CEDAR BRAKES II LLC - 10-Q Quarterly Report

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

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FORM 10-Q

(MARK ONE)

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

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

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 333-84206

CEDAR BRAKES II, L.L.C.
(Exact Name of Registrant as Specified in its Charter)

DELAWARE [76-0613853]
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)

EL PASO BUILDING
1001 LOUISIANA STREET
HOUSTON, TEXAS 77002
(Address of Principal Executive Offices) (Zip Code)

Registrant's Telephone Number, Including Area Code: (713) 420-2600

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 [ ]

As of August 13, 2002, 100 percent of the membership interest of Cedar
Brakes II, L.L.C. is owned directly by Mesquite Investors, L.L.C. Such
membership interest is not publicly traded and therefore has no separate,
quantifiable market value.

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PART I -- FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CEDAR BRAKES II, L.L.C.

CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
(UNAUDITED)

See accompanying notes.

1

CEDAR BRAKES II, L.L.C.

CONDENSED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)

See accompanying notes.

2

CEDAR BRAKES II, L.L.C.

CONDENSED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

See accompanying notes.

3

CEDAR BRAKES II, L.L.C.

NOTES TO THE CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

1. BASIS OF PRESENTATION

We are a single member Delaware limited liability company organized in May
2001, under the terms of a limited liability company agreement. We are a wholly
owned direct subsidiary of Mesquite Investors, L.L.C., an entity which is
indirectly owned by the Limestone Electron Trust and a subsidiary of El Paso
Corporation. Our sole business is to sell electric energy and provide electric
capacity to Public Service Electric and Gas Company, a New Jersey corporation,
under an amended power purchase agreement that we entered into with Public
Service Electric. We began operating under this amended power purchase agreement
on December 13, 2001.

We prepared this Quarterly Report on Form 10-Q under the rules and
regulations of the United States Securities and Exchange Commission. Because
this is an interim period filing presented using a condensed format, it does not
include all of the disclosures required by generally accepted accounting
principles. You should read it along with our December 31, 2001 audited
financials statements as presented in the amendment to our registration
statement on Form S-4 which includes a summary of our significant accounting
policies and other disclosures. The financial statements as of June 30, 2002,
and for the quarter and six months ended June 30, 2002, are unaudited. We
derived the balance sheet as of December 31, 2001, from the audited balance
sheet filed in our amendment to our registration statement on Form S-4. We
believe we have made all adjustments, all of which are of a normal, recurring
nature, to fairly present our interim period results. Due to the seasonal nature
of our business, information for interim periods may not necessarily indicate
the results of operations for the entire year.

Our accounting policies are consistent with those discussed in our
amendment to our registration statement on Form S-4, except as discussed below.

Deferred Financing Costs

Our deferred financing costs represent the cost to issue our bonds and are
being amortized using the effective-interest method over the term of the bonds.
During the six months ended June 30, 2002, we incurred an additional $0.3
million of deferred financing costs related to the exchange of our 9.875% Series
A Senior Secured Bonds for registered 9.875% Series B Senior Secured Bonds.
Amortization of deferred financing costs was approximately $0.3 million for the
six months ended June 30, 2002 and is included in our statement of operations as
interest and debt expense.

Accounting for Amended Power Purchase and Mirror Power Purchase Agreements

We record our amended power purchase and mirror power purchase agreements
on our balance sheet at their respective fair values in accordance with
Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended. We estimate the fair
value of our amended power purchase agreement with Public Service Electric and
our mirror power purchase agreement with El Paso Merchant based on an estimate
of the cash receipts and payments under these agreements using anticipated
future power prices compared to the contractual prices under these agreements,
discounted at a risk-adjusted rate commensurate with the term of each contract,
the 10-year treasury rate, and the credit risk of the counterparty. Our policy
is to adjust this risk-adjusted rate assumption, or discount rate, when a
significant change in the treasury rate and/or the credit spread associated with
the counterparty to the contract occurs. As of June 30, 2002, the discount rate
used to calculate the fair value of the amended power purchase agreement was
7.02% and the discount rate used to calculate the fair value of the mirror power
purchase agreement was 7.77%.

