- --------
Michigan Producers ........... 41.9 66.0 86.3
Interstate Suppliers ......... 29.0 13.8 14.5
Canadian Suppliers ........... 31.7 31.3 37.3
Spot Market and other ........ 73.0 85.8 90.6
------- ------- --------
175.6 196.9 228.7
======= ======= ========
MichCon purchased 24% of its 1998 supply from Michigan producers, 58% from
producers in the southern and Midcontinent regions of the United States and 18%
from Canadian producers. These supplies are complemented by 124 Bcf of working
storage capacity from storage fields owned and operated by MichCon in Michigan,
of which 36 Bcf is leased to others, including 17 Bcf with an affiliate.
MichCon has long-term firm transportation agreements, expiring on various
dates through 2011, with ANR, Panhandle Eastern Pipe Line Co. (PEPL), Viking Gas
Transmission Company (Viking) and Great Lakes Gas Transmission Limited
Partnership (Great Lakes). ANR is obligated to transport for MichCon 375 MMcf/d
of supply from April through October 1999. Effective November 1, 1999, MichCon's
ANR capacity reduces to 285 MMcf/d. The capacity reduction results in roughly
$13 million in annual cost savings. ANR capacity delivers 117.5 MMcf/d of supply
sourced in the Gulf, 117.5 MMcf/d sourced in the Midcontinent and 50 MMcf/d is
Canadian supply. Viking transports 50 MMcf/d of Canadian supply to the ANR
system for delivery to MichCon and PEPL transports two MMcf/d of Gulf Coast
supply from the ANR system for delivery to MichCon. Additional Canadian supplies
of 30 MMcf/d are delivered through firm transport agreements with Great Lakes.
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MichCon has supply contracts, expiring on various dates through 2007, with
independent Michigan producers. Many of these contracts originally tied prices
to spot market indices coupled with transport rates. MichCon, as a result of a
recent MPSC Order and individually negotiated settlements, has successfully
amended a number of these contracts that were previously at above market prices
to a more competitive level.
At December 31, 1998, MichCon 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. MichCon uses its storage capacity to supplement its supply during the
winter months, replacing the gas in April through October when demand and
prices, generally, are at the lowest levels. The use of this storage capacity
also allows MichCon to lower its peak-day entitlement, thereby reducing
interstate pipeline charges during the winter months. During 1998, MichCon's
maximum one-day sendout exceeded 2.1 Bcf, of which approximately 68% came from
its underground storage fields. MichCon's gas distribution system has a maximum
daily sendout capability of 2.8 Bcf, with the capacity to supply nearly 70% from
underground storage.
REGULATION AND RATES
MichCon is subject to the jurisdiction of the MPSC as to various phases of
its operations, including gas sales and transportation rates, service and
accounting. MichCon is also subject to the requirements of other regulatory
agencies with respect to safety, the environment and health.
REGULATORY REFORM PLAN: In April 1998, the MPSC approved MichCon's
Regulatory Reform Plan. The plan includes a comprehensive experimental
three-year customer choice program, which is subject to annual caps on the level
of participation. The customer choice program begins April 1, 1999, when up to
75,000 customers will have the option of purchasing natural gas from suppliers
other than MichCon. Up to 75,000 additional customers can be added April 1 of
each of the next two years, eventually allowing up to 225,000 customers the
option to choose a gas supplier other than MichCon. MCN's gas marketing
affiliates also participate as alternative suppliers under the program. In each
of the three plan years, there is also a volume limitation on commercial and
industrial participants. The volume limitation for these participants is 10 Bcf
in 1999, 20 Bcf in 2000 and 30 Bcf in 2001. MichCon will continue to transport
and deliver the gas to the customers' premises at prices that maintain its
existing sales margins.
The plan also suspends the GCR mechanism for customers who continue to
purchase gas from MichCon and fixes the gas price component of MichCon's sales
rates at $2.95 per Mcf for the three-year period beginning on January 1, 1999.
Prior to January 1999, MichCon did not generate any earnings nor generally incur
any unrecovered costs on the gas supply portion of its operations. However,
under this plan, changes in cost of gas will directly impact earnings. As part
of its gas acquisition strategy, MichCon has entered into firm-price contracts
for a substantial portion of its expected gas supply requirements for the next
three years. These contracts, coupled with the use of MichCon's storage
facilities, will substantially mitigate risks from winter price and volume
fluctuations.
Also beginning in 1999, the plan established an income sharing mechanism
that will allow customers to share in profits if actual utility return on equity
exceeds predetermined thresholds. In October 1998, the MPSC denied a rehearing
and affirmed its approval of the plan. Various parties have appealed the MPSC's
decision to the Michigan Court of Appeals. While management believes that the
order will be upheld based upon applicable Michigan law, there can be no
assurance as to the outcome.
GENERAL RATE PROCEEDINGS: MichCon received authorization to defer
manufactured gas plant (MGP) investigation and remediation costs in excess of
the $11.7 million previously reserved by MichCon. The remaining balance of this
initial reserve at December 31, 1998 is approximately $0.1 million. Any excess
costs are to be deferred and amortized over a 10-year period beginning in the
year subsequent to the year environmental investigation and remediation costs
are paid. The recovery of any remediation costs incurred will be reviewed in a
future rate case.
MichCon filed an application with the MPSC in October 1996 requesting
authority to decrease depreciation rates from an average rate of 4.1% to 3.5%.
In December 1997, the MPSC issued an order approving a reduction in
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annual depreciation costs by more than $16 million. While the Michigan Attorney
General has appealed the depreciation order, management believes the MPSC order
approving the lower depreciation rates without a corresponding gas rate
reduction will be upheld.
GAS COST RECOVERY(GCR): Prior to January 1, 1999, the GCR process allowed
MichCon to recover its cost of gas sold if the MPSC determined that such costs
were reasonable and prudent. As previously discussed, beginning January 1, 1999,
the MichCon plan suspends the GCR mechanism and fixes the gas commodity
component of MichCon's sales rate at $2.95 per Mcf for three years.
The GCR process included an annual Gas Supply and Cost Review, in which the
MPSC approved maximum monthly GCR factors. A subsequent annual GCR
reconciliation proceeding provided a review of gas costs incurred during the
year, determined whether approved gas costs had been overcollected or
undercollected and, as a result, whether a refund or surcharge, including
interest, was required to be returned to or collected from GCR customers. In
September 1998, a settlement regarding MichCon's 1997 GCR Reconciliation Case
was approved by the MPSC indicating a net underrecovery of approximately $13
million, including interest. In April 1998, the MPSC issued an order in
MichCon's 1998 GCR Plan Case approving a $3.20 per Mcf maximum GCR factor
including the net underrecovery for 1997 referred to above. MichCon's 1998 GCR
overrecovery is approximately $15 million, including interest of $2.3 million.
Pursuant to the terms of the plan that approved suspension of the GCR clause,
MichCon will refund the overrecovery through surcharge credits during January
through March 1999. In February 1997, MichCon filed its 1996 GCR reconciliation
case indicating a net underrecovery of approximately $28 million, including
interest. The total 1996 underrecovery was rolled into MichCon's 1997 GCR cost
recovery. In September 1997, the MPSC issued an order finding that all of
MichCon's 1996 gas costs were reasonable and prudent.
FERC RATE MATTERS: In February 1998, FERC approved a settlement agreement in
an ANR rate case entitling MichCon to refunds totaling $9.4 million. In April
1998, MichCon received $5.5 million relating to transportation services provided
by ANR to MichCon. In June 1998, MichCon received the remaining refund, which
was reflected as a reduction to MichCon's cost of gas.
ENVIRONMENTAL MATTERS
Prior to the construction of major natural gas pipelines, gas for heating
and other uses was manufactured from processes involving coal, coke or oil.
MichCon owns, or previously owned, 16 such former MGP sites.
During the mid-1980s, preliminary environmental investigations were
conducted at these former MGP sites, and some contamination related to the
by-products of gas manufacturing was discovered at each site. The existence of
these sites and the results of the environmental investigations have been
reported to the Michigan Department of Environmental Quality (MDEQ). None of
these former MGP sites is on the National Priorities List prepared by the U.S.
Environmental Protection Agency (EPA).
MichCon is involved in an administrative proceeding before the EPA regarding
one of the former MGP sites. MichCon has executed an order with the EPA,
pursuant to which MichCon is legally obligated to investigate and remediate the
MGP site. MichCon is remediating four of the former MGP sites and conducting
more extensive investigations at four other former MGP sites. In 1998, MichCon
completed the remediation of one of the former MGP sites, which was confirmed by
the MDEQ. Additionally, the MDEQ has determined with respect to one other former
MGP site that MichCon is not a responsible party for the purpose of assessing
remediation expenditures.
In 1984, MichCon established an $11.7 million reserve for environmental
investigation and remediation. During 1993, MichCon received MPSC approval of a
cost deferral and rate recovery mechanism for investigation and remediation
costs incurred at former MGP sites in excess of this reserve.
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MichCon employed outside consultants to evaluate remediation alternatives
for these sites, to assist in estimating its potential liabilities and to review
its archived insurance policies. The findings of these investigations indicate
that the estimated total expenditures for investigation and remediation
activities for these sites could range from $30 million to $170 million based on
undiscounted 1995 costs. As a result of these studies, MichCon accrued an
additional liability and a corresponding regulatory asset of $32 million during
1995.
MichCon notified more than 40 current and former insurance carriers of the
environmental conditions at these former MGP sites. MichCon concluded settlement
negotiations with certain carriers in 1996 and 1997 and has received payments
from several carriers. In October 1997, MichCon filed suit against major
nonsettling carriers seeking recovery of incurred costs and a declaratory
judgment of the carriers' liability for future costs of environmental
investigation and remediation costs at former MGP sites. Discovery is ongoing in
the case, and a preliminary trial date has been scheduled for August 1999.
During 1998, 1997, and 1996, MichCon spent $1.6 million, $0.8 million, and
$0.9 million, respectively, investigating and remediating these former MGP
sites. At December 31, 1998, the reserve balance was $32.1 million, of which
$0.1 million was classified as current. Any significant change in assumptions,
such as remediation techniques, nature and extent of contamination and
regulatory requirements, could impact the estimate of remedial action costs for
the sites and, therefore, have an effect on MichCon's financial position and
cash flows. However, management believes that insurance coverage and the cost
deferral and rate recovery mechanism approved by the MPSC will prevent
environmental costs from having a material adverse impact on MichCon's results
of operations.
In 1998, MichCon received written notification from ANR, alleging that
MichCon has responsibility for a portion of the costs associated with responding
to environmental conditions present at a natural gas storage field in Michigan
currently owned and operated by an affiliate of ANR. At least some portion of
the natural gas storage field was formerly owned by MichCon. MichCon is
evaluating ANR's allegations to determine whether and to what extent, if any, it
may have legal responsibility for these costs. Management does not believe that
this matter will have a material impact on MCN's financial statements.
FRANCHISES
MichCon operates in more than 530 cities, villages and townships under
franchises or permits that typically are revocable at will and have a 30-year
maximum duration. In 1993, MichCon began a structured process to renew or
re-establish formal franchises in 233 municipalities. During the period
between January 1994 and December 1998, an additional 184 franchises expired. To
date, 391 franchises have been renewed, including nine renewed in 1998 that
account for gas sales volumes of approximately 115 MMcf annually. Additionally,
one new franchise was acquired. There were no franchises lost during 1998.
As for the 26 franchises that are currently expired, MichCon's gas
distribution systems are rightfully occupying the streets with the consent or
acquiescence of the municipalities. While MichCon could be ordered by any
municipality in which its franchise has expired to remove its property, it could
lose ownership only by its consent and the payment of an agreed upon
price, or by condemnation and the payment of the fair value of such property.
Should any of these municipalities seek to terminate MichCon's operations
therein and substitute another gas utility operation, publicly or privately
owned, the municipality must either (i) acquire and operate MichCon's system,
(ii) construct a new system or (iii) grant a franchise to another privately
owned utility to construct or acquire its own distribution system.
ITEM 2. PROPERTIES
MichCon operates natural gas distribution, transmission and storage
facilities in Michigan. At December 31, 1998, MichCon's distribution system
included 16,722 miles of distribution mains, 1,083,607 service lines and
8
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1,202,722 active meters. MichCon owns 2,604 miles of transmission and production
lines that deliver natural gas to the distribution districts and interconnect
its storage fields with the sources of supply and the market areas. MichCon also
owns properties relating to four underground storage fields with an aggregate
storage capacity of approximately 124 Bcf. Additionally, MichCon owns district
office buildings, service buildings and gas receiving and metering stations. In
January 1998, MichCon purchased its principal office building in Detroit, The
Guardian Building, ending its long-term capital lease obligation. MichCon
occupies its principal office building in Grand Rapids under a long-term lease.
Portions of these buildings are subleased to affiliates and others.
Most of MichCon's properties are held in fee, by easement, or under lease
agreements expiring at various dates to 2006, with renewal options extending
beyond that date. The principal plants and properties of MichCon are held
subject to the lien of MichCon's Indenture of Mortgage and Deed of Trust under
which MichCon's First Mortgage Bonds are issued. Some existing properties are
being fully utilized and new properties are being added to meet the requirements
of expansion into new areas. MichCon's capital expenditures for 1998 totaled
$153.5 million and for 1999 are anticipated to be approximately $132 million.
The Saginaw Bay Pipeline Company, a wholly-owned subsidiary of MichCon
Pipeline, owns a 66 2/3% interest in the Saginaw Bay Area Limited Partnership,
which owns substantially all of the properties used in the conduct of its
business, primarily a 126-mile major gathering line. The Saginaw Bay Lateral
Company, a wholly-owned subsidiary of MichCon Pipeline, owns a 46% interest in
the Saginaw Bay Lateral Limited Partnership, which owns substantially all of the
properties used in the conduct of its business, primarily lateral lines related
to the Saginaw Bay major gathering line. Westside Pipeline Company, a
wholly-owned subsidiary of MichCon Pipeline, owns an 82.62% interest in Jordan
Valley Pipeline, a 14-mile major gathering line, and the Terra-Hayes Pipeline,
an 18-mile major gathering line. MichCon Gathering Company, a wholly-owned
subsidiary of MichCon Pipeline, owns substantially all of the properties used in
the conduct of its business, including 44.7-mile, 8.6-mile, 11-mile and
25.2-mile major gathering lines and a 2,400 horsepower compressor station.
Thunder Bay Gathering Company, a wholly-owned subsidiary of MichCon
Pipeline, owns substantially all of the properties used in the conduct of its
business, including 44 miles of gathering lines.
ITEM 3. LEGAL PROCEEDINGS
In addition to the regulatory proceedings and other matters described in
Item 1, "Business," MichCon also is involved in a number of lawsuits and
administrative proceedings in the ordinary course of business with respect to
taxes, environmental matters, contracts, personal injury, property damage claims
and other matters.
