CONSUMERS ENERGY CO - Quarter Report: 2000 June (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000

OR

[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from        to      

Indicate by check mark whether the Registrants (1) have 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 Registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes  X      No      

Panhandle Eastern Pipe Line Company meets the conditions set forth in General Instructions H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q with the reduced disclosure format. In accordance with Instruction H, Part I, Item 2 has been reduced and Part II, Items 2, 3 and 4 have been omitted.

CMS Energy Corporation
and
Consumers Energy Company
and
Panhandle Eastern Pipe Line Company

Quarterly reports on Form 10-Q to the Securities and Exchange Commission
for the Quarter Ended June 30, 2000

This combined Form 10-Q is separately filed by each of CMS Energy Corporation, Consumers Energy Company and Panhandle Eastern Pipe Line Company. Information contained herein relating to each individual registrant is filed by such registrant on its own behalf. Accordingly, except for their respective subsidiaries, Consumers Energy Company and Panhandle Eastern Pipe Line Company make no representation as to information relating to any other companies affiliated with CMS Energy Corporation.

TABLE OF CONTENTS

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GLOSSARY

Certain terms used in the text and financial statements are defined below.

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CMS Energy Corporation

Management’s Discussion and Analysis

CMS Energy is the parent holding company of Consumers and Enterprises. Consumers is a combination electric and gas utility company serving the Lower Peninsula of Michigan. Enterprises, through subsidiaries, is engaged in several domestic and international diversified energy businesses including: natural gas transmission, storage and processing; independent power production; oil and gas exploration and production; energy marketing, services and trading; and international energy distribution. On March 29, 1999, CMS Energy completed the acquisition of Panhandle, as further discussed in the Capital Resources and Liquidity section of this MD&A and Note 1. Panhandle is primarily engaged in the interstate transportation and storage of natural gas.

The MD&A of this Form 10-Q should be read along with the MD&A and other parts of CMS Energy’s 1999 Form 10-K. This MD&A also refers to, and in some sections specifically incorporates by reference, CMS Energy’s Condensed Notes to Consolidated Financial Statements and should be read in conjunction with such Statements and Notes. This report and other written and oral statements made by CMS Energy from time to time contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” and “plans,” and variations of such words and similar expressions, are intended to identify forward-looking statements that involve risk and uncertainty. These forward-looking statements are subject to various factors which could cause CMS Energy’s actual results to differ materially from those anticipated in such statements. CMS Energy disclaims any obligation to update or revise forward-looking statements, whether from new information, future events or otherwise. CMS Energy details certain risk factors, uncertainties and assumptions in this MD&A and particularly in the section entitled “CMS Energy, Consumers and Panhandle Forward-Looking Statements Cautionary Factors” in CMS Energy’s 1999 Form 10-K Item 1 and periodically in various public filings it makes with the SEC. This discussion of potential risks and uncertainties is by no means complete but is designed to highlight important factors that may impact CMS Energy’s outlook. This report also describes material contingencies in the Condensed Notes to Consolidated Financial Statements and readers are encouraged to read such Notes.

RESULTS OF OPERATIONS

CMS Energy Consolidated Earnings

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The increase in consolidated net income for the second quarter 2000 over the comparable period in 1999 resulted from increased earnings from CMS Energy’s diversified energy businesses, including the independent power production business, the natural gas transmission, storage and processing business, the oil and gas exploration and production business, the marketing, services and trading business and the international energy distribution business, as well as gains on the sale of non-strategic assets. Partially offsetting these increases were decreased earnings from the electric and gas utilities, as well as higher interest expense principally related to the Panhandle acquisition. Second quarter 2000 results include approximately $50 million or $.43 per diluted share, of after-tax gains from major asset sales. CMS Energy’s recurring asset optimization program is expected to generate $50 million of pre-tax gains, or approximately $.30 per diluted share, from asset sales annually. As a result, approximately $.13 per diluted share of after-tax gains exceeds the amount CMS Energy expects to sustain in future years.

The decrease in consolidated net income for the six months ended June 30, 2000 over the comparable period in 1999 resulted from decreased earnings from the electric and gas utilities, coupled with higher interest expense principally related to the Panhandle acquisition. Partially offsetting these decreases were increased earnings from CMS Energy’s diversified energy businesses, including the natural gas transmission, storage and processing business primarily reflecting ownership of Panhandle for the entire first six months of 2000 versus only the second quarter of 1999, the independent power production business, the oil and gas exploration and production business, the international energy distribution business, and the marketing, services and trading business, as well as gains on the sale of non-strategic assets. The six months ended June 30, 2000 results include approximately $50 million, or $.43 per diluted share of after-tax gains from major asset sales. Approximately $.13 per diluted share of after-tax gains exceeds the amount CMS Energy expects to sustain in future years as part of its recurring asset optimization program.

