CEDAR BRAKES II LLC - 10-K Annual Report

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UNITED STATES 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, 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 333-50828

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

DELAWARE 76-0613853
(State or Other Jurisdiction of (I.R.S. Employer
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

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 [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

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

STATE THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES
OF THE REGISTRANT: None

As of March 24, 2003, 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.

DOCUMENTS INCORPORATED BY REFERENCE: None
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CEDAR BRAKES II, L.L.C.

TABLE OF CONTENTS

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Below is a list of terms that are common to our industry and used throughout
this document:

KWh = Kilowatt hours MWh = megawatt hours

When we refer to "us", "we", "our", "ours", or "Cedar Brakes" we are describing
Cedar Brakes II, L.L.C.

When we refer to "El Paso," we are describing El Paso Corporation.

PART I

ITEM 1. BUSINESS

We are a single member Delaware limited liability company formed on May 3,
2001. We are a wholly owned subsidiary of Mesquite Investors, L.L.C., an entity
which is indirectly owned by Limestone Electron Trust and a subsidiary of El
Paso Corporation. We are classified as a public utility subject to regulation by
the Federal Energy Regulatory Commission under the Federal Power Act. We began
operations on December 13, 2001 when we acquired a long-term power purchase
agreement to sell electric energy and provide electric capacity to Public
Service Electric and Gas Company.

Our sole business is the wholesale sale of electric energy and electric
capacity to Public Service Electric, our sole customer, under a power purchase
agreement that expires in 2013. We receive the electric energy we sell and the
electric capacity we provide under a mirror power purchase agreement with our
affiliate, El Paso Merchant Energy, L.P., a subsidiary of El Paso. Performance
under this agreement by El Paso Merchant is guaranteed by El Paso. We have no
employees and El Paso Merchant carries out all of our administrative activities
under an administrative services agreement. Our material assets consist of our
amended power purchase agreement with Public Service Electric, receivables
generated under that agreement and cash held from the collection of those
receivables. We were created solely to carry out the terms of our material
agreements and repay our debt obligations with the cash generated from the
execution of these agreements. For a detailed discussion of our significant
agreements, see Item 8, Financial Statements and Supplementary Data, Note 5.

Our principal executive offices are located at 1001 Louisiana Street,
Houston, Texas 77002. Our telephone number is (713) 420-2600.

MANAGERS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Pursuant to our limited liability company agreement, our company is managed
by a committee comprised of five managers. Three of these managers are appointed
by Mesquite Investors, L.L.C., our parent company, and two managers are
independent.

We utilize the employees of and management services provided by El Paso
Merchant pursuant to the administrative services agreement. We reimburse El Paso
Merchant for reasonable general and administrative expenses, and other
reasonable expenses, incurred on our behalf. The following table sets forth
information regarding our executive officers and managers.

Robert W. Baker has served as our President since February 2003. He has
also served as Executive Vice President of El Paso and President of El Paso
Global Power since January 2003. He was Senior Vice President and Deputy General
Counsel of El Paso from December 2001 to January 2003. Prior to that time, he
held various positions with El Paso since 1996.

John L. Harrison has served as our Senior Vice President, Chief Financial
Officer and Treasurer since our formation. He has served as a Class A Manager
since May 2001. He has served as Senior Vice President,

1

Chief Financial Officer and Treasurer of El Paso Merchant since 2001. Prior to
that period, he served as Vice President and Senior Managing Director of El Paso
Merchant since 2000. Prior to that, he held various positions with El Paso
Merchant since 1996.

Bryan E. Seas has served as our Vice President and Controller since
September 2002. Prior to that period, he served as director of Corporate
Accounting for El Paso since January 2000. He was Director of Accounting for
Southern Natural Gas Company since October 1999. Prior to that, he held various
positions with Sonat Inc. since 1993.

John J. O'Rourke is a Class A Manager of the Management Committee and has
served as our Vice President and Managing Director since 2001. He is also Vice
President and Managing Director of El Paso Merchant Energy North America
Company. Prior to joining El Paso in May 2000, Mr. O'Rourke was a Director of
Business Management for FPL Energy since 1992.

Kurt Regulski has served as a Class A Manager since May 2001. Mr. Regulski
has also served in various positions with El Paso Merchant from 1999 to our
formation. He was a Director for Sonat Power Marketing since 1997. Prior to that
period, he was a Manager with Sonat Power Marketing.

Dean A. Christiansen, a Class B Manager, has been President of Lord
Securities Corporation, a firm specializing in providing services to structured
finance transactions, since October 2000. In his position with Lord, he serves
as an officer, manager, member and/or director of several special purpose
entities. Prior to his employment with Lord, in 1990 Mr. Christiansen founded
Acacia Capital, Inc. a New York City based corporate advisory firm. Mr.
Christiansen is a 1983 graduate of the University of Notre Dame with a degree in
Government.

Vice Admiral Henry C. Mustin (USN, Retired) has served as our Class B
Manager since May 2001. He is the Chairman of the Board of his own consulting
company since 1992 and serves as director on a number of boards and committees.

Our Class A Managers serve until resignation or until their respective
successors are elected and qualified. Our officers serve until removal or
resignation. Our Class B Managers serve until their successors are elected and
qualified.

Our Class A Managers and our officers are also officers or employees of El
Paso or its affiliates. Since our daily operations are managed by employees of
El Paso Merchant pursuant to the administrative services agreement, we have no
employees. We do not expect that our managers and officers will face a conflict
regarding the allocation of their time between our interests and the other
business interests of El Paso and its affiliates.

ITEM 2. PROPERTIES

None.

ITEM 3. LEGAL PROCEEDINGS

None.

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

None.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

None.

ITEM 6. SELECTED FINANCIAL DATA

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(1) Represents the period from our inception, May 3, 2001, to December 31, 2001.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

GENERAL

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 have no material assets other than this agreement and
amounts generated by this agreement, including deposits we are required to
maintain. We have no material obligations other than those under our bonds, our
mirror power purchase agreement and administrative services agreement with El
Paso Merchant Energy, L.P., our affiliate. We have no employees and rely on El
Paso Merchant to carry out our obligations under these agreements.