Our estimates of the timing of cash receipts and payments are based on the
anticipated timing of power delivered under these agreements. These estimates
also consider the minimum and maximum energy delivery
4

requirements under our agreements. Estimates of the future prices of power are
based on the forward pricing curve of the appropriate power delivery and receipt
points, and this curve is derived from actual prices observed in the market,
price quotes from brokers and extrapolation models that rely on actively quoted
prices and historical information. Changes in these values in the future, which
could be positive or negative, will occur as our estimates of each of these
variables change and as additional market data becomes available, and these
changes could be material from period to period. However, the pricing of our
power agreements is fixed over their term and, as a result, despite short-term
fluctuations in market factors, our long-term reported results will be more
reflective of the terms of these agreements. Future changes in interest rates or
counterparty credit spreads, if significant, will have a significant impact on
our results of operations and balance sheet.

NEW ACCOUNTING PRONOUNCEMENTS

Goodwill and Other Intangible Assets

In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 142, Goodwill and Other Intangible Assets. This standard requires that
goodwill no longer be amortized but periodically tested for impairment, at least
on an annual basis, or whenever an event occurs to indicate that an impairment
may have occurred. Other intangible assets are to be amortized over their useful
life and reviewed for impairment in accordance with the provisions of SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to
be Disposed Of. An intangible asset with an indefinite useful life can no longer
be amortized until its useful life becomes determinable. This statement has
various effective dates, the most significant of which is January 1, 2002. The
adoption of this standard on January 1, 2002 did not have a material effect on
our financial statements.

NEW ACCOUNTING PRONOUNCEMENTS ISSUED BUT NOT YET ADOPTED

Reporting Gains and Losses from the Early Extinguishment of Debt

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. This statement addresses how to report gains or losses resulting
from the early extinguishment of debt. Under current accounting rules, any gains
or losses on early extinguishment of debt are reported as an extraordinary item.
When we adopt SFAS No. 145, we will be required to evaluate whether the debt
extinguishment is truly extraordinary in nature. If we routinely extinguish debt
early, the gain or loss will be included in income from continuing operations.
This statement will be effective for our 2003 year-end reporting.

Accounting for Costs Associated with Exit or Disposal Activities

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. This statement will require us to recognize
costs associated with exit or disposal activities when they are incurred rather
than when we commit to an exit or disposal plan. Examples of costs covered by
this guidance include lease termination costs, employee severance costs that are
associated with a restructuring, discontinued operations, plant closings, or
other exit or disposal activities. The provisions of this statement are
effective for fiscal years beginning after December 31, 2002 and will impact any
exit or disposal activities initiated after January 1, 2003.

2. COMMITMENTS AND CONTINGENCIES

Amended Power Purchase Agreement

We have an amended power purchase agreement with Public Service Electric
that extends through March 5, 2013. Under the amended power purchase agreement,
we sell and deliver electric energy to Public Service Electric at established
prices and delivery points within the Pennsylvania-New Jersey-Maryland power
system. Additionally, we are required to arrange for 189 megawatts per day of
capacity through October 31, 2008 and 149 megawatts per day of electric capacity
from November 1, 2008 through the end of the agreement to be made available to
Public Service Electric. The prices under the agreement are specified on an

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annual basis and escalate each year over the contract term beginning in 2003.
The price is $80.88 per megawatt hour (MWh) in 2002, $77.75 per MWh in 2003, and
increases annually thereafter to $105.42 per MWh in 2013. Annual energy
deliveries cannot exceed the specified maximum amounts, which range from
1,501,825 MWh in 2002 to 1,171,424 MWh in 2012 and 205,400 in 2013.

If we fail to deliver all or part of the scheduled energy or fail to
schedule sufficient deliveries to meet the minimum energy deliveries for reasons
within our control, Public Service Electric's payment to us may be reduced by a
credit as specified in the amended power purchase agreement, if any, for energy
purchased by Public Service Electric over the prices stated in our amended power
purchase agreement. No credits were applied during the six months ended June 30,
2002.

If we fail to provide all or part of the required electric capacity for
reasons within our control, Public Service Electric must use reasonable efforts
to purchase replacement capacity in the amount of the shortfall. We must
reimburse Public Service Electric for all costs associated with the replacement
capacity. If Public Service Electric is unable to replace this capacity
shortfall, Public Service Electric's payment to us will be reduced by a credit
as specified in the amended power purchase agreement. Generally, the credit
would equal the excess of the average market marginal hourly price, if any, over
the price as stated in our amended power purchase agreement for those hours in
which the shortfall occurred. No credits were applied during the six months
ended June 30, 2002.