For further information, see the individual results of operations for each CMS Energy business segment in this MD&A.

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Consumers’ Electric Utility Results of Operations

Electric Pretax Operating Income: For the three months ended June 30, 2000, electric pretax operating income decreased $13 million from the comparable period in 1999. The earnings decrease reflects increased power costs not totally recoverable from customers, the 5 percent residential customer rate reduction resulting from the Customer Choice and Electricity Reliability Act, and increased operating expenses. For the six months ended June 30, 2000, electric pretax operating income decreased $32 million from the comparable period in 1999. The earnings decrease also reflects the increased cost of purchased power and the impact of the electric rate reduction partially offset by increased electric sales to customers. Due to changes in regulation, since 1998 differences in power supply costs now impact Consumers’ earnings. In the past, such cost changes did not impact electric pretax operating income because Consumers passed the cost of electric power on to electric customers. During the current year, Consumers needed additional purchased electric power to meet customer requirements due to scheduled and unscheduled outages at Consumers’ internal generators. The following table quantifies these impacts on pretax operating income:

Electric Deliveries: Electric deliveries were 10.1 billion kWh for the three months ended June 30, 2000, essentially unchanged from the second quarter of 1999. Electric deliveries were 19.8 billion kWh for the six months ended June 30, 2000, a slight decrease from the corresponding 1999 period. Total electric deliveries decreased due to lower intersystem sales, less usage by industrial customers, and lower residential space heating.

Power Supply Costs:

Power supply costs were essentially unchanged for the three months ended June 30, 2000 from the comparable period in 1999 but increased for the six month period, primarily due to higher interchange power costs. Consumers had to purchase more external power because internal generation decreased due to scheduled and unscheduled outages.

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Consumers’ Gas Utility Results of Operations

Gas Pretax Operating Income:

Gas pretax operating income decreased in the three months ended June 30, 2000 by $44 million. The earnings decrease primarily reflects sharply higher gas prices in 2000 and the establishment of a $45 million regulatory obligation related to the higher prices above the frozen gas customer rate. These decreases are partially offset by higher gas deliveries due to cooler temperatures in the three months ended June 30, 2000. Gas pretax operating income decreased in the six months ended June 30, 2000 by $59 million. The earnings decrease primarily reflects decreased gas deliveries in the six months ended June 30, 2000 due to warmer temperatures during the heating season and the higher gas prices purchased for the next heating season as described for the three month period. Due to a temporary change in regulation, differences in gas costs directly impact Consumers’ earnings. This change in regulation relates to the gas industry restructuring initiatives, which provide Consumers the opportunity to temporarily benefit or lose from changes in commodity gas prices. See Note 2, Uncertainties, “Consumers’ Gas Utility Matters — Gas Restructuring”, for more detailed information on this matter. The following table quantifies these impacts on Pretax Operating Income.

Gas Deliveries: Gas system deliveries for the three months ended June 30, 2000, including miscellaneous transportation totaled 66 bcf, an increase of 4 bcf or 6 percent compared with 1999. The increased deliveries reflect cooler temperatures during the second quarter of 2000. Gas system deliveries for the six months ended June 30, 2000, including miscellaneous transportation totaled 227 bcf, a decrease of 1 bcf or .5 percent compared with 1999.

Cost of Gas Sold:

The cost of gas sold increased for the three months ended June 30, 2000 due to higher gas prices and increased gas deliveries due to cooler than normal temperature. Higher gas prices also impacted the cost of gas sold for the six months ended June 30, 2000. These higher gas costs were partially offset by decreased sales from warmer than normal temperatures during the first quarter of 2000.

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Natural Gas Transmission, Storage and Processing Results of Operations

Pretax Operating Income: Pretax operating income for the three months ended June 30, 2000 increased $4 million (9 percent) from the comparable period in 1999. The increase reflects increased earnings from international and domestic operations, including Sea Robin, which was acquired in March 2000, partially offset by decreased earnings from Panhandle. Pretax operating income for the six months ended June 30, 2000 increased $78 million (170 percent) from the comparable period in 1999. The increase reflects earnings from Panhandle and Sea Robin, which CMS Energy acquired in March 1999 and March 2000, respectively, as well as increased earnings from other international and domestic operations and lower operating expenses.