RECENT DEVELOPMENTS

DOWNGRADE OF OUR BONDS

On November 27, 2002, Moody's Investors Service downgraded its ratings on
our senior secured bonds to "Ba2" from "Baa3". On December 2, 2002, Standard &
Poor's Ratings Services lowered its ratings on our bonds to "BB-" from "BBB-".
On February 10, 2003, Standard and Poor's further downgraded its ratings on our
bonds to "B". On February 12, 2003, Moody's further downgraded its ratings on
our bonds to "Caa1". In January 2003, Fitch Ratings downgraded its ratings on
our bonds to "BB+" from "BBB" and, on February 14, 2003, Fitch cut its ratings
further to "B". The downgrades by all of the rating agencies are the result of
previous actions taken by the rating agencies on the credit ratings of El Paso,
which guarantees El Paso Merchant's performance under our mirror power purchase
and administrative services agreements. All of the rating agencies maintain a
negative outlook on our credit ratings indicating the possibility of further
downgrades.

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POTENTIAL CHANGES IN MESQUITE INVESTORS' OWNERSHIP

Chaparral Investors, L.L.C. is the parent of Mesquite Investors, our sole
member. At December 31, 2002, Chaparral was owned approximately 20 percent by a
wholly owned subsidiary of El Paso and 80 percent by Limestone Electron Trust,
an unaffiliated third party. In March 2003, El Paso contributed $1 billion to
Limestone in exchange for a non-controlling interest which increased El Paso's
effective ownership in Chaparral to approximately 90 percent. Also in March
2003, El Paso notified Limestone that it would exercise its rights to purchase
all of the outstanding third party equity in Limestone on May 31, 2003. If El
Paso acquires the remaining Limestone equity interest in Chaparral, we would
become a wholly owned, indirect subsidiary of El Paso.

DOWNGRADE OF EL PASO CORPORATION'S CREDIT RATINGS

On February 7, 2003, Standard and Poor's downgraded El Paso's senior
unsecured debt to a rating of "B." On February 11, 2003, Moody's downgraded El
Paso's senior unsecured debt ratings to "Caa1." Both rating agencies maintain a
negative outlook on El Paso's credit ratings, indicating the possibility of
further ratings downgrades. El Paso is the parent of El Paso Merchant. The
credit rating downgrades of El Paso may impact El Paso Merchant's ability to
perform under the provisions of the mirror power purchase or administrative
services agreements.

EL PASO CORPORATION ANNOUNCES EXIT OF ENERGY TRADING ACTIVITIES

El Paso's credit downgrades in the third and fourth quarters and the
deterioration of the energy trading environment led to its decision in November
2002 to exit the energy trading business and pursue an orderly liquidation of
its trading portfolio. El Paso anticipates this liquidation may occur through
2004. If El Paso seeks to assign its obligations under the mirror power purchase
and administrative services agreements to another party, our indenture requires
the consent of the bondholders to any such assignment. El Paso has guaranteed to
us the punctual performance of all of El Paso Merchant's obligations under the
mirror power purchase and administrative services agreements. We are in the
process of evaluating what impact, if any, this announcement will have on these
agreements. If El Paso Merchant ceases to perform its obligations under its
agreements with us and El Paso fails to meet its obligations under the guaranty,
there can be no assurance that we will be able to make payments of principal and
interest on our debt. In such event, we would be able to seek a replacement
power provider and administrative services provider and to pursue our remedies
under the contracts with El Paso Merchant and the guaranty issued by El Paso.

EL PASO PROXY CONTEST

On February 18, 2003, Selim Zilkha, a stockholder of El Paso, announced his
intention to initiate a proxy solicitation to replace El Paso's entire board of
directors with his own nominees and on March 11, 2003, Mr. Zilkha filed his
preliminary proxy statement to that effect with the SEC. This proxy contest may
be highly disruptive and may negatively impact El Paso's ability to achieve the
stated objectives of its 2003 Operational and Financial Plan. In addition, El
Paso may have difficulty attracting and retaining key personnel until such proxy
content is resolved. Therefore, this proxy contest, whether or not successful,
could have a material adverse effect on El Paso's liquidity and financial
condition, which, in turn, could adversely affect our liquidity and financial
condition.

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.

4

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 existing 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 sold a portion of
and Camden sold all of its generating capacity and associated energy from their
respective facilities to Public Service Electric and 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
this requirement benefited us because now we can buy 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. The benefits of 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
5

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 electric capacity to Public Service Electric and purchases of
electric energy and electric 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 Statement
of Financial Accounting Standards (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 with changes in the estimated fair
values recorded in our statement of operations. We reflected the difference
between the book value of these agreements and their estimated fair value at
December 13, 2001 as an initial gain on power agreements of $228.2 million in
our 2001 statement of operations.

The amended power purchase and mirror power purchase agreements are
reflected as assets or liabilities on our balance sheet and had estimated fair
values as follows:

The estimated fair value of these agreements is 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
consider a combination of available market data and pricing information supplied
by a third party. The differences between market and contractual prices are then
discounted using discount rates that consider the counterparty credit risk and
current and anticipated market conditions as reflected in the United States
treasury rate. We make adjustments to this discount rate when we believe that
market changes in the rates result in changes in fair values that can be
realized.

Our estimates of 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 and pricing information supplied by a
third party. The timing of cash receipts and payments are based on the expected
timing of electric energy and electric capacity delivered under these
agreements.

The net decrease in fair value of $40.9 million for the year ended December
31, 2002 is reflected as an increase in operating expenses in our statement of
operations. The decrease in fair value of the amended power purchase agreement
is attributable primarily to an increase in the estimated market prices of power
and 2002 settlements. The increase in the mirror power purchase agreement is due
primarily to an increase in estimated market prices of power, partly offset by
an increase in the discount rate used to estimate fair value for this agreement,
resulting from the decline in the credit ratings of El Paso as discussed
previously, and 2002 settlements.

