CMS Energy 10-K 2008
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2007
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Securities registered pursuant to Section 12(b) of the Act:
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
CMS Energy Corporation: Yes [X] No o Consumers Energy Company: Yes [X] No o
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
CMS Energy Corporation: Yes o No [X] Consumers Energy Company: Yes o No [X]
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 o
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 Registrants 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. o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check One):
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check One):
Indicate by check mark whether the Registrant is a shell company (as defined in Exchange Act Rule 12b-2).
CMS Energy Corporation: Yes o No [X] Consumers Energy Company: Yes o No [X]
The aggregate market value of CMS Energy voting and non-voting common equity held by non-affiliates was $3.863 billion for the 224,583,688 CMS Energy Common Stock shares outstanding on June 30, 2007 based on the closing sale price of $17.20 for CMS Energy Common Stock, as reported by the New York Stock Exchange on such date.
There were 225,177,071 shares of CMS Energy Common Stock outstanding on February 19, 2008. On February 19, 2008, CMS Energy held all voting and non-voting common equity of Consumers.
Documents incorporated by reference: CMS Energys proxy statement and Consumers information statement relating to the 2008 annual meeting of shareholders to be held May 16, 2008, is incorporated by reference in Part III, except for the compensation and human resources committee report and audit committee report contained therein.
CMS Energy Corporation
Consumers Energy Company
Annual Reports on Form 10-K to the Securities and Exchange Commission for the Year Ended
December 31, 2007
This combined Form 10-K is separately filed by CMS Energy Corporation and Consumers Energy Company. Information in this combined Form 10-K relating to each individual registrant is filed by such registrant on its own behalf. Consumers Energy Company makes no representation regarding information relating to any other companies affiliated with CMS Energy Corporation other than its own subsidiaries. None of CMS Energy Corporation, CMS Enterprises Company nor any of CMS Energys other subsidiaries (other than Consumers Energy Company) has any obligation in respect of Consumers Energy Companys debt securities and holders of such securities should not consider CMS Energy Corporation, CMS Enterprises Company nor any of CMS Energys subsidiaries (other than Consumers Energy Company and its own subsidiaries (in relevant circumstances)) financial resources or results of operations in making a decision with respect to Consumers Energy Companys debt securities. Similarly, Consumers Energy Company has no obligation in respect of debt securities of CMS Energy Corporation.
TABLE OF CONTENTS
(This page intentionally left blank)
Certain terms used in the text and financial statements are defined below
(This page intentionally left blank)
ITEM 1. BUSINESS
CMS Energy was formed in Michigan in 1987 and is an energy holding company operating through subsidiaries in the United States, primarily in Michigan. Its two principal subsidiaries are Consumers and Enterprises. Consumers is a public utility that provides electricity and/or natural gas to almost 6.5 million of Michigans 10 million residents and serves customers in all 68 counties of Michigans Lower Peninsula. Enterprises, through various subsidiaries and certain equity investments, is engaged primarily in domestic independent power production.
CMS Energys consolidated operating revenue was $6.464 billion in 2007, $6.126 billion in 2006, and $5.879 billion in 2005. CMS Energy manages its businesses by the nature of services each provides and operates principally in three business segments: electric utility, gas utility, and enterprises. See BUSINESS SEGMENTS in this Item 1 for further discussion of each segment.
Consumers was formed in Michigan in 1968 and is the successor to a corporation organized in Maine in 1910 that conducted business in Michigan from 1915 to 1968. Consumers serves individuals and companies operating in the automotive, metal, chemical and food products industries as well as a diversified group of other industries. In 2007, Consumers served 1.8 million electric customers and 1.7 million gas customers.
Consumers consolidated operations account for a majority of CMS Energys total assets, income, and operating revenue. Consumers consolidated operating revenue was $6.064 billion in 2007, $5.721 billion in 2006, and $5.232 billion in 2005.
Consumers rates and certain other aspects of its business are subject to the jurisdiction of the MPSC and the FERC, as described in CMS ENERGY AND CONSUMERS REGULATION in this Item 1.
Consumers Properties General: Consumers owns its principal properties in fee, except that most electric lines and gas mains are located in public roads or on land owned by others and are accessed by Consumers pursuant to easements and other rights. Almost all of Consumers properties are subject to the lien of its First Mortgage Bond Indenture. For additional information on Consumers properties, see BUSINESS SEGMENTS Consumers Electric Utility Electric Utility Properties, and Consumers Gas Utility Gas Utility Properties as described later in this Item 1.
For further information with respect to operating revenue, net operating income, and identifiable assets and liabilities attributable to all of CMS Energys business segments and operations, see ITEM 8. CMS ENERGYS FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA SELECTED FINANCIAL INFORMATION, CONSOLIDATED FINANCIAL STATEMENTS and NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
For further information with respect to operating revenue, net operating income, and identifiable assets and liabilities attributable to Consumers electric and gas utility operations, see ITEM 8. CONSUMERS FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA SELECTED FINANCIAL INFORMATION, CONSOLIDATED FINANCIAL STATEMENTS and NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
Consumers Electric Utility
Consumers electric utility operating revenue was $3.443 billion in 2007, $3.302 billion in 2006, and $2.701 billion in 2005. Consumers electric utility operations include the generation, purchase, distribution and sale of electricity. At year-end 2007, Consumers was authorized to provide service in 61 of the 68 counties of Michigans Lower Peninsula. Principal cities served include Battle Creek, Flint, Grand Rapids, Jackson, Kalamazoo, Midland, Muskegon and Saginaw. Consumers electric utility customer base comprises a mix of residential, commercial and diversified industrial customers, the largest segment of which is the automotive industry (which represents 5 percent of Consumers revenues). Consumers electric utility operations are not dependent upon a single customer, or even a few customers, and the loss of any one or even a few such customers is not reasonably likely to have a material adverse effect on its financial condition.
Consumers electric utility operations are seasonal. The summer months typically increase the use of electric energy, primarily due to the use of air conditioners and other cooling equipment. In 2007, Consumers electric deliveries were 39 billion kWh, which included ROA deliveries of 1 billion kWh. In 2006, Consumers electric deliveries were 38 billion kWh, which included ROA deliveries of 1 billion kWh.
Consumers 2007 summer peak demand was 8,183 MW excluding ROA loads and 8,391 MW including ROA loads. For the 2006-07 winter period, Consumers peak demand was 5,985 MW excluding ROA loads and 6,178 MW including ROA loads. Alternative electric suppliers were providing generation services to ROA customers of 315 MW at December 31, 2007 and 300 MW at December 31, 2006. Consumers had an 11 percent Reserve Margin target for summer 2007. Consumers owns or controls capacity necessary to supply approximately 118 percent of projected firm peak load for summer 2008.
In 2007, through the Midwest Energy Market, long-term purchase contracts, options, spot market and other seasonal purchases, Consumers purchased up to 3,979 MW of net capacity from others, which amounted to 49 percent of Consumers total system requirements.
Electric Utility Properties
Generation: At December 31, 2007, Consumers electric generating system consisted of the following:
Distribution: Consumers distribution system includes:
Consumers is interconnected to METC. METC owns an interstate high-voltage electric transmission system in Michigan and is interconnected with neighboring utilities as well as other transmission systems.
Fuel Supply: As shown in the following table, Consumers generated electricity primarily from coal and from its former ownership in nuclear power.
The cost of all fuels consumed, shown in the following table, fluctuates with the mix of fuel used.
Consumers has four generating plant sites that burn coal. In 2007, these plants produced a combined total of 17,903 million kWh of electricity, which represents 90 percent of Consumers 19,863 million kWh baseload supply, the capacity used to serve a constant level of customer demand. These plants burned 9.4 million tons of coal in 2007. On December 31, 2007, Consumers had on hand a 50-day supply of coal.
Consumers has entered into coal supply contracts with various suppliers and associated rail transportation contracts for its coal-fired generating plants. Under the terms of these agreements, Consumers is obligated to take physical delivery of the coal and make payment based upon the contract terms. Consumers coal supply contracts expire through 2010 and total an estimated $376 million. Its coal transportation contracts expire through 2009 and total an estimated $263 million. Long-term coal supply contracts have accounted for approximately 60 to 90 percent of Consumers annual coal requirements over the last 10 years. Consumers believes that it is within the historical 60 to 90 percent range.
At December 31, 2007, Consumers had future unrecognized commitments to purchase capacity and energy under long-term power purchase agreements with various generating plants. These contracts require monthly capacity payments based on the plants availability or deliverability. These payments for 2008 through 2030 total an
estimated $21.025 billion. This amount may vary depending upon plant availability and fuel costs. Consumers is obligated to pay capacity charges based upon the amount of capacity available at a given time, whether or not power is delivered to Consumers.
Consumers Gas Utility
Consumers gas utility operating revenue was $2.621 billion in 2007, $2.374 billion in 2006, and $2.483 billion in 2005. Consumers gas utility operations purchase, transport, store, distribute and sell natural gas. Consumers is authorized to provide service in 46 of the 68 counties in Michigans Lower Peninsula. Principal cities served include Bay City, Flint, Jackson, Kalamazoo, Lansing, Pontiac and Saginaw, as well as the suburban Detroit area, where nearly 900,000 of Consumers gas customers are located. Consumers gas utility operations are not dependent upon a single customer, or even a few customers, and the loss of any one or even a few such customers is not reasonably likely to have a material adverse effect on its financial condition.
Consumers gas utility operations are seasonal. Consumers injects natural gas into storage during the summer months for use during the winter months when the demand for natural gas is higher. Peak demand occurs in the winter due to colder temperatures and the resulting use of heating fuels. In 2007, deliveries of natural gas sold through Consumers pipeline and distribution network totaled 347 bcf.
Gas Utility Properties: Consumers gas distribution and transmission system located throughout Michigans Lower Peninsula consists of:
Gas Supply: In 2007, Consumers purchased 67 percent of the gas it delivered from United States producers and 25 percent from Canadian producers. Authorized suppliers in the gas customer choice program supplied the remaining 8 percent of gas that Consumers delivered.
Consumers firm gas transportation agreements are with ANR Pipeline Company, Great Lakes Gas Transmission, L.P., Trunkline Gas Co., Panhandle Eastern Pipe Line Company, and Vector Pipeline. Consumers uses these agreements to deliver gas to Michigan for ultimate deliveries to market. Consumers firm transportation and city gate arrangements are capable of delivering over ninety percent of Consumers total gas supply requirements. As of December 31, 2007, Consumers portfolio of firm transportation from pipelines to Michigan is as follows:
Consumers purchases the balance of its required gas supply under incremental firm transportation contracts, firm city gate contracts and, as needed, interruptible transportation contracts. The amount of interruptible transportation service and its use vary primarily with the price for such service and the availability and price of the spot supplies being purchased and transported. Consumers use of interruptible transportation is generally in off-peak summer months and after Consumers has fully utilized the services under the firm transportation agreements.
Enterprises, through various subsidiaries and certain equity investments, is engaged primarily in domestic independent power production. Enterprises operating revenue included in Continuing Operations in our consolidated financial statements was $383 million in 2007, $438 million in 2006, and $693 million in 2005. Operating revenue included in Discontinued Operations in our consolidated financial statements was $235 million in 2007, $684 million in 2006, and $409 million in 2005.
In 2007, Enterprises made a significant change in business strategy by exiting the international marketplace and refocusing its business strategy to concentrate on its independent power business in the United States.
CMS Generation was formed in 1986. It invested in and operated non-utility power generation plants in the United States and abroad. The independent power production business segments operating revenue included in Continuing Operations in our consolidated financial statements was $41 million in 2007, $103 million in 2006, and $104 million in 2005. Operating revenue included in Discontinued Operations in our consolidated financial statements was $124 million in 2007, $437 million in 2006, and $211 million in 2005. In 2007, Enterprises sold CMS Generation and all of its international assets and power production facilities and transferred its domestic independent power plant operations to its subsidiary, Hydra-Co. For more information on the asset sales, see ITEM 8. CMS ENERGYS FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2. ASSET SALES, DISCONTINUED OPERATIONS AND IMPAIRMENT CHARGES ASSET SALES.
Independent Power Production Properties: At December 31, 2007, CMS Energy had ownership interests in independent power plants totaling 1,199 gross MW or 1,078 net MW (net MW reflects that portion of the gross capacity in relation to CMS Energys ownership interest).
The following table details CMS Energys interest in independent power plants at December 31, 2007:
For information on capital expenditures, see ITEM 7. CMS ENERGYS MANAGEMENTS DISCUSSION AND ANALYSIS CAPITAL RESOURCES AND LIQUIDITY.
CMS Gas Transmission was formed in 1988 and owned, developed and managed domestic and international natural gas facilities. CMS Gas Transmissions operating revenue included in Continuing Operations in our consolidated financial statements was less than $1 million in 2007, $1 million in 2006, and less than $1 million in 2005. Operating revenue included in Discontinued Operations in our consolidated financial statements was $3 million in 2007, $17 million in 2006, and $18 million in 2005.
In 2003, CMS Gas Transmission sold Panhandle to Southern Union Panhandle Corp. Also in 2003, CMS Gas Transmission sold CMS Field Services to Cantera Natural Gas, Inc. In 2004, CMS Gas Transmission sold its interest in Goldfields and its Parmelia business to APT.
In March 2007, CMS Gas Transmission sold a portfolio of its businesses in Argentina and its northern Michigan non-utility natural gas assets to Lucid Energy. In August 2007, CMS Gas Transmission sold its investment in GasAtacama to Endesa S.A. For more information on these asset sales, see ITEM 8. CMS ENERGYS FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2. ASSET SALES, DISCONTINUED OPERATIONS AND IMPAIRMENT CHARGES ASSET SALES.