ENVIRONMENTAL
In 1994, MichCon received a general notice of liability letter from the EPA
stating that it was one of two potentially responsible parties at the Lower
Ecorse Creek Superfund site in Wyandotte, Michigan. The EPA requested that
MichCon conduct a remedial investigation and feasibility the study at that site.
MichCon investigated its prior activities in the area and the EPA's bases for
its conclusion, and concluded that it was not the responsible for contamination
discovered at that site. MichCon informed the EPA of this belief and did not
undertake the requested activities.
In September 1996, the EPA sent MichCon a second general notice of liability
letter for the site and demanded reimbursement of approximately $2.3 million in
past costs, plus interest. The EPA then issued MichCon and the other potentially
responsible party a unilateral administrative order under section 106 of the
Comprehensive Environmental Response Compensation and Liability Act to implement
the remedy. The EPA estimates the cost of the remedy to be approximately
$650,000. MichCon again reviewed the EPA's bases for determining that it is a
potentially responsible party and concluded again that it was not responsible
for contamination discovered at that site and informed the EPA of its decision.
The EPA has not taken any subsequent action against MichCon. The EPA may sue
MichCon to force compliance with the order or may implement the remedy and then
sue MichCon for recovery of all incurred costs. If the EPA institutes and
prevails in such a suit and if the court determines that MichCon did not have
sufficient cause
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to comply with the order, the court may impose civil penalties and punitive
damages. Management believes that MichCon was not responsible for contamination
at the site and has sufficient cause not to comply with this order and that the
resolution of this matter will not have a material adverse effect on MichCon's
financial statements.
ENERGY CONSERVATION PROGRAMS
In July 1998, the Wayne County Michigan Circuit Court approved a settlement
of two class action lawsuits in relation to a discontinued energy conservation
program. There were 46,000 class members. The notice of settlement was sent in
June 1998 to the class members. Terms of the settlement included capped
co-payments for the repair of chimney damages or the installation of a chimney
liner and a reduced price for a carbon monoxide detector purchased from MichCon.
The request for reimbursement period ended on October 9, 1998, at which time
only 30 class members participated in the settlement. Claims totaling $3,105
were paid out in November 1998. MichCon is continuing its lawsuit against
certain of the manufacturers, contractors and installers of the plaintiffs'
furnaces.
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 MCN, and constitute
100% of the voting securities of MichCon. Therefore, no market exists for
MichCon's common stock. On January 31, 1996, MichCon called for redemption the
remaining 104,732 shares of its redeemable cumulative preferred stock.
MichCon paid cash dividends of $46.1 million in 1998, $40.0 million in 1997
and $11.3 million in 1996 on its common stock.
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ITEM 6. SELECTED FINANCIAL DATA (UNAUDITED)
Selected Financial Data 1998 1997 1996 1995 1994
- --------------------------------------------- ----------- ----------- ----------- ----------- -----------
(Dollars in thousands)
INCOME AVAILABLE FOR COMMON STOCK ........... $ 76,976 $ 79,020 $ 79,824 $ 71,488 $ 59,387
=========== =========== =========== =========== ===========
Cash Dividends Declared on Common Stock ..... $ 46,084 $ 40,000 $ 11,263 $ 6,500 $ 8,500
=========== =========== =========== =========== ===========
RETURN ON AVERAGE COMMON SHAREHOLDER'S
EQUITY...................................... 12.2% 13.3% 14.7% 15.8% 15.2%
=========== =========== =========== =========== ===========
PROPERTY, PLANT AND EQUIPMENT ............... $ 2,889,020 $ 2,790,352 $ 2,668,294 $ 2,413,120 $ 2,189,150
Less - accumulated depreciation and
depletion................................... 1,396,940 1,322,392 1,243,060 1,151,160 1,071,588
----------- ----------- ----------- ----------- -----------
Net property, plant and equipment ........... $ 1,492,080 $ 1,467,960 $ 1,425,234 $ 1,261,960 $ 1,117,562
=========== =========== =========== =========== ===========
TOTAL ASSETS ................................ $ 2,172,525 $ 2,136,336 $ 2,058,344 $ 1,798,493 $ 1,571,910
=========== =========== =========== =========== ===========
CAPITAL EXPENDITURES ........................ $ 153,475 $ 155,208 $ 212,668 $ 235,767 $ 145,421
=========== =========== =========== =========== ===========
CAPITALIZATION
Long-term debt .............................. $ 615,419 $ 611,763 $ 536,561 $ 501,396 $ 431,870
Long-term capital lease obligations ......... 4,416 5,344 13,757 15,168 16,459
Redeemable cumulative preferred stock ....... -- -- -- -- 2,618
Common shareholder's equity ................. 646,843 616,024 577,004 489,821 417,833
----------- ----------- ----------- ----------- -----------
Total capitalization ........................ $ 1,266,678 $ 1,233,131 $ 1,127,322 $ 1,006,385 $ 868,780
=========== =========== =========== =========== ===========
SOURCES OF OPERATING REVENUES
Gas sales ................................... $ 853,463 $ 1,079,530 $ 1,058,499 $ 896,707 $ 954,537
Application of (provision for) refunds-net .. (29,717) (16,736) 27,346 20,473 223
End user transportation ..................... 82,016 84,516 82,210 80,360 76,228
Intermediate transportation ................. 63,218 55,221 48,570 31,913 28,745
Storage services ............................ 7,243 7,630 6,956 8,857 8,054
Conservation and other assistance programs .. -- (2,914) (2,483) 14,499 18,716
Other ....................................... 57,435 46,432 37,687 28,004 25,175
----------- ----------- ----------- ----------- -----------
Total operating revenues .................... $ 1,033,658 $ 1,253,679 $ 1,258,785 $ 1,080,813 $ 1,111,678
=========== =========== =========== =========== ===========
DISPOSITION OF GAS (MMcf)
Gas sales ................................... 168,906 205,760 217,672 206,951 201,423
End user transportation ..................... 140,051 144,963 146,662 145,288 139,800
Intermediate transportation ................. 537,532 586,496 527,510 341,550 303,617
----------- ----------- ----------- ----------- -----------
846,489 937,219 891,844 693,789 644,840
Company use and lost gas .................... 4,811 3,896 5,746 2,990 2,239
----------- ----------- ----------- ----------- -----------
Total disposition of gas .................... 851,300 941,115 897,590 696,779 647,079
=========== =========== =========== =========== ===========
EFFECT OF WEATHER
Degree days ................................. 5,471 6,830 7,171 6,777 6,489
Percent colder (warmer) than normal ......... (19.3)% .8 % 5.4 % .3 % (4.2)%
Increase (decrease) from normal in:
Gas markets (MMcf) ........................ (40,272) 589 10,909 1,488 (4,353)
Net income ................................ $ (35,314) $ 467 $ 9,886 $ 1,415 $ (3,984)
UTILITY CUSTOMERS
Residential ................................. 1,104,033 1,092,334 1,087,450 1,077,668 1,061,300
Total ....................................... 1,190,508 1,178,543 1,169,690 1,159,140 1,141,463
EMPLOYEES ................................... 2,724 2,867 3,062 3,128 3,273
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ITEM 7. MANAGEMENT DISCUSSION & ANALYSIS
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
MichCon's earnings for 1998 were $77.0 million, a decrease of $2.0 million from
1997. Results for 1998 include an unusual charge which reduced earnings by $11.2
million. As subsequently discussed, the unusual charge represents the write-down
of certain gas gathering properties. Excluding the unusual charge, MichCon had
1998 earnings of $88.2 million, an improvement of $9.2 million over 1997.
Earnings for 1997 were $79.0 million, representing a slight decrease from 1996.
Earnings comparisons were impacted by variations in weather and cost-saving
initiatives resulting in significantly lower operating costs. The cost-saving
initiatives allowed MichCon to continue its record of solid financial
performance.
- --------------------------------------------------------------------------------
EARNINGS COMPONENTS (IN MILLIONS)
---------------------------------------------------
Comparing 1998 To 1997 Comparing 1997 To 1996
---------------------- ----------------------
Dollar Percent Dollar Percent
Change Change Change Change
-------- -------- -------- --------
Operating Revenues .............. $ (220.0) (17.6)% $ (5.1) (.4)%
Cost of Gas ..................... (180.7) (28.6) (4.4) (.7)
Gross Margin .................... (39.3) (6.3) (.7) (.1)
Operation and Maintenance ....... (30.2) (10.7) (11.6) (4.0)
Depreciation and Depletion ...... (10.8) (10.4) 5.6 5.7
Property and Other Taxes ........ (5.3) (8.7) (1.0) (1.7)
Property Write-down ............. 24.8 -- -- --
Other Income and Deductions ..... (5.9) (11.8) 3.0 6.4
Income Tax Provision ............ (9.8) (21.6) 4.2 10.1
Net Income ...................... (2.0) (2.6) (.8) (1.0)
- --------------------------------------------------------------------------------
GROSS MARGIN
Gross margin (operating revenues less cost of gas) decreased $39.3 million and
$.7 million in 1998 and 1997, respectively, reflecting changes in gas sales and
end user transportation deliveries due primarily to abnormally warm weather in
1998 and significantly colder weather in 1996. Additionally, gross margins in
1998 and 1997 were favorably affected by the continued growth in intermediate
transportation services as well as increased other operating revenues resulting
from providing gas-related services.
- -------------------------------------------------------------------------------------------
EFFECT OF WEATHER ON GAS MARKETS AND EARNINGS 1998 1997 1996
-------- -------- --------
Percentage Colder (Warmer) Than Normal ...... (19.3)% .8% 5.4%
Increase (Decrease) From Normal in:
Gas markets (in Bcf) ..................... (40.3) .6 10.9
Net income (in Millions) ................. $ (35.3) $ .5 $ 9.9
- ---------------------------------------------------------------------------------------------
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MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
GAS SALES AND END USER TRANSPORTATION revenues in total decreased $241.5 million
in 1998 and $20.7 million in 1997. Revenues were affected by fluctuations in gas
sales and end user transportation deliveries that decreased by 41.8 Bcf to 309.0
Bcf in 1998 and decreased by 13.6 Bcf to 350.8 in 1997. The decreases in gas
sales and end user transportation deliveries for both periods were due primarily
to weather, which was 20.1% warmer in 1998 and 4.6% warmer in 1997 compared to
the previous years. The decrease in revenues in 1998 was also affected by a
reduction in gas sales rates resulting from lower gas costs. The impact of
reduced gas sales and transportation deliveries in 1997 was partially offset by
an increase in gas sales rates due to higher gas costs. As discussed in the
"Cost of Gas" section that follows, MichCon's sales rates through the end of
1998 were set to recover all of its reasonably and prudently incurred gas costs.
Therefore, the effect of any fluctuations in cost of gas sold was substantially
offset by a change in gas sales revenues.
End user transportation services are provided to large-volume commercial and
industrial customers who purchase gas directly from producers and brokers and
contract with MichCon to transport the gas to their facilities. MichCon
continues to enter into multi-year, competitively priced transportation
agreements with large-volume users to maintain these gas markets over the long
term.
- --------------------------------------------------------------------------------
1998 1997 1996
-------- -------- --------
Operating Revenues (in Millions)
Gas Sales ..................... $ 823.8 $1,062.8 $1,085.8
End User Transportation ....... 82.0 84.5 82.2
Intermediate Transportation ... 63.2 55.2 48.6
Other ......................... 64.7 51.2 42.2
-------- -------- --------
$1,033.7 $1,253.7 $1,258.8
======== ======== ========
Gas Markets (Bcf)
Gas Sales ..................... 168.9 205.8 217.7
End User Transportation ....... 140.1 145.0 146.7
Intermediate Transportation ... 537.5 586.4 527.5
-------- -------- --------
846.5 937.2 891.9
======== ======== ========
- --------------------------------------------------------------------------------
INTERMEDIATE TRANSPORTATION revenues increased by $8.0 million and $6.6 million
in 1998 and 1997, respectively, due in part to increased fees generated from the
transfer of gas title among and between intermediate transportation service
users and various gas owners. Intermediate transportation is a gas delivery
service provided to gas producers, gas brokers and other gas companies that own
the natural gas but are not the ultimate consumers.
Although intermediate transportation revenues increased in 1998, volumes
delivered decreased 48.9 Bcf. Intermediate transportation deliveries increased
in 1997 by 58.9 Bcf. The decrease in intermediate transportation deliveries in
1998 reflects lower off-system demand caused by the warmer weather and lower
volumes transported for fixed-fee customers. Although transported volumes for
fixed-fee customers may fluctuate, revenues from such customers are not
affected. Intermediate transportation revenues and volumes delivered for both
1998 and 1997 were affected by additional Antrim gas volumes transported for
Michigan gas producers and brokers. There has been a significant increase in
Michigan Antrim gas production over the past several years, resulting in a
growing demand by gas producers and brokers for intermediate transportation
services. In order to meet the increased demand, MichCon expanded the
transportation capacity of its northern Michigan gathering system in 1996. In
December 1997, MichCon purchased an existing pipeline system and further
expanded the capacity of this system.
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MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
Although intermediate transportation volumes are a significant part of total
markets, profit margins on this service are considerably less than margins on
gas sales or for end user transportation services.
OTHER OPERATING REVENUES increased $13.5 million in 1998 and $9.0 million in
1997. The improvement in both periods is due in part to an increase in late
payment fees, appliance maintenance services and other gas-related services. The
comparisons are also impacted by unfavorable adjustments in 1997 and 1996
related to the discontinuance of MichCon's energy conservation programs.
COST OF GAS
Cost of gas is affected by variations in sales volumes and the cost of purchased
gas as well as related transportation costs. Under the Gas Cost Recovery (GCR)
mechanism in effect through 1998 (Note 7b), MichCon adjusted its sales rates to
recover all of its reasonably and prudently incurred gas costs. Therefore,
fluctuations in cost of gas sold had little effect on gross margins.
Cost of gas sold decreased by $180.7 million in 1998 and by $4.4 million in 1997
as a result of lower sales volumes, primarily due to warmer weather. The
decrease in 1998 also reflects lower prices paid for gas purchased of $.40 (13%)
per thousand cubic feet (Mcf). Additionally, the decrease in 1997 was impacted
by supplier refunds, partially offset by higher prices paid for gas purchased of
$.19 per Mcf (7%).
OTHER OPERATING EXPENSES
OPERATION AND MAINTENANCE expenses declined by $30.2 million in 1998 and $11.6
million in 1997. These reductions reflect management's continuing efforts to
control operating costs. More specifically, the reductions for both 1998 and
1997 reflect lower benefit costs, primarily pension and retiree healthcare
costs, as well as lower uncollectible gas accounts expense.
MichCon has streamlined its organizational structure over the past several years
while increasing its customer base and expanding energy services to customers.
MichCon implemented an early retirement program in early 1998 that reduced its
net workforce by approximately 6%. The cost of the program and the related
savings were largely offsetting in 1998 but will contribute to lower operating
costs in future years. Since 1995, the number of employees has declined by 404
or 13%, while the number of customers has increased by over 30,000 or 3%.