During the latter half of 2002, long term treasury rates continued to
decline. We did not adjust our discount rate for this decline in treasury rates
since this decrease, combined with the significant uncertainties in the capital
markets, did not result in an increased fair value that we believe could have
been realized in the market. As of December 31, 2002 and December 31, 2001, the
discount rate used to calculate the fair value of the amended power purchase
agreement was 7.02 percent and the discount rates used to calculate the fair
value of the mirror power purchase agreement were 14.72 percent and 7.67
percent.

6

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.

YEAR ENDED DECEMBER 31, 2002

For the year ended December 31, 2002, we had a net loss of $11.6 million.
During the year ended 2002, we generated operating revenues of $121.4 million
from the sale of approximately 1,501,000 megawatt hours of electric energy and
from providing electric capacity to Public Service Electric. Our operating
expenses for the year ended December 31, 2002 were $89.3 million and include
purchases of electric energy from El Paso Merchant of $48.0 million and a
decrease in the fair value of power agreements of $40.9 million. Our operating
expenses also include fees incurred under our administrative services agreement
with El Paso Merchant. Interest and debt expense for the year ended December 31,
2002 was $44.3 million.

PERIOD FROM INCEPTION (MAY 3, 2001) TO DECEMBER 31, 2001

From December 13, 2001 to December 31, 2001, we generated revenues of
approximately $7.0 million from the sale of approximately 76,000 megawatt hours
of electric energy, and from electric capacity provided to Public Service
Electric. Operating expenses were approximately $4.7 million, primarily from
payments to El Paso Merchant for purchases of power. Our amended power purchase
agreement and mirror power purchase agreement qualify as derivatives and are
therefore required to be recorded at their fair value, with changes in their
fair value reported in our statement of operations. Our results during the
period include a gain of $228.2 million in other income, representing our
initial adjustment of the carrying value of our contributed power purchase
agreements to their fair value. A decrease in this initial value to the end of
the year of $2.3 million, is reflected as a component of operating expenses.
Interest and debt expense for the period was $2.3 million. Our net income during
this period was $228.2 million. Our operating expenses also include fees to El
Paso Merchant under the administrative services agreement. The annual fees to El
Paso Merchant under this agreement are $0.1 million.

CRITICAL ACCOUNTING POLICY

Our most critical accounting policy that impacts our financial statements
from period to period pertains to our accounting for derivative instruments. Our
amended power purchase and mirror power purchase agreements qualify as
derivative instruments and must be recorded at their estimated fair values on
our balance sheets. Changes in the estimated fair values of these agreements are
reported in our statement of operations as change in fair value of power
agreements. The fair values of these agreements are calculated based on expected
cash receipts and payments under the agreements compared to the estimated future
market prices of power. The estimated market prices for power consider a
combination of available market data and pricing information supplied by a third
party. The differences between market and contractual prices are then discounted
using discount rates that consider an appropriate risk-free rate, adjusted for
counterparty credit risk and current and anticipated market conditions. We make
adjustments to these discount rates when we believe that market changes in the
rates result in changes in fair values that can be realized. 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 under 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. If
significant future changes in interest rates or counterparty credit risks occur,
it will have a significant impact on our financial position and results of
operations.

For additional information concerning the impact on the fair value of the
amended power purchase and mirror power purchase agreements, and therefore, on
our financial statements, that could result from changes in discount rates and
commodity prices, see Item 7A, Quantitative and Qualitative Disclosures About
Market Risk.

7

Under the amended power purchase agreement, electricity rates are set
annually in accordance with a schedule to the amended power purchase agreement.
The following table sets forth the amount of annual energy deliveries, the rates
at which we purchase electricity from El Paso Merchant and the rates we receive
when we sell electricity to Public Service Electric:

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(1) Through March 5, 2013.

The maximum amount of the annual energy payments for any year can be
readily determined. Payments to us under the amended power purchase agreement
are determined by multiplying the contract rate by the amount of energy
delivered.

Our results of operations in the future will depend primarily on revenues
from the sale of electric energy and electric capacity and the level of our
expenses. There can be no assurance that we can find alternative buyers for the
electric energy and electric capacity purchased from El Paso Merchant in the
event of the termination of the amended power purchase agreement, the loss of
which would accordingly have a material affect on our business.

We believe, based solely upon our review of information contained in Public
Service Electric's filings with the SEC and the credit ratings assigned to
Public Service Electric's senior unsecured debt by Standard and Poor's, Moody's
and Fitch, that Public Service Electric has adequate financial resources to
fulfill its payment obligations under the terms of the amended power purchase
agreement.

RELATED PARTY TRANSACTIONS

Our material related party agreements include an administrative services
agreement and a mirror power purchase agreement both with El Paso Merchant, our
affiliate. Both agreements were entered into on terms that we believe were based
on market rates at the dates they were negotiated. However, market rates can and
do change and there is no guarantee that the rates we originally agreed to in
these contracts will be indicative of market rates in the future.

LIQUIDITY AND CAPITAL RESOURCES

CASH FROM OPERATING ACTIVITIES

Net cash provided by operating activities was approximately $46.0 million
for the year ended December 31, 2002 and was derived primarily from electric
energy and electric capacity sales to Public Service Electric, net of
electricity purchases, other operating expenses and cash paid for interest. Net
cash provided by operating activities for the period ended December 31, 2001 was
$20,000 and was derived solely

8

from interest income earned on cash held during the period as we did not
commence operations until December 13, 2001.

CASH FROM FINANCING ACTIVITIES

Net cash used in financing activities was approximately $14.8 million for
the year ended December 31, 2002 and consisted primarily of a $5.8 million
principal payment on our long-term debt and an $8.5 million distribution to our
member in September 2002.

In December 2001, we issued 9.875% Series A senior secured bonds with an
aggregate principal amount of $431.4 million at a discount of $6.4 million and
incurred debt issuance costs of $6.3 million. The proceeds from the issuance of
our bonds were used to establish the collections, liquidity and damages and
indemnity accounts, and to make a payment to Public Service Electric of $64.0
million under the terms of the amended power purchase agreement. The remaining
proceeds of $333.7 million were distributed to our member in 2001. In July 2002,
we completed an offer to exchange the Series A bonds with 9.875% Series B senior
secured bonds due on September 1, 2013. Debt issuance costs associated with this
exchange were approximately $0.5 million.