Natural Gas Transmission Properties: At December 31, 2007, CMS Gas Transmission had a 23.5 percent ownership interest in 3,362 miles of pipelines in Argentina which remain subject to a potential sale to the government of Argentina or other form of disposition.
In 2004, CMS ERM changed its name from CMS Marketing, Services and Trading Company to CMS Energy Resource Management Company. Also, in 2004, CMS ERM discontinued its natural gas retail program as customer contracts expired.
CMS ERM purchases and sells energy commodities in support of CMS Energys generating facilities. In 2007, CMS ERM marketed approximately 38 bcf of natural gas and 2,687 GWh of electricity. Its operating revenue was $342 million in 2007, $334 million in 2006, and $589 million in 2005.
The international energy distribution business segments operating revenue, all of which was reflected in Discontinued Operations in our consolidated financial statements, was $108 million in 2007, $230 million in 2006, and $180 million in 2005. In April 2007, CMS Energy sold its ownership interest in SENECA. In June 2007, CMS Energy sold CPEE. For more information on these asset sales, see ITEM 8. CMS ENERGYS FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2. ASSET SALES, DISCONTINUED OPERATIONS AND IMPAIRMENT CHARGES ASSET SALES.
CMS Energy is a public utility holding company that was previously exempt from registration under the PUHCA of 1935. The PUHCA of 1935 was repealed and replaced by the Energy Policy Act of 2005, effective February 8, 2006. CMS Energy, Consumers and their subsidiaries are subject to regulation by various federal, state, local and foreign governmental agencies, including those described in the following sections.
Consumers is subject to the jurisdiction of the MPSC, which regulates public utilities in Michigan with respect to retail utility rates, accounting, utility services, certain facilities and other matters.
The Michigan Attorney General, ABATE, and the MPSC staff typically intervene in MPSC proceedings concerning Consumers and appeal most significant MPSC orders. Certain appeals of the MPSC orders are pending in the Court of Appeals.
Rate Proceedings: In 2005, the MPSC issued an order that established the electric authorized rate of return on common equity at 11.15 percent. During 2007, we filed an electric rate case with the MPSC requesting an 11.25 percent authorized rate of return, which is still pending. In August 2007, the MPSC approved a partial settlement agreement for our 2007 gas rate case, which established the gas authorized rate of return on common equity at 10.75 percent. This proceeding is still pending with the MPSC. In February 2008, we filed a gas rate case with the MPSC requesting an 11 percent authorized rate of return.
The PSCR and GCR processes allow for recovery of reasonable and prudent power supply and gas costs. The MPSC reviews these costs for reasonableness and prudency in annual plan proceedings and in plan reconciliation proceedings. For additional information, see ITEM 8. CMS ENERGYS FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NOTE 3 OF CMS ENERGYS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINGENCIES) CONSUMERS ELECRIC UTILITY RATE MATTERS and CONSUMERS GAS UTILITY RATE MATTERS and ITEM 8. CONSUMERS FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NOTE 3 OF CONSUMERS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINGENCIES) ELECTRIC RATE MATTERS and GAS RATE MATTERS.
MPSC Regulation and Michigan Legislation: Effective January 2002, the Customer Choice Act provided that all electric customers have the choice to buy generation service from an alternative electric supplier. The Customer Choice Act also imposed rate reductions, rate freezes and rate caps, which expired at the end of 2005. The Michigan legislature introduced several bills in December 2007 that would significantly reform the Customer Choice Act. For additional information regarding the Customer Choice Act, see ITEM 7. CMS ENERGYS MANAGEMENTS DISCUSSION AND ANALYSIS OUTLOOK ELECTRIC UTILITY BUSINESS UNCERTAINTIES ELECTRIC ROA and ITEM 7. CONSUMERS MANAGEMENTS DISCUSSION AND ANALYSIS OUTLOOK ELECTRIC BUSINESS UNCERTAINTIES ELECTRIC ROA.
Consumers transports some of the natural gas it sells to customers through facilities owned by competitors including gas producers, marketers and others. Pursuant to a self implemented gas customer choice program that began in April 2003, all of Consumers gas customers are eligible to select an alternative gas commodity supplier.
The FERC has exercised limited jurisdiction over several independent power plants in which Enterprises has ownership interests, as well as over CMS ERM and DIG. Among other things, FERC has jurisdiction over acquisitions, operation and disposal of certain assets and facilities, services provided and rates charged, and limited jurisdiction over other holding company matters with respect to CMS Energy. Some of Consumers gas business is also subject to regulation by the FERC, including a blanket transportation tariff pursuant to which Consumers may transport gas in interstate commerce.
The FERC also regulates certain aspects of Consumers electric operations including compliance with FERC accounting rules, wholesale rates, operation of licensed hydro-electric generating plants, transfers of certain facilities, and corporate mergers and issuance of securities.
The Energy Policy Act of 2005 modified the FERCs responsibilities, which affects both Consumers and Enterprises. The new law repeals the PUHCA of 1935, streamlines electric transmission siting rules, promotes wholesale competition and investment, and requires mandatory electric supply reliability planning. In addition, the 2005 Act gave the FERC the authority to require a wide range of activities to improve the bulk power systems reliability. During 2007, more than ninety new regulations in this area went into effect.
The FERC is currently in the process of establishing standards for ensuring a more reliable system of providing electricity throughout North America through increased regulation of generation owners and operators, load serving entities, and others.
The Secretary of Energy regulates imports and exports of natural gas and has delegated various aspects of this jurisdiction to the FERC and the DOEs Office of Fossil Fuels.
Consumers pipelines are subject to the Natural Gas Pipeline Safety Act of 1968 and the Pipeline Safety Improvement Act of 2002, which regulate the safety of gas pipelines.
CMS Energy, Consumers and their subsidiaries are subject to various federal, state and local regulations for environmental quality, including air and water quality, waste management, zoning and other matters.
CMS Energy has a recorded a significant liability for its obligations associated with Bay Harbor. For additional information, see ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NOTE 3 (CONTINGENCIES) OF CMS ENERGYS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS and ITEM 1A. RISK FACTORS.
Consumers has installed and is currently installing modern emission controls at its electric generating plants and has converted and is converting electric generating units to burn cleaner fuels. Consumers expects that the cost of future environmental compliance, especially compliance with clean air laws, will be significant because of EPA regulations and proposed regulations regarding nitrogen oxide, particulate-related emissions, and mercury. Consumers will spend $835 million through 2015 to comply with the Clean Air Interstate Rule and will spend $480 million through 2015 to comply with the State of Michigans proposed mercury plan.
Consumers completed the closure of an ash landfill at one plant in 2007 and is awaiting MDEQ certification of that closure. Consumers is also in the process of closing some older areas at an ash landfill at another plant. Construction, operation, and closure of a modern solid waste disposal area for ash can be expensive because of strict federal and state requirements. In order to significantly reduce ash field closure costs, Consumers has worked with others to use bottom ash and fly ash as part of a temporary and final cover for ash disposal areas instead of native materials, in cases where such use of bottom ash and fly ash is compatible with environmental standards. To reduce disposal volumes, Consumers sells coal ash for use as a Portland cement replacement in concrete products, as a filler for asphalt, as feedstock for the manufacture of Portland cement and for other environmentally compatible uses. The EPA has announced its intention to develop new nationwide standards for ash disposal areas. Consumers intends to work through industry groups to help ensure that any such regulations require only the minimum cost necessary to adhere to standards that are consistent with protection of the environment.
Consumers electric generating plants must comply with rules that significantly reduce the number of fish killed by plant cooling water intake systems. Consumers is studying options to determine the most cost-effective solutions for compliance.
Like most electric utilities, Consumers has PCB in some of its electrical equipment. During routine maintenance activities, Consumers identified PCB as a component in certain paint, grout and sealant materials at the Ludington Pumped Storage facility. Consumers removed and replaced part of the PCB material with non-PCB material. Consumers has proposed a plan to the EPA to deal with the remaining materials and is waiting for a response from the EPA.
Certain environmental regulations affecting CMS Energy and Consumers include, but are not limited to, the Clean Air Act Amendments of 1990 and Superfund. Superfund can require any individual or entity that may have owned or operated a disposal site, as well as transporters or generators of hazardous substances that were sent to such a site, to share in remediation costs for the site.
CMS Energys and Consumers current insurance program does not extend to cover the risks of certain environmental cleanup costs or environmental damages, such as claims for air pollution, damage to sites owned by CMS Energy or Consumers, and for some past PCB contamination, and for some long-term storage or disposal of pollutants.
For additional information concerning environmental matters, including estimated capital expenditures to reduce nitrogen oxide related emissions, see ITEM 7. CMS ENERGYS MANAGEMENTS DISCUSSION AND ANALYSIS OUTLOOK ELECTRIC UTILITY BUSINESS UNCERTAINTIES ELECTRIC ENVIRONMENTAL ESTIMATES and ITEM 7. CONSUMERS MANAGEMENTS DISCUSSION AND ANALYSIS OUTLOOK ELECTRIC BUSINESS UNCERTAINTIES ELECTRIC ENVIRONMENTAL ESTIMATES.
CMS ENERGY AND CONSUMERS COMPETITION
Consumers electric utility business experiences actual and potential competition from many sources, both in the wholesale and retail markets, as well as in electric generation, electric delivery, and retail services.
Michigans Customer Choice Act gives all electric customers the right to buy generation service from an alternative electric supplier. In January 2006, the MPSC approved cost-based ROA distribution tariffs. A significant decrease in retail electric competition occurred in 2005 due to changes in market conditions, including increased uncertainty and volatility in fuel commodity prices. Energy market volatility continued into 2006. At December 31, 2007, alternative electric suppliers were providing 315 MW of generation service to ROA customers. This amount represents an increase of 5 percent compared to December 31, 2006, and is 4 percent of Consumers total distribution load. It is difficult to predict future ROA customer trends.
In addition to retail electric customer choice, Consumers has competition or potential competition from:
Consumers addresses this competition by monitoring activity in adjacent areas and enforcing compliance with MPSC and FERC rules, providing non-energy services, and providing tariff-based incentives that support economic development.
Consumers offers non-energy revenue-producing services to electric customers, municipalities and other utilities in an effort to offset costs. These services include engineering and consulting, construction of customer-owned distribution facilities, sales of equipment (such as transformers), power quality analysis, energy management services, meter reading, and joint construction for phone and cable. Consumers faces competition from many sources, including energy management services companies, other utilities, contractors, and retail merchandisers.
CMS ERM, a non-utility electric subsidiary, continues to focus on optimizing CMS Energys independent power production portfolio. CMS Energys independent power production business, a non-utility electric subsidiary, faces competition from generators, marketers and brokers, as well as other utilities marketing power at lower prices on the wholesale market.
For additional information concerning electric competition, see ITEM 7. CMS ENERGYS MANAGEMENTS DISCUSSION AND ANALYSIS OUTLOOK ELECTRIC UTILITY BUSINESS UNCERTAINTIES and ITEM 7. CONSUMERS MANAGEMENTS DISCUSSION AND ANALYSIS OUTLOOK ELECTRIC BUSINESS UNCERTAINTIES.
Competition exists in various aspects of Consumers gas utility business, and is likely to increase. Competition comes from other gas suppliers taking advantage of direct access to Consumers customers and from alternative fuels and energy sources, such as propane, oil, and electricity.
CMS Energy and its subsidiaries, including Consumers, maintain insurance coverage similar to comparable companies in the same lines of business. The insurance policies are subject to terms, conditions, limitations and exclusions that might not fully compensate CMS Energy for all losses. A portion of each loss is generally assumed by CMS Energy in the form of deductibles and self-insured retentions that, in some cases, are substantial. As CMS Energy renews its policies it is possible that some of the current insurance coverage may not be renewed or obtainable on commercially reasonable terms due to restrictive insurance markets.
For a discussion of environmental insurance coverage, see ITEM 1. BUSINESS CMS ENERGY AND CONSUMERS ENVIRONMENTAL COMPLIANCE.
At December 31, 2007, CMS Energy and its wholly owned subsidiaries, including Consumers, had 7,898 full-time equivalent employees. Included in the total are 3,475 employees who are covered by union contracts.
At December 31, 2007, Consumers and its subsidiaries had 7,614 full-time equivalent employees. Included in the total are 3,147 full-time operating, maintenance and construction employees and 322 full-time and part-time call center employees who are represented by the Utility Workers Union of America.
CMS ENERGY EXECUTIVE OFFICERS (as of February 1, 2008)
There are no family relationships among executive officers and directors of CMS Energy.
The present term of office of each of the executive officers extends to the first meeting of the Board of Directors after the next annual election of Directors of CMS Energy (scheduled to be held on May 16, 2008).
CONSUMERS EXECUTIVE OFFICERS (as of February 1, 2008)
There are no family relationships among executive officers and directors of Consumers.
The present term of office of each of the executive officers extends to the first meeting of the Board of Directors after the next annual election of Directors of Consumers (scheduled to be held on May 16, 2008).
CMS Energys internet address is www.cmsenergy.com. You can access free of charge on our website all of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act. Such reports are available soon after they are electronically filed with the SEC. Also on our website are our:
We will provide this information in print to any shareholder who requests it.
You may also read and copy any materials we file with the SEC at the SECs Public Reference Room at 100 F Street, NE, Washington DC, 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address is http://www.sec.gov.