MichCon's uncollectible gas accounts expense declined by $8.7 million in 1998
and $5.7 million in 1997 reflecting the impact of warmer weather on accounts
receivable balances, the successful implementation of a more aggressive
collection program, as well as increased home heating assistance funding
obtained by low-income customers.
MichCon's uncollectible gas accounts expense is directly affected by the level
of government funded heating assistance its qualifying customers receive. The
State of Michigan provides this assistance in the form of Michigan Home Heating
Credits that are funded almost exclusively by the Federal Low-Income Home Energy
Assistance Program (LIHEAP). Congress approved funding for the 1997 and 1998
fiscal years at $1 billion and $1.1 billion, respectively, compared to funding
of $.9 billion for the 1996 fiscal year. The State of Michigan's share of LIHEAP
funds was decreased from $64 million in fiscal year 1997 to $54 million in 1998.
MichCon received $13.4 million of these funds in 1998, $.7 million more than in
1997. Home Heating Credits assisted 73,000 MichCon customers in 1998, compared
to 83,000 in 1997. During 1998, Congress approved a budget that maintains
federal LIHEAP funding at $1.1 billion for fiscal year ending September 1999.
Any future change in this funding may impact MichCon's uncollectible gas
accounts expense.
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MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
DEPRECIATION AND DEPLETION decreased by $10.8 million in 1998 and increased by
$5.6 million in 1997. The decrease in 1998 resulted from lower depreciation
rates for utility property, plant and equipment that became effective in January
1998. Depreciation on higher plant balances partially offset the 1998 rate
decrease and resulted in the increase in 1997. The higher plant balances reflect
capital expenditures of $153.5 million in 1998 and $155.2 million in 1997.
PROPERTY AND OTHER TAXES decreased $5.3 million in 1998 and $1.0 million in
1997. The decreases for both 1998 and 1997 are attributable to lower property
taxes based on pending appeals of personal property tax assessments. If MichCon
is unsuccessful in its appeals, that outcome is not expected to have a
significant adverse effect on its results of operations. The decrease in 1998 is
also due to lower Michigan Single Business taxes resulting from a decrease in
taxable income. Property and other taxes increased in 1996 as a result of higher
plant balances.
PROPERTY WRITE-DOWN of $24.8 million in 1998 reflects the impairment of certain
gas gathering properties in northern Michigan (Note 2). As a result of the need
to divert certain untreated gas away from the gathering system, a new gas
reserve analysis was performed. This analysis revealed that projected cash flows
from the gathering system were not sufficient to cover the system's carrying
value. Therefore, an impairment loss was recorded representing the amount by
which the carrying value of the system exceeded its estimated fair value.
OTHER INCOME AND DEDUCTIONS
Other income and deductions decreased $5.9 million in 1998 and increased $3.0
million in 1997. Other income and deductions for both 1998 and 1997 include
higher interest costs on increased borrowings required to finance capital
investments. MichCon issued $150 million of first mortgage bonds in 1998 and $85
million of first mortgage bonds in 1997. Additionally, nonutility subsidiaries
of MichCon borrowed $40 million in 1997 under a nonrecourse credit agreement.
Accordingly, interest expense increased $2.8 million in 1998 and $5.5 million in
1997. Offsetting the impact of higher interest costs in 1998 was a change in
minority interest reflecting joint venture partners' share of the write-down of
certain gas gathering properties (Note 2). Other income and deductions in 1998
were also affected by a gain recorded from the sale of land as well as by an
increase in the capitalization of the cost of equity funds used during
construction resulting from higher construction balances.
INCOME TAXES
Income taxes decreased in 1998 and increased in 1997. Income tax comparisons
were affected by variations in pre-tax earnings and by 1998 tax credits and a
provision for tax issues. Income taxes in 1997 and 1996 include amounts for the
favorable resolution of prior years' tax issues and tax credits.
ENVIRONMENTAL MATTERS
Prior to the construction of major natural gas pipelines, gas for heating and
other uses was manufactured from processes involving coal, coke or oil. MichCon
owns, or previously owned, 16 such former manufactured gas plant (MGP) sites.
During the mid-1980s, MichCon conducted preliminary environmental investigations
at former MGP sites, and some contamination related to the by-products of gas
manufacturing was discovered at each site. The existence of these sites and the
results of the environmental investigations have been reported to the Michigan
Department of Environmental Quality (MDEQ). None of these former MGP sites is on
the National Priorities List prepared by the U.S. Environmental Protection
Agency (EPA).
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MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
MichCon is involved in an administrative proceeding before the EPA regarding one
of the former MGP sites. MichCon has executed an order with the EPA, pursuant to
which MichCon is legally obligated to investigate and remediate the MGP site.
MichCon is remediating four of the former MGP sites and conducting more
extensive investigations at four other former MGP sites. In 1998, MichCon
completed the remediation of one of the former MGP sites, which was confirmed by
the MDEQ. Additionally, the MDEQ has determined with respect to one other former
MGP site that MichCon is not a responsible party for the purpose of assessing
remediation expenditures.
In 1984, MichCon established an $11.7 million reserve for environmental
investigation and remediation. During 1993, MichCon received MPSC approval of a
cost deferral and rate recovery mechanism for investigation and remediation
costs incurred at former MGP sites in excess of this reserve.
MichCon employed outside consultants to evaluate remediation alternatives for
these sites, to assist in estimating its potential liabilities and to review its
archived insurance policies. The findings of these investigations indicate that
the estimated total expenditures for investigation and remediation activities
for these sites could range from $30 million to $170 million based on
undiscounted 1995 costs. As a result of these studies, MichCon accrued an
additional liability and a corresponding regulatory asset of $32 million during
1995.
MichCon notified more than 40 current and former insurance carriers of the
environmental conditions at these former MGP sites. MichCon concluded settlement
negotiations with certain carriers in 1996 and 1997 and has received payments
from several carriers. In October 1997, MichCon filed suit against major
nonsettling carriers seeking recovery of incurred costs and a declaratory
judgment of the carriers' liability for future costs of environmental
investigation and remediation costs at former MGP sites. Discovery is ongoing in
the case, and a preliminary trial date has been scheduled for August 1999.
During 1998, 1997, and 1996, MichCon spent $1.6 million, $.8 million and $.9
million, respectively, investigating and remediating these former MGP sites. At
December 31, 1998, the reserve balance is $32.1 million, of which $.1 million is
classified as current. Any significant change in assumptions, such as
remediation techniques, nature and extent of contamination and regulatory
requirements, could impact the estimate of remedial action costs for the sites
and, therefore, have an effect on MichCon's financial position and cash flows.
However, management believes that insurance coverage and the cost deferral and
rate recovery mechanism approved by the MPSC will prevent environmental costs
from having a material adverse impact on MichCon's results of operations.
In 1998, MichCon received written notification from ANR Pipeline Company (ANR)
alleging that MichCon has responsibility for a portion of the costs associated
with responding to environmental conditions present at a natural gas storage
field in Michigan currently owned and operated by an affiliate of ANR. At least
some portion of the natural gas storage field was formerly owned by MichCon.
MichCon is evaluating ANR's allegations to determine whether and to what extent,
if any, it may have legal responsibility for these costs. Management does not
believe this matter will have a material impact on MichCon's financial
statements.
16
21
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
CAPITAL RESOURCES AND LIQUIDITY
OPERATING ACTIVITIES
MichCon's cash flow from operating activities increased $30.7 million in 1998
and $85.6 million in 1997. The increase for both years reflects lower working
capital requirements and higher earnings after adjusting for noncash items
(depreciation, the unusual charge and deferred taxes) as compared to prior
years.
FINANCING ACTIVITIES
MichCon maintains a relatively consistent amount of cash and cash equivalents
through the use of short-term borrowings. Short-term borrowings are normally
reduced in the first part of each year as gas inventories are depleted and funds
are received from winter heating sales. During the latter part of each year,
MichCon's short-term borrowings normally increase as funds are used to finance
increases in gas inventories and customer accounts receivable. To meet its
seasonal short-term borrowing needs, MichCon normally issues commercial paper
that is backed by credit lines with several banks. MichCon has established
credit lines to allow for borrowings of up to $150 million under a 364-day
revolving credit facility and up to $150 million under a three-year revolving
credit facility, both of which were renewed in July 1998. At December 31, 1998,
commercial paper of $218.4 million was outstanding under this program.
During 1998, MichCon issued $150 million of remarketable debt securities
(Note 5). Proceeds from these issuances were used to retire first mortgage
bonds, fund capital expenditures and for general corporate purposes.
Also during 1998, MichCon redeemed through a tender offer $89.7 million and
repaid $20 million of first mortgage bonds (Note 5).
During 1997, MichCon issued $85 million of first mortgage bonds. The funds from
this issuance were used to retire first mortgage bonds, fund capital
expenditures and for general corporate purposes. During 1997, nonutility
subsidiaries of MichCon borrowed $40 million under a nonrecourse credit
agreement that matures in 2005. Proceeds were used to finance the expansion of
the northern Michigan gathering system.
During 1997, MichCon redeemed $17 million of long-term debt and also repaid $50
million of first mortgage bonds.
During 1996, MichCon issued first mortgage bonds totaling $70 million. The
proceeds were used to repay short-term obligations, finance capital expenditures
and for general corporate purposes. Also during 1996, MichCon repaid all amounts
owing under its Trust Demand Note program and did not renew this program which
allowed for borrowings of up to $25 million.
As of December 1998, MichCon had an outstanding shelf registration with $250
million remaining to be issued in the form of debt securities.
17
22
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
The following table sets forth the ratings for securities issued by
MichCon:
- ----------------------------------------------------------------------------------------
Standard Duff &
& Poors Moody's Phelp's Fitch
-------- ------- ------- -----
Commercial paper ....................... A2 P1 D1 F1
First mortgage bonds ................... A- A2 A+ A
- ----------------------------------------------------------------------------------------
INVESTING ACTIVITIES
MichCon's capital expenditures totaled $153.5 million during 1998, a decrease of
$1.7 million from 1997. Capital expenditures primarily represent the
construction of new distribution lines to attach new customers, new computer
systems and improvements to existing storage, distribution and transmission
systems. Capital expenditures for 1999 are expected to total $132 million.
In December 1998, MichCon invested $28.2 million in a Grantor Trust to meet
future cash flow obligations related to certain postretirement health care
costs.
It is management's opinion that MichCon will have sufficient capital resources,
both internal and external to meet anticipated capital requirements.
OUTLOOK
MichCon's strategy is to expand its role as the preferred provider of natural
gas and high-value energy services within Michigan. Accordingly, MichCon's
objectives are to grow its revenues and control its costs in order to deliver
strong shareholder returns and provide customers high-quality service at
competitive prices. Revenue growth will be achieved through initiatives to
expand MichCon's 900 Bcf of gas markets, its 1.2 million residential, commercial
and industrial customer base, as well as by providing new energy-related
services that capitalize on its expertise, capabilities and efficient systems.
MichCon expects to provide natural gas to approximately 13,000 new customers in
1999. MichCon's market share for residential heating customers in the
communities it serves is approximately 80%. While this saturation rate is high,
growth opportunities exist through conversion of existing homes from other fuels
as well as from new construction. MichCon continues to expand industrial and
commercial markets by aggressively facilitating the use of existing gas
technologies and equipment.
Management is continually assessing ways to improve cost competitiveness. Among
other cost saving initiatives, MichCon implemented an early retirement incentive
program in 1998 that reduced its net workforce by 6%. Although this program did
not have a material impact on 1998 net income, the early retirement of employees
is expected to contribute toward reducing operating costs in future years.
The challenges and opportunities resulting from increased competition in the
natural gas industry have been a catalyst for MPSC action in the development of
major reforms in utility regulation aimed at giving all customers added choices
and more price certainty. The overall package of regulatory changes connected
with the gas industry restructuring is expected to generate additional revenue
and cost savings opportunities. MichCon is positioning itself to respond to
changes in regulation and increased competition by reducing its cost of
operations while maintaining a safe and reliable system for customers.
18
23
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
MichCon plans to capitalize on opportunities resulting from the gas industry
restructuring by implementing its Regulatory Reform Plan, which was approved by
the MPSC in April 1998. The plan includes a comprehensive experimental
three-year customer choice program that offers all sales customers added choices
and greater price certainty. Beginning April 1, 1999, a limited number of
customers will have the option of purchasing natural gas from suppliers other
than MichCon. However, MichCon will continue to transport and deliver the gas to
the customers' premises at prices that maintain its existing sales margins.
The plan also suspends the GCR mechanism for customers who continue to purchase
gas from MichCon and fixes the gas commodity component of MichCon's sales rates
at $2.95 per Mcf for the three-year period beginning on January 1, 1999. Prior
to 1999, MichCon did not generate earnings on the gas commodity portion of its
operations. However, under this plan, changes in the cost of gas will directly
impact gross margins and earnings. As part of its gas acquisition strategy,
MichCon has entered into firm-price contracts for a substantial portion of its
expected gas supply requirements for the next three years. These contracts,
coupled with the use of MichCon's storage facilities, will substantially
mitigate risks from winter price and volume fluctuations.
Also beginning in 1999 under the plan, an income sharing mechanism will allow
customers to share in profits when actual utility return on equity exceeds
predetermined thresholds. Although the plan increases MichCon's risk associated
with generating margins that cover its gas costs, management believes this
program will have a favorable impact on future earnings. In October 1998, the
MPSC denied a request for rehearing and affirmed its approval of the plan.
Various parties have appealed the MPSC's decision to the Michigan Court of
Appeals.
As described in Note 7a to the consolidated financial statements, MichCon
complies with the provisions of Statement of Financial Accounting Standards
(SFAS), No. 71, "Accounting for the Effects of Certain Types of Regulation."
Future regulatory changes or changes in the competitive environment could result
in MichCon discontinuing the application of SFAS No. 71 for all or part of its
business and require the write-off of the portion of any regulatory asset or
liability that was no longer probable of recovery or refund. If MichCon were to
discontinue application of SFAS No. 71 for all of its operations as of December
31, 1998, it would have an extraordinary, noncash increase to net income of
approximately $65.8 million. Factors that could give rise to the discontinuance
of SFAS No. 71 include (1) increasing competition that restricts MichCon's
ability to establish prices to recover specific costs, and (2) a significant
change in the manner in which rates are set by regulators from cost-based
regulation to another form of regulation. Based on a current evaluation of the
various factors and conditions that are expected to impact future regulation,
management believes currently available facts support the continued application
of SFAS No. 71.
YEAR 2000
Background - As a result of computer programs being written using two digits
rather than four digits to define the year, any programs that have time
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. This Year 2000 issue, if not addressed, could cause computer
systems to malfunction and have a material adverse impact on MichCon's
operations and business processes. The effects of the Year 2000 issue could be
exacerbated as a result of companies' dependence on partners, operators,
suppliers and government agencies.