Other than the obligations to repay our bonds, we have no significant
capital requirements, either in the short or long term. We believe that cash
flows from operations will be sufficient to satisfy our cash and liquidity
requirements, including the payment of interest and principal on the bonds and
the payment of our operating expenses, although we cannot assure you that this
will be the case.

Our primary sources of liquidity and capital resources are the payments to
be made by Public Service Electric under the amended power purchase agreement,
shortfall payments and excess amounts, if any, required to be paid to us by El
Paso Merchant under the mirror power purchase agreement and guaranteed by El
Paso under the El Paso performance guaranty, and amounts on deposit in the
liquidity account or acceptable credit support provided in place of cash
deposits (see discussion of the liquidity account in Item 8, Financial
Statements and Supplementary Data, Note 4). We are prohibited by our bond
indenture from incurring additional indebtedness (other than additional bonds
issued under the indenture). We would, therefore, be unable to make up any
shortfalls in cash through additional borrowings to pay amounts due under the
bonds. All scheduled payments of principal and interest on the bonds have been
calculated to be paid solely from the margin created between sales of electric
energy and electric capacity to Public Service Electric and purchases of
electric energy and electric capacity from El Paso Merchant, each for the full
amount of the required energy deliveries.

Pursuant to the amended power purchase agreement, we have the right to
schedule and deliver the annual energy deliveries for each year. In order to
meet our payments of principal and interest on the bonds, we need to schedule
and deliver (x) 42% of the annual energy deliveries to Public Service Electric
by June 30 of each year and (y) the remaining annual energy deliveries by
December 31 of each year. If El Paso Merchant fails to deliver the energy
deliveries described above, then El Paso Merchant must pay us an energy
shortfall liquidated damage payment, which will enable us to meet our payments
of principal and interest on the bonds.

The annual energy deliveries may be scheduled and delivered at any time
during the calendar year (subject to meeting the minimum energy deliveries
requirements, prior notification provisions and maximum delivery rate limits).
Although our revenues, determined on an annual basis, should remain stable, our
monthly revenues may vary. We receive our last monthly payment from Public
Service Electric for each year on January 31 of the following calendar year.
Principal payments and interest payments are made semi-annually, on March 1 and
September 1 of each year beginning in September 2002.

9

Assuming that we schedule and deliver all of the required energy deliveries
each year, the minimum debt service coverage ratio for any payment period is
expected to be 1.07 to 1.00 and the average debt service coverage ratio for any
payment period is expected to be 1.19 to 1.00. The following table sets forth
cash expected to be available for debt service and debt service for the bonds,
which includes interest as well as principal amounts, commencing in the year
2003.

Our projection of a minimum debt service coverage ratio of 1.07 to 1.00 is
also based upon the assumption that (1) El Paso Merchant will pay the energy
shortfall liquidated damage payments that would be required in the event that it
is unable to fulfill its obligations under the mirror power purchase agreement
and (2) that no additional bonds will be issued under the indenture. El Paso
Merchant may be required to make payments to us in the event that it fails to
deliver the minimum energy deliveries, fails to schedule energy deliveries or
fails to deliver energy at the contractually specified delivery point. If, for
example, El Paso Merchant has not met its delivery obligations for that month,
it will be required to pay us an amount determined by reference to Public
Service Electric's cost of replacement energy for that month. If El Paso
Merchant or El Paso is unable to pay these excess amounts, we may be unable to
pay corresponding amounts that we are required to pay Public Service Electric
under the amended power purchase agreement.

Further, if El Paso Merchant does not schedule and deliver (1) 42% of the
required annual energy deliveries to us by June 30 in any year and (2) the
remaining annual energy deliveries to us in any year, it will be required to pay
to us energy shortfall liquidated damage payments. These shortfall payments are
sized so that they are equivalent to the shortfall between our expected revenues
under the amended power purchase agreement for each semi-annual period assuming
the full delivery of the energy described above, and the

10

actual amount of energy deliveries made during that semi-annual period. If El
Paso Merchant or El Paso is unable to pay shortfall payments, we may be unable
to make payments on the bonds.

We also agreed to fund the liquidity account with the trustee in an amount
equal to the liquidity reserve required balance (which on the closing date of
the offering of the Series A bonds was $21.0 million and which at all times will
be a minimum of $14.25 million) out of the proceeds of the offering of the
Series A bonds. The purpose of the liquidity account is to provide the trustee
with cash if we do not have sufficient funds in the collections account to make
a principal or interest payment. The trustee will withdraw amounts from the
liquidity account to make such payment to the extent that funds are in the
liquidity account. Once funds have been withdrawn from the liquidity account,
those funds will only be replenished out of funds otherwise available in the
collections account. If surplus funds are not available from the collections
account, the liquidity reserve required balance will not be maintained. El Paso
has the right from time to time to withdraw all or a portion of the cash on
deposit in the liquidity account if El Paso replaces that cash with acceptable
credit support.

DISTRIBUTIONS AND DEBT SERVICE

Pursuant to the bond indenture, payments to our bondholders are given
priority over payments to our member. Under the indenture, cash distributions
may be made to our member on March 1 and September 1 of each year, provided that
no event of default or defaults have occurred and the debt service coverage
ratio calculated as of that date for the most recently ended six month period
equals or exceeds 1.03 to 1.00, and provided further that the proceeds of
additional bonds issued under the indenture (which are only available if our
bonds are rated equal to our original bond ratings) may be distributed to our
member at any time. We expect that all excess cash flow (after the payment of
debt service, operating expenses and deposits to the liquidity account) will be
distributed semi-annually to our member, as permitted by the indenture.

During the six months ended August 31, 2002, we generated funds of $35.2
million available for debt service from the sale of electric energy and electric
capacity. Interest for the period was approximately $21.3 million, providing an
interest coverage ratio of 1.65. Including proportionate principal payments for
the same period of approximately $4.1 million, the debt service ratio was 1.39.
During the year ended December 31, 2002, we generated funds of approximately
$73.6 million available for debt service from the sale of electric energy and
electric capacity. Interest for this period was approximately $42.4 million,
providing an interest coverage ratio of 1.74. Including the proportionate
principal payments for the same period of approximately $13.7 million, this debt
service coverage ratio was 1.31. In September 2002, we distributed $8.5 million
to our member as permitted by the terms of our bond indenture and our limited
liability company agreement.