Independent Power Production Results of Operations

Pretax Operating Income: Pretax operating income for the three months ended June 30, 2000 increased $29 million (74 percent) from the comparable period in 1999. The increase primarily reflects the earnings benefits from a new facility in Asia, the restructuring of a power supply contract and increased earnings from international and domestic plant operations. Partially offsetting these increases were higher operating expenses and a scheduled reduction in operating fees. Pretax operating income for the six months ended June 30, 2000 increased $19 million (29 percent) from the comparable period in 1999. The increase is attributable to earnings from the new Asian facility, the restructuring of a power supply contract and increased earnings from international plant operations. Partially offsetting these increases were decreased earnings from domestic plants and the MCV Facility, a scheduled reduction in operating fees and higher operating expenses.

Oil and Gas Exploration and Production Results of Operations

Pretax Operating Income: Pretax operating income for the three months ended June 30, 2000 increased $1 million (20 percent) from the comparable period in 1999 as a result of higher realized commodity prices and increased production from West Texas and Powder River properties, partially offset by increased general and administrative expenses and reduced earnings from northern Michigan oil and gas properties which were sold in March 2000. Pretax operating income for the six months ended June 30, 2000 increased $3 million (43 percent) from the comparable period in 1999 as a result of higher realized commodity prices and increased production from West Texas and Powder River properties, partially offset by lower northern Michigan production as a result of the aforementioned sale in March 2000 and higher operating, general and administrative, and exploration costs.

Marketing, Services and Trading Results of Operations

Pretax Operating Income: Pretax operating earnings for the three months ended June 30, 2000 increased $4 million from the comparable period in 1999. The increase primarily reflects increased earnings from wholesale gas activities, including mark-to-market adjustments on trading contracts, which benefited from natural gas market price increases, partially offset by reduced margins from wholesale electric activities. Pretax operating income for the six months ended June 30, 2000 increased $4 million from the comparable period in 1999 as a result of increased wholesale gas earnings due to increases in natural gas market prices, increased LNG sales and earnings benefits from an energy management services acquisition made in late 1999, partially offset by reduced margins from wholesale electric activities.

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International Energy Distribution Results of Operations

Pretax Operating Income: Pretax operating income for the three months ended June 30, 2000 increased $2 million (100 percent) from the comparable period in 1999. The increase primarily reflects earnings from new investments in a Brazilian electric distribution utility as well as lower operating expenses. Pretax operating income for the six months ended June 30, 2000 increased $14 million (350 percent) from the comparable period in 1999. The increase is the result of increased earnings from new investments in a Brazilian electric distribution utility, increased earnings from Argentine and Venezuelan electric distribution utilities, and lower operating expenses.

Market Risk Information

CMS Energy is exposed to market risks including, but not limited to, changes in interest rates, currency exchange rates, and certain commodity and equity security prices. Management employs established policies and procedures to manage its risks associated with these market fluctuations, including the use of various derivative instruments such as futures, swaps, options and forward contracts. Management believes that any losses incurred on derivative instruments used to hedge risk would be offset by an opposite movement of the value of the hedged item.

In accordance with SEC disclosure requirements, CMS Energy has performed sensitivity analyses to assess the potential loss in fair value, cash flows and earnings based upon hypothetical 10 percent increases and decreases in market exposures. Management does not believe that sensitivity analyses alone provide an accurate or reliable method for monitoring and controlling risks. Therefore, CMS Energy and its subsidiaries rely on the experience and judgment of senior management and traders to revise strategies and adjust positions as they deem necessary. Losses in excess of the amounts determined in the sensitivity analyses could occur if market rates or prices exceed the 10 percent shift used for the analyses.

Commodity Price Risk: Management uses commodity futures contracts, options and swaps (which require a net cash payment for the difference between a fixed and variable price) to manage commodity price risk. The prices of energy commodities, such as gas, oil, electric and natural gas liquids, fluctuate due to changes in the supply of and demand for those commodities. To reduce price risk caused by these market fluctuations, CMS Energy hedges certain inventory and purchases and sales contracts. A hypothetical 10 percent adverse shift in quoted commodity prices in the near term would not have had a material impact on CMS Energy’s consolidated financial position, results of operations or cash flows as of June 30, 2000. The analysis assumes that the maximum exposure associated with purchased options is limited to prices paid. The analysis also does not quantify short-term exposure to hypothetically adverse price fluctuations in inventories.