Plan and State of Readiness - MichCon, aware of the Year 2000 potential impact,
initiated a business systems replacement program in 1995. Additionally, MichCon
established a corporate-wide program in 1997 under the direction of a Year 2000
Project Office. The Year 2000 project is overseen by a vice president of the
company who reports regularly to the Chairman and Board of Directors of MCN
19
24
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
Energy Group Inc., MichCon's parent company. MichCon has also retained the
services of expert consultants to evaluate its Year 2000 program and to
independently assess and validate its processes. MichCon has implemented a
four-phase Year 2000 approach consisting of: i) inventory - identification of
the components of MichCon's systems, equipment and facilities; ii) assessment
assessing Year 2000 readiness and prioritizing the risks of items identified in
the inventory phase; iii) remediation - upgrading, repairing and replacing
non-compliant systems, equipment and facilities; and iv) testing - verifying
items remediated. MichCon is on schedule to have its mission critical business
systems and measurement and control systems (including embedded microprocessors)
Year 2000 ready by mid-1999, as detailed below. MichCon's business systems
primarily consist of general ledger, payroll, customer billing and inventory
control systems and their related hardware. MichCon's measurement and control
systems primarily consist of the "SCADA" system, which measures and monitors the
transportation and distribution of gas, as well as regulators, pressure controls
and meters. The estimated completion status of these systems and the projected
status for the future follows:
- --------------------------------------------------------------------------------
Inventory Assessment Remediation Testing
---------- ---------- ----------- ----------
Business Systems:
December 31, 1998 ............ 100% 95% 15% 15%
March 31, 1999 ............... 100% 100% 80% 70%
June 30, 1999 ................ 100% 100% 100% 100%
Measurement and Control Systems:
December 31, 1998 ............ 98% 90% 70% 60%
March 31, 1999 ............... 100% 100% 95% 90%
June 30, 1999 ................ 100% 100% 100% 100%
- --------------------------------------------------------------------------------
MichCon also has visited key operators and suppliers to review their Year 2000
issues and share information. To the extent that any of these parties experience
Year 2000 problems in their systems, MichCon's operations may be adversely
affected. The majority of MichCon's key operators and suppliers have represented
to MichCon that they have completed their Year 2000 inventory and assessment
phases. MichCon is continuing to monitor the progress of these key operators and
suppliers toward their completion of the remediation and testing phases.
Cost of Remediation - Costs associated with the Year 2000 issue are not expected
to have a material adverse effect on MichCon's results of operation, liquidity
or financial condition. The total costs are estimated to be between $3 million
and $4 million, of which approximately $2.3 million was incurred through
December 1998.
The anticipated costs are not higher due in part to the ongoing replacement of
significant older systems, particularly MichCon's customer information system.
MichCon has made a substantial investment in new systems that are in process of
being installed, as well as those installed over the past few years. The
replacement of these systems, and the customer information system in particular,
was necessary to maintain a high level of customer satisfaction and to respond
to changes in regulation and increased competition within the energy industry.
While the system replacements were not accelerated due to Year 2000 issues, MCN
expects the new systems to be Year 2000 ready.
20
25
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
Risk and Contingency Planning - MichCon anticipates a smooth transition to the
Year 2000. However, the failure to correct a material Year 2000 problem could
result in an interruption in or a failure of certain business activities and
operations such as: i) delivery of gas to customers; ii) control and operation
of the distribution system by electronic devices; iii) communication with
customers for purposes of service calls or inquiries; and iv) timely billing and
collection. The risk and impact of such failures is largely dependent on
critical vendors and the external infrastructure that includes
telecommunications providers and gas suppliers. The most reasonably likely worst
case scenarios would be the extended inability to deliver gas due to the failure
of embedded systems in the distribution process or the extended inability to
communicate with and respond to customers due to the loss of telecommunications.
Such failures could have a material adverse effect on MichCon's results of
operations, liquidity and financial condition. Due to the uncertainty inherent
in the Year 2000 issue, resulting in part from the uncertainty of the Year 2000
readiness of key operators, suppliers and government agencies, MichCon cannot
certify that it will be unaffected by Year 2000 complications. MichCon has
addressed the Year 2000 risks of its business by prioritizing such risks based
on the worst case scenarios and their impact on the business. Focusing first on
the safety and welfare of MichCon's customers and employees, the following two
mission-critical processes were identified: gas supply and distribution, and
leak management emergency response.
While MichCon believes it will be able to remediate and test all internal
systems that support these processes, it fully recognizes its dependence on
operators, suppliers and government agencies. In order to reduce its Year 2000
risk, MichCon is developing contingency plans for mission-critical processes in
the event of a Year 2000 complication. Through failure scenario identification,
MichCon's approach is to develop reasonable and practical contingency plans to
maintain operations in case of non-performance. Ten contingency planning teams
have been established to address specific scenarios and mission critical
functions identified in support of the safety and welfare of customers and
employees. External suppliers have been contacted for their participation in the
contingency planning efforts for gas supply and transportation, and materials
management. Contingency plans for several essential gas transmission facilities
were tested during December 1998 under a "power outage" scenario and achieved
excellent results. Contingency plans will continue to be refined throughout 1999
as MichCon works with operators, suppliers and governmental agencies.
MARKET RISK INFORMATION
MichCon's primary market risk arises from fluctuations in natural gas prices and
interest rates. MichCon manages natural gas price and interest rate risk through
the use of various derivative instruments and limits the use of such instruments
to hedging activities. If MichCon did not use derivative instruments, its
exposure to such risk would be higher. A further discussion of MichCon's risk
management activities is included in Note 10 to the Consolidated Financial
Statements.
NATURAL GAS PRICE RISK
MichCon closely monitors and manages its exposure to natural gas price risk
through a variety of risk management techniques. Natural gas swap agreements are
used to manage MichCon's exposure to the risk of market price fluctuations on
natural gas purchase contracts.
A sensitivity analysis model was used to calculate the fair values of MichCon's
natural gas swap agreements utilizing applicable forward commodity rates in
effect at December 31, 1998. The sensitivity analysis involved increasing or
decreasing the forward rates by a hypothetical 10% and calculating the resulting
unfavorable change in the fair values of the natural gas swap agreements.
21
26
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
INTEREST RATE RISK
MichCon is subject to interest rate risk in connection with the issuance of
variable- and fixed-rate debt. In order to manage interest costs, MichCon uses
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. MichCon's exposure to interest rate risk arises
primarily from changes in U.S. Treasury rates and London Inter-Bank Offered
Rates (LIBOR).
A sensitivity analysis model was used to calculate the fair values or cash flows
of MichCon's debt and interest rate swaps, utilizing applicable forward interest
rates in effect at December 31, 1998. The sensitivity analysis involved
increasing and decreasing the forward rates by a hypothetical 10% and
calculating the resulting unfavorable change in the fair values or cash flows of
the interest rate sensitive instruments.
The results of the sensitivity model calculations follow:
AMOUNT UNFAVORABLE
RISK (IN MILLIONS) CHANGE IN
------------- -----------
Commodity Price Sensitive:*
Swaps - pay fixed/receive variable............................... $ 3.8 Fair Value
Interest Rate Sensitive:
Debt - fixed rate................................................ $ 66.0 Fair Value
- variable rate............................................. $ .6 Cash Flow
Swaps - pay fixed/receive variable............................... $ .2 Fair Value
- pay variable/receive fixed............................... $ 1.8 Fair Value
*Includes only the risk related to the swaps that serve as hedges and does not
include the related underlying hedged item.
NEW ACCOUNTING PRONOUNCEMENTS
COMPUTER SOFTWARE
In March 1998, the Accounting Standards Executive Committee (AcSEC) of the
American Institute of Certified Public Accountants issued Statement of Position
(SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use." SOP 98-1 requires the capitalization of internal-use software
and specifically identifies which costs should be capitalized and which costs
should be expensed. The statement is effective for fiscal years beginning after
December 15, 1998. Management does not expect the SOP to have a material impact
on MichCon's financial statements.
START-UP ACTIVITIES
In April 1998, the AcSEC issued SOP 98-5, "Reporting on the Costs of Start-up
Activities." SOP 98-5 requires organizational and start-up costs to be expensed
as incurred and is effective for fiscal years beginning after December 15, 1998.
Management does not expect the SOP to have a material impact on MichCon's
financial statements.
22
27
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS (CONCLUDED)
DERIVATIVE AND HEDGING ACTIVITIES
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" effective for
fiscal years beginning after June 15, 1999. SFAS No. 133 expands the definition
of the types of contracts considered derivatives, requires all derivatives to be
recognized in the balance sheet as either assets or liabilities measured at
their fair value, and sets forth conditions in which a derivative instrument may
be designated as a hedge. The Statement requires that changes in the fair value
of derivatives be recognized currently in earnings unless specific hedge
accounting criteria are met. Special accounting for qualifying hedges allows a
derivative's gains and losses to be recorded to other comprehensive income or to
offset related results on the hedged item in earnings.
MichCon manages gas price risk and interest rate risk through the use of various
derivative instruments and limits the use of such instruments to hedging
activities. The effects of SFAS No. 133 on MichCon's financial statements are
subject to fluctuations in the market value of hedging contracts, which are, in
turn, affected by variations in gas prices and in interest rates. Management
cannot quantify the effects of adopting SFAS No. 133 at this time.
FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K 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. Factors that may impact
forward-looking statements include, but are not limited to, the following: (i)
the effects of weather and other natural phenomenon; (ii) increased competition
from other energy suppliers as well as alternative forms of energy; (iii) the
capital intensive nature of MichCon's business; (iv) economic climate and growth
in the geographic areas in which MichCon does business; (v) the uncertainty of
gas reserve estimates; (vi) the timing and extent of changes in commodity prices
for natural gas, electricity and crude oil; (vii) conditions of capital markets
and equity markets; (viii) the timing, nature and impact of Year 2000
activities; and (ix) the effects of changes in governmental policies and
regulatory actions, including income taxes, environmental compliance and
authorized rates.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Quantitative and Qualitative Disclosures About Market Risk is contained in
Item 7. Management Discussion and Analysis - Market Risk Information, page 21
of this Report.
23
28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
Year ended December 31, 1998 1997 1996
- --------------------------------------------- ----------- ----------- -----------
(Thousands of Dollars) Note(s)
OPERATING REVENUES
Gas Sales ................................. $ 823,746 $ 1,062,794 $ 1,085,845
Transportation and storage services ....... 12 152,477 147,367 137,737
Other ..................................... 12 57,435 43,518 35,203
----------- ----------- -----------
Total Operating Revenues ................ 1,033,658 1,253,679 1,258,785
----------- ----------- -----------
OPERATING EXPENSES
Cost of gas ............................... 451,529 632,229 636,594
Operation and maintenance ................. 12 252,397 282,640 294,281
Depreciation and depletion ................ 92,883 103,703 98,147
Property and other taxes .................. 55,438 60,744 61,762
Property write-down ....................... 2 24,800 -- --
----------- ----------- -----------
Total operating expenses ................ 877,047 1,079,316 1,090,784
----------- ----------- -----------
OPERATING INCOME ............................ 156,611 174,363 168,001
----------- ----------- -----------
OTHER INCOME AND (DEDUCTIONS)
Interest income ........................... 12 5,688 4,659 3,900
Interest on long-term debt ................ (44,884) (45,526) (40,703)
Other interest expense .................... (12,113) (8,664) (8,012)
Minority interest ......................... 2 5,727 (1,882) (988)
Equity in earnings - joint ventures ....... 1,946 1,199 886
Other ..................................... (182) 536 (1,756)
----------- ----------- -----------
Total other income and (deductions) ..... (43,818) (49,678) (46,673)
----------- ----------- -----------
INCOME BEFORE INCOME TAXES .................. 112,793 124,685 121,328
INCOME TAX PROVISION ........................ 13 35,817 45,665 41,486
----------- ----------- -----------
NET INCOME .................................. 76,976 79,020 79,842
DIVIDENDS ON PREFERRED STOCK ................ -- -- 18
----------- ----------- -----------
NET INCOME AVAILABLE FOR COMMON STOCK ....... $ 76,976 $ 79,020 $ 79,824
=========== =========== ===========
The notes to the consolidated financial statements are an integral part of this
statement.
24
29
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
December 31 1998 1997
- --------------------------------------------------------------------- ---------- ----------
(Thousands of Dollars) Note(s)
ASSETS
CURRENT ASSETS
Cash and cash equivalents. ...................................... $ 6,603 $ 14,353
Accounts receivable, less allowance for doubtful accounts of
$8,928 and $15,015 respectively ............................... 142,818 195,662
Accrued unbilled revenues ....................................... 86,767 91,896
Gas in inventory ................................................ 3 56,969 40,201
Property taxes assessed applicable to future periods ............ 71,165 64,827
Accrued gas cost recovery revenues .............................. 7a -- 12,862
Other ........................................................... 30,169 33,361
---------- ----------
394,491 453,162
---------- ----------
DEFERRED CHARGES AND OTHER ASSETS
Investment in and advances to joint ventures .................... 19,343 19,643
Long-term investments ........................................... 9c 65,556 35,110
Deferred environmental costs .................................... 6b,7a 28,169 27,699
Prepaid benefit costs ........................................... 9 113,879 85,790
Other 59,007 46,972
---------- ----------
285,954 215,214
---------- ----------
PROPERTY, PLANT AND EQUIPMENT, AT COST ............................ 8 2,889,020 2,790,352
Less - Accumulated depreciation and depletion ................... 1,396,940 1,322,392
---------- ----------
1,492,080 1,467,960
---------- ----------
$2,172,525 $2,136,336
========== ==========
LIABILITIES AND CAPITALIZATION
CURRENT LIABILITIES
Accounts payable ................................................ $ 98,891 $ 130,267
Notes payable ................................................... 4 221,169 241,691
Current portion of long-term debt and capital lease obligations . 5a,8 58,288 34,956
Federal income, property and other taxes payable ................ 61,059 78,630
Deferred gas cost recovery revenues ............................. 7a 14,980 --
Exchange gas payable ............................................ 25,337 2,063
Customer deposits ............................................... 18,769 16,363
Other ........................................................... 67,222 65,717
---------- ----------
565,715 569,687
---------- ----------
DEFERRED CREDITS AND OTHER LIABILITIES
Deferred income taxes ........................................... 13 88,567 83,905
Unamortized investment tax credit ............................... 29,784 32,745
Tax benefits amortizable to customers ........................... 7a 130,120 122,922
Accrued environmental costs ..................................... 6b 32,000 32,000
Minority interest ............................................... 2 8,201 17,283
Other ........................................................... 51,460 44,663
---------- ----------
340,132 333,518
---------- ----------
COMMITMENTS AND CONTINGENCIES 6,8
CAPITALIZATION (SEE ACCOMPANYING STATEMENT)
Long-term debt, including capital lease obligations ............. 5a,8,10 619,835 617,107
Common shareholder's equity ..................................... 646,843 616,024
---------- ----------
1,266,678 1,233,131
---------- ----------
$2,172,525 $2,136,336
========== ==========
The notes to the consolidated financial statements are an integral part of this
statement.