ITEM 1A. RISK FACTORS
Actual results in future periods for CMS Energy and consolidated Consumers could differ materially from historical results and the forward-looking statements contained in this report. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the following sections. The companies business is influenced by many factors that are difficult to predict, involve uncertainties that may materially affect actual results and are often beyond the companies control. Additional risks and uncertainties not presently known or that the companies management currently believes to be immaterial may also adversely affect the companies. The risk factors described in the following sections, as well as the other information included in this annual report and in the other documents filed with the SEC, should be carefully considered before making an investment in securities of CMS Energy and Consumers. Risk factors of Consumers are also risk factors for CMS Energy.
Due to its holding company structure, CMS Energy depends on dividends from its subsidiaries to meet its debt obligations. Restrictions contained in Consumers preferred stock provisions and other legal restrictions, such as certain terms in its articles of incorporation, limit Consumers ability to pay dividends or acquire its own stock from CMS Energy. At December 31, 2007, Consumers had $269 million of unrestricted retained earnings available to pay common stock dividends. If sufficient dividends are not paid to CMS Energy by its subsidiaries, CMS Energy may not be able to generate the funds necessary to fulfill its cash obligations, thereby adversely affecting its liquidity and financial condition.
CMS Energy has substantial indebtedness that could limit its financial flexibility and hence its ability to meet its debt service obligations.
As of December 31, 2007, CMS Energy had $1.891 billion aggregate principal amount of indebtedness, including $178 million of subordinated indebtedness relating to its convertible preferred securities. $4.374 billion of subsidiary debt is not included in the preceding total. In April 2007, CMS Energy entered into the Seventh Amended and Restated Credit Agreement providing revolving credit and commitments in the amount of $300 million, which was increased to $550 million in January 2008. As of December 31, 2007, there were $278 million of letters of credit outstanding under the Seventh Amended and Restated Credit Agreement. CMS Energy and its subsidiaries may incur additional indebtedness in the future.
The level of CMS Energys present and future indebtedness could have several important effects on its future operations, including, among others:
CMS Energys ability to meet its debt service obligations and to reduce its total indebtedness will depend on its future performance, which will be subject to general economic conditions, industry cycles and financial, business and other factors affecting its operations, many of which are beyond its control. CMS Energy cannot make assurances that its business will continue to generate sufficient cash flow from operations to service its indebtedness. If it is unable to generate sufficient cash flows from operations, it may be required to sell additional assets or obtain additional financing. CMS Energy cannot assure that additional financing will be available on commercially acceptable terms or at all.
CMS Energy cannot predict the outcome of claims regarding its participation in the development of Bay Harbor or other litigation in which substantial monetary claims are involved.
As part of the development of Bay Harbor by certain subsidiaries of CMS Energy, pursuant to an agreement with the MDEQ, third parties constructed a golf course and park over several abandoned CKD piles, left over from the former cement plant operations on the Bay Harbor site. The third parties also undertook a series of remedial actions, including removing abandoned buildings and equipment; consolidating, shaping and covering CKD piles with soil and vegetation; removing CKD from streams and beaches; and constructing a leachate collection system at an identified seep. Leachate is formed when water passes through CKD. In 2002, CMS Energy sold its interest in Bay Harbor, but retained its obligations under environmental indemnifications entered into at the start of the project.
In September 2004, the MDEQ issued a notice of noncompliance after finding high-pH leachate in Lake Michigan adjacent to the property. The MDEQ also alleged higher than acceptable levels of heavy metals, including mercury, in the leachate flow.
In 2005, the EPA along with CMS Land and CMS Capital executed an AOC and approved a Removal Action Work Plan to address problems at Bay Harbor. Among other things, the plan called for the installation of collection trenches to capture high-pH leachate flow to the lake. Collection systems required under the plan have been installed and shoreline monitoring is ongoing. CMS Land and CMS Capital are required to address observed exceedances in pH, including required enhancements of the collection system. In May 2006, the EPA approved a pilot carbon dioxide enhancement plan to improve pH results in a specific area of the collection system. The enhanced system was installed in June 2006. CMS Land and CMS Capital also engaged in other enhancements of the installed collection systems.
In November 2007, the EPA sent CMS Land and CMS Capital a letter identifying three separate areas representing approximately 700 feet of shoreline in which the EPA claimed pH levels were unacceptable. The letter also took the position that CMS Land and CMS Capital are required to remedy the claimed noncompliance. CMS Land and CMS Capital submitted a formal objection to the EPAs conclusions. In their objections, CMS Land and CMS Capital noted that the AOC did not require perfection and that over 97 percent of the measured pH levels were in the correct range. Further, the limited number of exceedances were not much above the pH nine level set by the AOC and posed no threat to the public health and safety. In addition, CMS Land and CMS Capital noted in their objection that the actions they had already taken fully complied with the terms of the AOC. In January 2008, the EPA advised CMS Land and CMS Capital that it had rejected their objections, and that CMS Land and CMS Capital were obligated to submit a plan to augment measures to collect high pH leachate under the terms of the November 2007 EPA letter as modified in the January 2008 letter. CMS Land and CMS Capital submitted a proposed augmentation plan in February 2008.
In February 2006, CMS Land and CMS Capital submitted to the EPA a proposed Remedial Investigation and Feasibility Study (RIFS) for one of the CKD piles known as the East Park CKD pile. A similar RIFS is planned to be submitted for the remaining CKD piles in 2008. The EPA approved a schedule for near-term activities, which includes consolidating certain CKD materials and installing collection trenches in the East Park leachate release area. In June 2006, the EPA approved an East Park CKD Removal Action Work Plan and Final Engineering Design for Consolidation. However, the EPA has not approved the RIFS for the East Park.
As a result of the installation of collection systems at the Bay Harbor sites, CMS Land and CMS Capital are collecting and treating 135,000 gallons of liquid per day and shipping it by truck for disposal at a nearby well and at a municipal wastewater treatment plant located in Traverse City, Michigan. To address both short term and longer-term disposal of liquid, CMS Land has filed two permit applications with the MDEQ and the EPA, the first to treat the collected leachate at the Bay Harbor sites before releasing the water to Lake Michigan and the second to dispose of it in a deep injection well in Alba, Michigan, that CMS Land or its affiliate would own and operate. In February 2008, the MDEQ and the EPA granted permits for CMS Land or its affiliate to construct and operate a deep injection well near Alba, Michigan in eastern Antrim County. Certain environmental groups and a local township have indicated they may challenge these permits before the agencies or the courts.
CMS Land and CMS Capital, the MDEQ, and the EPA have ongoing discussions concerning the long-term remedy for the Bay Harbor sites. These negotiations are addressing, among other things, issues relating to the disposal of leachate, the location and design of collection lines and upstream diversion of water, potential flow of leachate below the collection system, applicable criteria for various substances such as mercury, and other matters that are likely to affect the scope of remedial work CMS Land and CMS Capital may be obliged to undertake. Negotiations have been ongoing for over a year, but CMS Land and CMS Capital have not been able to resolve these issues with the regulators and they remain pending.
CMS Land has entered into various access, purchase and settlement agreements with several of the affected landowners at Bay Harbor, and entered into a confidential settlement with one landowner to resolve a lawsuit filed by that landowner. We have received demands for indemnification relating to claims made by a property owner at Bay Harbor. CMS Land has purchased five unimproved lots and two lots with houses.
CMS Energy has recorded a cumulative charge of $140 million, which includes accretion expense, for its obligations. An adverse outcome of this matter could, depending on the size of any indemnification obligation or liability under environmental laws, have a potentially significant adverse effect on CMS Energys financial condition and liquidity and could negatively impact CMS Energys results of operations. CMS Energy cannot predict the financial impact or outcome of this matter.
The agreements CMS Energy enters into for the sale of assets customarily include provisions whereby it is required to:
Many of these contingent liabilities can remain open for extended periods of time after the sales are closed. Depending on the extent to which the buyers may ultimately seek to enforce their rights under these contractual provisions, and the resolution of any disputes CMS Energy may have concerning them, these liabilities could have a material adverse effect on its financial condition, liquidity and future results of operations.
Risks Related to CMS Energy and Consumers
CMS Energy and Consumers have financing needs and they may be unable to obtain bank financing or access the capital markets.
CMS Energy and Consumers may be subject to liquidity demands pursuant to commercial commitments under guarantees, indemnities and letters of credit.
CMS Energy continues to explore financing opportunities to supplement its financial plan. These potential opportunities include: entering into leasing arrangements and refinancing and/or issuing new capital markets debt, preferred stock and/or common equity. CMS Energy cannot guarantee the capital markets acceptance of its securities or predict the impact of factors beyond its control, such as actions of rating agencies. If CMS Energy is unable to obtain bank financing or access the capital markets to incur or refinance indebtedness, there could be a material adverse effect upon its financial condition, liquidity or results of operations. Similarly, Consumers currently plans to seek funds through the capital markets and commercial lenders. Entering into new financings is subject in part to capital market receptivity to utility industry securities in general and to Consumers securities issuances in particular. Consumers cannot guarantee the capital markets acceptance of its securities or predict the impact of factors beyond its control, such as actions of rating agencies. If Consumers is unable to obtain bank financing or access the capital markets to incur or refinance indebtedness, there could be a material adverse effect upon its liquidity and operations.
Certain of CMS Energys securities and those of its affiliates, including Consumers, are rated by various credit rating agencies. Any reduction or withdrawal of one or more of its credit ratings could have a material adverse impact on CMS Energys or Consumers ability to access capital on acceptable terms and maintain commodity lines of credit and could make its cost of borrowing higher. If it is unable to maintain commodity lines of credit, CMS Energy may have to post collateral or make prepayments to certain of its suppliers pursuant to existing contracts with them. In addition, certain bonds of Consumers are supported by municipal bond insurance policies, and the interest rates on those bonds have been affected by ratings downgrades of bond insurers. Further, any adverse developments to Consumers, which provides dividends to CMS Energy, that result in a lowering of Consumers credit ratings could have an adverse effect on CMS Energys credit ratings. CMS Energy and Consumers cannot guarantee that any of their current ratings will remain in effect for any given period of time or that a rating will not be lowered or withdrawn entirely by a rating agency.
Regulatory changes and other developments have resulted and could continue to result in increased competition in the domestic energy business. Generally, increased competition threatens market share in certain segments of CMS Energys business and can reduce its and Consumers profitability.
As of January 1, 2002, the Customer Choice Act allows all electric customers in Michigan the choice of buying electric generation service from Consumers or an alternative electric supplier. Consumers had experienced, and could experience in the future, a significant increase in competition for generation services due to ROA. At December 31, 2007, alternative electric suppliers were providing 315 MW of generation service to ROA customers. This amount represents 4 percent of Consumers total distribution load, which is down from a high of 12 percent in 2004. Consumers cannot predict the total amount of electric supply load that may be lost to competitor suppliers in the future.
Electric industry regulation could adversely affect CMS Energys and Consumers business, including their ability to recover costs from their customers.
Federal and state regulation of electric utilities has changed dramatically in the last two decades and could continue to change over the next several years. These changes could adversely affect CMS Energys and Consumers business, financial condition and profitability.
There are multiple proceedings pending before the FERC involving transmission rates, regional transmission organizations and electric bulk power markets and transmission. FERC is also reviewing the standards under which electric utilities are allowed to participate in wholesale power markets without price restrictions. CMS Energy and Consumers cannot predict the impact of these electric industry restructuring proceedings on their financial condition, liquidity or results of operations.
CMS Energy and Consumers could incur significant capital expenditures to comply with environmental standards and face difficulty in recovering these costs on a current basis.
CMS Energy, Consumers, and their subsidiaries are subject to costly and increasingly stringent environmental regulations. They expect that the cost of future environmental compliance, especially compliance with clean air and water laws, will be significant.
In March 2005, the EPA adopted the Clean Air Interstate Rule that requires additional coal-fired electric generating plant emission controls for nitrogen oxides and sulfur dioxide. Consumers plans to meet the nitrogen oxides requirements by installing equipment that reduces nitrogen oxides emissions and purchasing emissions allowances. Consumers also will meet the sulfur dioxide requirements by injecting a chemical that reduces sulfur dioxide emissions, installing scrubbers and purchasing emission allowances. Consumers plans to spend an additional $835 million for equipment installation through 2015.
In March 2005, the EPA issued the CAMR, which requires initial reductions of mercury emissions from coal-fired electric generating plants by 2010 and further reductions by 2018. Certain portions of the CAMR were appealed to the U.S. Court of Appeals for the District of Columbia by a number of states and other entities. The U.S. Court of Appeals for the District of Columbia decided the case on February 8, 2008, and determined that the
rules developed by the EPA were not consistent with the Clean Air Act. CMS Energy and Consumers continue to monitor the development of federal regulations in this area.
In April 2006, Michigans governor proposed a plan that would result in mercury emissions reductions of 90 percent by 2015. We are working with the MDEQ on the details of this plan; however, we have developed preliminary cost estimates and a mercury emissions reduction scenario based on our best knowledge of control technology options and initially proposed requirements. We estimate that costs associated with Phase I of the states mercury plan will be approximately $220 million by 2010 and an additional $200 million by 2015.
The EPA has alleged that some utilities have incorrectly classified plant modifications as routine maintenance rather than seeking permits from the EPA to modify their plants. Consumers responded to information requests from the EPA on this subject in 2000, 2002, and 2006. Consumers believes that it has properly interpreted the requirements of routine maintenance. If the EPA finds that its interpretation is incorrect, Consumers could be required to install additional pollution controls at some or all of its coal-fired electric generating plants and pay fines. Additionally, Consumers would need to assess the viability of continuing operations at certain plants.