Interest Rate Risk: Management uses a combination of fixed-rate and variable-rate debt to reduce interest rate exposure. Interest rate swaps and rate locks may be used to adjust exposure when deemed appropriate, based upon market conditions. These strategies attempt to provide and maintain the lowest cost of capital. The carrying amount of long-term debt was $7.2 billion at June 30, 2000 with a fair value of $6.7 billion. The fair value of CMS Energy’s interest rate swaps at June 30, 2000, with a notional amount of $1.9 billion, was $1 million, representing the amount CMS Energy would pay upon settlement. A hypothetical 10 percent adverse shift in interest rates in the near term would not have a material effect on CMS Energy’s consolidated financial position, results of operations or cash flows as of June 30, 2000.

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Currency Exchange Risk: Management uses forward exchange and option contracts to hedge certain investments in foreign operations. A hypothetical 10 percent adverse shift in currency exchange rates would not have a material effect on CMS Energy’s consolidated financial position or results of operations as of June 30, 2000, but would result in a net cash settlement of approximately $21 million. The estimated fair value of the foreign exchange and option contracts at June 30, 2000 was $18 million, representing the amount CMS Energy would pay upon settlement.

Equity Security Price Risk: CMS Energy and certain of its subsidiaries have equity investments in companies in which they hold less than a 20 percent interest. A hypothetical 10 percent adverse shift in equity security prices would not have a material effect on CMS Energy’s consolidated financial position, results of operations or cash flows as of June 30, 2000.

For a discussion of accounting policies related to derivative transactions, see Note 5.

CAPITAL RESOURCES AND LIQUIDITY

Cash Position, Investing and Financing

CMS Energy’s primary ongoing source of cash is dividends and distributions from subsidiaries. During the first six months of 2000, Consumers paid $109 million in common dividends and Enterprises paid $454 million in common dividends and distributions to CMS Energy. In July 2000, Consumers declared a $17 million dividend payable in August 2000 to CMS Energy. CMS Energy’s consolidated cash requirements are met by its operating and financing activities.

Operating Activities: CMS Energy’s consolidated net cash provided by operating activities is derived mainly from the processing, storage, transportation and sale of natural gas; the generation, transmission, distribution and sale of electricity; and the sale of oil. Consolidated cash from operations totaled $183 million and $440 million for the first six months of 2000 and 1999, respectively. The $257 million decrease resulted primarily from a decrease in earnings, excluding gains from asset sales, the timing of cash receipts and payments related to working capital items, a decrease in deferred taxes, and an increase in undistributed equity earnings of unconsolidated subsidiaries. CMS Energy uses its cash derived from operating activities primarily to maintain and expand its international and domestic businesses, to maintain and expand electric and gas systems of Consumers, to pay interest on and retire portions of its long-term debt, and to pay dividends.

Investing Activities: CMS Energy’s consolidated net cash used in investing activities totaled $37 million and $2.441 billion for the first six months of 2000 and 1999, respectively. The decrease of $2.404 billion primarily reflects the acquisition of Panhandle in March 1999 for $1.9 billion and a $558 million increase in proceeds from the sales of assets. CMS Energy’s expenditures (excluding acquisitions) during the first six months of 2000 for its utility and diversified energy businesses were $243 million and $279 million, respectively, compared to $197 million and $357 million, respectively, during the comparable period in 1999.

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Financing Activities: CMS Energy’s net cash used in financing activities totaled $38 million for the first six months of 2000, while net cash provided by financing activities totaled $2.113 billion for the first six months of 1999. Net cash provided in 1999 primarily related to funding the approximately $1.9 billion Panhandle acquisition in March 1999. The decrease of $2.151 billion in net cash provided by financing activities resulted from a decrease of $2.119 billion in the issuance of new securities (see table below for securities issued in first six months of 2000), an increase in the retirement of bonds and other long-term debt ($186 million), and an increase in the repurchase of common stock, net of common stock issuances ($177 million), partially offset by decreases in the retirement of notes payable ($138 million) and preferred stock ($194 million).

For the first six months of 2000, CMS Energy declared and paid $82 million in cash dividends to holders of CMS Energy Common Stock. In July 2000, the Board of Directors declared a quarterly dividend of $.365 per share on CMS Energy Common Stock, payable in August 2000.

Other Investing and Financing Matters: At June 30, 2000, the book value per share of CMS Energy Common Stock was $21.36.

At August 1, 2000, CMS Energy had an aggregate $1.6 billion in securities registered for future issuance.

CMS Energy’s Senior Credit Facility consists of a $1 billion one-year revolving credit facility maturing in June 2001. Additionally, CMS Energy has unsecured lines of credit as anticipated sources of funds to finance working capital requirements and to pay for capital expenditures between long-term financings. At June 30, 2000, the total amount available under the Senior Credit Facility was $270 million, and under the unsecured lines of credit was $24 million. For detailed information, see Note 3, incorporated by reference herein.