25
30
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended December 31, 1998 1997 1996
- ---------------------------------------------------------------- --------- --------- ---------
(Thousands of Dollars) Note(s)
CASH FLOW FROM OPERATING ACTIVITIES
Net income ................................................... $ 76,976 $ 79,020 $ 79,842
Adjustments to reconcile net income to net cash flow provided
from operating activities:
Depreciation and depletion
Per statement of income ................................ 92,883 103,703 98,147
Charged to other accounts 7,946 7,663 7,579
Property write-down , net of taxes and minority
interest................................................ 2 11,200 -- --
Deferred income taxes - current .......................... (961) (3,130) 4,963
Deferred income taxes and investment tax credit, net ..... 15,005 10,853 6,999
Other .................................................... (4,430) (679) (2,629)
Changes in assets and liabilities, exclusive of changes
shown separately ....................................... 19,299 (10,167) (93,207)
--------- --------- ---------
Net cash provided from operating activities .......... 217,918 187,263 101,694
--------- --------- ---------
CASH FLOW FROM FINANCING ACTIVITIES
Notes payable, net ........................................... 4 (20,522) (23,435) 68,491
Issuance of long-term debt ................................... 5a 153,052 124,051 69,645
Cash dividend paid:
Common Stock .............................................. (46,084) (40,000) (11,263)
Preferred Stock ........................................... -- -- (54)
Equity Investment ............................................ -- -- 1,614
Retirement of long-term debt ................................. 5a (126,292) (76,854) (6,384)
--------- --------- ---------
Net cash provided from (used for)
financing activities ............................... (39,846) (16,238) 122,049
--------- --------- ---------
CASH FLOW FROM INVESTING ACTIVITIES
Notes receivable - affiliate, net ............................ 12 (3,249) -- --
Capital expenditures ......................................... (153,475) (155,208) (212,668)
Other, net ................................................... (29,098) (11,474) (9,534)
--------- --------- ---------
Net cash used for investing activities ............... (185,822) (166,682) (222,202)
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ........... (7,750) 4,343 1,541
CASH AND CASH EQUIVALENTS, JANUARY 1 ........................... 14,353 10,010 8,469
--------- --------- ---------
CASH AND CASH EQUIVALENTS, DECEMBER 31 ......................... $ 6,603 $ 14,353 $ 10,010
========= ========= =========
CHANGES IN ASSETS AND LIABILITIES,
EXCLUSIVE OF CHANGES SHOWN SEPARATELY
Accounts receivable - net .................................. $ 50,174 $ (43,510) $ 7,807
Accrued/deferred gas cost recovery revenues ................ 27,843 14,810 (28,250)
Accrued unbilled revenues .................................. 5,129 15,481 (16,243)
Gas in inventory ........................................... (16,768) 28,008 (27,719)
Property taxes assessed applicable to future periods ....... (6,338) (4,235) (3,643)
Accounts payable ........................................... (30,617) (585) 21,401
Federal income, property and other taxes payable ........... (17,602) (6,228) (2,424)
Exchange gas payable ....................................... 23,274 2,063 --
Deferred and prepaid benefit costs ......................... (28,089) (16,620) (44,021)
Other current assets and liabilities ....................... 11,191 (2,353) 6,312
Deferred assets and liabilities ............................ 1,102 3,002 (6,427)
--------- --------- ---------
$ 19,299 $ (10,167) $ (93,207)
========= ========= =========
SUPPLEMENTAL DISCLOSURES
Cash paid for:
Interest, net of amounts capitalized ...................... $ 56,250 $ 52,172 $ 48,254
========= ========= =========
Federal income taxes ...................................... $ 27,090 $ 46,984 $ 31,927
========= ========= =========
Noncash financing activities:
Transfer of pipeline net assets from MCN .................. $ -- $ -- $ 17,008
========= ========= =========
The notes to the consolidated financial statements are an integral part of this
statement.
26
31
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CAPITALIZATION
Year Ended December 31 1998 1997 1996
- ---------------------------------------------------------------------- -------------- -------------- --------------
(Thousands of dollars) Note(s)
LONG-TERM DEBT, EXCLUDING CURRENT REQUIREMENTS 5A
FIRST MORTGAGE BONDS, INTEREST PAYABLE SEMI-ANNUALLY
6.3 % series due 1998 .............................................. $ -- $ -- $ 20,000
6.51 % series due 1999 ............................................. -- 30,000 30,000
5.75 % series due 2001 ............................................. 40,000 60,000 60,000
8 % series due 2002 ................................................ 17,314 70,000 70,000
6.72 % series due 2003 ............................................. 4,150 4,150 4,150
6.8 % series due 2003 .............................................. 15,850 15,850 15,850
9.125 % series due 2004 ............................................ 18,000 55,000 55,000
7.15 % series due 2006 ............................................. 40,000 40,000 40,000
7.21 % series due 2007 ............................................. 30,000 30,000 --
7.06 % series due 2012 ............................................. 40,000 40,000 --
8.25 % series due 2014 ............................................. 80,000 80,000 80,000
7.6 % series due 2017 .............................................. 14,980 14,990 --
9.5 % series due 2019 .............................................. -- -- 5,000
7.5 % series due 2020 .............................................. 29,641 29,641 29,812
9.5 % series due 2021 .............................................. 40,000 40,000 40,000
6.75 % series due 2023 ............................................. 16,617 17,177 17,782
7 % series due 2025 ................................................ 40,000 40,000 40,000
Unamortized discount ............................................... (1,130) (1,235) (1,349)
Remarketable securities, interest payable semi-annually
6.2 % series due 2038 ............................................. 75,000 -- --
6.45 % series due 2038 ............................................. 75,000 -- --
Unamortized premium ................................................ 3,871 -- --
Unsecured Notes - 9.750 % series due 2000 ............................ -- -- 12,000
Long-term capital lease obligations .................................. 8 4,416 5,344 13,757
Other long-term debt ................................................. 36,126 46,190 18,316
---------- ---------- ----------
Total............................................................... 619,835 617,107 550,318
---------- ---------- ----------
COMMON SHAREHOLDER'S EQUITY
COMMON STOCK, PAR VALUE $1 PER SHARE - AUTHORIZED, FOR
all periods, 15,100,000 shares; outstanding 10,300,000 shares .... 10,300 10,300 10,300
---------- ---------- ----------
ADDITIONAL PAID-IN CAPITAL
Balance - beginning of period .................................... 230,399 230,399 211,777
Equity investment ................................................ -- -- 18,622
---------- ---------- ----------
Balance - end of period .......................................... 230,399 230,399 230,399
---------- ---------- ----------
RETAINED EARNINGS
Balance - beginning of period .................................... 375,325 336,305 267,744
Net income ....................................................... 76,976 79,020 79,842
Dividends declared:
Common stock ................................................... (46,157) (40,000) (11,263)
Preferred stock ................................................ -- -- (18)
---------- ---------- ----------
Balance - end of period .......................................... 406,144 375,325 336,305
---------- ---------- ----------
Total common shareholder's equity .................................... 646,843 616,024 577,004
---------- ---------- ----------
Total capitalization ................................................. $1,266,678 $1,233,131 $1,127,322
========== ========== ==========
The notes to the consolidated financial statements are an integral part of this
statement.
27
32
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF ACCOUNTING POLICIES
COMPANY DESCRIPTION
Michigan Consolidated Gas Company (MichCon) is a public utility engaged
in the distribution and transmission of natural gas in the state of
Michigan. MichCon is subject to the accounting requirements of and rate
regulation by the Michigan Public Service Commission (MPSC) with respect
to the distribution and intrastate transportation of natural gas. The
major services provided by MichCon are gas sales, end user
transportation and intermediate transportation. MichCon serves more than
1.2 million residential, commercial and industrial customers. MichCon is
not dependent upon any one customer or group of customers. Its principal
markets are located in the Detroit, Grand Rapids, Ann Arbor, Traverse
City, and Muskegon metropolitan areas. MichCon's non-regulated operations
are not material. MichCon is an indirect wholly owned subsidiary of MCN
Energy Group Inc. (MCN).
BASIS OF PRESENTATION
The accompanying consolidated financial statements were prepared in
conformity with generally accepted accounting principles. In connection
with their preparation, management was required to make estimates and
assumptions that affect the reported amounts of assets, liabilities,
revenues, expenses and the disclosure of contingent liabilities. Actual
results could differ from those estimates. Certain reclassifications
have been made to prior years' statements to conform to the 1998
presentation.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of MichCon
and all of its subsidiaries. Investments in 50% or less owned entities
have been accounted for under the equity method because MichCon has
significant but not controlling influence over these entities.
REVENUES AND COST OF GAS
MichCon accrues revenues for gas service provided but unbilled at month
end. Through December 31, 1998, MichCon's accrued revenues included a
component for cost of gas sold that was recoverable through the gas cost
recovery (GCR) mechanism. Prior to 1999, GCR proceedings before the MPSC
permitted MichCon to recover the prudent and reasonable cost of gas
sold. The overcollection of gas costs totaling $14,980,000 at December
31, 1998, including interest, will be refunded to customers through
reduced rates.
Beginning in 1999, MichCon implemented a Regulatory Reform Plan,
approved by the MPSC. The plan suspends the GCR mechanism and fixes the
gas component of MichCon's sales rates for the three-year period
beginning January 1, 1999.
28
33
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at cost and includes amounts for
labor, materials, overhead, and an allowance for funds used during
construction. Upon retirement, the cost of property, plant and equipment
and net removal costs are charged to accumulated depreciation.
MichCon records depreciation for a major portion of its property, plant
and equipment on the basis of straight-line rates prescribed by the
MPSC. Unit of production depreciation and depletion is used for certain
production and transmission property. Depreciation rates vary by class
of property. The ratio of the provision for depreciation to the average
cost of depreciable property was 3.5% in 1998, 4.1% in 1997 and 4.4% in
1996.
ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION
MichCon capitalizes an allowance for both debt and equity funds used
during construction in the cost of major additions to utility plant. The
total amount capitalized was $4,699,000, $3,188,000 and $5,233,000 in
1998, 1997 and 1996, respectively.
DEFERRED DEBT COSTS
In accordance with MPSC regulations, MichCon defers reacquisition and
unamortized issuance costs of reacquired long-term debt when such debt
is refinanced. These costs are amortized over the term of the
replacement debt.
INCOME TAXES AND INVESTMENT TAX CREDIT
Tax Benefits Amortizable to Customers represents the net revenue
equivalent of the difference in property-related accumulated deferred
income taxes computed in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes," as compared
to the amounts previously reflected in setting utility rates. This
amount is primarily due to current tax rates being lower than the rates
in effect when the original deferred taxes were recorded and because of
temporary differences, including accumulated investment tax credits, for
which deferred income taxes were not previously recorded in setting
utility rates. These net tax benefits are being amortized in accordance
with the regulatory treatment over the life of the related plant, as the
temporary differences reverse.
Investment tax credits relating to property placed into service were
deferred and are being credited to income over the life of the related
property.
CONSOLIDATED STATEMENT OF CASH FLOWS
For purposes of this statement, MichCon considers all highly liquid
investments purchased with a maturity of three months or less, to be
cash equivalents.
29
34
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
2. PROPERTY WRITE-DOWN
During 1998, MichCon recognized a $24,800,000 pre-tax loss ($11,200,000 net of
taxes and minority interest) from the write-down of a gas gathering pipeline
system. A new gas reserve analysis was performed in 1998 to determine the
impact of the diversion of certain untreated gas away from the gathering
system. This analysis revealed that projected cash flows from the gathering
system were not sufficient to cover the system's carrying value. Therefore, an
impairment loss was recorded representing the amount by which the carrying
value of the system exceeded its estimated fair value.
3. GAS IN INVENTORY
Inventory gas is priced on a last-in, first-out (LIFO) basis. At December 31,
1998, the replacement cost exceeded the $56,969,000 LIFO cost by $151,381,000.
At December 31, 1997, the replacement cost exceeded the $40,201,000 LIFO cost
by $170,240,000.
A portion of gas in underground storage used as a pressure base is included in
"Property, Plant and Equipment" in the amount of $32,041,000 at December 31,
1998 and $32,493,000 at December 31, 1997.
4. CREDIT FACILITIES AND SHORT-TERM BORROWINGS
At December 31, 1998, MichCon had credit lines permitting borrowings of up to
$150,000,000 under a 364-day revolving credit facility and up to $150,000,000
under a three-year revolving credit facility, both of which were renewed in
July 1998. MichCon issues commercial paper in lieu of an equivalent amount of
borrowings under these lines of credit. Commercial paper outstanding at
December 31, 1998 and 1997 totaled $218,447,000 and $236,740,000 and was at
weighted average interest rates of 5.6% and 5.8%, respectively. This debt is
classified as short-term. Fees are paid to compensate banks for lines of
credit.
5. CAPITALIZATION
a. LONG-TERM DEBT
In 1998, MichCon issued a total of $150,000,000 of remarketable debt
securities with various interest rates. These securities are "fall-away
mortgage" debt and, as such, are secured debt as long as MichCon's
current first mortgage bonds are outstanding and become senior unsecured
debt thereafter. The securities are structured such that the interest
rates of the issues can be reset at various remarketing dates over the
life of the debt. The initial remarketing dates are in June 2003 and
2008. MichCon received option premiums in return for granting options to
the underwriters to reset the interest rate for a period of ten years at
the initial remarketing dates. The option premiums received, net of
financing costs incurred, totaled $3,052,000 and are being amortized to
income over the initial interest and corresponding option periods. If
the underwriters elect not to exercise their reset options, the
securities become subject to the remarketing feature. If MichCon and the
remarketing agent cannot agree on an interest rate or the remarketing
agent is unable to remarket the securities, MichCon will be required to
repurchase the securities at their principal amounts.
30
35
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
In 1998, MichCon redeemed through a tender offer $37,000,000 of the
outstanding $55,000,000 balance of 9.125% first mortgage bonds due 2004,
and $52,686,000 of the outstanding $70,000,000 balance of 8% first
mortgage bonds due 2002.
During 1997, nonutility subsidiaries of MichCon borrowed $40,000,000
under a nonrecourse credit agreement. Under the terms of the agreement,
certain alternative variable interest rates are available at the
borrowers' option during the life of the agreement. Quarterly principal
payments commenced in 1997, with a final installment due November 2005.
The loan is secured by a pledge of stock of the borrowers and a security
interest in certain of their assets. MichCon may be required to support
the credit agreement through limited capital contributions to the
subsidiaries if certain cash flow and operating targets are not met. At
December 31, 1998 and 1997, $29,200,000 and $36,400,000 were outstanding
at weighted average interest rates of 5.8% and 6.4%, respectively.