Several legislative proposals have been introduced in the United States Congress that would require reductions in emissions of greenhouse gases, including carbon dioxide. These laws, or similar state laws or rules, if enacted, could require Consumers to replace equipment, install additional equipment for pollution controls, purchase allowances, curtail operations, or take other steps.
CMS Energy and Consumers expect to collect fully from its customers, through the ratemaking process, these and other required environmental expenditures. However, if these expenditures are not recovered from customers in Consumers rates, CMS Energy and/or Consumers may be required to seek significant additional financing to fund these expenditures, which could strain their cash resources. We can give no assurances that CMS Energy and/or Consumers will have access to bank financing or capital markets to fund any such environmental expenditures.
Market performance and other changes may decrease the value of benefit plan assets, which then could require significant funding.
The performance of the capital markets affects the values of assets that are held in trust to satisfy future obligations under CMS Energys pension and postretirement benefit plans. CMS Energy has significant obligations in this area and holds significant assets in these trusts. These assets are subject to market fluctuations and will yield uncertain returns, which may fall below CMS Energys forecasted return rates. A decline in the market value of the assets may increase the funding requirements of these obligations. Also, changes in demographics, including increased number of retirements or changes in life expectancy assumptions may also increase the funding requirements of the obligations related to the pension and postretirement benefit plans. If CMS Energy is unable to successfully manage its pension and postretirement plan assets, its results of operations and financial position could be affected negatively.
Periodic reviews of the values of CMS Energys and Consumers assets could result in accounting charges.
CMS Energy and Consumers are required by GAAP to review periodically the carrying value of their assets, including those that may be sold. Market conditions, the operational characteristics of their assets and other factors could result in recording additional impairment charges for their assets, which could have an adverse effect on their stockholders equity and their access to additional financing. In addition, they may be required to record impairment charges at the time they sell assets, depending on the sale prices they are able to secure and other factors.
CMS Energy and Consumers may be adversely affected by regulatory investigations regarding round-trip trading by CMS MST as well as civil lawsuits regarding pricing information that CMS MST and CMS Field Services provided to market publications.
As a result of round-trip trading transactions (simultaneous, prearranged commodity trading transactions in which energy commodities were sold and repurchased at the same price) at CMS MST, CMS Energy is under
investigation by the DOJ. CMS Energy received subpoenas in 2002 and 2003 from U.S. Attorneys Offices regarding investigations of those trades. CMS Energy responded to those subpoenas in 2003 and 2004.
In March 2004, the SEC approved a cease-and-desist order settling an administrative action against CMS Energy relating to round-trip trading. The order did not assess a fine and CMS Energy neither admitted nor denied the orders findings.
CMS Energy and Consumers cannot predict the outcome of the investigations. It is possible that the outcome in one or more of the investigations could, affect adversely CMS Energys and Consumers financial condition, liquidity or results of operations.
CMS Energy and Consumers may be adversely affected by regulatory investigations and civil lawsuits regarding pricing information that CMS MST and CMS Field Services provided to market publications.
CMS Energy has notified appropriate regulatory and governmental agencies that some employees at CMS MST and CMS Field Services appeared to have provided inaccurate information regarding natural gas trades to various energy industry publications which compile and report index prices. CMS Energy is cooperating with an ongoing investigation by the DOJ regarding this matter. CMS Energy is unable to predict the outcome of the DOJ investigation and what effect, if any, the investigation will have on CMS Energy.
CMS Energy, CMS MST, CMS Field Services, Cantera Natural Gas, Inc. (the company that purchased CMS Field Services) and Cantera Gas Company are named as defendants in various lawsuits arising as a result of alleged false natural gas price reporting. Allegations include manipulation of NYMEX natural gas futures and options prices, price-fixing conspiracies, and artificial inflation of natural gas retail prices in Colorado, Kansas, Missouri, Tennessee, and Wyoming.
CMS Energy and Consumers cannot predict the outcome of the investigations. It is possible that the outcome in one or more of the investigations could affect adversely CMS Energys and Consumers financial condition, liquidity or results of operations.
CMS Energys and Consumers revenues and results of operations are subject to risks that are beyond their control, including but not limited to future terrorist attacks or related acts of war.
The cost of repairing damage to CMS Energys and Consumers facilities due to storms, natural disasters, wars, terrorist acts and other catastrophic events, in excess of insurance recoveries and reserves established for these repairs, may adversely impact their results of operations, financial condition and cash flows. The occurrence or risk of occurrence of future terrorist activity and the high cost or potential unavailability of insurance to cover this terrorist activity may impact their results of operations and financial condition in unpredictable ways. These actions could also result in disruptions of power and fuel markets. In addition, their natural gas distribution system and pipelines could be directly or indirectly harmed by future terrorist activity.
The MCV Partnership, which leases and operates the MCV Facility, contracted to sell electricity to Consumers for a 35-year period beginning in 1990. The cost that Consumers incurred under the MCV PPA exceeded the recovery amount allowed by the MPSC, including $39 million in 2007, until it exercised the regulatory-out provision in the MCV PPA in September 2007. This action limited its capacity and fixed energy payments to the MCV Partnership to the amounts that it collects from its customers. However, it uses the direct savings from the RCP, after allocating a portion to customers, to offset a portion of its capacity and fixed energy underrecoveries expense. The MCV Partnership has notified Consumers that it disputes its right to exercise the regulatory-out provision. Consumers believes that the provision is valid and fully effective, but cannot assure that it will prevail in the event of a proceeding on this issue.
As a result of our exercise of the regulatory-out provision, the MCV Partnership may, under certain circumstances, have the right to terminate or reduce the amount of capacity sold under the MCV PPA. If the MCV Partnership terminates the MCV PPA or reduces the amount of capacity sold under the MCV PPA, Consumers would seek to replace the lost capacity to maintain an adequate electric Reserve Margin. This could involve entering
into a new power purchase agreement or entering into electric capacity contracts on the open market. Consumers cannot predict its ability to enter into such contracts at a reasonable price. Consumers also is unable to predict regulatory approval of the terms and conditions of such contracts, or that the MPSC would allow full recovery of its incurred costs.
CMS Energy and Consumers cannot predict the financial impact or outcome of these matters.
Consumers energy risk management strategies may not be effective in managing fuel and electricity pricing risks, which could result in unanticipated liabilities to Consumers or increased volatility of its earnings.
Consumers is exposed to changes in market prices for natural gas, coal, electricity and emission credits. Prices for natural gas, coal, electricity and emission credits may fluctuate substantially over relatively short periods of time and expose Consumers to commodity price risk. A substantial portion of Consumers operating expenses for its plants consists of the costs of obtaining these commodities. Consumers manages these risks using established policies and procedures, and it may use various contracts to manage these risks, including swaps, options, futures and forward contracts. No assurance can be made that these strategies will be successful in managing Consumers pricing risk, or that they will not result in net liabilities to Consumers as a result of future volatility in these markets.
Natural gas prices in particular have historically been volatile. Consumers routinely enters into contracts to offset its positions, such as hedging exposure to the risks of demand, market effects of weather and changes in commodity prices associated with its gas distribution business. These positions are taken in conjunction with the GCR mechanism, which allows Consumers to recover prudently incurred costs associated with those positions. However, Consumers does not always hedge the entire exposure of its operations from commodity price volatility. Furthermore, the ability to hedge exposure to commodity price volatility depends on liquid commodity markets. As a result, to the extent the commodity markets are illiquid, Consumers may not be able to execute its risk management strategies, which could result in greater open positions than preferred at a given time. To the extent that open positions exist, fluctuating commodity prices can improve or worsen CMS Energys and Consumers financial condition or results of operations.
Changes in taxation as well as inherent difficulty in quantifying potential tax effects of business decisions could negatively impact CMS Energys and Consumers results of operations.
CMS Energy and Consumers are required to make judgments regarding the potential tax effects of various financial transactions and results of operations in order to estimate their obligations to taxing authorities. The tax obligations include income, real estate, sales and use taxes, employment-related taxes and ongoing issues related to these tax matters. The judgments include reserves for potential adverse outcomes regarding tax positions that have been taken that may be subject to challenge by IRS and/or other taxing authorities. Unfavorable settlements of any of the issues related to these reserves at CMS Energy or Consumers Energy could adversely affect their financial condition or results of operations.
Consumers electric and gas utility businesses are impacted by the economic cycles of the customers it serves. In its service territories in Michigan, the economy has been sluggish and hampered by negative developments in the manufacturing industry and limited growth in non-manufacturing sectors of the states economy. In the event economic conditions in Michigan or the region continue to decline, Consumers may experience reduced demand for electricity or natural gas that could result in decreased earnings and cash flow. In addition, economic conditions in its service territory impact its collections of accounts receivable and its financial results.
CMS Energys and Consumers energy sales and operations are impacted by seasonal factors and varying weather conditions from year to year.
Consumers electric and gas utility businesses are generally seasonal businesses. Demand for electricity is greater in the summer and winter months associated with cooling and heating, and demand for natural gas peaks in the winter heating season. Accordingly, its overall results in the future may fluctuate substantially on a seasonal
basis. Mild temperatures during the summer cooling season and winter heating season will negatively impact CMS Energys and Consumers results of operations and cash flows.
Unforeseen maintenance may be required to safely produce electricity. As a result of unforeseen maintenance, Consumers may be required to make spot market purchases of electricity that exceed its costs of generation. Its financial condition or results of operations may be negatively affected if it is unable to recover those increased costs.
Failure to implement successfully new processes and information systems could interrupt our operations.
CMS Energy and Consumers depend on numerous information systems for operations and financial information and billings. They are in the midst of a multi-year company-wide initiative to improve existing processes and implement new core information systems. Failure to implement successfully new processes and new core information systems could interrupt their operations.
Consumers may not be able to obtain an adequate supply of coal, which could limit its ability to operate its facilities.
Consumers is dependent on coal for much of its electric generating capacity. While Consumers has coal supply and transportation contracts in place, there can be no assurance that the counterparties to these agreements will fulfill their obligations to supply coal to Consumers. The suppliers under the agreements may experience financial or operational problems that inhibit their ability to fulfill their obligations to Consumers. In addition, suppliers under these agreements may not be required to supply coal to Consumers under certain circumstances, such as in the event of a natural disaster. If it is unable to obtain its coal requirements under existing or future coal supply and transportation contracts, Consumers may be required to purchase coal at higher prices, or it may be forced to make additional MWh purchases through other potentially higher cost generating resources in the Midwest energy market. Higher coal costs increase its working capital requirements.
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2. PROPERTIES
Descriptions of CMS Energys and Consumers properties are found in the following sections of Item 1, all of which are incorporated by reference in this Item 2:
ITEM 3. LEGAL PROCEEDINGS
CMS Energy, Consumers and some of their subsidiaries and affiliates are parties to certain routine lawsuits and administrative proceedings incidental to their businesses involving, for example, claims for personal injury and property damage, contractual matters, various taxes, and rates and licensing. For additional information regarding various pending administrative and judicial proceedings involving regulatory, operating and environmental matters, see ITEM 1. BUSINESS CMS ENERGY AND CONSUMERS REGULATION, both CMS Energys and Consumers ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS and both CMS Energys and
Consumers ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
On August 5, 2004, CMS Energy received a request from the SEC that CMS Energy voluntarily produce documents and data relating to the SECs inquiry into payments made to officials or relatives of officials of the government of Equatorial Guinea. On August 17, 2004, CMS Energy submitted its response, advising the SEC of the information and documentation it had available. On March 8, 2005, CMS Energy received a request from the SEC that CMS Energy voluntarily produce certain of such documents. The SEC subsequently issued a formal order of private investigation on this matter on August 1, 2005. CMS Energy and several other companies that have conducted business in Equatorial Guinea, received subpoenas from the SEC to provide documents regarding payments made to officials or relatives of officials of the government of Equatorial Guinea. CMS Energy is cooperating and will continue to produce documents responsive to the subpoena.
Texas-Ohio Energy, Inc. filed a putative class action lawsuit in the United States District Court for the Eastern District of California in November 2003 against a number of energy companies engaged in the sale of natural gas in the United States (including CMS Energy). The complaint alleged defendants entered into a price-fixing scheme by engaging in activities to manipulate the price of natural gas in California. The complaint alleged violations of the federal Sherman Act, the California Cartwright Act, and the California Business and Professions Code relating to unlawful, unfair and deceptive business practices. The complaint sought both actual and exemplary damages for alleged overcharges, attorneys fees and injunctive relief regulating defendants future conduct relating to pricing and price reporting. In April 2004, a Nevada MDL panel ordered the transfer of the Texas-Ohio case to a pending MDL matter in the Nevada federal district court that at the time involved seven complaints originally filed in various state courts in California. These complaints make allegations similar to those in the Texas-Ohio case regarding price reporting. The court issued an order granting the defendants motion to dismiss on April 8, 2005 and entered a judgment in favor of the defendants on April 11, 2005. Texas-Ohio appealed the dismissal to the Ninth Circuit Court of Appeals.
While that appeal was pending, CMS Energy agreed to settle the Texas-Ohio case and three others cases originally filed in California federal courts (Fairhaven, Abelman Art Glass and Utility savings), for a total payment of $700,000. On September 10, 2007, the court entered an order granting final approval of the settlement and dismissing the CMS Energy defendants from these cases. On September 26, 2007, the Ninth Circuit Court of Appeals reversed the ruling of the trial judge in the Texas-Ohio case and held that the filed rate doctrine is not applicable to the claims. The Ninth Circuit Court of Appeals then remanded the case to the federal district court. While CMS Energy is no longer a party to the Texas-Ohio case, the Ninth Circuit Court of Appeals ruling may affect the positions of CMS Energy entities in other pending cases.