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Consumers has credit facilities, lines of credit and a trade receivable sale program in place as anticipated sources of funds to fulfill its currently expected capital expenditures. For detailed information about these sources of funds, see Note 3, incorporated by reference herein.

CMS Energy has identified for possible sale certain assets that are expected to contribute little or no earnings benefit in the short to medium term. From December 1999 through August 1, 2000, CMS Energy had sold or had reached agreements to sell $664 million of these assets, including a partial interest in its Northern Header gathering system, all of its ownership interest in a Brazilian distribution system, all of its northern Michigan oil and gas properties, its ownership interest in the Lakewood Cogeneration plant located in Lakewood, New Jersey, and all of its ownership interest in certain oil reserves located in Ecuador. These asset sales have resulted in total cash proceeds and associated reduction of consolidated project debt of approximately $850 million. CMS Energy plans to continue to sell additional assets resulting in cash proceeds and associated reduction of consolidated project debt, as more fully discussed in the Outlook-Financial Plan section below.

In addition, in February 2000, CMS Energy announced its intention to sell its 50 percent interest in Loy Yang. The amount CMS Energy ultimately realizes from the sale of Loy Yang could differ materially from the approximately $500 million investment amount currently reflected as an asset on the balance sheet.

Capital Expenditures

CMS Energy estimates that capital expenditures, including new lease commitments and investments in new business developments through partnerships and unconsolidated subsidiaries, will total $4.4 billion during 2000 through 2002. These estimates are prepared for planning purposes and are subject to revision. CMS Energy expects to satisfy a substantial portion of the capital expenditures with cash from operations. CMS Energy will continue to evaluate capital markets in 2000 as a potential source for financing its subsidiaries’ investing activities. CMS Energy estimates capital expenditures by business segment over the next three years as follows:

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CMS Energy currently plans investments in the years 2000 through 2002 in focused markets, which include: North and South America; West Africa; the Middle East and India. Investments will be made in market segments which align with CMS Energy’s varied business units’ skills with a focus on optimization and integration of existing assets, as further discussed in Outlook section below.

OUTLOOK

As the deregulation and privatization of the energy industry takes place in global energy markets, CMS Energy has positioned itself to be a leading international integrated energy company acquiring, developing and operating energy facilities and providing energy services in the United States and selected world growth markets. In the immediate future, CMS Energy expects to continue to sharpen its geographic focus on key growth areas where it has significant business concentrations and opportunities. CMS Energy provides a complete range of international energy expertise from energy production to consumption. CMS Energy intends to pursue global growth by making energy investments that provide expansion opportunities for multiple CMS Energy businesses.

CMS Energy also enhances its growth strategy through an active portfolio management program (the ongoing sale of non-strategic assets), with proceeds reinvested in assets with greater potential for synergies with existing or planned assets. In particular, CMS Energy is reviewing its options regarding certain assets performing below prior expectations, including Argentine generating assets. CMS Energy also continues to seek improvement in the profitability of all assets retained in its portfolio.

Financial Plan

CMS Energy is currently implementing a financial plan to strengthen its balance sheet, reduce fixed expenses and enhance earnings per share growth. CMS Energy plans to raise $1 billion of asset sale proceeds and $400 million of consolidated project debt eliminations from asset sales by year-end 2000. As of August 1, 2000, CMS Energy has completed the sale of assets resulting in approximately $850 million of cash proceeds and associated debt reduction of consolidated project debt.

CMS Energy management believes that the sale of specific assets to interested industry buyers will allow CMS Energy to achieve more geographic and business focus, thereby permitting CMS Energy to concentrate on its most profitable and growing ventures.

CMS Energy will continue to evaluate alternatives to strengthen its balance sheet and to enhance shareholder value. These actions are expected to make further issuance of CMS Energy Common Stock unnecessary in the foreseeable future, except for issuances in connection with existing convertible securities, a major acquisition, employee benefit plans and the stock purchase plan.

The Board of Directors approved the repurchase of up to 10 million shares of CMS Energy Common Stock, from time to time, in open market or private transactions. As of August 1, 2000, CMS Energy had repurchased approximately 6.6 million shares.