Mirror Power Purchase Agreement

In order to meet our electric energy delivery and electric capacity
commitments under the amended power purchase agreement, we entered into a mirror
power purchase agreement with El Paso Merchant Energy, L.P., our affiliate. The
mirror power purchase agreement has the same term as the amended power purchase
agreement. Under this agreement, we purchase energy at an established price and
at quantities sufficient to meet our obligations to Public Service Electric. The
established price under the amended power purchase agreement is $32.00 per MWh
for the term of the contract.

Under the mirror power purchase agreement, El Paso Merchant must schedule
and deliver to us during each year both the minimum hourly electric energy
deliveries and the full amount of electric energy deliveries that we are
obligated to deliver under our amended power purchase agreement with Public
Service Electric and El Paso Merchant must make available to us capacity credits
equal to the electric capacity we are required to provide under our amended
power purchase agreement with Public Service Electric. If El Paso Merchant fails
to deliver all or part of the scheduled energy to us for any reason within their
control, our payment to El Paso Merchant will be reduced by a credit calculated
in the same manner as the credit to Public Service Electric described above. No
credits were taken during the six months ended June 30, 2002. El Paso Merchant's
performance under this agreement has been guaranteed by El Paso Corporation
under a performance guaranty (see Note 3).

If El Paso Merchant fails in any month to provide all or part of the
capacity, for any reason within their control, our payment to El Paso Merchant
will be reduced by a credit calculated in the same manner as the credit to
Public Service Electric as a direct result of our failure to provide capacity
under the amended power purchase agreement. No credits were taken during the six
months ended June 30, 2002.

Because our amended power purchase and mirror power purchase agreements are
similar in terms of the amount of capacity provided and the quantities of energy
bought and sold, and since prices under these agreements are established, the
execution of these agreements results in our ability to receive a determinable
cash margin over the term of the agreements. Assuming that minimum energy
delivery requirements are met and all capacity requirements are made available,
this margin will range from $45.75 to $73.42 per MWh sold over the remaining
life of the agreements.

6

3. RELATED PARTY TRANSACTIONS

Mirror Power Purchase Agreement

El Paso Merchant provides electric energy and electric capacity to us under
the mirror power purchase agreement as discussed in Note 2. Expenses under this
agreement are based on market rates at the time the agreement was negotiated.
Total purchases during 2002 are reflected as electricity purchases -- affiliate
in our statements of operations. Amounts owed under the agreement are included
in our accounts payable -- affiliate on our balance sheets.

Administrative Services Agreement

We have an administrative services agreement with El Paso Merchant to
provide project management, finance and accounting services to us for a fee of
$100,000 per year through 2013. In addition to the base fee, we are obligated to
reimburse El Paso Merchant for direct expenses other than project management,
finance and accounting services that may be incurred on our behalf. Fees and
expenses under this agreement are due and payable only to the extent that we
have sufficient cash after paying obligations under our bond indenture. Total
fees incurred under this agreement during 2002 are reflected as administrative
fees to affiliate in our statements of operations.

El Paso Corporation Performance Guaranty

El Paso Corporation, the parent company of El Paso Merchant, entered into a
performance guaranty with us on December 12, 2001, which expires after the
expiration of El Paso Merchant's obligations under the mirror power purchase and
administrative services agreements. Under the performance guaranty, El Paso
Corporation guarantees to us the punctual performance of all of El Paso
Merchant's obligations under the mirror power purchase agreement and the
administrative services agreement.

Distributions

As permitted by our senior secured bond indenture and our limited liability
company agreement, cash distributions may be made to our member bi-annually
starting September 1, 2002 for all excess cash, provided that no event of
default or defaults has occurred, and the debt coverage ratio calculated as of
that date for the most recently ended six-month period equals or exceeds 1.03 to
1.00. We have not yet made any distributions to our member.

See Note 2 for additional discussion on commitments with related parties.

4. FAIR VALUE OF FINANCIAL INSTRUMENTS

As of June 30, 2002 and December 31, 2001, the carrying amounts of our
financial instruments including cash, cash equivalents and trade receivables and
payables are representative of fair value because of their short-term nature.
The fair value of our long-term debt was $463.6 million as of June 30, 2002, and
$432.0 million as of December 31, 2001. The fair value of our long-term debt has
been estimated based on quoted market prices for the same or similar issues.