Commencing in or about February 2004, 15 state law complaints containing allegations similar to those made in the Texas-Ohio case, but generally limited to the California Cartwright Act and unjust enrichment, were filed in various California state courts against many of the same defendants named in the federal price manipulation cases discussed in the preceding paragraphs. In addition to CMS Energy, CMS MST is named in all 15 state law complaints. Cantera Gas Company and Cantera Natural Gas, LLC (erroneously sued as Cantera Natural Gas, Inc.) are named in all but one complaint.
In February 2005, these 15 separate actions, as well as nine other similar actions that were filed in California state court but do not name CMS Energy or any of its former or current subsidiaries, were ordered coordinated with pending coordinated proceedings in the San Diego Superior Court. The 24 state court complaints involving price reporting were coordinated as Natural Gas Antitrust Cases V. Plaintiffs in Natural Gas Antitrust Cases V were ordered to file a consolidated complaint, but a consolidated complaint was filed only for the two putative class action lawsuits. Pursuant to a ruling dated August 23, 2006, CMS Energy, Cantera Gas Company and Cantera Natural Gas, LLC were dismissed as defendants in the master class action and the 13 non-class actions, due to lack
of personal jurisdiction. CMS MST remains a defendant in all of these actions. In September 2006, CMS MST reached an agreement in principle to settle the master class action for $7 million. In March 2007, CMS Energy paid $7 million into a trust fund account following preliminary approval of the settlement by the judge. On June 12, 2007, the court entered a judgment, final order and decree granting final approval to the class action settlement with CMS MST. Certain of the individual cases filed in the California State Court remain pending.
Samuel D. Leggett, et al v. Duke Energy Corporation, et al, a class action complaint brought on behalf of retail and business purchasers of natural gas in Tennessee, was filed in the Chancery Court of Fayette County, Tennessee in January 2005. The complaint contains claims for violations of the Tennessee Trade Practices Act based upon allegations of false reporting of price information by defendants to publications that compile and publish indices of natural gas prices for various natural gas hubs. The complaint seeks statutory full consideration damages and attorneys fees and injunctive relief regulating defendants future conduct. The defendants include CMS Energy, CMS MST and CMS Field Services. On August 10, 2005, certain defendants, including CMS MST, filed a motion to dismiss and CMS Energy and CMS Field Services filed a motion to dismiss for lack of personal jurisdiction. Defendants attempted to remove the case to federal court, but it was remanded to state court by a federal judge. On February 2, 2007, the state court granted defendants motion to dismiss the complaint. Plaintiffs filed a notice of appeal on April 4, 2007. Oral arguments were heard on November 8, 2007.
J.P. Morgan Trust Company, in its capacity as Trustee of the FLI Liquidating Trust, filed an action in Kansas state court in August 2005 against a number of energy companies, including CMS Energy, CMS MST and CMS Field Services. The complaint alleges various claims under the Kansas Restraint of Trade Act relating to reporting false natural gas trade information to publications that report trade information. Plaintiff is seeking statutory full consideration damages for its purchases of natural gas between January 1, 2000 and December 31, 2001. The case was removed to the United States District Court for the District of Kansas on September 8, 2005 and transferred to the MDL proceeding on October 13, 2005. A motion to remand the case back to Kansas state court was denied on April 21, 2006. The court issued an order granting the motion to dismiss on December 18, 2006, but later reversed the ruling on reconsideration and has now denied the defendants motion to dismiss. On September 7, 2007, the CMS Energy defendants filed an answer to the complaint.
On November 20, 2005, CMS MST was served with a summons and complaint which named CMS Energy, CMS MST and CMS Field Services as defendants in a putative class action filed in Kansas state court, Learjet, Inc., et al. v. Oneok, Inc., et al. Similar to the other actions that have been filed, the complaint alleges that during the putative class period, January 1, 2000 through October 31, 2002, defendants engaged in a scheme to violate the Kansas Restraint of Trade Act by knowingly reporting false or inaccurate information to the publications, thereby affecting the market price of natural gas. Plaintiffs, who allege they purchased natural gas from defendants and others for their facilities, are seeking statutory full consideration damages consisting of the full consideration paid by plaintiffs for natural gas. On December 7, 2005, the case was removed to the United States District Court for the District of Kansas and later that month a motion was filed to transfer the case to the MDL proceeding. On January 6, 2006, plaintiffs filed a motion to remand the case to Kansas state court. On January 23, 2006, a conditional transfer order transferring the case to the MDL proceeding was issued. On February 7, 2006, plaintiffs filed an opposition to the conditional transfer order, and on June 20, 2006, the MDL Panel issued an order transferring the case to the MDL proceeding. The court issued an order dated August 3, 2006 denying the motion to remand the case to Kansas state court. Defendants filed a motion to dismiss, which was denied on July 27, 2007. On September 7, 2007, the CMS Energy defendants filed an answer to the complaint.
Breckenridge Brewery of Colorado, LLC and BBD Acquisition Co. v. Oneok, Inc., et al., a class action complaint brought on behalf of retail direct purchasers of natural gas in Colorado, was filed in Colorado state court in May 2006. Defendants, including CMS Energy, CMS Field Services, and CMS MST, are alleged to have violated the Colorado Antitrust Act of 1992 in connection with their natural gas price reporting activities. Plaintiffs are seeking full refund damages. The case was removed to the United States District Court for the District of Colorado on June 12, 2006, a conditional transfer order transferring the case to the MDL proceeding was entered on June 27, 2006, and an order transferring the case to the MDL proceeding was entered on October 17, 2006. The court issued an order dated December 4, 2006 denying the motion to remand the case back to Colorado state court. Defendants have filed a motion to dismiss. On August 21, 2007, the court granted the motion to dismiss by CMS Energy on the basis of a lack of jurisdiction. The other defendants remain in the case, and they filed an answer to the complaint on
September 7, 2007. The remaining CMS Energy defendants also filed a summary judgment motion which remains pending.
On October 30, 2006, CMS Energy and CMS MST were each served with a summons and complaint which named CMS Energy, CMS MST and CMS Field Services as defendants in an action filed in Missouri state court, titled Missouri Public Service Commission v. Oneok, Inc. The Missouri Public Service Commission purportedly is acting as an assignee of six local distribution companies, and it alleges that from at least January 2000 through at least October 2002, defendants knowingly reported false natural gas prices to publications that compile and publish indices of natural gas prices, and engaged in wash sales. The complaint contains claims for violation of the Missouri Anti-Trust Law, fraud and unjust enrichment. Defendants removed the case to Missouri federal court and then transferred it to the Nevada MDL proceeding. On October 30, 2007, the court granted the plaintiffs motion to remand the case to state court in Missouri. The CMS Energy defendants will be filing an answer. A second action, Heartland Regional Medical Center, et al. v. Oneok Inc. et al., was filed in Missouri state court in March 2007 alleging violations of Missouri anti-trust laws. The second action is denoted as a class action. Defendants also removed this case to Missouri federal court, and it has been conditionally transferred to the Nevada MDL proceeding. Plaintiffs also filed a motion to remand this case back to state court but that motion has not yet been decided.
A class action complaint, Arandell Corp., et al v. XCEL Energy Inc., et al, was filed on or about December 15, 2006 in Wisconsin state court on behalf of Wisconsin commercial entities that purchased natural gas between January 1, 2000 and October 31, 2002. Defendants, including CMS Energy, CMS ERM and Cantera Gas Company, LLC, are alleged to have violated Wisconsins Anti-Trust statute by conspiring to manipulate natural gas prices. Plaintiffs are seeking full consideration damages, plus exemplary damages in an amount equal to three times the actual damages, and attorneys fees. The action was removed to Wisconsin federal district court and CMS Energy entered a special appearance for purpose of filing a motion to dismiss all the CMS Energy defendants due to lack of personal jurisdiction. That motion was filed on September 10, 2007. The court has not yet ruled on the motion. The court denied plaintiffs motion to remand the case back to Wisconsin state court, and the case has been transferred to the Nevada MDL proceeding.
CMS Energy and the other CMS Energy defendants will defend themselves vigorously against these matters but cannot predict their outcome.
From May 2000 through January 2002, CMS MST engaged in simultaneous, prearranged commodity trading transactions in which energy commodities were sold and repurchased at the same price. These transactions, referred to as round-trip trades, had no impact on previously reported consolidated net income, EPS or cash flows, but had the effect of increasing operating revenues and operating expenses by equal amounts.
CMS Energy is cooperating with an investigation by the DOJ concerning round-trip trading, which the DOJ commenced in May 2002. CMS Energy is unable to predict the outcome of this matter and what effect, if any, this investigation will have on its business. In March 2004, the SEC approved a cease-and-desist order settling an administrative action against CMS Energy related to round-trip trading. The order did not assess a fine and CMS Energy neither admitted to nor denied the orders findings. The settlement resolved the SEC investigation involving CMS Energy and CMS MST. Also in March 2004, the SEC filed an action against three former employees related to round-trip trading at CMS MST. One of the individuals has settled with the SEC. CMS Energy is currently advancing legal defense costs for the remaining two individuals in accordance with existing indemnification policies. The two individuals filed a motion to dismiss the SEC action, which was denied.
On November 1, 2001, Quicksilver sued CMS MST in Texas State Court in Fort Worth, Texas for breach of contract in connection with a Base Contract for Sale and Purchase of natural gas, pursuant to which Quicksilver agreed to sell, and CMS MST agreed to buy, natural gas. Quicksilver contended that a special provision in the contract requires CMS MST to pay Quicksilver 50 percent of the difference between $2.47/MMBtu and the index price each month. CMS MST disagrees with Quicksilvers interpretation of the special provision and contends that it
has paid all monies owed for delivery of gas according to the contract. Quicksilver was seeking damages of approximately $126 million, plus prejudgment interest and attorneys fees, which in CMS Energys judgment was unsupported by the facts.
The trial commenced on March 19, 2007. The jury verdict awarded Quicksilver zero compensatory damages but $10 million in punitive damages. The jury found that CMS MST breached the contract and committed fraud but found no actual damage related to such a claim.
On May 15, 2007, the trial court vacated the jury award of punitive damages but held that the contract should be rescinded prospectively. The judicial rescission of the contract caused CMS Energy to record a charge in the second quarter of 2007 of approximately $24 million, net of tax. To preserve its appellate rights, CMS MST filed a motion to modify, correct or reform the judgment and a motion for a judgment contrary to the jury verdict with the trial court. The trial court dismissed these motions. CMS MST has filed a notice of appeal with the Texas Court of Appeals. Quicksilver has filed a notice of cross appeal.
In February 2008, Consumers received a data request relating to an investigation FERC is conducting into possible violations of the FERCs posting and competitive bidding regulations for pre-arranged released firm capacity on natural gas pipelines. Consumers will cooperate with the FERC in responding to the request. Consumers cannot predict the outcome of this matter.
CMS Energy and Consumers
Beginning in May 2002, a number of complaints were filed against CMS Energy, Consumers and certain officers and directors of CMS Energy and its affiliates in the United States District Court for the Eastern District of Michigan. The cases were consolidated into a single lawsuit (the Shareholder Action), which generally sought unspecified damages based on allegations that the defendants violated United States securities laws and regulations by making allegedly false and misleading statements about CMS Energys business and financial condition, particularly with respect to revenues and expenses recorded in connection with round-trip trading by CMS MST. In January 2005, the court granted a motion to dismiss Consumers and three of the individual defendants, but denied the motions to dismiss CMS Energy and the 13 remaining individual defendants. In March 2006, the court conditionally certified a class consisting of all persons who purchased CMS Common Stock during the period of October 25, 2000 through and including May 17, 2002 and who were damaged thereby. The court excluded purchasers of CMS Energys 8.75 percent Adjustable Convertible Trust Securities (ACTS) from the class and, in response, a new class action lawsuit was filed on behalf of ACTS purchasers (the ACTS Action) against the same defendants named in the Shareholder Action. The settlement described in the following paragraph has resolved both the Shareholder and ACTS actions.
On January 3, 2007, CMS Energy and other parties entered into a Memorandum of Understanding (the MOU), subject to court approval, regarding settlement of the two class action lawsuits. The settlement was approved by a special committee of independent directors and by the full Board of Directors of CMS Energy. Both judged that it was in the best interests of shareholders to eliminate this business uncertainty. Under the terms of the MOU, the litigation was settled for a total of $200 million, including the cost of administering the settlement and any attorney fees the court awards. CMS Energy made a payment of approximately $123 million plus interest on the settlement amount on September 20, 2007. CMS Energys insurers paid $77 million, the balance of the settlement amount. In entering into the MOU, CMS Energy made no admission of liability under the Shareholder Action and the ACTS Action. The parties executed a Stipulation and Agreement of Settlement dated May 22, 2007 (Stipulation) incorporating the terms of the MOU. In accordance with the Stipulation, CMS Energy has paid approximately $1 million of the settlement amount to fund administrative expenses. On September 6, 2007, the court issued a final order approving the settlement. The remaining settlement amount was paid following the September 6, 2007 hearing.
On October 5, 2007, two former officers of Consumers filed an appeal of the order approving the settlement of the shareholder litigation. Their principal complaint was with the exclusion of all present and former officers and their immediate families from participation in the settlement. The two former officers have resolved their objections to the terms of the settlement order. On December 12, 2007, their appeal was dismissed by the court.