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. All of our forward-looking
statements, whether written or oral, are expressly qualified by these cautionary
statements and any other cautionary statements that may accompany such
forward-looking statements. In addition, we disclaim any obligation to update
any forward-looking statements to reflect events or circumstances after the date
of this report.

11

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE RISK

The fair value of our debt is exposed to changing interest rates and
underlying credit risks. The table below shows the carrying value and average
interest rates of our long-term 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.

On November 27, 2002, Moody's Investors Service downgraded its ratings on
our senior secured bonds to "Ba2" from "Baa3". On December 2, 2002, Standard and
Poor's Ratings Services lowered its ratings on our senior secured bonds to "BB-"
from "BBB-". On January 10, 2003, Standard and Poor's further downgraded its
ratings on our bonds to "B". On February 12, 2003, Moody's further downgraded
its ratings on our bonds to "Caa1". In January 2003, Fitch Ratings downgraded
its ratings on our bonds to "BB+" from "BBB" and on February 14, 2003, Fitch cut
its ratings to "B". The downgrade by all rating agencies is the result of
previous actions taken by the rating agencies on the credit ratings of El Paso,
which guarantees El Paso Merchant's performance under our mirror power purchase
and administrative services agreements. All rating agencies maintain a negative
outlook on our credit ratings and El Paso's credit ratings, indicating the
possibility of further downgrades. Further downgrades of El Paso's credit
ratings could indirectly have a negative impact on the fair value of our
long-term debt.

Our power agreements are also sensitive to interest rate fluctuations since
the anticipated cash flows from these agreements are discounted at a United
States Treasury rate, adjusted for credit risk, to arrive at their fair value.
Changes in these rates impact our fair value estimates. The sensitivity of the
fair value of our power agreements to changes in interest rates are as follows:

COMMODITY PRICE RISK

Our amended power purchase agreement and our mirror power purchase
agreement meet the definition of a derivative under the provisions of SFAS No.
133, as amended, and are carried at estimated fair value. The fair value of
these agreements at December 31, 2002 was estimated considering 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 agreement
and the credit risk of the counterparty. Our estimates of the timing of cash
receipts and payments are based on the anticipated timing of electric energy and
electric capacity delivered under these agreements. These estimates also
consider the minimum and maximum energy delivery requirements under those
agreements. Estimates of the future prices of power consider the forward pricing
curve of the appropriate power delivery and receipt points, and this curve is
derived form the actual prices observed in the market and

12

pricing information supplied by a third party. Changes in future prices impact
the fair value of these agreements.

The sensitivity of the fair value of our power agreements to changes in
commodity prices is as follows:

13

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CEDAR BRAKES II, L.L.C.

STATEMENTS OF OPERATIONS

See accompanying notes.
14

CEDAR BRAKES II, L.L.C.

BALANCE SHEETS

See accompanying notes.
15

CEDAR BRAKES II, L.L.C.

STATEMENTS OF CASH FLOWS

See accompanying notes.
16

CEDAR BRAKES II, L.L.C.

STATEMENTS OF MEMBER'S CAPITAL
FOR THE YEAR ENDED DECEMBER 31, 2002 AND
THE PERIOD FROM INCEPTION (MAY 3, 2001) TO DECEMBER 31, 2001

See accompanying notes.
17

CEDAR BRAKES II, L.L.C.

NOTES TO THE FINANCIAL STATEMENTS

1. ORGANIZATION AND NATURE OF OPERATIONS

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. El Paso Chaparral Management, L.P., a wholly owned indirect
subsidiary of El Paso, manages the operations of Mesquite Investors. 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
when the Cogen Technologies NJ Venture, or Bayonne, power purchase agreement and
the Camden Cogen, L.P., or Camden, power purchase agreement, which had an
aggregate book value of $299.1 million, were contributed to us by our member. We
do not have any employees and our operations are carried out by our affiliate,
El Paso Merchant Energy, L.P., a subsidiary of El Paso, under an administrative
services agreement (see Note 6). We purchase the electric capacity and electric
energy necessary to meet our obligations under a mirror power purchase agreement
with El Paso Merchant (see Notes 5 and 6).

POTENTIAL CHANGES IN MESQUITE INVESTORS' OWNERSHIP

Chaparral Investors, L.L.C. is the parent of Mesquite Investors, our sole
member. At December 31, 2002, Chaparral was owned approximately 20 percent by a
wholly owned subsidiary of El Paso and 80 percent by Limestone Electron Trust,
an unaffiliated third party. In March 2003, El Paso contributed $1 billion to
Limestone in exchange for a non-controlling interest which increased El Paso's
effective ownership in Chaparral to approximately 90 percent. Also in March
2003, El Paso notified Limestone that it would exercise its rights to purchase
all of the outstanding third party equity in Limestone on May 31, 2003. If El
Paso acquires the remaining Limestone equity interest in Chaparral, we would
become a wholly owned, indirect subsidiary of El Paso.

2. LIMITED LIABILITY COMPANY

As a limited liability company, our member is not personally obligated for
our debt, obligations or other liabilities simply because they are our member.
These debts, obligations and other liabilities are solely ours. We shall
continue indefinitely until dissolved in accordance with our limited liability
company agreement.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

Our financial statements are prepared on the accrual basis of accounting in
accordance with accounting principles generally accepted in the United States of
America.

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses and disclosure of contingent assets and
liabilities that exist at the date of the financial statements. Actual results
may differ from those estimates.

CASH AND CASH EQUIVALENTS

We consider short-term investments purchased with an original maturity of
three months or less to be cash equivalents.

18

CEDAR BRAKES II, L.L.C.

NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)

RESTRICTED CASH

As required by our bond indenture (see Note 4), we established a restricted
cash fund from the proceeds of our bond issuance equal to the amount of a
semi-annual interest payment. We must maintain this fund through the maturity
date of the bonds. As of December 31, 2002 and 2001, we had restricted cash of
$21.0 million.