MichCon has variable interest rate swap agreements with notional
principal amounts aggregating $92,000,000 in connection with its first
mortgage bonds. Swap agreements of $40,000,000 through May 2002 have
reduced the average cost of the related debt from 7.3% to 6.3% for the
year ended December 31, 1998. Swap agreements of $40,000,000 through May
2005 have reduced the average cost of the related debt from 7.1% to 5.9%
for the year ended December 31, 1998. Swap agreements of $12,000,000
through April 2000 have reduced the average cost of the related debt
from 8.3% to 4.4% for the year ended December 31, 1998. A nonutility
subsidiary of MichCon has an interest rate swap agreement on the
$14,080,000 outstanding balance of its project loan agreement at
December 31, 1998, that effectively fixes the interest rate at 7.5%
through February 2003.
Substantially all of the net utility properties of MichCon in the
approximate amount of $1,240,000,000, are pledged as security for the
payment of outstanding first mortgage bonds.
Maturities and sinking fund requirements during the next five years for
long-term debt outstanding at December 31, 1998, are $57,360,000 in
1999, $26,960,000 in 2000, $26,560,000 in 2001, $23,674,000 in 2002, and
$25,960,000 in 2003.
b. CUMULATIVE PREFERRED AND PREFERENCE STOCK
MichCon is authorized to issue 7,000,000 shares of $1 per share par
value preferred stock and 4,000,000 shares of $1 per share par value
preference stock. At December 31, 1998, no issuances of preferred or
preference stock were made under these authorizations.
6. COMMITMENTS AND CONTINGENCIES
a. GUARANTY
A subsidiary of MichCon and an unaffiliated corporation have formed a
series of partnerships engaged in the construction and development of a
residential community on the Detroit riverfront (Harbortown). One of the
partnerships obtained $12,000,000 of tax-exempt financing due June 2004
through the Michigan State Housing Development Authority. Both partners
and their parent corporations have issued guaranties for the full amount
of this financing and each parent corporation has agreed to reimburse
the other for 50% of any payments made as a result of these guaranties.
31
36
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
b. ENVIRONMENTAL MATTERS
Prior to the construction of major natural gas pipelines, gas for
heating and other uses was manufactured from processes involving coal,
coke or oil. MichCon owns, or previously owned, 16 such former
manufactured gas plant (MGP) sites.
During the mid-1980s, MichCon conducted preliminary environmental
investigations at former MGP sites, and some contamination related to
the by-products of gas manufacturing was discovered at each site. The
existence of these sites and the results of the environmental
investigations have been reported to the Michigan Department of
Environmental Quality (MDEQ). None of these former MGP sites is on the
National Priorities List prepared by the U.S. Environmental Protection
Agency (EPA).
MichCon is currently involved in an administrative proceeding before the
EPA regarding one of the former MGP sites. MichCon has executed an order
with the EPA, pursuant to which MichCon is legally obligated to
investigate and remediate the MGP site. MichCon is remediating four of
the former MGP sites and is conducting more extensive investigations at
four other former MGP sites. In 1998, MichCon completed the remediation
of one of the former MGP sites, which was confirmed by the MDEQ.
Additionally, the MDEQ has determined with respect to one other former
MGP site that MichCon is not a responsible party for the purpose of
assessing remediation expenditures.
In 1984, MichCon established an $11,700,000 reserve for environmental
investigation and remediation. During 1993, MichCon received MPSC
approval of a cost deferral and rate recovery mechanism for
investigation and remediation costs incurred at former MGP sites in
excess of this reserve.
MichCon employed outside consultants to evaluate remediation
alternatives for these sites, to assist in estimating its potential
liabilities and to review its archived insurance policies. The findings
of these investigations indicate that the estimated total expenditures
for investigation and remediation activities for these sites could range
from $30,000,000 to $170,000,000 based on undiscounted 1995 costs. As a
result of these studies, MichCon accrued an additional liability and a
corresponding regulatory asset of $32,000,000 during 1995.
MichCon notified more than 40 current and former insurance carriers of
the environmental conditions at these former MGP sites. MichCon
concluded settlement negotiations with certain carriers in 1996 and 1997
and has received payments from several carriers. In October 1997,
MichCon filed suit against major nonsettling carriers seeking recovery
of incurred costs and a declaratory judgment of the carriers' liability
for future costs of environmental investigation and remediation costs at
former MGP sites. Discovery is ongoing in the case, and a preliminary
trial date has been scheduled for August 1999.
During 1998, 1997 and 1996, MichCon spent $1,649,000, $835,000 and
$900,000, respectively, investigating and remediating these former MGP
sites. At December 31, 1998, the reserve balance was $32,092,000, of
which $92,000 was classified as current. Any significant change in
assumptions, such as remediation techniques, nature and extent of
contamination and regulatory
32
37
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
requirements, could impact the estimate of remedial action costs for the
sites and, therefore, have an effect on MichCon's financial position and
cash flows. However, management believes that insurance coverage and the
cost deferral and rate recovery mechanism approved by the MPSC will
prevent environmental costs from having a material adverse impact on
MichCon's results of operations.
In 1998, MichCon received written notification from ANR Pipeline Company
(ANR), alleging that MichCon has responsibility for a portion of the
costs associated with responding to environmental conditions present at
a natural gas storage field in Michigan currently owned and operated by
an affiliate of ANR. At least some portion of the natural gas storage
field was formerly owned by MichCon. Presently, MichCon is evaluating
ANR's allegations to determine whether and to what extent, if any, that
MichCon may have legal responsibility for these costs. Pending the
completion of this evaluation, MichCon has not recognized any liability
for this matter. Management does not believe this will have a material
impact on MichCon's financial statements.
c. COMMITMENTS
MichCon has entered into long-term purchase and transportation contracts
with various suppliers and producers. In general, purchase prices are
under fixed price and volume contracts. MichCon has firm purchase
commitments through 2001 for approximately 487 Bcf of gas. MichCon
expects that sales, based on normal weather, will approximate its
minimum purchase commitments. MichCon has long-term transportation
contracts with various pipeline companies expiring on various dates
through the year 2011. MichCon is committed to pay demand charges of
approximately $53,100,000 during 1999 related to firm transportation
agreements.
Capital investments for 1999 are expected to approximate $132,000,000
and certain commitments have been made in connection with such capital
investments.
d. OTHER
MichCon is involved in certain legal and administrative proceedings
before various courts and governmental agencies concerning claims
arising in the ordinary course of business. Management cannot predict
the final disposition of such proceedings, but believes that adequate
provision has been made for probable losses. It is management's belief,
after discussion with legal counsel, that the ultimate resolution of
those proceedings still pending will not have a material adverse effect
on MichCon's financial statements.
7. REGULATORY MATTERS
a. REGULATORY ASSETS AND LIABILITIES
MichCon's operations are subject to the provisions SFAS No. 71,
"Accounting for the Effects of Certain Types of Regulation." As a
result, several regulatory assets and liabilities are recorded in
MichCon's financial statements. Regulatory assets represent costs that
will be recovered from customers through the ratemaking process.
Regulatory liabilities represent benefits that will be refunded to
customers through reduced rates.
33
38
]
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following regulatory assets and liabilities were reflected in the
Consolidated Statement of Financial Position as of December 31:
- -------------------------------------------------------------------------------
(in thousands) 1998 1997
-------- --------
Regulatory Assets:
Accrued gas cost recovery revenues ............. $ -- $ 12,862
Unamortized loss on retirement of debt ......... 15,548 10,181
Deferred environmental costs (Note 6b) ......... 28,169 27,699
Other .......................................... 196 986
-------- --------
$ 43,913 $ 51,728
======== ========
Regulatory Liabilities:
Deferred gas cost recovery revenues ............ $ 14,980 $ --
Tax benefits amortizable to customers .......... 130,120 122,922
-------- --------
$145,100 $122,922
======== ========
- -------------------------------------------------------------------------------
MichCon currently has regulatory precedents and orders in effect which
provide for the probable recovery or refund of its regulatory assets and
liabilities. Future regulatory changes or changes in the competitive
environment could result in MichCon discontinuing the application of
SFAS No. 71 for all or part of its business and require the write-off of
the portion of any regulatory asset or liability which was no longer
probable of recovery or refund. If MichCon were to have discontinued the
application of SFAS No. 71 for all of its operations as of December 31,
1998, it would have had an extraordinary, noncash increase to net income
of approximately $65,800,000. Management believes that currently
available facts support the continued application of SFAS No. 71.
b. REGULATORY REFORM PLAN
In April 1998, the MPSC approved MichCon's Regulatory Reform Plan. The
plan includes a comprehensive experimental three-year customer choice
program, which is subject to annual caps on the level of participation.
The customer choice program begins April 1, 1999, when up to 75,000
customers will have the option of purchasing natural gas from suppliers
other than MichCon. Up to 75,000 additional customers can be added by
April 1 of each of the next two years, eventually allowing up to 225,000
customers the option to choose a gas supplier other than MichCon. In each
of the three plan years, there is also a volume limitation on commercial
and industrial participants. The volume limitation for these participants
is 10 Bcf in 1999, 20 Bcf in 2000 and 30 Bcf in 2001. MichCon will
continue to transport and deliver the gas to the customers' premises at
prices that maintain its existing sales margins.
The plan also suspends the GCR mechanism for customers who continue to
purchase gas from MichCon and fixes the gas commodity component of
MichCon's sales rates at $2.95 per Mcf for
34
39
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
the three-year period beginning on January 1, 1999. Prior to January
1999, MichCon did not generate earnings on the gas commodity portion of
its operations. However, under this plan, changes in cost of gas will
directly impact earnings. As part of its gas acquisition strategy,
MichCon has entered into firm-price contracts for a substantial portion
of its expected gas supply requirements for the next three years. These
contracts, coupled with the use of MichCon's storage facilities, will
substantially mitigate risks from winter price and volume fluctuations.
Also beginning in 1999, the plan established an income sharing mechanism
that will allow customers to share in profits if actual utility return
on equity exceeds predetermined thresholds. In October 1998, the MPSC
denied a rehearing and affirmed its approval of the plan. Various
parties have appealed the MPSC's decision to the Michigan Court of
Appeals. While management believes that based upon applicable Michigan
law the order will be upheld on appeal, there can be no assurance as to
the outcome.
8. CAPITAL AND OPERATING LEASES
MichCon leases certain property (principally a warehouse, office building and
parking structure) under lease arrangements expiring at various dates to 2006,
with renewal options extending beyond that date. Portions of the office
building and parking structure are subleased to various tenants.
In January 1998, MichCon purchased its home office building, thereby
eliminating the related long-term capital lease obligation. As a result, the
long-term capital lease obligation of $6,818,000 was reclassified as a current
capital lease obligation at December 31, 1997. Other long-term capital lease
obligations are not significant.
Operating lease payments for the years ended December 31, 1998, 1997, and 1996
were $2,050,000, $2,015,000, and $2,239,000, respectively.
9. RETIREMENT BENEFITS AND TRUSTEED ASSETS
In 1998, MichCon adopted SFAS No. 132, "Employers' Disclosures about Pensions
and Other Postretirement Benefits," which standardizes the disclosure
requirements for pensions and other postretirement benefits.
a. PENSION PLAN BENEFITS
MichCon participates in separate defined benefit retirement plans,
maintained by MCN, for union and nonunion employees. The plans are
noncontributory, cover substantially all employees and provide for
normal retirement at age 65, but with the option to retire earlier or
later under certain conditions. The plans provide pension benefits that
are based on each employee's compensation and years of credited service.
Currently these plans meet the full funding limitations of the Internal
Revenue Code. Accordingly, no contributions for the 1998, 1997 or 1996
plan years were made, and none is expected to be made for the 1999 plan
year.
35
40
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Net pension credit for the years ended December 31 includes the following
components:
- ------------------------------------------------------------------------------------------
(in Thousands) 1998 1997 1996
-------- -------- --------
Service Cost ................................ $ 9,719 $ 9,406 $ 10,400
Interest Cost ............................... 36,195 34,408 33,262
Expected Return on Plan Assets .............. (71,780) (61,615) (55,765)
Amortization of:
Net gain ................................. (6,479) (5,177) (1,664)
Prior service cost ....................... 1,031 (163) (163)
Net transition asset ..................... (4,938) (4,993) (4,993)
Special Termination Benefits ................ 5,054 -- --
Settlements ................................. (6,935) (3,250) --
-------- -------- --------
Net Pension Credit .......................... $(38,133) $(31,384) $(18,923)
======== ======== ========
- ------------------------------------------------------------------------------------------
36
41
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth a reconciliation of the obligations,
assets and funded status of the plans as well as the amounts recognized
as prepaid pension cost in the Consolidated Statement of Financial
Position:
- -------------------------------------------------------------------------------------------------------
(in Thousands) 1998 1997
----------- -----------
Measurement Date October 31 October 31
Accumulated Benefit Obligation at the End of the Period ... $ 441,296 $ 396,265
=========== ===========
Projected Benefit Obligation at the Beginning of the Period $ 465,098 $ 430,100
Service Cost .............................................. 9,719 9,406
Interest Cost ............................................. 36,195 34,408
Plan Amendments ........................................... 22,564 --
Actuarial Loss ............................................ 45,200 24,294
Special Termination Benefits .............................. 5,054 --
Settlements Due to Lump Sums .............................. (20,639) (8,490)
Regular Benefits .......................................... (28,355) (24,620)
----------- -----------
Projected Benefit Obligation at the End of the Period ..... $ 534,836 $ 465,098
=========== ===========
Plan Assets at Fair Value at the Beginning of the Period .. $ 814,548 $ 707,987
Actual Return on Plan Assets .............................. 102,153 138,863
Settlements Due to Lump Sums .............................. (15,956) (5,145)
Regular Benefits .......................................... (28,355) (27,157)
----------- -----------
Plan Assets at Fair Value at the End of the Period ........ $ 872,390 $ 814,548
=========== ===========
Funded Status of the Plans ................................ $ 337,554 $ 349,450
Unrecognized:
Net gain ............................................... (214,328) (237,923)
Prior service cost ..................................... 19,298 (1,439)
Net transition asset ................................... (28,645) (34,342)
----------- -----------
Prepaid Pension Cost and Total Recognized ................. $ 113,879 $ 75,746
=========== ===========
- -------------------------------------------------------------------------------------------------------
In determining the actuarial present value of the projected benefit
obligation, the weighted average discount rate was 6.5%, 7.5% and 8% for
1998, 1997 and 1996, respectively. The rate of increase in future
compensation levels used was 5% for 1998 and 1997. The expected
long-term rate of return on plan assets, which are invested primarily in
equity and fixed income securities, was 9.5% for 1998 and 9.25% for 1997
and 1996.
In 1998, MichCon implemented an early retirement program under which
approximately 6% of its workforce retired in 1998 with incentives. The
program increased the projected benefit obligation and 1998 pension
costs by $5,054,000.
37
42
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MichCon also sponsors defined contribution retirement savings plans.