In May 2002, Standard and Poor's lowered the senior unsecured credit rating
of our only customer, Public Service Electric, from BBB+ to BBB-. Although our
credit rating is not directly related to the credit rating of Public Service
Electric, an indirect result of the credit rating downgrade of Public Service
Electric was a downgrade in the credit rating of our bonds in June 2002 by
Standard and Poor's from BBB to BBB-. Further downgrades of Public Service
Electric could indirectly have a negative impact on the fair value of our
long-term debt.

7

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The information contained in Item 2 updates, and you should read it in
conjunction with, information disclosed in our registration statement on Form
S-4/A (Registration No. 333-84206) dated June 21, 2002, in addition to the
financial statements and notes presented in Item 1 of this Quarterly Report on
Form 10-Q.

GENERAL

Power Contract Restructurings

Our sole business is to sell electric energy and provide electric capacity
to Public Service Electric under our amended power purchase agreement with them.
We were formed in May 2001, but did not begin operations until December 13, 2001
when the Cogen Technologies NJ Venture, or Bayonne, power purchase agreement
with Public Service Electric and the Camden Cogen, L.P., or Camden, power
purchase agreement with Public Service Electric were contributed to us by our
member. The amended power purchase agreement combined and superseded the Bayonne
and Camden power purchase agreements with Public Service Electric. The
contribution of these power purchase agreements to us was a part of the process
that has become known in the power industry as a "power contract restructuring."
Many domestic power plants have long-term power purchase agreements with
regulated utilities that were entered into under the Public Utility Regulatory
Policies Act of 1978 (PURPA). The power sold to the utility under these PURPA
contracts is required to be delivered from a specified power generation plant at
power prices that are usually significantly higher than the cost of power in the
wholesale power market. The cost of generating power at these PURPA power plants
is typically higher than the cost that would be incurred by obtaining the power
in the wholesale power market, principally because the PURPA power plants are
less efficient than newer power generation facilities.

In a power contract restructuring, the PURPA power purchase agreement is
amended so that the power sold to the utility does not have to be provided from
the specific power plant. Because we are able to buy lower cost power in the
wholesale power market, we have the ability to reduce the cost paid by the
utility, thereby inducing the utility to enter into the power contract
restructuring transaction. Following the contract restructuring, the power plant
operates on a merchant basis, which means that it is no longer dedicated to one
buyer and will operate only when power prices are high enough to make operations
economical. Prior to a power contract restructuring, the power plant and its
related PURPA power purchase agreement are accounted for at their historical
cost, which is either the cost of construction or, if acquired, the acquisition
cost. Revenues and expenses prior to restructuring are, in most cases, accounted
for on an accrual basis as power is generated and sold to the utility. As part
of the restructuring, any related fuel supply and steam agreements are generally
amended or terminated, the value of the remaining merchant plant is evaluated
for possible impairment, and the restructured power agreements are adjusted to
their estimated fair value. The restructured power purchase agreement can then
be sold or we can enter into an offsetting, or mirror, power purchase agreement.
In cases when we enter into a mirror power purchase agreement, we use the
restructured agreement and the mirror power purchase agreement along with the
fixed-price spread between these agreements as collateral to obtain financing.
The offsetting power purchase agreement requires the power supplier, which can
be an affiliate or third-party, to provide long-term fixed price power in
amounts sufficient for us to meet our obligations under the restructured power
agreements.

Under the pre-existing power purchase agreements, Bayonne and Camden sold
generating capacity and associated energy from the Bayonne and Camden facilities
to Public Service Electric. Under the pre-existing power purchase agreements,
the Bayonne and Camden facilities were required to be qualifying facilities
under PURPA. The Bayonne power purchase agreement and the Camden power purchase
agreement each required that the sellers under the respective agreements source
capacity and energy only from their respective facilities. The amended power
purchase agreement eliminated the requirement that the Bayonne facility and the
Camden facility be the only sources of energy provided under that agreement. The
elimination of the requirement that the Bayonne and Camden facilities be the
only source of energy under the amended power purchase agreement is beneficial
to us because we can source energy from any source connected to the
Pennsylvania-New Jersey-Maryland (PJM) market, and the cost of energy sourced in
this manner may be less expensive than the cost to produce such energy at the
Bayonne or Camden facilities alone. The benefits of

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the amended power purchase agreement also include significantly more flexibility
in scheduling energy deliveries, including a greater degree of daily delivery
flexibility. From the perspective of Public Service Electric, our ability to
source lower cost power in the market allowed us to provide Public Service
Electric with a benefit in the form of a payment from us of $64.0 million when
the restructured power purchase agreement became effective.