CASH DISTRIBUTIONS

Under our bond indenture and our limited liability company agreement,
following the initial distribution to our member from the net proceeds of our
bond offering in December 2001, cash distributions may be made to our member
semi-annually of all excess cash, provided that no event of default 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. During the year
ended December 31, 2002, we distributed $8.5 million to our member.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

We review collectibility of our accounts receivable on a regular basis,
primarily under the specific identification method. At December 31, 2002 and
2001, no allowance for doubtful accounts was recorded.

BOND DISCOUNT

Our bonds were issued at a discount. The bond discount is amortized using
the effective interest method over the term of the bonds. Amortization of the
bond discount was approximately $0.9 million for the year ended December 31,
2002 and is included in our statement of operations as interest and debt expense
(see Note 4).

DEFERRED FINANCING COSTS

Our deferred financing costs represent the cost to issue our bonds and are
amortized using the effective interest method over the term of the bonds. During
the year ended December 31, 2002, we incurred an additional $0.5 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 $0.9 million for the year ended
December 31, 2002 and is included in our statement of operations as interest and
debt expense. Accumulated amortization was $1.0 million at December 31, 2002 and
$47,000 at December 31, 2001.

INCOME TAXES

Since we are a limited liability company, income taxes accrue to our
member. As a result, we have not reflected a provision for income taxes in our
financial statements.

REVENUE RECOGNITION

We recognize revenue when we deliver electric energy and provide electric
capacity. Revenue is based on the quantity of electricity delivered at rates
specified in our amended power purchase agreement.

ACCOUNTING FOR AMENDED POWER PURCHASE AND MIRROR POWER PURCHASE AGREEMENTS

Our member contributed our power purchase agreements to us on December 12,
2001 at their book value of $299.1 million. Immediately following the
contribution, we paid Public Service Electric $64.0 million to amend the power
purchase agreements and, among other things, enter into one amended power
purchase agreement. We also entered into the mirror power purchase agreement
with El Paso Merchant, our affiliate.

19

CEDAR BRAKES II, L.L.C.

NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)

These agreements qualify as derivative instruments and are recorded on our
balance sheets at their estimated fair values in accordance with Statement of
Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended. The difference between the book
value of the amended power purchase and the mirror power purchase agreements and
their estimated fair value at December 13, 2001 of $228.2 million is included in
other income in our 2001 statement of operations. We included this amount as
other income since this initial gain was incidental to the operation and
execution of our power purchase agreements. This initial gain is comprised of
the initial value of our amended power purchase agreement of $262.8 million,
less the initial value of our mirror power purchase agreement of $34.6 million.
Following this initial valuation, net changes in the fair values of these
agreements, which were $2.3 million through December 31, 2001 and $40.9 million
for the year ended December 31, 2002, have been reflected as a change in fair
value of power agreements in operating expenses. This amount is included in our
operating income since changes in the value of our power agreements result
primarily from the execution of our power agreements.

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 rate that is based upon the
10-year United States Treasury rate, adjusted for the credit risk of each
counterparty. We make adjustments to this discount rate when we believe that
market changes in the rates result in changes in fair values that can be
realized.

During the latter half of 2002, long-term treasury rates continued to
decline. We did not adjust our discount rate for this decline in treasury rates
since this decrease, combined with the significant uncertainties in the capital
markets, did not result in an increased fair value that we believe could have
been realized in the market. Additionally, during 2002, El Paso's credit risk
increased as their senior unsecured debt was downgraded by the rating agencies
(see Note 6). Prior to the fourth quarter, we did not adjust the discount rate
used to value the mirror power purchase agreement for this charge in credit risk
as the estimated fair value resulted in a liability and we did not believe that
the decrease in our liability to El Paso Merchant, resulting from an increase in
the discount rate, would be realized. In the fourth quarter, changes in
estimated power prices resulted in an increase in the fair value such that the
estimated fair value of the mirror power purchase agreement resulted in an
asset. Accordingly, we adjusted the discount rate used to determine the fair
value of this agreement, to reflect El Paso's increased credit spread in the
fourth quarter. The discount rate used to calculate the fair value of the
amended power purchase agreement was 7.02 percent at December 31, 2002 and 2001
and the rate used to calculate the fair value of the mirror power purchase
agreement was 14.72 percent at December 31, 2002 and 7.67 percent at December
31, 2001.

Our estimates of the timing of cash receipts and payments are based on the
anticipated timing of electric energy and electric capacity delivered under
these agreements. These estimates also consider the minimum and maximum energy
delivery 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 and pricing information supplied by a third party. 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. If
significant future changes in interest rates or counterparty credit risks occur,
it will have a significant impact on our financial position and results of
operations.

20

CEDAR BRAKES II, L.L.C.

NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)

4. LONG-TERM DEBT

In December 2001, we issued 9.875% Series A senior secured bonds with an
aggregate principal amount of $431.4 million at a discount of $6.4 million. The
bonds mature on September 1, 2013, with principal and interest due semi-annually
on each March 1 and September 1 beginning in September 2002. The effective
interest rate of our bonds was 10.08% at December 31, 2002 and 10.17% at
December 31, 2001. The bonds are collateralized by all of our assets.

In July 2002, we completed an offer to exchange the Series A bonds with
9.875% Series B senior secured bonds due on September 1, 2013. 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.

We may choose to redeem the bonds, in whole or part, at any time, on not
less than 30 or more than 60 days notice to the bond holders at a redemption
price equal to the principal amount plus accrued and unpaid interest to the
redemption date, plus a make-whole premium, if any. The make-whole premium is
based on the rates of United States Treasury securities with average lives
comparable to the remaining lives of the applicable bonds, plus 50 basis points.

Obligations under our bonds are non-recourse to our member or any of its
affiliates.