Participation in one of these plans is available to substantially all
union and nonunion employees. MichCon matches employee contributions up
to certain predefined limits based upon salary and years of credited
service. The cost of these plans was $4,800,000 in 1998, $5,200,000 in
1997 and $5,300,000 in 1996.
b. OTHER POSTRETIREMENT BENEFITS
MichCon provides certain healthcare and life insurance benefits for
retired employees who may become eligible for these benefits if they
reach retirement age while working for MichCon. These benefits are being
accounted for under SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions," which requires the use of
accrual accounting. Upon adoption of SFAS No. 106 MichCon deferred its
1993 postretirement costs in excess of claims paid (including the
amortization of the initial transition obligation) until 1994, when new
rates to recover such costs became effective.
MichCon's policy is to fund certain trusts to the extent its
postretirement benefit costs are recognized in rates. Separate qualified
Voluntary Employees' Beneficiary Association (VEBA) trusts exist for
union and nonunion employees. Funding to the VEBA trusts totaled
$2,000,000, $6,500,000 and $41,600,000 in 1998, 1997 and 1996,
respectively. The expected long-term rate of return on plan assets that
are invested in life insurance policies, equity securities and fixed
income securities, was 9.8% for 1998 and 9.1% for 1997 and 1996.
Net postretirement cost for the years ended December 31 includes the
following components:
- -------------------------------------------------------------------------------------------------------------------
(in Thousands) 1998 1997 1996
---------- ---------- ----------
Service Cost ........................... $ 3,699 $ 4,094 $ 4,259
Interest Cost .......................... 16,423 17,430 16,395
Expected Return on Plan Assets ......... (13,482) (11,026) (9,838)
Amortization of:
Net gain ............................ (5,684) (4,872) (4,307)
Net transition obligation ........... 12,702 13,391 13,391
Special Termination Benefits ........... 1,186 -- --
---------- ---------- ----------
Total Postretirement Cost .............. 14,844 19,017 19,900
Regulatory Adjustment .................. -- 4,863 7,509
---------- ---------- ----------
Net Postretirement Cost ................ $ 14,844 $ 23,880 $ 27,409
========== ========== ==========
- -------------------------------------------------------------------------------------------------------------------
38
43
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth a reconciliation of the obligations,
assets and funded status of the plans as well as the amounts recorded as
accrued postretirement cost in the Consolidated Statement of Financial
Position:
- ----------------------------------------------------------------------------------------------------------------------
(in Thousands) 1998 1997
Measurement Date ---------- ----------
October 31 October 31
Accumulated Postretirement Benefit Obligation at the Beginning of the Period ........ $ 223,124 $ 217,883
Service Cost ........................................................................ 3,699 4,094
Interest Cost ....................................................................... 16,423 17,430
Plan Amendments ..................................................................... (8,269) --
Actuarial (Gain) Loss ............................................................... 24,320 (4,909)
Special Termination Benefits ........................................................ 1,186 --
Benefits Paid ....................................................................... (11,546) (11,374)
---------- ----------
Accumulated Postretirement Benefit Obligation at the End of the Period .............. $ 248,937 $ 223,124
========== ==========
Plan Assets at Fair Value at the Beginning of the Period ............................ $ 151,645 $ 126,282
Actual Return on Plan Assets ........................................................ 25,677 26,125
Company Contributions ............................................................... 6,500 7,000
Regular Benefits .................................................................... (10,674) (7,762)
---------- ----------
Plan Assets at Fair Value at the End of the Period .................................. $ 173,148 $ 151,645
========== ==========
Funded Status of the Plans .......................................................... $ (75,789) $ (71,479)
Unrecognized:
Net gain ......................................................................... (116,191) (124,760)
Net transition obligation ........................................................ 188,026 200,728
Contributions Made After Measurement Date ........................................... 2,000 6,500
Regular Benefits Made After Measurement Date ........................................ (11,720) (945)
---------- ----------
Accrued Postretirement Asset (Liability) ............................................ $ (13,674) $ 10,044
========== ==========
- ----------------------------------------------------------------------------------------------------------------------
The rate at which healthcare costs are assumed to increase is the most
significant factor in estimating MichCon's postretirement benefit
obligation. MichCon used a rate of 6% for 1999, and a rate that
gradually declines each year until it stabilizes at 5% in 2003. A one
percentage point increase in the assumed rates would increase the
accumulated postretirement benefit obligation at December 31, 1998 by
$31,854,000 (13%) and increase the sum of the service and interest rate
cost by $2,863,000 (14%) for the year then ended. A one percentage point
decrease in the assumed rates would decrease the accumulated
postretirement benefit obligation at December 31, 1998 by $27,946,000
(11%) and decrease the sum of the service and interest rate cost by
$2,474,000 (12%) for the year then ended.
The discount rate used in determining the accumulated postretirement
benefit obligation was 6.5%, 7.5% and 8% for 1998, 1997 and 1996,
respectively.
39
44
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
In 1998, MichCon implemented an early retirement program under which
approximately 6% of its workforce retired in 1998 with incentives. The
program increased the postretirement benefit obligation and 1998
postretirement costs by $1,186,000.
c. GRANTOR TRUST
MichCon established a Grantor Trust and contributed $28,200,000 in 1998
and $31,300,000 in 1997 to the trust, which invested such proceeds in
life insurance contracts and income securities. By funding the Grantor
Trust and the VEBA trusts (Note 9b), MichCon is complying with MPSC
directives that it fund various trusts to the extent its postretirement
benefit costs are recognized in rates. Employees and retirees have no
right, title or interest in the assets of the Grantor Trust, and MichCon
can revoke such trust subject to providing the MPSC with prior
notification.
10. RISK MANAGEMENT ACTIVITIES AND DERIVATIVE FINANCIAL INSTRUMENTS
a. NATURAL GAS PRICE HEDGING
As part of its gas acquisition strategy (Note 7b), MichCon has entered
into firm-price contracts, including natural gas swap agreements, for a
substantial portion of its expected gas supply requirements for the
three year period 1999-2001. These swap agreements are used to manage
MichCon's exposure to the risk of market price fluctuations on gas
purchase commitments and effectively fixes the commodity rate portion of
certain gas purchase agreements. If MichCon did not use natural gas swap
agreements, its exposure to such risk would be higher. Although this
strategy reduces risk, it also limits potential gains from favorable
changes in gas prices.
Changes in the market value of the swap agreements are deferred and
included in inventory costs until the hedged transaction is completed,
at which time the realized gain or loss is included in the cost of gas.
As of December 31, 1998, MichCon's deferred loss from swap contracts was
$3,313,000. Any unrealized gains and losses on natural gas swap
agreements that were to be terminated or sold would continue to be
deferred until such time as the initial hedged transactions are
completed. In the instance when a hedged item no longer exists or is no
longer probable of occurring, unrealized gains and losses would be
included in income unless the derivative is redesignated to a similar
transaction and qualifies for hedge accounting.
b. INTEREST RATE HEDGING
In order to manage interest costs, MichCon uses 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. Interest rate swaps are subject to market
risk as interest rates fluctuate. The difference to be received or paid
on these agreements is accrued and recorded as an adjustment to interest
expense over the life of the agreements. The fair value of the swap
agreements and changes in the fair value as a result of changes in
market interest rates are not recognized in the financial statements. In
the event of an interest rate swap termination, any associated gains and
losses would be deferred and amortized as an adjustment to interest
expense related to the debt over the remaining term of the original
contract life of the terminated swap
40
45
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
agreement. In the event of an early extinguishment of a designated debt
obligation, unrealized gains and losses would be included in income,
unless the swap agreement is redesignated as a hedge of another
outstanding debt obligation with similar characteristics and qualifies
for hedge accounting.
At December 31, 1998, MichCon had interest rate swap agreements with
notional principal amounts totaling $106,100,000 (Note 5a) and a
weighted average remaining life of 4.3 years. At December 31, 1997, the
notional principal amount of outstanding interest rate swaps totaled
$107,800,000. 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.
11. FINANCIAL INSTRUMENTS
MichCon has estimated the fair value of its financial instruments using
available market information and appropriate valuation methodologies.
Considerable judgment is required in developing the estimates of the fair value
of financial instruments and, therefore, the values are not necessarily
indicative of the amounts that MichCon could realize in a current market
exchange. The carrying amounts of certain financial instruments, such as notes
payable, customer deposits and notes receivable, are assumed to approximate
fair value due to their short-term nature.
The carrying amount and fair value of other financial instruments consist of
the following:
- -----------------------------------------------------------------------------------------------------------
(in Thousands) 1998 1997
- ------------------------------------------------------------------------- -----------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------------ ------------ ------------ ------------
Assets:
Long-term investments .................. $ 65,556 $ 65,556 $ 35,110 $ 35,110
Liabilities and Shareholders' Equity:
Long-term debt, excluding capital
lease obligations .................... 615,419 668,063 611,763 651,980
Derivative Financial Instruments:
Natural gas swaps:
with unrealized losses ............... 3,313 3,313 -- --
Interest rate swaps:
with unrealized gains ................ 6,340 4,048
with unrealized losses ............... 696 415
- -----------------------------------------------------------------------------------------------------------
The fair values are determined based on the following:
Long-term investments - carrying amount approximates fair value taking
into consideration interests rates available to MichCon for investments
with similar provisions.
41
46
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Long-term debt - interest rates available to MichCon for issuance of
debt with similar terms and remaining maturities.
Natural gas and interest rate swaps - estimated amounts that MichCon
would receive or pay to terminate the swap agreements, taking into
account current gas prices, interest rates and the credit-worthiness of
the counterparties.
Guaranty - management is unable to practicably estimate the fair value
of the Harbortown guaranty (Note 6a) due to the nature of the
transaction.
The fair value estimates presented herein are based on information available to
management as of December 31, 1998 and 1997. Management is not aware of any
subsequent factors that would significantly affect the estimated fair value
amounts.
12. RELATED PARTY TRANSACTIONS
MichCon enters into transactions with affiliated companies to provide
transportation and storage services. MichCon purchased computer operations
services from an affiliated company that was sold by MCN in June 1996. Under a
service agreement with MCN, MichCon receives various tax, financial and legal
services and provides construction, engineering, human resources, information
technology and other services. The following is a summary of transactions with
affiliated companies:
- -------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars) 1998 1997 1996
------------------------------------------------------- ------------ ------------ ------------
Revenues:
Storage and transportation services............... $ 11,566 $ 14,744 $ 14,542
Other services ................................... 6,820 1,774 898
Interest revenue.................................. 1,502 -- --
Costs:
Computer operations services...................... -- -- 6,800
Corporate expenses and other services............. 15,534 20,179 16,486
- ------------------------------------------------------------------------------------------------------------------
MichCon's accounts receivable from affiliated companies totaled $21,640,000 and
$20,990,000, and accounts payable to affiliated companies totaled $11,501,000
and $28,942,000 at December 31, 1998 and 1997, respectively.
MichCon is a participant in an intercompany credit agreement whereby it can
borrow needed cash from and loan available cash to MCN and its subsidiaries. The
outstanding balance of notes receivable from affiliated companies was $3,249,000
at December 31, 1998, with interest at the prime rate of 7.75%. There was no
outstanding balance of notes receivable from affiliated companies at December
31, 1997. MichCon had no outstanding balances of notes payable to affiliated
companies at December 31, 1998 and 1997.
42
47
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
13. SUMMARY OF INCOME TAXES
MichCon is part of the consolidated federal income tax return of MCN. The
federal income tax expense for MichCon and its subsidiaries is determined on an
individual company basis with no allocation of tax benefits or expenses from
other affiliates of MCN.
- ------------------------------------------------------------------------------------------------------------
(in Thousands) 1998 1997 1996
- -------------------------------------------------------- ---------- ---------- ----------
Effective Federal Income Tax Rate 31.5 % 36.4 % 33.8 %
========== ========== ==========
Income Taxes Consist of:
Current provision .................................. $ 27,768 $ 37,901 $ 31,318
Deferred provision ................................. 11,010 9,607 12,018
Investment tax credits ............................. (2,961) (1,843) (1,850)
---------- ---------- ----------
$ 35,817 $ 45,665 $ 41,486
========== ========== ==========
Reconciliation Between Statutory and Actual
Income Taxes:
Statutory Federal Income Taxes at a Rate of 35% ....... $ 39,477 $ 43,640 $ 42,465
Adjustments to Federal Tax Expense:
Book over tax depreciation ......................... 1,071 5,301 6,367
Adjustments to taxes provided in prior periods ...... 1,080 300 (3,368)
Investment tax credits ............................. (2,961) (1,843) (1,850)
Other - net ........................................ (2,850) (1,733) (2,128)
---------- ---------- ----------
$ 35,817 $ 45,665 $ 41,486
========== ========== ==========
- ------------------------------------------------------------------------------------------------------------
Deferred tax assets and liabilities are recognized for the estimated future tax
effect of temporary differences between the tax basis of assets or liabilities
and the reported amounts in the financial statements. Deferred tax assets and
liabilities are classified as current or noncurrent according to the
classification of the related assets or liabilities.
43
48
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The tax effect of temporary differences that gave rise to MichCon's deferred tax
assets and liabilities consisted of the following:
- ------------------------------------------------------------------------------------------------------------------
(in Thousands) 1998 1997
- --------------------------------------------------------------------------------- ------------ ------------
Deferred Tax Assets:
Employee Benefits............................................................. $ 5,406 $ 9,391
Uncollectibles................................................................ 3,125 4,671
Vacation accrual.............................................................. 2,259 3,442
Postretirement benefits....................................................... 5,394 --
Other......................................................................... 1,351 2,283
------------ ------------
17,535 19,787
------------ ------------
Deferred Tax Liabilities:
Depreciation and other property related basis
differences, net.......................................................... 51,965 58,215
Pensions...................................................................... 37,911 24,564
Property taxes................................................................ 13,360 13,313
Gas cost recovery undercollection............................................. 57 4,502
Postretirement benefits....................................................... -- 3,515
Other......................................................................... 12,060 9,795
------------ ------------
115,353 113,904
------------ ------------
Net Deferred Tax Liability....................................................... 97,818 94,117
Less: Net Deferred Tax Liability-Current....................................... 9,251 10,212
------------ ------------
Net Deferred Tax Liability-Noncurrent............................................ $ 88,567 $ 83,905
============ ============
- ------------------------------------------------------------------------------------------------------------------
14. STOCK INCENTIVE PLAN
MCN's Stock Incentive Plan authorizes the use of performance units, restricted
stock, stock options or other stock-related awards to key employees, primarily
management. MichCon's current policy is to issue performance units which
encourages a strategic focus on long-term performance and has a high employee
retention value. The performance units are denominated in shares of MCN common
stock and issued to employees based on total shareholder return over a six year
period, as compared to a group of peer companies. The initial number of
performance units granted is based on total shareholder return relative to the
peer group during the previous three year period. Participants receive dividend
equivalents on the units granted. The initial grants will be adjusted upward or
downward based on total shareholder return relative to the peer group for the
subsequent three-year period. The final awards are then payable in shares of
MCN common stock or can be deferred. Participants must retain 50% of any common
shares paid until certain stock ownership guidelines are met. The deferred units
must be retained by the participants until their employment with MichCon ceases.