Through a series of transactions, the pre-existing power purchase
agreements were distributed to our member who, in turn, contributed them to us
on December 12, 2001 at a book value of $299.1 million. We subsequently combined
and amended the pre-existing power purchase agreements and began operating under
our amended power purchase agreement on December 13, 2001. In order to meet our
energy delivery and electric capacity commitments under the amended power
purchase agreement, we entered into a mirror power purchase agreement with El
Paso Merchant. The mirror power purchase agreement has the same term as the
amended power purchase agreement and we purchase energy at an established price
and at quantities sufficient to meet our obligations to Public Service Electric.

In December 2001, we issued 9.875% Series A Senior Secured Bonds, due 2013,
with an aggregate principal amount of $431.4 million at a discount of $6.4
million. We completed an exchange of the Series A bonds for registered 9.875%
Series B Senior Secured Bonds, due 2013, on July 31, 2002. The terms of the
Series B bonds and the Series A bonds are substantially the same in all material
respects, except that the Series B bonds are registered with the Securities and
Exchange Commission. Scheduled payments of principal and interest on the bonds
will be paid from the positive margin created between the sales of electric
energy and capacity to Public Service Electric and purchases of electric energy
and capacity from El Paso Merchant.

We account for our amended power purchase agreement and our mirror power
purchase agreement as derivative instruments under the provisions of SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities, as amended.
As a result, the amended power purchase agreement and the mirror power purchase
agreement are recorded on our balance sheet at their estimated fair values. We
reflected the difference between the book value of these agreements and their
estimated market value at December 13, 2001 as a gain of $228.2 million in our
2001 statement of income.

As of June 30, 2002, these agreements had an estimated fair value of $574.6
million. For the six months ended June 30, 2002, the change in estimated fair
value of these agreements was a decrease of $14.5 million and was recorded as a
component of operating expenses in our condensed statement of operations. The
fair values of these agreements were calculated based on expected cash receipts
and payments under the agreements compared to the estimated future market prices
of power. These estimated market prices for power were derived based on a
combination of available market data, broker quotations and models that are
derived based on historical market prices. The differences between market and
contractual prices are then discounted using discount rates that reflect the
counterparty credit risk and current market conditions. Discount rates are
modified only when a significant change in the counterparty credit risk, market
condition, or both occurs. As of June 30, 2002, the discount rate used to
calculate the fair value of the amended power purchase agreement was 7.02
percent and the discount rate used to calculate the fair value of the mirror
power purchase agreement was 7.77 percent.

We also adjust our valuations for factors such as market liquidity, market
price correlation and model risk, as needed. Future power prices are based on
the forward pricing curve of the appropriate power delivery and receipt points
in the applicable power market. This forward pricing curve is derived from a
combination of actual prices observed in the applicable market, price quotes
from brokers and extrapolation models that rely on actively quoted prices and
historical information. The timing of cash receipts and payments are based on
the expected timing of power delivered under these contracts.

RESULTS OF OPERATIONS

We were formed in May 2001, but did not begin operations until December 13,
2001 when we began operating under the amended power purchase agreement with
Public Service Electric and Gas Company. As a result, our discussion of
financial condition and results of operations only encompasses those periods in
which we had operations.
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Quarter Ended June 30, 2002

For the quarter ended June 30, 2002, we had net income of $1.0 million.
During the second quarter of 2002, we generated operating revenues of $30.1
million from the sale of approximately 372,000 megawatt hours of electric
energy, and from providing electric capacity to Public Service Electric. Our
operating expenses totaled approximately $18.1 million, and were comprised
primarily of payments to El Paso Merchant for purchases of energy of $11.9
million, and a decrease in the fair value of our power agreements of $6.2
million. Our operating expenses also include fees incurred under our
administrative services agreement with El Paso Merchant. Interest and debt
expense for the period was $11.2 million.

Six Months Ended June 30, 2002

For the six months ended June 30, 2002, we had a net loss of $2.3 million.
During the first six months of 2002, we generated operating revenues of $56.5
million from the sale of approximately 698,000 megawatt hours of electric energy
and from providing electric capacity to Public Service Electric. Our operating
expenses for the first six months of 2002 were $36.9 million and include a
decrease in the fair value of our power agreements of $14.5 million and
purchases of electric energy from El Paso Merchant of $22.3 million. Our
operating expenses also include fees incurred under our administrative services
agreement with El Paso Merchant. Interest and debt expense for the six months
ended June 30, 2002 was $22.2 million.