CMS Energy and Consumers, as well as their subsidiaries and affiliates, are subject to various federal, state and local laws and regulations relating to the environment. Several of these companies have been named parties to various actions involving environmental issues. Based on their present knowledge and subject to future legal and factual developments, they believe it is unlikely that these actions, individually or in total, will have a material adverse effect on their financial condition or future results of operations. For additional information, see both CMS Energys and Consumers ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS and both CMS Energys and Consumers ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2007, CMS Energy did not submit any matters to a vote of security holders.
During the fourth quarter of 2007, Consumers did not submit any matters to a vote of security holders.
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market prices for CMS Energys Common Stock and related security holder matters are contained in ITEM 7. CMS ENERGYS MANAGEMENTS DISCUSSION AND ANALYSIS and ITEM 8. CMS ENERGYS FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NOTE 17 OF CMS ENERGYS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (QUARTERLY FINANCIAL AND COMMON STOCK INFORMATION (UNAUDITED) which is incorporated by reference herein. At February 19, 2008, the number of registered holders of CMS Energy Common Stock totaled 47,647, based upon the number of record holders. In January 2003, CMS Energy suspended dividends on its common stock. On January 26, 2007, CMS Energys Board of Directors reinstated a quarterly dividend on CMS Energy Common Stock of $0.05 per share. On January 25, 2008, CMS Energys Board of Directors increased the quarterly dividend on CMS Energy Common Stock to $0.09 per share. Information regarding securities authorized for issuance under equity compensation plans is included in our definitive proxy statement, which is incorporated by reference herein.
Consumers common stock is privately held by its parent, CMS Energy, and does not trade in the public market. Consumers paid cash dividends on its common stock of $94 million in February 2007, $41 million in May 2007, $41 million in August 2007, and $75 million in November 2007. Consumers paid cash dividends on its common stock of $40 million in February 2006, $31 million in August 2006, and $76 million in November 2006.
The table below shows our repurchases of equity securities for the three months ended December 31, 2007:
ITEM 6. SELECTED FINANCIAL DATA
Selected financial information is contained in ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CMS ENERGYS SELECTED FINANCIAL INFORMATION, which is incorporated by reference herein.
Selected financial information is contained in ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSUMERS SELECTED FINANCIAL INFORMATION, which is incorporated by reference herein.
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Managements discussion and analysis of financial condition and results of operations is contained in ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CMS ENERGYS MANAGEMENTS DISCUSSION AND ANALYSIS, which is incorporated by reference herein.
Managements discussion and analysis of financial condition and results of operations is contained in ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSUMERS MANAGEMENTS DISCUSSION AND ANALYSIS, which is incorporated by reference herein.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and Qualitative Disclosures About Market Risk is contained in ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CMS ENERGYS MANAGEMENTS DISCUSSION AND ANALYSIS CRITICAL ACCOUNTING POLICIES ACCOUNTING FOR FINANCIAL AND DERIVATIVE INSTRUMENTS, TRADING ACTIVITIES, AND MARKET RISK INFORMATION, which is incorporated by reference herein.
Quantitative and Qualitative Disclosures About Market Risk is contained in ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - CONSUMERS MANAGEMENTS DISCUSSION AND ANALYSIS CRITICAL ACCOUNTING POLICIES ACCOUNTING FOR FINANCIAL AND DERIVATIVE INSTRUMENTS AND MARKET RISK INFORMATION, which is incorporated by reference herein.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
2007 Consolidated Financial Statements
CMS Energy Corporation
CMS Energy Corporation
This MD&A is a consolidated report of CMS Energy. The terms we and our as used in this report refer to CMS Energy and its subsidiaries as a consolidated entity, except where it is clear that such term means only CMS Energy.
This Form 10-K and other written and oral statements that we make contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Our intention with the use of words such as may, could, anticipates, believes, estimates, expects, intends, plans, and other similar words is to identify forward-looking statements that involve risk and uncertainty. We designed this discussion of potential risks and uncertainties to highlight important factors that may impact our business and financial outlook. We have no obligation to update or revise forward-looking statements regardless of whether new information, future events, or any other factors affect the information contained in the statements. These forward-looking statements are subject to various factors that could cause our actual results to differ materially from the results anticipated in these statements. Such factors include our inability to predict or control:
For additional information regarding these and other uncertainties, see the Outlook section included in this MD&A, Note 3, Contingencies, and Item 1A. Risk Factors.
CMS Energy is an energy company operating primarily in Michigan. We are the parent holding company of Consumers and Enterprises. Consumers is a combination electric and gas utility company serving in Michigans Lower Peninsula. Enterprises, through various subsidiaries and equity investments, is engaged primarily in
domestic independent power production. We manage our businesses by the nature of services each provides and operate principally in three business segments: electric utility, gas utility, and enterprises.
We earn our revenue and generate cash from operations by providing electric and natural gas utility services, electric power generation, and gas distribution, transmission, and storage. Our businesses are affected primarily by:
During the past several years, our business strategy has emphasized improving our consolidated balance sheet and maintaining focus on our core strength: utility operations and service. Consistent with our commitment to our utility business, we invested $650 million in Consumers during 2007.
We completed the sale of our international Enterprises assets in 2007, resulting in gross cash proceeds of $1.491 billion. We used the proceeds to retire debt and to invest in our utility business.
We also made important progress at Consumers to reduce business risk and to meet the future needs of our customers. We sold Palisades to Entergy in April 2007 for $380 million, and received $363 million after various closing adjustments. The sale improved our cash flow, reduced our nuclear operating and decommissioning risk, and increased our financial flexibility to support other utility investments.
In September 2007, we exercised the regulatory-out provision in the MCV PPA, thus limiting the amount we pay the MCV Partnership for capacity and fixed energy to the amount recoverable from our customers. The MCV Partnership may, under certain circumstances, have the right to terminate or reduce the amount of capacity sold under the MCV PPA, which could affect our need to build or purchase additional generating capacity. The MCV Partnership has notified us that it disputes our right to exercise the regulatory-out provision.
In May 2007, we filed with the MPSC our Balanced Energy Initiative, which is a comprehensive plan to meet customer energy needs over the next 20 years. The plan is designed to meet the growing customer demand for electricity with energy efficiency, demand management, expanded use of renewable energy, and development of new power plants to complement existing generating sources. In September 2007, we filed with the MPSC the second phase of our Balanced Energy Initiative, which contains our plan for construction of a new 800 MW clean coal plant at an existing site located near Bay City, Michigan.
In December 2007, we purchased a 935 MW natural gas-fired power plant located in Zeeland, Michigan from Broadway Gen Funding LLC, an affiliate of LS Power Group, for $519 million. This plant fits in with our Balanced Energy Initiative as it will help provide the capacity we need to meet the growing needs of our customers.
We took an important step in our business plan in 2007 by reinstating a quarterly dividend of $0.05 per share on our common stock, after a four-year suspension. We paid $45 million in common stock dividends in 2007. In January 2008, we increased the quarterly dividend on our common stock to $0.09 per share.
In September 2007, we also resolved a long-outstanding litigation issue by settling two class action lawsuits related to round-trip trading by CMS MST. We believe that eliminating this business uncertainty was in the best interests of our shareholders.
We also restructured our investment in DIG. In November 2007, we negotiated the termination of certain electricity sales agreements in order to eliminate future losses under those agreements. We recorded a liability and recognized a loss of $279 million in 2007, representing the cost to terminate the agreements. In February 2008, we closed the transaction and paid $275 million. Resolving the issues associated with the unfavorable supply contracts allows us to maximize future benefits from our DIG investment.
In the future, we will focus our strategy on:
As we execute our strategy, we will need to overcome a sluggish Michigan economy that has been hampered by negative developments in Michigans automotive industry and limited growth in the non-manufaturing sectors of the states economy. While the recent sub-prime mortgage market weakness has disrupted financial markets and the U.S. economy, it has not impacted materially our financial condition. We will continue to monitor developments for potential impacts on our business.
RESULTS OF OPERATIONS
CMS Energy Consolidated Results of Operations
For 2007, our net loss was $227 million compared with a net loss of $90 million for 2006. The increase in net loss was due to the termination of contracts at CMS ERM. Further increasing the net loss were charges related to the exit from our international businesses, the absence of earnings from these businesses, and additional Bay Harbor environmental remediation expenses. The increase in losses was partially offset by increased earnings at our utility primarily due to the positive effects of rate orders and increased sales. Further reducing the year-over-year change were the absence of the shareholder settlement liability recorded in 2006 and the absence of activities related to our former interest in the MCV Partnership.
Specific changes to net loss available to common stockholders for 2007 versus 2006 are:
For 2006, our net loss was $90 million compared with a net loss of $94 million for 2005. The improvement is primarily due to increased net income at our electric utility, as the positive effects of regulatory actions, the return of open access customers, and favorable tax adjustments more than offset the negative impacts of increased operating expenses and milder summer weather. The improvements at the electric utility were essentially negated by earnings reductions or increased losses at our other segments. At our Enterprises segment, the negative impacts of mark-to-market valuation losses and the net loss on the sale of our investment in the MCV Partnership more than offset the reduction in asset impairment charges. At our gas utility, net income decreased as the benefits derived from lower operating costs and a gas rate increase authorized by the MPSC in November 2006 were more than offset by lower, weather-driven sales. At our corporate interest and other segment, the cost of our agreement to settle the shareholder class action lawsuits more than offset reduced corporate expenditures.
Specific changes to net loss available to common stockholders for 2006 versus 2005 are:
Electric Utility Results of Operations
Electric deliveries: For 2007, electric delivery revenues increased $18 million versus 2006, as deliveries to end-use customers were 38.8 billion kWh, an increase of 0.3 billion kWh or 0.8 percent versus 2006. The increase in electric deliveries was primarily due to favorable weather, which resulted in an increase in electric delivery revenues of $14 million. The increase also reflects $2 million of additional revenue from the inclusion of the Zeeland power plant in rates and $2 million related to the return of additional former ROA customers.
For 2006, electric delivery revenues increased by $193 million over 2005 despite the fact that electric deliveries to end-use customers were 38.5 billion kWh, a decrease of 0.4 billion kWh or 1.2 percent versus 2005. The decrease in deliveries was primarily due to milder summer weather compared with 2005, which resulted in a decrease in revenue of $16 million. However, despite these lower electric deliveries, electric delivery revenues increased $160 million due to an approved electric rate order in December 2005 and $49 million related to the return of additional former ROA customers.
Surcharge Revenue: For 2007, the $6 million increase in surcharge revenue was primarily due to a surcharge that we started collecting in the first quarter of 2006 that the MPSC authorized under Section 10d(4) of the Customer Choice Act. The surcharge factors increased in January 2007 pursuant to an MPSC order. This surcharge increased electric delivery revenue by $13 million in 2007 versus 2006. Partially offsetting this increase was a decrease in the collection of Customer Choice Act transition costs, due to the expiration of the surcharge period for our large commercial and industrial customers. The absence of this surcharge decreased electric delivery revenue by $7 million in 2007 versus 2006.
In the first quarter of 2006, we started collecting the surcharge that the MPSC authorized under Section 10d(4) of the Customer Choice Act. This surcharge increased electric delivery revenue by $51 million in 2006 versus 2005. In addition, in the first quarter of 2006, we started collecting customer choice transition costs from our residential customers that increased electric delivery revenue by $12 million in 2006 versus 2005. Reductions in other surcharges decreased electric delivery revenue by $2 million in 2006 versus 2005.
Palisades Revenue to PSCR: Consistent with the MPSC order related to the April 2007 sale of Palisades, $136 million of revenue related to Palisades was designated toward recovery of PSCR costs.
Power Supply Costs and Related Revenue: For 2007, PSCR revenue decreased by $17 million versus 2006. This decrease primarily reflects amounts excluded from recovery in the 2006 PSCR reconciliation case. The decrease also reflects the absence, in 2007, of an increase in Power Supply Revenue associated with the 2005 PSCR reconciliation case.
For 2006, PSCR revenue increased $57 million versus 2005. The increase was due to the absence, in 2006, of rate caps which allowed us to record power supply revenue to offset fully our power supply costs. Our ability to recover these power supply costs resulted in an $82 million increase in electric revenue in 2006 versus 2005. Additionally, electric revenue increased $9 million in 2006 versus 2005 primarily due to the return of former
special-contract customers to full-service rates in 2006. Partially offsetting these increases was the absence, in 2006, of deferrals of transmission and nitrogen oxides allowance expenditures related to our capped customers recorded in 2005. These costs were not fully recoverable due to the application of rate caps, so we deferred them for recovery under Section 10d(4) of the Customer Choice Act. In December 2005, the MPSC approved the recovery of these costs. For 2005, deferrals of these costs were $34 million.
Other Operating Expenses, Other Income, and Non-Commodity Revenue: For 2007, other operating expenses decreased $150 million, other income increased $21 million, and non-commodity revenue decreased $12 million versus 2006.
The decrease in other operating expenses was primarily due to lower operating and maintenance expense. Operating and maintenance expense decreased primarily due to the sale of Palisades in April 2007. Also contributing to the decrease was the absence, in 2007, of costs incurred in 2006 related to a planned refueling outage at Palisades, and lower overhead line maintenance and storm restoration costs. These decreases were partially offset by increased depreciation and amortization expense due to higher plant in service and greater amortization of certain regulatory assets.
Other income increased in 2007 versus 2006 primarily due to higher interest income on short-term cash investments. The increase in short-term cash investments was primarily due to proceeds from the Palisades sale. Non-commodity revenue decreased in 2007 versus 2006 primarily due to lower transmission services revenue.