During 1998, 1997 and 1996, MichCon granted 125,016, 102,750 and 122,669
performance units, respectively, with a weighted-average grant date fair value
of $37.00, $31.00 and $24.625 per unit, respectively. MichCon accounts for
stock-based compensation awards under the fair value-based method as prescribed
under SFAS No. 123, "Accounting for Stock-Based Compensation."
44
49
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONCLUDED)
Accordingly, the costs of performance units awarded, measured at their fair
value on the grant date, are being recorded as compensation expense over their
vesting period. MichCon adjusts compensation expense and Additional Paid-in
Capital for changes in the number of performance units that are expected to
vest. A stock-based compensation benefit of $1,493,000 was recognized during
1998 for all awards outstanding as a result of a reduction in the number of
performance units expected to vest. Stock-based compensation cost recognized
during 1997 and 1996 for all awards outstanding totaled $7,430,000, and
$6,885,000, respectively.
In February 1999, MichCon revised its policy whereby a portion of any
stock-related awards under the Stock Incentive Plan will be in the form of
stock options. The remaining portion of any awards will continue to be in the
form of performance units.
45
50
INDEPENDENT AUDITORS' REPORT
Michigan Consolidated Gas Company:
We have audited the accompanying consolidated statements of financial position
of Michigan Consolidated Gas Company and subsidiaries (the "Company") as of
December 31, 1998 and 1997, and the related consolidated statements of income,
cash flows and capitalization for each of the three years in the period ended
December 31, 1998. Our audits also included the consolidated financial
statement schedule listed in Item 8. 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 financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 1998 and 1997, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1998 in
conformity with generally accepted accounting principles. Also, in our opinion,
such consolidated financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, presents fairly,
in all material respects, the information shown therein.
/s/ Deloitte & Touche LLP
- -------------------------
Detroit, Michigan
February 25, 1999
46
51
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
SUPPLEMENTARY FINANCIAL INFORMATION
QUARTERLY OPERATING RESULTS (UNAUDITED)
Due to the seasonal nature of MichCon's business, revenues and net income
tend to be higher in the first and fourth quarters of the calendar year.
First Second Third Fourth
Quarter Quarter Quarter Quarter
- ------------------------------- ---------- ---------- ---------- ----------
(Thousands of Dollars)
1998
Operating Revenue ............ $ 429,227 $ 172,787 $ 122,428 $ 309,216
Operating Income (Loss)....... 109,669 15,962 (25,997) 56,977
Net Income (Loss)............. 61,664 3,014 (18,338) 30,636
1997
Operating Revenue ............ $ 527,445 $ 209,800 $ 119,114 $ 397,320
Operating Income (Loss)....... 106,772 14,810 (11,369) 64,150
Net Income (Loss)............. 62,193 931 (16,036) 31,932
47
52
SCHEDULE II
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
(Thousands of Dollars)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
Additions
------------------------
Provisions charged to Deductions
------------------------ for Purposes
Balance at Utility Plant/ for Which the Balance
Beginning Regulatory Reserves Were at End
Description of Period Income Asset Provided of Period
-------- --------- -------- -------- - --------
YEAR ENDED DECEMBER 31, 1998
Reserve deducted from Assets in
Consolidated Statement of Financial Position:
Allowance for doubtful accounts........................ $ 15,015 $ 13,029 $ -- $ 19,116 $ 8,928
======== ======== ======== ======== ========
Reserve included in Current Liabilities - Other and in Accrued
Environmental
Costs in Consolidated Statement of Financial Position:
Environmental testing.................................. $ 33,741 $ -- $ -- $ 1,649 $ 32,092
======== ======== ======== ======== ========
Reserves included in Deferred Credits and
Other Liabilities - Other
in Consolidated Statement of Financial Position:
Injuries and damages................................. $ 4,838 $ (328) $ 438 $ 2,433 $ 2,515
======== ======== ======== ======== ========
YEAR ENDED DECEMBER 31, 1997
Reserve deducted from Assets in
Consolidated Statement of Financial Position:
Allowance for doubtful accounts........................ $ 17,707 $ 21,680 $ -- $ 24,372 $ 15,015
======== ======== ======== ======== ========
Reserve included in Current Liabilities - Other
in Consolidated Statement of Financial Position:
Environmental testing.................................. $ 34,576 $ -- $ -- $ 835 $ 33,741
======== ======== ======== ======== ========
Reserves included in Deferred Credits and
Other Liabilities - Other
in Consolidated Statement of Financial Position:
Injuries and damages................................. $ 9,182 $ 1,400 $ 608 $ 6,352 $ 4,838
======== ======== ======== ======== ========
YEAR ENDED DECEMBER 31, 1996
Reserve deducted from Assets in
Consolidated Statement of Financial Position:
Allowance for doubtful accounts........................ 13,250 $ 29,052 $ -- $ 24,595 $ 17,707
======== ======== ======== ======== ========
Reserve included in Current Liabilities - Other
in Consolidated Statement of Financial Position:
Environmental testing.................................. $ 35,451 $ -- $ -- $ 875 $ 34,576
======== ======== ======== ======== ========
Reserves included in Deferred Credits and
Other Liabilities - Other
in Consolidated Statement of Financial Position:
Injuries and damages................................. $ 8,013 $ 3,052 $ 674 $ 2,557 $ 9,182
======== ======== ======== ======== ========
48
53
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Omitted per general instruction I (2) (c) of Form 10-K for wholly-owned
subsidiaries (reduced disclosure format).
ITEM 11. EXECUTIVE COMPENSATION
Omitted per general instruction I (2) (c) of Form 10-K for wholly-owned
subsidiaries (reduced disclosure format).
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Omitted per general instruction I (2) (c) of Form 10-K for wholly-owned
subsidiaries (reduced disclosure format).
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Omitted per general instruction I (2) (c) of Form 10-K for wholly-owned
subsidiaries (reduced disclosure format).
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 10-K
(A) LIST OF DOCUMENTS FILED AS PART OF THE REPORT:
1. For a list of the financial statements included herein, see the section
titled "Financial Statements and Supplementary Data", page 24 in Part II, Item 8
of this Report.
2. For the financial statement schedule included herein, see the section
titled "Financial Statements and Supplementary Data", page 24 in Part II, Item 8
of this Report.
Schedules other than those referred to above are omitted as not applicable
or not required, or the required information is shown in the financial
statements or notes thereto.
49
54
3. Exhibits, including those incorporated by reference:
EXHIBIT NO. DESCRIPTION
----------- -----------
3-1 Restated Articles of Incorporation of MichCon (Exhibit 3-1
to March 31, 1993 Form 10-Q).
3-2 By-Laws of MichCon (Exhibit 3-2 to March 31, 1993 Form
10-Q).
4-1 MichCon's Indenture of Mortgage and Deed of Trust dated
March 1, 1944 (Exhibit 7-D to Registration Statement No.
2-5252); Twenty-ninth Supplemental Indenture, dated July
15, 1989 (Exhibit 4-1 to July 27, 1989 Form 8-K); Thirtieth
Supplemental Indenture, dated September 1, 1991 (Exhibit
4-1 to September 27, 1991 Form 8-K); Thirty-first
Supplemental Indenture, dated December 15, 1991 (Exhibit
4-1 to February 28, 1992 Form 8-K); Thirty-second
Supplemental Indenture, dated January 1, 1993 (Exhibit 4-1
to 1992 Form 10-K); Thirty-third Supplemental Indenture,
dated May 5, 1995 (Exhibit 4-2 to Registration Statement
No. 33-59093); and Thirty-fourth Supplemental Indenture,
dated November 1, 1996 (Exhibit 4-2 to Registration
Statement No. 333-16285; Note - MichCon hereby agrees to
furnish to the SEC, upon request, a copy of any instruments
defining the rights of holders of long-term debt issued by
MichCon.
10-1 MCN Stock Option Plan Post-Effective Amendment No. 1 (MCN
Registration Statement No. 33-21930-99).
10-2 Form of Employment Agreement (Exhibit 99-2 to MCN's June
30, 1997 Form 10-Q).
10-3 MCN Energy Group Inc. Executive Annual Performance Plan (As
amended effective January 1, 1998).*
10-4 MCN Energy Group Inc. Stock Incentive Plan (Exhibit 10-1 to
MCN's March 31, 1995 Form 10-Q).
10-5 MCN Executive Deferred Compensation Plan, as amended
(Exhibit 10-1 to MCN's September 30, 1996 Form 10-Q).
10-6 MichCon Supplemental Death Benefit and Retirement Income
Plan (Exhibit 10-2 to MCN's September 30, 1996 Form 10-Q).
10-7 MichCon Supplemental Retirement Plan (Exhibit 10-3 to MCN's
September 30, 1996 Form 10-Q).
10-8 MCN Mandatory Deferred Compensation Plan, as amended
(Exhibit 10-11 to MCN's 1996 Form 10-K).
10-9 MCN Energy Group Inc. Supplemental Savings Plan (Exhibit
10-12 to MCN's 1996 Form 10-K).
10-10 MCN Energy Group Inc. Long-Term Incentive Performance Share
Plan (As amended and restated October 1, 1997).*
10-11 MCN Energy Group Savings and Stock Ownership Plan (As
amended and restated effective as of January 1, 1998).*
10-12 MichCon Investment and Stock Ownership Plan (As amended and
restated effective as of January 1, 1998).*
12-1 Computation of Ratio of Earnings to Fixed Charges.*
50
55
EXHIBIT NO. DESCRIPTION
---------- -----------
23-1 Independent Auditors' Consent - Deloitte & Touche LLP.*
24-1 Powers of Attorney.*
27-1 Financial Data Schedule.*
(B) REPORTS ON FORM 8-K:
None.
- ----------------------
* Indicates document filed herewith.
References are to MichCon (File No. 1-7310) for MichCon documents incorporated
by reference. References are to MCN (File No. 1-10070) for MCN documents
incorporated by reference.
51
56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Annual Report to be
signed on its behalf by the undersigned, thereunto duly authorized.
MICHIGAN CONSOLIDATED GAS COMPANY
(Registrant)
By: /s/ Harold Gardner
--------------------------------------------
Harold Gardner
VICE PRESIDENT AND CHIEF ACCOUNTING OFFICER
MARCH 11, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities and on the date indicated.
TITLE DATE
----- ----
* Director and Chairman March 11, 1999
------------------------------------
Alfred R. Glancy III
* Director, President and Chief March 11, 1999
------------------------------------ Executive Officer
Stephen E. Ewing
* Director, Senior Vice President, March 11, 1999
------------------------------------ Treasurer, and Chief Financial Officer
Howard L. Dow III
/s/ Harold Gardner Vice President, Chief Accounting March 11, 1999
------------------------------------ Officer
Harold Gardner
* Director, Vice President, General March 11, 1999
------------------------------------ Counsel and Secretary
Ronald E. Christian
* Director, Vice President, Marketing March 11, 1999
------------------------------------ and Sales
Anne R. Cooke
* Director, Senior Vice President, March 11, 1999
------------------------------------ Regional Operations
Steven Kurmas
* Director March 11, 1999
------------------------------------
William K. McCrackin
*By: /s/ Harold Gardner
-----------------------------------
Harold Gardner
Attorney-in-Fact
52
57
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
----------- -----------
3-1 Restated Articles of Incorporation of MichCon (Exhibit 3-1
to March 31, 1993 Form 10-Q).
3-2 By-Laws of MichCon (Exhibit 3-2 to March 31, 1993 Form
10-Q).
4-1 MichCon's Indenture of Mortgage and Deed of Trust dated
March 1, 1944 (Exhibit 7-D to Registration Statement No.
2-5252); Twenty-ninth Supplemental Indenture, dated July
15, 1989 (Exhibit 4-1 to July 27, 1989 Form 8-K); Thirtieth
Supplemental Indenture, dated September 1, 1991 (Exhibit
4-1 to September 27, 1991 Form 8-K); Thirty-first
Supplemental Indenture, dated December 15, 1991 (Exhibit
4-1 to February 28, 1992 Form 8-K); Thirty-second
Supplemental Indenture, dated January 1, 1993 (Exhibit 4-1
to 1992 Form 10-K); Thirty-third Supplemental Indenture,
dated May 5, 1995 (Exhibit 4-2 to Registration Statement
No. 33-59093); and Thirty-fourth Supplemental Indenture,
dated November 1, 1996 (Exhibit 4-2 to Registration
Statement No. 333-16285; Note - MichCon hereby agrees to
furnish to the SEC, upon request, a copy of any instruments
defining the rights of holders of long-term debt issued by
MichCon.
10-1 MCN Stock Option Plan Post-Effective Amendment No. 1 (MCN
Registration Statement No. 33-21930-99).
10-2 Form of Employment Agreement (Exhibit 99-2 to MCN's June
30, 1997 Form 10-Q).
10-3 MCN Energy Group Inc. Executive Annual Performance Plan (As
amended effective January 1, 1998).*
10-4 MCN Energy Group Inc. Stock Incentive Plan (Exhibit 10-1 to
MCN's March 31, 1995 Form 10-Q).
10-5 MCN Executive Deferred Compensation Plan, as amended
(Exhibit 10-1 to MCN's September 30, 1996 Form 10-Q).
10-6 MichCon Supplemental Death Benefit and Retirement Income
Plan (Exhibit 10-2 to MCN's September 30, 1996 Form 10-Q).
10-7 MichCon Supplemental Retirement Plan (Exhibit 10-3 to MCN's
September 30, 1996 Form 10-Q).
10-8 MCN Mandatory Deferred Compensation Plan, as amended
(Exhibit 10-11 to MCN's 1996 Form 10-K).
10-9 MCN Energy Group Inc. Supplemental Savings Plan (Exhibit
10-12 to MCN's 1996 Form 10-K).
10-10 MCN Energy Group Inc. Long-Term Incentive Performance Share
Plan (As amended and restated October 1, 1997).*
10-11 MCN Energy Group Savings and Stock Ownership Plan (As
amended and restated effective as of January 1, 1998).*
10-12 MichCon Investment and Stock Ownership Plan (As amended and
restated effective as of January 1, 1998).*
12-1 Computation of Ratio of Earnings to Fixed Charges.*
53
58
EXHIBIT NO. DESCRIPTION
----------- -----------
23-1 Independent Auditors' Consent - Deloitte & Touche LLP.*
24-1 Powers of Attorney.*
27-1 Financial Data Schedule.*
(B) REPORTS ON FORM 8-K:
None.
- ----------------------
* Indicates document filed herewith.
References are to MichCon (File No. 1-7310) for MichCon documents incorporated
by reference. References are to MCN (File No. 1-10070) for MCN documents
incorporated by reference.
54