The following are aggregate maturities of the principal amounts of our
bonds for each of the next five years and in total thereafter:

As required by our bond indenture, we established three separate cash
accounts from the proceeds of our bond issuance: a collections account, a
liquidity account and a damages and indemnity account. The collections account
was established to receive all payments that we are entitled to receive,
including revenue from electric energy and electric capacity sales to Public
Service Electric under the amended power purchase agreement. The liquidity
account was established to pay interest and principal due on the bonds in the
event sufficient funds are not available in the collections account to make the
interest and principal payments. We are required to maintain in the liquidity
account a cash balance equal to the maximum amount of interest that will be due
on any single subsequent interest payment date. The damages and indemnity
account was established to receive all payments from El Paso Merchant under the
terms of the mirror power purchase agreement (see Note 5) and El Paso under the
terms of the El Paso performance guaranty (see Note 6). These cash accounts are
required to be maintained for the life of the bond indenture. The balance in the
liquidity account is reported as restricted cash on our balance sheets.

We are able to issue additional senior secured debt as long as our bonds'
credit rating is reaffirmed at the original ratings of "BBB" and "Baa2" and the
minimum debt service coverage ratio is at least 1.03.

21

CEDAR BRAKES II, L.L.C.

NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)

5. POWER AGREEMENTS

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
annual basis and escalate each year over the contract term beginning in 2003.
The price was $92.76 per megawatt hour (MWh) in 2001, $80.88 per MWh in 2002, is
$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 MWh
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 periods ended December
31, 2002 and 2001.

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 deficiency charge, if any, payable by Public Service Electric as
a direct result of our failure to provide the required electric capacity. No
credits were applied during the periods ended December 31, 2002 and 2001.

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. 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 mirror 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 periods ended December 31, 2002 and 2001. The
mirror power purchase agreement also requires that we invoice El Paso Merchant
for lost margin if they fail to schedule the required annual energy delivery
quantity as defined by the amended power purchase agreement. For the year ended
December 31, 2002, El Paso Merchant failed to deliver the required annual energy
delivery quantity by 1,025 MWh's. As a result, we have invoiced El Paso Merchant
for damages of $50,102 for

22

CEDAR BRAKES II, L.L.C.

NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)

deliveries during 2002. El Paso Merchant's performance under this agreement has
been guaranteed by El Paso under a performance guaranty (see Note 6).

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
periods ended December 31, 2002 and 2001.

6. 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 above. Purchases under this
agreement are based on market rates at the time the agreement was negotiated.
Total purchases are reflected as electricity purchases -- affiliate in our
statements of operations. Amounts owed under the agreement are included in
accounts payable -- affiliate on our balance sheets. See Note 5 for further
discussion.

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 and 2001 are reflected as
administrative fees -- affiliate in our statements of operations. Amounts
payable under this agreement were approximately $33,000 as of December 31, 2002
and approximately $5,000 as of December 31, 2001 and are included in accounts
payable -- affiliate on our balance sheets.

EL PASO CORPORATION PERFORMANCE GUARANTY

El Paso, 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 guarantees to us
the punctual performance of all of El Paso Merchant's obligations under the
mirror power purchase and administrative services agreements.

On February 7, 2003, Standard and Poor's downgraded El Paso's senior
unsecured debt to a rating of "B" and on February 11, 2003, Moody's downgraded
El Paso's senior unsecured debt ratings to "Caa1". Both rating agencies maintain
a negative outlook on El Paso's credit ratings, indicating the possibility of
further ratings downgrades.

EL PASO CORPORATION ANNOUNCES EXIT OF ENERGY TRADING ACTIVITIES

El Paso's credit downgrades in the third and fourth quarters and the
deterioration of the energy trading environment led to its decision in November
2002 to exit the energy trading business and pursue an orderly liquidation of
its trading portfolio. El Paso anticipates this liquidation may occur through
2004. If El Paso seeks to assign its obligations under the mirror power purchase
and administrative services agreements to another party, our indenture requires
the consent of the bondholders to any such assignment. El Paso has guaranteed to
us the punctual performance of all of El Paso Merchant's obligations under the
mirror power purchase and administrative services agreements.

23

CEDAR BRAKES II, L.L.C.

NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)

7. CONCENTRATION OF CREDIT RISK

Our cash and accounts receivable potentially subject us to credit risk. Our
cash accounts are held by major financial institutions. Our trade receivables
and revenues are from a single customer, Public Service Electric, who purchases
electric energy and electric capacity from us under a long-term power purchase
agreement. Public Service Electric's senior unsecured debt is rated "Baa1" by
Moody's, "BBB-" by Standard and Poor's and "A-" by Fitch Ratings.

We purchase all of the electric energy and electric capacity that we
provide to Public Service Electric from our affiliate, El Paso Merchant, under a
mirror power purchase agreement (see Notes 5 and 6). El Paso guarantees El Paso
Merchant's performance under this mirror power purchase agreement. Recently, El
Paso's senior unsecured debt was downgraded by the rating agencies and it
remains on negative watch (see Note 6). If El Paso Merchant ceases to perform
its obligations under its agreement with us, and El Paso fails to meet its
obligations under the guaranty, there can be no assurance that we will be able
to make payments of principal and interest on our bonds. In such event, we would
be able to seek a replacement power provider and to pursue our remedies under
the agreement with El Paso Merchant and the guaranty issued by El Paso.

8. FAIR VALUE OF FINANCIAL INSTRUMENTS

As of December 31, 2002 and 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 maturity. The fair
values of our derivative instruments are reflected on our balance sheets.

The following table reflects the carrying amount and estimated fair value
of our other financial instruments at December 31:

DOWNGRADE OF OUR BONDS

The fair value of our long-term debt has been estimated based on quoted
market prices for the same or similar issues. On October 4, 2002, Moody's
Investors Service downgraded its ratings on our bonds to "Baa3" from "Baa2". On
November 27, 2002, Moody's further downgraded its ratings on our bonds to "Ba2".
On December 2, 2002, Standard & Poor's Ratings Services lowered its ratings on
our bonds to "BB-" from "BBB-". On February 10, 2003, Standard and Poor's
further downgraded its ratings on our bonds to "B". On February 12, 2003,
Moody's further downgraded its ratings on our bonds to "Caa1". In January 2003,
Fitch Ratings downgraded its ratings on our bonds to "BB+" from "BBB" and, on
February 14, 2003, Fitch cut its ratings further to "B". The downgrade by all
rating agencies is the result of previous actions taken by the rating agencies
on the credit ratings of El Paso, which guarantees El Paso Merchant's
performance under our mirror power purchase and administrative services
agreements. All of the rating agencies maintain a negative outlook on our credit
ratings, indicating the possibility of further downgrades. These downgrades and
further downgrades of El Paso's credit ratings could indirectly have a negative
impact on the fair value of our long-term debt.