LIQUIDITY AND CAPITAL RESOURCES

Cash from Operating Activities

Net cash provided by operating activities was $32.3 million for the six
months ended June 30, 2002 and was derived primarily from operating income and
working capital changes.

Cash from Financing Activities

Net cash used in financing activities was $0.7 million for the six months
ended June 30, 2002 and consisted of a change in our restricted cash balances
and payment of debt issuance costs.

Debt Service

Under our bond indenture, cash distributions may be made to our member
bi-annually starting September 1, 2002 for all excess cash, provided that no
event of default or defaults has occurred, and the debt coverage ratio
calculated as of that date for the most recently ended six-month period equals
or exceeds 1.03 to 1.00. We have not yet made any distributions to our member.
For the period from inception through June 30, 2002, we generated funds of
approximately $32.3 million available for debt service from the sale of power.
Interest for this period was approximately $21.1 million, providing an interest
coverage ratio of 1.53. Including the proportionate principal payments for the
same period of approximately $3.4 million, this debt service coverage ratio was
1.29.

CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995

This report contains or incorporates by reference forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Where any forward-looking statement includes a statement of the
assumptions or bases underlying the forward-looking statement, we caution that,
while we believe these assumptions or bases to be reasonable and to be made in
good faith, assumed facts or bases almost always vary from the actual results,
and the differences between assumed facts or bases and actual results can be
material, depending on the circumstances. Where, in any forward-looking
statement, we or our management express an expectation or belief as to future
results, that expectation or belief is expressed in good faith and is believed
to have a reasonable basis. We cannot assure you, however, that the statement of
expectation or belief will result or be achieved or accomplished. The words
"believe," "expect," "estimate," "anticipate" and similar expressions will
generally identify forward-looking statements.

10

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE RISK

We are exposed to changing interest rates. The table below shows the
carrying amounts and weighted average interest rates of our interest bearing
debt, by expected maturity date. The fair value of our fixed rate long-term debt
was estimated based on quoted market prices for the same or similar issues.

The sensitivity of the fair value of these agreements to changes in these
discount rates are as follows:

COMMODITY PRICE RISK

Our amended power purchase agreement and mirror power purchase agreement
meet the definition of derivatives under the provisions of SFAS No. 133 and are
carried at their fair value. The fair value of these agreements at June 30,
2002, was estimated based on the expected estimated cash receipts and payments
under these agreements using contractual prices under these agreements compared
to anticipated future power prices, discounted at a risk-adjusted rate
commensurate with the term of each contract and the credit risk of the
counterparty. Our estimates of the timing of cash receipts and payments are
based on the anticipated timing of power delivery under these agreements. These
estimates also consider the minimum and maximum energy delivery requirements
under those agreements. Estimates of the future prices of power are based on the
forward pricing curve of the appropriate power delivery and receipt points, and
this curve is derived from the actual prices observed in the market, price
quotes from brokers and extrapolation models that rely on actively, quoted
prices and historical information.

The sensitivity of the fair value of our power agreements to changes in the
forward pricing curve is as follows:

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PART II -- OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

a. Exhibits

Each exhibit identified below is filed as part of this report. Exhibits not
incorporated by reference to a prior filing are designated by an "*"; all
exhibits not so designated are incorporated herein by reference to a prior
filing as indicated.

Undertaking

We hereby undertake, pursuant to Regulation S-K, Item 601(b),
paragraph (4)(iii), to furnish to the United States Securities and Exchange
Commission, upon request, all constituent instruments defining the rights
of holders of our long-term debt not filed herewith for the reason that the
total amount of securities authorized under any of such instruments does
not exceed 10 percent of our total consolidated assets.

b. Reports on Form 8-K

None.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.

CEDAR BRAKES II, L.L.C.

Date: August 14, 2002 /s/ JOHN L. HARRISON
--------------------------------------------
John L. Harrison
Senior Vice President, Chief Financial
Officer,
Treasurer and Class A Manager
(Principal Financial Officer)

Date: August 14, 2002 /s/ CECILIA T. HEILMANN
--------------------------------------------
Cecilia T. Heilmann
Vice President, Managing
Director and Controller
(Principal Accounting Officer)

13

INDEX TO EXHIBITS

Each exhibit identified below is filed as part of this report. Exhibits not
incorporated by reference to a prior filing are designated by an "*"; all
exhibits not so designated are incorporated herein by reference to a prior
filing as indicated.