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Diversified Energy Outlook

CMS Energy expects to grow its diversified energy businesses (all businesses except for Consumers and Panhandle) by focusing on acquisitions and greenfield (new construction) projects in the United States, as well as high-growth markets in India, South America and the Middle East. Additionally, the growth strategy includes exploiting its West Africa oil and gas reserves, further developing markets for the fuel and methanol product derived in West Africa, and investigating expansion opportunities for its existing independent power project in West Africa. CMS Energy seeks to minimize operational and financial risks when operating internationally by utilizing multilateral financing institutions, procuring political risk insurance and hedging foreign currency exposure where appropriate.

CMS Energy intends to use its marketing, services and trading business to improve the return on CMS Energy’s other business assets. One method to achieve this goal is to use marketing and trading to enhance performance of assets, such as gas reserves and power plants. Other strategies include expanding CMS Energy’s industrial and commercial energy services to enhance our commodity marketing business, using CMS Energy’s gas production as a hedge to commodity risk in other areas of our business, and developing risk management products that address customer needs.

CMS Energy also intends to grow its oil and gas exploration and production business focusing its domestic interest gas exploration and production in west Texas and the Powder River Basin and its international interest in South America and Africa.

Consumers’ Electric Utility Outlook

Growth: Consumers expects average annual growth of approximately two and one half percent per year in electric system deliveries for the years 2000 to 2005 based on a steadily growing customer base. This growth rate does not take into account the possible impact on the industry of restructuring or changing regulation. Abnormal weather, changing economic conditions or the developing competitive market for electricity may affect actual electric deliveries by Consumers in future periods.

Competition and Regulatory Restructuring: Generally, electric restructuring is the regulatory and legislative attempt to introduce competition to the electric industry by allowing customers to choose their electric generation supplier. Competition affects, and will continue to affect, Consumers’ retail electric business. To remain competitive, Consumers has multi-year electric supply contracts with some of its largest industrial customers to provide power to some of their facilities. The MPSC approved these contracts as part of its phased introduction to competition. During the period from 2000 through 2005, depending on future business and regulatory circumstances, these contracts can be terminated or restructured. These contracts involve approximately 600 MW of customer power supply requirements. The ultimate financial impact of changes related to these power supply contracts is not known at this time.

As a result of a transition of the wholesale and retail electric businesses in Michigan to competition, Detroit Edison, in December 1996, gave Consumers the required four-year notice of its intent to terminate the current agreements under which the companies jointly operate the MEPCC. At the same time, Detroit Edison filed with the FERC seeking early termination of the agreements. The FERC has not acted on Detroit Edison’s application. Detroit Edison and Consumers are currently in negotiations to terminate or restructure the MEPCC operations. Consumers is unable to predict the outcome of these negotiations, but does not anticipate any adverse impacts caused by termination or restructuring of the MEPCC.

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Since 1997, there have been repeated efforts made in the Michigan Legislature to enact electric restructuring legislation. On June 3, 2000, these efforts resulted in the passage of the “Customer Choice and Electricity Reliability Act,” which became effective June 5, 2000.

Uncertainty exists with respect to the enactment of federal legislation restructuring the electric power industry. A variety of bills introduced in Congress in recent years seek to change existing federal regulation of the industry. These federal bills could potentially affect or supercede state regulation; however, none have been enacted. Consumers cannot predict the outcome of electric restructuring on its financial position, liquidity, or results of operations.

Rate Matters: Prior to June 5, 2000 there were several pending rate issues that could have affected Consumers’ electric business. As a result of the passage of the Customer Choice and Electricity Reliability Act, certain MPSC rate proceedings and a complaint by ABATE seeking a reduction in rates have been dismissed.

For further information and material changes relating to the rate matters and restructuring of the electric utility industry, see Note 1, Corporate Structure and Basis of Presentation, and Note 2, Uncertainties, “Consumers’ Electric Utility Rate Matters – Electric Restructuring” and “Consumers’ Electric Utility Rate Matters – Electric Proceedings,” incorporated by reference herein.

Uncertainties: Several electric business trends or uncertainties may affect CMS Energy’s financial results and condition. These trends or uncertainties have, or CMS Energy reasonably expects could have, a material impact on net sales, revenues, or income from continuing electric operations. Such trends and uncertainties include: 1) capital expenditures for compliance with the Clean Air Act; 2) environmental liabilities arising from compliance with various federal, state and local environmental laws and regulations, including potential liability or expenses relating to the Michigan Natural Resources and Environmental Protection Act and Superfund; 3) electric industry restructuring, including the ability to offset the 5 percent reduction in residential rates with savings from Securitization and the ability to recover Stranded Costs; 4) the ability to meet peak electric demand loads at a reasonable cost and without market disruption and initiatives undertaken to reduce exposure to energy price increases; and 5) ongoing issues relating to the storage of spent nuclear fuel and the operating life of Palisades. For detailed information about these trends or uncertainties, see Note 2, Uncertainties, incorporated by reference herein.