For 2006, other operating expenses increased $236 million versus 2005. The increase in other operating expenses reflects higher operating and maintenance, customer service, depreciation and amortization, and pension and benefit expenses. Operating and maintenance expense increased primarily due to costs related to a planned refueling outage at Palisades, and higher tree trimming and storm restoration costs.
Regulatory Return on Capital Expenditures: For 2007, the return on capital expenditures in excess of our depreciation base increased income by $5 million versus 2006. The increase reflects the equity return on the regulatory asset authorized by the MPSCs December 2005 order which provided for the recovery of $333 million of Section 10d(4) costs over five years.
For 2006, the return on capital expenditures in excess of our depreciation base increased income by $22 million versus 2005.
General Taxes: For 2007, the $15 million increase in general taxes versus 2006 was primarily due to higher property tax expense, reflecting higher millage rates and lower property tax refunds versus 2006.
For 2006, the $7 million increase in general taxes versus 2005 reflects higher MSBT expense, partially offset by property tax refunds.
Interest Charges: For 2007, interest charges increased $18 million versus 2006. The increase was primarily due to interest on amounts to be refunded to customers as a result of the sale of Palisades as ordered by the MPSC.
For 2006, interest charges increased $34 million versus 2005 primarily due to lower capitalized interest and interest expense related to an IRS income tax audit settlement. In 2005, we capitalized $33 million of interest in connection with the MPSCs December 2005 order in our Section 10d(4) Regulatory Asset case. The IRS income tax settlement in 2006 recognized that our taxable income for prior years was higher than originally filed, resulting in interest on the tax liability for these prior years.
Income Taxes: For 2007, income taxes increased $5 million versus 2006 primarily due to the absence, in 2007, of a $4 million income tax benefit from the restoration and utilization of income tax credits resulting from the resolution of an IRS income tax audit.
For 2006, income taxes increased $10 million versus 2005 primarily due to higher earnings by the electric utility, partially offset by the resolution of an IRS income tax audit, which resulted in a $4 million income tax benefit caused by the restoration and utilization of income tax credits. Further reducing the increase in income taxes was $5 million of income tax benefits, primarily reflecting the tax treatment of items related to property, plant and equipment as required by past MPSC orders.
Gas Utility Results of Operations
Gas Deliveries: For 2007, gas delivery revenues increased by $10 million versus 2006 as gas deliveries, including miscellaneous transportation to end-use customers, were 300 bcf, an increase of 18 bcf or 6.4 percent. The increase in gas deliveries was primarily due to colder weather, partially offset by lower system efficiency.
In 2006, gas delivery revenues decreased by $61 million versus 2005 as gas deliveries, including miscellaneous transportation to end-use customers, were 282 bcf, a decrease of 36 bcf or 11.3 percent. The decrease in gas deliveries was primarily due to warmer weather in 2006 versus 2005 and increased customer conservation efforts in response to higher gas prices.
Gas Rate Increase: In November 2006, the MPSC issued an order authorizing an annual rate increase of $81 million. In August 2007, the MPSC issued an order authorizing an annual rate increase of $50 million. As a result of these orders, gas revenues increased $81 million for 2007 versus 2006.
In May 2006, the MPSC issued an interim gas rate order authorizing an $18 million annual rate increase. In November 2006, the MPSC issued an order authorizing an annual increase of $81 million. As a result of these orders, gas revenues increased $14 million for 2006 versus 2005.
Gas Wholesale and Retail Services, Other Gas Revenues, and Other Income: For 2007, the $14 million increase in gas wholesale and retail services, other gas revenue and other income primarily reflects higher interest income on short-term cash investments. The increase in short-term cash investments was primarily due to proceeds from the Palisades sale.
For 2006, the $24 million increase in gas wholesale and retail services, other gas revenues, and other income primarily reflects higher pipeline revenues and higher pipeline capacity optimization in 2006 versus 2005.
Other Operating Expenses: For 2007, other operating expenses increased $19 million versus 2006 primarily due to higher uncollectible accounts expense and payments, beginning in November 2006, to a fund that provides energy assistance to low-income customers.
For 2006, other operating expenses decreased $7 million versus 2005 primarily due to lower operating expenses, partially offset by higher customer service and pension and benefit expenses.
General Taxes and Depreciation: For 2007, general taxes and depreciation increased $11 million versus 2006. The increase in general taxes reflects higher property tax expense due to higher millage rates and lower property tax refunds versus 2006. The increase in depreciation expense is primarily due to higher plant in service.
For 2006, general taxes and depreciation expense increased $10 million versus 2005. The increase in depreciation expense was primarily due to higher plant in service. The increase in general taxes reflects higher MSBT expense, partially offset by lower property tax expense.
Interest Charges: For 2007, interest charges decreased $4 million reflecting lower average debt levels and a lower average interest rate versus 2006.
For 2006, interest charges increased $6 million primarily due to higher interest expense on our GCR overrecovery balance and an IRS income tax audit settlement. The settlement recognized that Consumers taxable income for prior years was higher than originally filed, resulting in interest on the tax liability for these prior years.
Income Taxes: For 2007, income taxes increased $29 million versus 2006 primarily due to higher earnings by the gas utility.
For 2006, income taxes decreased $21 million versus 2005 primarily due to lower earnings by the gas utility. Also contributing to the decrease was the absence, in 2006, of the write-off of general business credits of $2 million that expired in 2005, and the resolution, in 2006, of an IRS income tax audit, which resulted in a $3 million income tax benefit caused by the restoration and utilization of income tax credits. Further reducing the increase in income taxes was $5 million of income tax benefits, primarily reflecting the tax treatment of items related to property, plant and equipment as required by past MPSC orders.
Operating Revenues: For 2007, operating revenues decreased $9 million versus 2006 primarily due to decreased third-party gas sales of $52 million, the write-off of $40 million of derivative assets associated with the Quicksilver contract that was voided by the trial judge in May 2007, $18 million in mark-to-market losses related to the amendment of an electricity sales agreement, and the absence of third-party financial settlements of $16 million in 2007 all at CMS ERM. Also contributing to the decrease in operating revenues was the absence of third-party tolling revenue of $17 million at DIG in 2007. These decreases were partially offset by an increase in mark-to-market gains of $89 million on power and gas contracts versus 2006 and increased power sales of $45 million at CMS ERM.
For 2006, operating revenues decreased $253 million versus 2005 primarily due to lower revenue of $102 million at CMS ERM related to mark-to-market losses on power and gas contracts, compared with gains on such items in 2005. In addition, CMS ERM had lower third-party power sales of $53 million, decreased sales to MISO of $22 million, and decreased financial revenue of $76 million resulting from the termination of prepaid gas contracts.
Cost of Gas and Purchased Power: For 2007, cost of gas and purchased power decreased $36 million versus 2006. The decrease was primarily due to lower power purchases from MISO of $26 million at CMS ERM and a decrease in the cost of gas sold of $10 million due to lower gas prices.
For 2006, cost of gas and purchased power decreased by $128 million versus 2005. The decrease was primarily due to decreases in the cost of gas sold of $93 million resulting from lower gas prices partially offset by increased usage, and decreases in third-party wholesale purchased power of $61 million resulting from the implementation of the MISO market all at CMS ERM, and a decrease in transmission costs of $3 million at DIG. These decreases were partially offset by power purchases from MISO of $29 million at CMS ERM.
Earnings from Equity Method Investees: For 2007, equity earnings decreased $48 million versus 2006. The decrease was due to the absence of $61 million of earnings associated with our investments in Africa, the Middle East and India that were sold in May 2007 and $6 million of earnings associated with our investments in Argentina and Chile that were sold in March and August 2007. Also contributing to the decrease was a $5 million reduction in earnings from our former investment in GasAtacama due to the shortage of gas from Argentina. These decreases were partially offset by the absence, in 2007, of a $20 million provision for higher foreign taxes in Argentina and an increase of $4 million in earnings from our remaining assets in Argentina.
For 2006, equity earnings decreased $37 million versus 2005. The decrease was primarily due to the establishment of tax reserves totaling $23 million related to foreign investments, higher tax expense primarily at Jorf Lasfar of $5 million due to lower tax relief and lower earnings at Shuweihat of $1 million due to higher operating and maintenance costs.
Gain (Loss) on Sale of Assets, Net: For 2007, the net gain on asset sales was $21 million. The net gain consisted of a $34 million gain on the sale of our equity investment in El Chocon to Endesa S.A., and $5 million in gains on the sale of other assets, partially offset by a $13 million net loss on the sale of our equity investments in Africa, the Middle East and India to TAQA and a $5 million net loss on the sale of our Argentine and Michigan assets to Lucid Energy.
For 2006, there were no gains or losses on asset sales. In 2005, we had gains on the sale of GVK and SLAP totaling $6 million.
For a discussion of the 2006 sale of our interest in the MCV Partnership, see The MCV Partnership in this section. For additional information, see Note 2, Asset Sales, Discontinued Operations and Impairment Charges.
Operation and Maintenance: For 2007, operation and maintenance expenses increased $7 million versus 2006 due to the absence of a favorable 2006 arbitration settlement related to DIG of $20 million and increased maintenance expense of $2 million, partially offset by the reduction of $6 million in expenses associated with assets sold during 2007, the reimbursement of $3 million in arbitration costs at CMS Gas Transmission in 2007 and the absence of $6 million in losses on the termination of prepaid gas contracts in 2006.
For 2006, operation and maintenance expenses decreased $19 million versus 2005 due to a favorable arbitration settlement related to DIG of $20 million and a $3 million reduction in losses on the termination of prepaid gas contracts. These decreases were partially offset by increased expenditures related to prospecting initiatives in North America of $4 million.
Electric Sales Contract Termination: For 2007, CMS ERM recorded a charge of $279 million related to the termination of electricity sales agreements. For additional information, see the Enterprises Outlook section included in this MD&A.
General Taxes, Depreciation, and Other Income, Net: For 2007, the net of general tax expense, depreciation and other income contributed to a $20 million increase in operating income versus 2006. Other income increased due to gains of $8 million recognized on the rebalancing of SERP investments and the absence, in 2007, of $4 million of accretion expense related to prepaid gas contracts at CMS ERM recorded in 2006, and general tax expense and depreciation decreased $8 million due to the sale of assets in 2007.
For 2006, the net of general tax expense, depreciation, and other income contributed to a $7 million increase in operating income versus 2005. Other income increased due to a decrease in accretion expense of $13 million related
to the prepaid gas contracts at CMS ERM, partially offset by an increase of $4 million in general tax expense and depreciation and the absence, in 2006, of a $2 million favorable settlement recorded at CMS Gas Transmission in 2005.
Asset Impairment Charges, Net of Insurance Reimbursement: For 2007, asset impairment charges decreased $29 million versus 2006. For 2007, we recorded net impairment charges of $187 million that included $262 million for the reduction in fair value of our investments in TGN, Jamaica, GasAtacama and PowerSmith, and a $75 million credit to recognize a prior insurance award associated with our ownership interest in TGN. For 2006, we recorded a $214 million charge for the reduction in the fair value of our former equity investment in GasAtacama and related notes receivable and other impairment charges of $2 million at Enterprises. For additional information, see Note 2, Asset Sales, Discontinued Operations and Impairment Charges.
For 2006, asset impairment charges increased $216 million versus 2005 primarily due to 2006 charges of $214 million recorded for the impairment of our former equity investment in GasAtacama and related notes receivable, and $2 million of other impairment charges.
For a discussion of asset impairment charges related to our former interest in the MCV Partnership, see The MCV Partnership in this section.
Environmental Remediation: Our environmental remediation charges relate to our projections of future costs associated with Bay Harbor. These charges were $44 million in 2007, $9 million in 2006, and $40 million in 2005. Total remediation charges including accretion expense were $140 million. For additional information, see Note 3, Contingencies.
Fixed Charges: For 2007, fixed charges decreased $14 million versus 2006 due to lower interest expense on subsidiary debt of $12 million resulting from asset sales in 2007. Also contributing to the decrease was the absence, in 2007, of $2 million of interest expense at DIG related to an arbitration settlement recorded in 2006.
For 2006, fixed charges increased $9 million versus 2005 due to higher interest expense of $7 million resulting from an increase in subsidiary debt and $2 million in higher interest expense at DIG related to an arbitration settlement.
Minority Interest: The allocation of profits to minority owners decreases our net income, and the allocation of losses to minority owners increases our net income. For 2007, minority owners shared in a portion of increased earnings at our subsidiaries versus 2006. This was primarily due to increased earnings and gains due to asset sales.
For 2006, minority owners shared in a portion of increased earnings at our subsidiaries versus 2005. This was primarily due to increased earnings, partially offset by losses from asset impairments.
Income Taxes: For 2007, income tax expense decreased $41 million versus 2006. The decrease reflects $93 million in lower tax expenses resulting from higher net losses in 2007 versus 2006 and $27 million of tax benefits primarily related to lower tax reserves in 2007. These benefits were partially offset by $79 million of tax expense on earnings associated with the recognition of previously deferred foreign earnings of subsidiaries.
For 2006, income tax expense decreased $103 million versus 2005. The decrease reflects $119 million in lower tax expenses resulting from higher net losses in 2006 versus 2005 and $23 million of tax benefit related to higher deferred foreign earnings of subsidiaries and resolution of an IRS income tax audit of $8 million, primarily for the restoration and utilization of income tax credits. These benefits were partially offset by the absence of $30 million of income tax benefit related to the American Jobs Creation Act recorded in 2005 and $17 million of tax expense primarily related to higher tax reserves in 2006.