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 this downgrade was a reduction 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.

24

CEDAR BRAKES II, L.L.C.

NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)

9. SUPPLEMENTAL SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

Financial information by quarter is summarized below:

- ---------------

(1) We did not commence operations until December 13, 2001.

25

REPORT OF INDEPENDENT ACCOUNTANTS

To the Member of Cedar Brakes II, L.L.C.:

In our opinion, the accompanying balance sheets and the related statements
of operations, of member's capital and of cash flows present fairly, in all
material respects, the financial position of Cedar Brakes II, L.L.C. at December
31, 2002 and 2001, and the results of its operations and its cash flows for the
year ended December 31, 2002 and for the period from inception (May 3, 2001) to
December 31, 2001, in conformity with accounting principles generally accepted
in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

Houston, Texas
March 27, 2003

26

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

Information regarding our executive officers is presented in Item 1,
Business, of this Form 10-K under the caption "Managers and Executive Officers
of the Registrant."

ITEM 11. EXECUTIVE COMPENSATION

None.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

None.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

None.

ITEM 14. CONTROLS AND PROCEDURES

Evaluation of Controls and Procedures. Under the supervision and with the
participation of management, including our principal executive officer and
principal financial officer, we have evaluated the effectiveness of the design
and operation of our disclosure controls and procedures (Disclosure Controls)
and internal controls (Internal Controls) within 90 days of the filing date of
this annual report pursuant to Rules 13a-15 and 15d-15 under the Securities
Exchange Act of 1934 (Exchange Act).

Definition of Disclosure Controls and Internal Controls. Disclosure
Controls are our controls and other procedures that are designed to ensure that
information required to be disclosed by us in the reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported, within
the time periods specified under the Exchange Act. Disclosure Controls include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by us in the reports that we file under the Exchange
Act is accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate to allow
timely decisions regarding required disclosure. Internal Controls are procedures
which are designed with the objective of providing reasonable assurance that (1)
our transactions are properly authorized; (2) our assets are safeguarded against
unauthorized or improper use; and (3) our transactions are properly recorded and
reported, all to permit the preparation of our financial statements in
conformity with generally accepted accounting principles.

Limitations on the Effectiveness of Controls. Our management, including the
principal executive officer and principal financial officer, does not expect
that our Disclosure Controls and Internal Controls will prevent all error and
all fraud. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain

27

assumptions about the likelihood of future event, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions. Over time, controls may become inadequate because of changes
in conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations is a cost-effective control
system, misstatements due to error or fraud may occur and not be detected.

No Significant Changes in Internal Controls. We have sought to determine
whether there were any "significant deficiencies" or "material weaknesses" in
our Internal Controls, or whether the company had identified any acts of fraud
involving personnel who have a significant role in our Internal Controls. This
information was important both for the controls evaluation generally and because
the principal executive officer and principal financial officer are required to
disclose that information to our Board and our independent auditors and to
report on related matters in this section of the Annual Report. The principal
executive officer and principal financial officer note that, from the date of
the controls evaluation to the date of this Annual Report, there have been no
significant changes in Internal Controls or in other factors that could
significantly affect Internal Controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Effectiveness of Disclosure Controls. Based on the controls evaluation, our
principal executive officer and principal financial officer have concluded that,
subject to the limitations discussed above, the Disclosure Controls are
effective to ensure that material information relating to us is made known to
management, including the principal executive officer and principal financial
officer, particularly during the period when our periodic reports are being
prepared.

Officer Certifications. The certifications from the principal executive
officer and principal financial officer required under Sections 302 and 906 of
the Sarbanes-Oxley Act of 2002 have been included herein, or as Exhibits to this
Annual Report, as appropriate.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) The following documents are filed as a part of this report:

1. Financial statements.

Our financial statements are included in Part II, Item 8 of this report:

2. Financial statement schedules and supplementary information required to
be submitted.

None.

3. Exhibit list............................................. 29

(b) Reports on Form 8-K:

None.

28

CEDAR BRAKES II, L.L.C.

EXHIBIT LIST
DECEMBER 31, 2002

Each exhibit identified below is filed as a part of this report. Exhibits
not incorporated by reference to a prior filing are designated by an asterisk;
all exhibits not so designated are incorporated herein by reference to a prior
filing as indicated. Exhibits designated with a "+" constitute a management
contract or compensatory plan or arrangement required to be filed as an exhibit
to this report pursuant to Item 15(c) of Form 10-K.

29

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of Houston, Texas, on March 31, 2003.

CEDAR BRAKES II, L.L.C.

By: /s/ JOHN L. HARRISON
------------------------------------
Name: John L. Harrison
Title: Senior Vice President, Chief
Financial Officer, Treasurer
and Class A Manager

Pursuant to the requirements of the Securities Act of 1934, as amended,
this report has been signed by the following persons in the capacities and on
the dates indicated:

30

CERTIFICATION

I, Robert W. Baker, certify that:

1. I have reviewed this annual report on Form 10-K of Cedar Brakes II,
L.L.C.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Date: March 31, 2003

/s/ ROBERT W. BAKER
--------------------------------------
Robert W. Baker
President
(Principal Executive Officer)
Cedar Brakes II, L.L.C.

31

CERTIFICATION

I, John L. Harrison, certify that:

1. I have reviewed this annual report on Form 10-K of Cedar Brakes II,
L.L.C.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Date: March 31, 2003

/s/ JOHN L. HARRISON
--------------------------------------
John L. Harrison
Senior Vice President,
Chief Financial Officer
(Principal Financial Officer)
Cedar Brakes II, L.L.C.

32

EXHIBIT INDEX