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Consumers Gas Utility Business Outlook

Growth: Consumers currently anticipates gas deliveries, including gas customer choice deliveries (excluding transportation to the MCV Facility and off-system deliveries), to grow at an average annual rate of between one and two percent over the next five years based primarily on a steadily growing customer base. Actual gas deliveries in future periods may be affected by abnormal weather, alternative energy prices, changes in competitive conditions, and the level of natural gas consumption per customer.

Gas Restructuring: In December 1997, the MPSC approved Consumers’ application to implement, effective April 1, 1998, a gas customer choice pilot program that was designed to encourage Consumers to minimize its purchased natural gas commodity costs while providing rate stability for its customers. The program allows 300,000 residential, commercial and industrial retail gas sales customers to choose an alternative gas commodity supplier in direct competition with Consumers. Unless some other arrangements are made, when this pilot program ends on March 31, 2001, these customers will again become Consumers’ gas commodity customers. The program is voluntary and participating natural gas customers are selected on a first-come, first-served basis, up to a limit of 100,000 per year. As of June 30, 2000, more than 160,000 customers chose alternative gas suppliers, representing approximately 11 bcf of gas load. Customers choosing to remain as sales customers of Consumers will not see a rate change in their gas rates. This three-year program: 1) freezes gas distribution rates through March 31, 2001, establishing a delivered gas commodity cost at a fixed rate of $2.84 per mcf; 2) establishes an earnings sharing mechanism with customers if Consumers’ earnings exceed certain pre-determined levels; and 3) establishes a gas transportation code of conduct that addresses the relationship between Consumers and marketers, including its affiliated marketers. In December 1999, the Court of Appeals affirmed in its entirety the December 1997 MPSC order. The Attorney General filed with the Michigan Supreme Court an application for leave to appeal the Court of Appeals’ decision. Subsequent to June 30, 2000, the MPSC issued an order directing Consumers and certain other Michigan gas utilities to undertake a collaborative process, including public meetings with MPSC staff and other interested parties during August and September 2000, for the purpose of developing uniform terms and conditions for the future provision of gas customer choice to all Michigan customers.

During the first two years of the pilot program, Consumers realized a benefit of $45 million as delivered gas commodity prices were below the $2.84 per mcf level collected from customers. Recent significant increases in gas prices have exposed Consumers to gas commodity losses during the last year of the program that ends March 31, 2001. Estimated loss of earnings for this last year of the program could range from $45 million to $135 million, of which Consumers has already recognized $45 million in the second quarter 2000 as a regulatory obligation. Under the provisions of the pilot program, Consumers has the right to request termination of the program at any time and to return to a GCR mechanism, pursuant to which the customer gas commodity prices would increase significantly from the current frozen rate. As an alternative to exercising that right, Consumers is considering an approach that, if approved by the MPSC, would potentially avoid further losses any greater than the $45 million already recognized and mitigate the customer rate increases that would otherwise result. It is expected that such an approach could be implemented this fall.

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In December 1999, several bills related to gas industry restructuring were introduced into the Michigan Legislature. Combined, these bills constitute the “gas choice program.” Consumers is participating in the legislative process involving these bills. They provide for 1) a phased-in approach to gas choice requiring 40 percent of the customers to be allowed choice by April 2002, 60 percent by April 2003 and all customers by April 2004; 2) a market-based, unregulated pricing mechanism for gas commodity for customers who exercise choice; and 3) a new “safe haven” pricing mechanism for customers who do not exercise choice under which NYMEX pricing would be used to establish a statutory cap on gas commodity prices that could be charged by gas utilities instead of traditional cost of service regulation. The proposed bills also provide for a gas distribution service rate freeze until December 31, 2005, a code of conduct governing business relationships with affiliated gas suppliers and the MPSC licensing of all gas suppliers doing business in Michigan and imposes financial penalties for noncompliance. They also provide customer protection by preventing “slamming”, the switching of a customer’s gas supplier without consent, and “cramming”, the inclusion of optional products and services without the customer’s authorization. The bills establishing the gas choice program have become the subject of extensive legislative hearings during which there will undoubtedly be various amendments offered by many parties, including the gas utility coalition. Consumers cannot predict the timing or outcome of this legislative process.