The MCV Partnership: We sold our ownership interests in the MCV Partnership in November 2006. As a result, we have condensed its consolidated results of operations for the years 2005, 2006 and 2007 for discussion purposes.
In 2006, our share of the MCV Partnerships loss was $60 million, net of tax and minority interest. This was primarily due to mark-to-market losses and the net impact of the sale transaction, including asset impairment charges. These losses were partially offset by operating income and a property tax refund received in 2006. For additional information, see Note 2, Asset Sales, Discontinued Operations and Impairment Charges.
For 2006 versus 2005, our share of the MCV Partnerships earnings increased by $225 million, net of tax, primarily due to the absence of a 2005 impairment charge to property, plant and equipment at the MCV Partnership. This increase was partially offset by the recognition of mark-to-market losses in 2006 versus mark-to-market gains in 2005.
For 2007, corporate interest and other net expenses were $30 million, a decrease of $123 million versus 2006. The $123 million decrease primarily reflects the absence, in 2007, of a charge for the settlement of our shareholder class action lawsuits partially offset by the absence of an insurance reimbursement received in June 2006. Also contributing to the decrease was the reduction of tax expense in 2007 related to the sale of our international operations. Partially offsetting the decrease is the absence, in 2007, of a tax benefit due to the resolution of an IRS income tax audit.
For 2006, corporate interest and other net expenses were $153 million, an increase of $18 million versus 2005. The increase reflects an $80 million after tax net charge recorded in 2006 as a result of our agreement to settle shareholder class action lawsuits. Also contributing to the increase was the recognition of a portion of the reduction in fair value in our investment in GasAtacama. Partially offsetting the increase was the 2006 resolution of an IRS income tax audit, which resulted in an income tax benefit primarily for the restoration and utilization of income tax credits. Further offsetting the increase were lower early debt retirement premiums, and the receipt of insurance proceeds for previously incurred legal expenses.
Discontinued Operations: For 2007, the net loss from discontinued operations was $89 million versus $54 million of net income in 2006. The $143 million change is primarily due to the net loss on the disposal of international businesses in 2007, which replaced earnings recorded for these businesses in 2006.
For 2006, we recorded $54 million in net income versus $57 million in net income in 2005. The $3 million reduction in net income is primarily due to the absence of income from the favorable resolution of certain accrued contingent liabilities in 2006 associated with previously disposed businesses.
The following accounting policies and related information are important to an understanding of our results of operations and financial condition and should be considered an integral part of our MD&A. For additional accounting policies, see Note 1, Corporate Structure and Accounting Policies.
In preparing our consolidated financial statements, we use estimates and assumptions that may affect reported amounts and disclosures. We use accounting estimates for asset valuations, depreciation, amortization, financial and derivative instruments, employee benefits, indemnifications and contingencies. Actual results may differ from estimated results due to changes in the regulatory environment, competition, foreign exchange, regulatory decisions, lawsuits, and other factors.
Contingencies: We record a liability for contingencies when we conclude that it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. We consider all relevant factors in making these assessments.
Income Taxes: The amount of income taxes we pay is subject to ongoing audits by federal, state, and foreign tax authorities, which can result in proposed assessments. Our estimate of the potential outcome of any uncertain tax issue is highly judgmental. We believe we have provided adequately for these exposures; however, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved or when statutes of limitation on potential assessments expire. Additionally, our judgment as to
our ability to recover our deferred tax assets may change. We believe our valuation allowances related to our deferred tax assets are adequate, but future results may include favorable or unfavorable adjustments. As a result, our effective tax rate may fluctuate significantly over time. On January 1, 2007, we adopted FIN 48, the FASBs interpretation on the recognition and measurement of uncertain tax positions. For additional details, see the Implementation of New Accounting Standards section included in this MD&A.
Long-Lived Assets and Equity Method Investments: Our assessment of the recoverability of long-lived assets and equity method investments involves critical accounting estimates. We periodically perform tests of impairment if certain triggering events occur or if there has been a decline in value that may be other than temporary. Of our total assets, recorded at $14.196 billion at December 31, 2007, 62 percent represent long-lived assets and equity method investments that are subject to this type of analysis. We base our evaluations of impairment on such indicators as:
The estimates we use can change over time, which could have a material impact on our consolidated financial statements. For additional details, see Note 1, Corporate Structure and Accounting Policies Impairment of Long-Lived Assets and Equity Method Investments.
We determined that certain consolidated subsidiaries met the criteria of assets held for sale under SFAS No. 144. At December 31, 2006, these subsidiaries included certain Argentine businesses, a majority of our Michigan non-utility businesses, CMS Energy Brasil S.A., Takoradi, SENECA, and certain associated holding companies. There were no assets classified as held for sale at December 31, 2007. For additional details, see Note 2, Asset Sales, Discontinued Operations and Impairment Charges.
Our involvement in a regulated industry requires us to use SFAS No. 71 to account for the effects of the regulators decisions that impact the timing and recognition of our revenues and expenses. As a result, we may defer or recognize revenues and expenses differently than a non-regulated entity.
For example, we may record as regulatory assets items that a non-regulated entity normally would expense if the actions of the regulator indicate such expenses will be recovered in future rates. Conversely, we may record as regulatory liabilities items that non-regulated entities may normally recognize as revenues if the actions of the regulator indicate they will require that such revenues be refunded to customers. Judgment is required to determine the recoverability of items recorded as regulatory assets and liabilities. At December 31, 2007, we had $2.059 billion recorded as regulatory assets and $2.137 billion recorded as regulatory liabilities.
Our PSCR and GCR cost recovery mechanisms also give rise to probable future revenues that will be recovered from customers or past overrecoveries that will be refunded to customers through the ratemaking process. Underrecoveries are included in Accrued power supply and gas revenue and overrecoveries are included in Accrued rate refunds on our Consolidated Balance Sheets. At December 31, 2007, we had $45 million recorded as regulatory assets for underrecoveries of power supply costs and $19 million recorded as regulatory liabilities for overrecoveries of gas costs.
For additional details, see Note 1, Corporate Structure and Accounting Policies - Utility Regulation.
Financial and Derivative Instruments, Trading Activities, and Market Risk Information
Financial Instruments: Debt and equity securities classified as available-for-sale are reported at fair value determined from quoted market prices. Unrealized gains and losses resulting from changes in fair value of available-for-sale debt and equity securities are reported, net of tax, in equity as part of AOCL. Unrealized losses are excluded from earnings unless the related changes in fair value are determined to be other than temporary.
Derivative Instruments: We use the criteria in SFAS No. 133 to determine if we need to account for certain contracts as derivative instruments. These criteria are complex and often require significant judgment in applying them to specific contracts. If a contract is a derivative and does not qualify for the normal purchases and sales exception under SFAS No. 133, it is recorded on our consolidated balance sheet at its fair value. Each quarter, we adjust the resulting asset or liability to reflect any change in the fair value of the contract, a practice known as marking the contract to market. For additional details on our derivatives, see Note 6, Financial and Derivative Instruments.
To determine the fair value of our derivatives, we use information from external sources, such as quoted market prices and other valuation information. For certain contracts, this information is not available and we use mathematical models to value our derivatives. These models use various inputs and assumptions, including commodity market prices and volatilities, as well as interest rates and contract maturity dates. The fair values we calculate for our derivatives may change significantly as commodity prices and volatilities change. The cash returns we actually realize on our derivatives may be different from the results that we estimate using models. If necessary, our calculations of fair value include reserves to reflect the credit risk of our counterparties.
The types of contracts we typically classify as derivatives are interest rate swaps, forward contracts for electricity and gas, option contracts for electricity and gas, gas futures, and electric swaps. Most of our commodity purchase and sale contracts are not subject to derivative accounting under SFAS No. 133 because:
Our coal purchase contracts are not derivatives because there is not an active market for the coal we purchase. If an active market for coal develops in the future, some of these contracts may qualify as derivatives. For Consumers, which is subject to regulatory accounting, the resulting mark-to-market gains and losses would be offset by changes in regulatory assets and liabilities and would not affect net income. For other CMS Energy subsidiaries, the resulting mark-to-market impact on earnings could be material.
Derivative Contracts Associated with Equity Investments: In May 2007, we sold our ownership interest in businesses in the Middle East, Africa, and India. Certain of these businesses held interest rate contracts and foreign exchange contracts that were derivatives. Before the sale, we recorded our share of the change in fair value of these contracts in AOCL if the contracts qualified for cash flow hedge accounting; otherwise, we recorded our share in Earnings from Equity Method Investees.
At the date of the sale, we had accumulated a net loss of $13 million, net of tax, in AOCL representing our share of mark-to-market gains and losses from cash flow hedges held by the equity method investees. After the sale, we reclassified this amount and recognized it in earnings as a reduction of the gain on the sale. For additional details on the sale of our interest in these equity method investees, see Note 2, Asset Sales, Discontinued Operations and Impairment Charges.
CMS ERM Contracts: In order to support CMS Energys ongoing operations, CMS ERM enters into contracts to purchase and sell electricity and natural gas in the future. These forward contracts will result in physical delivery of the commodity at a contracted price. These contracts are generally long-term in nature and are classified as non-trading contracts.
To manage commodity price risks associated with these forward purchase and sale contracts, CMS ERM uses various financial instruments, such as swaps, options, and futures. CMS ERM also uses these types of instruments
to manage commodity price risks associated with generation assets owned by CMS Energy and its subsidiaries. These financial contracts are classified as trading contracts.
Certain of CMS ERMs non-trading and trading contracts qualify as derivatives. We include the fair value of these derivatives in either Price risk management assets or Price risk management liabilities on our Consolidated Balance Sheets. The following tables provide a summary of these contracts at December 31, 2007:
Market Risk Information: We are exposed to market risks including, but not limited to, changes in interest rates, commodity prices, and equity security prices. We may use various contracts to limit our exposure to these
risks, including swaps, options, futures, and forward contracts. We enter into these risk management contracts using established policies and procedures, under the direction of two different committees: an executive oversight committee consisting of senior management representatives and a risk committee consisting of business unit managers.
These contracts contain credit risk, which is the risk that our counterparties will fail to meet their contractual obligations. We reduce this risk through established credit policies, such as evaluating our counterparties credit quality and setting collateral requirements as necessary. If terms permit, we use standard agreements that allow us to net positive and negative exposures associated with the same counterparty. Given these policies, our current exposures, and our credit reserves, we do not expect a material adverse effect on our financial position or future earnings because of counterparty nonperformance.
The following risk sensitivities illustrate the potential loss in fair value, cash flows, or future earnings from our financial instruments, including our derivative contracts, assuming a hypothetical adverse change in market rates or prices of 10 percent. Potential losses could exceed the amounts shown in the sensitivity analyses if changes in market rates or prices exceed 10 percent.
Interest Rate Risk: We are exposed to interest rate risk resulting from issuing fixed-rate and variable-rate financing instruments, and from interest rate swap agreements. We use a combination of these instruments to manage this risk as deemed appropriate, based upon market conditions. These strategies are designed to provide and maintain a balance between risk and the lowest cost of capital.
Interest Rate Risk Sensitivity Analysis (assuming an increase in market interest rates of 10 percent):
At December 31, 2007, Consumers had $131 million in variable auction rate tax exempt bonds, insured by monoline insurers, that are subject to rate reset every 35 days. The subprime mortgage problems have put monoline insurers credit ratings at risk of downgrade by rating agencies. This risk of downgrade could cause the interest rates on these bonds to rise. Consumers does not expect its interest rate risk exposure regarding these bonds to be material. Consumers is continuing to monitor the situation and its alternatives.
Commodity Price Risk: Operating in the energy industry, we are exposed to commodity price risk, which arises from fluctuations in the price of electricity, natural gas, coal, and other commodities. Commodity prices are influenced by a number of factors, including weather, changes in supply and demand, and liquidity of commodity markets. In order to manage commodity price risk, we enter into non-trading derivative contracts, such as forward purchase and sale contracts for electricity and natural gas. We also enter into trading derivative contracts, including options and swaps for electricity and gas. For additional details on these contracts, see Note 6, Financial and Derivative Instruments.
Commodity Price Risk Sensitivity Analysis (assuming an adverse change in market prices of 10 percent):
Investment Securities Price Risk: Our investments in debt and equity securities are exposed to changes in interest rates and price fluctuations in equity markets. The following table shows the potential effect of adverse changes in interest rates and fluctuations in equity prices on our available-for-sale investments.
Investment Securities Price Risk Sensitivity Analysis (assuming an adverse change in market prices of 10 percent):
For additional details on market risk and derivative activities, see Note 6, Financial and Derivative Instruments.
Pension: We have external trust funds to provide retirement pension benefits to our employees under a non-contributory, defined benefit Pension Plan. On September 1, 2005, the defined benefit Pension Plan was closed to new participants and we implemented the qualified DCCP, which provides an employer contribution of 5 percent of base pay to the existing Employees Savings Plan. An employee contribution is not required to receive the plans employer cash contribution. All employees hired on or after September 1, 2005 participate in this plan as part of their retirement benefit program. Previous cash balance pension plan participants also participate in the DCCP as of September 1, 2005. Additional pay credits under the cash balance pension plan were discontinued as of that date.
401(k): We resumed the employers match in CMS Energy Common Stock in our 401(k) savings plan on January 1, 2005. On September 1, 2005, we increased the employer match from 50 percent to 60 percent on eligible contributions up to the first six percent of an employees wages.
Beginning May 1, 2007, the CMS Energy Common Stock Fund was no longer an investment option available for investments in the 401(k) savings plan and the employer match was no longer in CMS Energy Common Stock. Participants had an opportunity to