Uncertainties: CMS Energy’s financial results and position may be affected by a number of trends or uncertainties that have, or CMS Energy reasonably expects could have, a material impact on net sales or revenues or income from continuing gas operations. Such trends and uncertainties include: 1) potential environmental costs at a number of sites, including sites formerly housing manufactured gas plant facilities; 2) a statewide experimental gas industry restructuring program; 3) permanent gas industry restructuring; and 4) implementation of a suspended GCR and the success or failure of initiatives undertaken to protect against gas commodity price increases.

Consumers’ Other Outlook

The Union represents Consumers’ operating, maintenance and construction employees. Consumers and the Union negotiated a new collective bargaining agreement that became effective as of June 1, 2000. By its terms, that agreement will continue in full force and effect until June 1, 2005. Consumers is evaluating the financial effect of changes in the agreement.

Consumers offers a variety of energy-related services to electric and gas customers focused upon appliance maintenance, home safety, commodity choice and assistance to customers purchasing heating, ventilation and air conditioning equipment. Consumers continues to look for additional growth opportunities in energy-related services for Consumers’ customers.

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Panhandle Outlook

CMS Energy intends to use Panhandle as a platform for expansion in the United States. The growth strategy around Panhandle includes enhancing the opportunities to extract value for other CMS businesses involved in electric power generation and distribution, gathering, processing, exploration and production. The market for transmission of natural gas to the Midwest is increasingly competitive, however, and may become more so in light of projects recently completed or in progress to increase Midwest transmission capacity for gas originating in Canada and the Rocky Mountain region. As a result, there continues to be pressure on prices charged by Panhandle and an increasing necessity to discount the prices charged from the legal maximum, which reduces revenues. New contracts in the current market conditions tend to be of shorter duration than the expiring contracts being replaced, which will also increase revenue volatility. In addition, Trunkline in 1996 filed with FERC and placed into effect a general rate increase; however, a subsequent January 2000 FERC order could, if approved without modification upon rehearing, reduce Trunkline’s tariff rates and future revenue levels by up to 3% of Panhandle’s consolidated revenues. Panhandle continues to be selective in offering discounts to maximize revenues from existing capacity and to advance projects that provide expanded services to meet the specific needs of customers.

Regulatory Matters: For detailed information about Panhandle’s regulatory uncertainties see Note 2, Uncertainties – Panhandle Matters, incorporated by reference herein.

OTHER MATTERS

New Accounting Rules

In 1999, the FASB issued SFAS 137, Accounting for Derivative Instruments and Hedging Activities – Deferral of the Effective Date of FASB Statement No.133. In June 2000, the FASB also issued SFAS 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, an amendment of FASB Statement No. 133. SFAS 137 defers the effective date of SFAS 133, Accounting for Derivative Instruments and Hedging Activities, to January 1, 2001, and SFAS 138 clarifies certain issues pertaining to SFAS 133. CMS Energy is currently studying SFAS 133 and will adopt SFAS 133 as of January 1, 2001, but has yet to quantify the effects of adoption on its financial statements.

Foreign Currency Translation

CMS Energy adjusts common stockholders equity to reflect foreign currency translation adjustments for the operation of long-term investments in foreign countries. The adjustment is primarily due to the exchange rate fluctuations between the United States dollar and each of the Australian dollar, Brazilian real and Argentine peso. From January 1, 2000 through June 30, 2000, the foreign currency translation amount realized from asset sales increased equity by $25 million and the change in the foreign currency translation adjustment decreased equity by $90 million, net of after-tax hedging proceeds. Although management currently believes that the currency exchange rate fluctuations over the long term will not have a material adverse affect on CMS Energy’s financial position, liquidity or results of operations, CMS Energy has hedged its exposure to the Australian dollar, the Brazilian real and the Argentine peso. CMS Energy uses forward exchange and option contracts to hedge certain receivables, payables, long-term debt and equity value relating to foreign investments. The notional amount of the outstanding foreign exchange contracts was $370 million at June 30, 2000, which includes $25 million, $150 million and $195 million for Australian, Brazilian and Argentine foreign exchange contracts, respectively. The estimated fair value of the foreign exchange and option contracts at June 30, 2000 was $18 million, representing the amount CMS Energy would pay upon settlement.

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CMS Energy Corporation
Consolidated Statements of Income
(Unaudited)

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The accompanying condensed notes are an integral part of these statements.

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CMS Energy Corporation
Consolidated Statements of Cash Flows
(Unaudited)

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All highly liquid investments with an original maturity of three months or less are considered cash equivalents.

The accompanying condensed notes are an integral part of these statements.

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CMS Energy Corporation
Consolidated Balance Sheets