ITEM 1. BUSINESS
MichCon is a Michigan corporation that was organized in 1898 and, with its predecessors, has been in business for nearly 150 years. MichCon is a public utility engaged in the distribution and transmission of natural gas in the state of Michigan. MichCon, a wholly-owned subsidiary of MCN, operates one of the largest natural gas distribution and transmission systems in the United States and the largest in Michigan.
At December 31, 1996, MichCon and its subsidiaries employed 3,062 persons. Of this amount, 46% are covered by five collective bargaining agreements. Two of the agreements expire in December 1997, while the remaining three agreements will expire in June 1998.
GAS SALES & TRANSPORTATION
MichCon serves 1.2 million customers in the Detroit, Grand Rapids, Ann Arbor, Traverse City and Muskegon metropolitan areas and in various other communities throughout the state of Michigan. The following services are provided by MichCon:
- Gas Sales - Includes the marketing and delivery of natural gas to residential and small-volume commercial customers. - End User Transportation - Through this service, large-volume commercial and industrial customers that purchase natural gas directly from producers or brokerage companies utilize the Company's gas distribution network to transport the gas to their facilities. - Intermediate Transportation - Provides transportation service to producers, brokers and other local distribution companies that own the natural gas, but are not the ultimate consumer.
EFFECT OF WEATHER: MichCon's gas sales and end user transportation volumes, revenues and net income are impacted by weather. Given the seasonal nature of the business, revenues and net income tend to be higher in the first and fourth quarters of the calendar year.
Effect of Weather on Gas Markets and Earnings - --------------------------------------------------------------------------------
GAS SALES: Revenues increased $168.6 million in 1996 primarily due to higher gas costs, colder weather and market expansion. This market represents 24% of total deliveries and produced approximately 78% of MichCon's gross profit margin from sales and transportation services (Gross Profit Margin). The average margin per Mcf from gas sales was $2.06 in 1996 and $2.09 in 1995.
Competition in the gas sales market comes primarily from alternative fuels such as electricity, propane, and to a lesser degree, oil and wood, and in a few areas from other natural gas providers. Natural gas continues to be the preferred fuel for Michigan residences and businesses. Nearly every residential and commercial developer in MichCon's service territories selects natural gas in new construction because of the convenience, cleanliness and price advantage of natural gas compared to propane, fuel oil and other alternative fuels. Service and price are the primary factors affecting this market.
MichCon continues to focus on challenges and opportunities resulting from increased competition with other natural gas distribution companies and other energy providers. The MPSC is reviewing various plans to reform Michigan's gas utility regulatory process to give all customers added choices and to increase competition. MichCon and other Michigan gas utilities will implement pilot transportation service programs in 1997 for small-volume commercial and residential customers. Under MichCon's two-year program, 47,000 customers in the pilot territory will have the opportunity to select alternative natural gas suppliers beginning in April 1997. This option has been available to MichCon's larger commercial and industrial customers for several years. MichCon currently generates no earnings on the gas supply portion of operations. Therefore, a customer's selection of an alternative supplier is generally expected to be income-neutral. The overall package of regulatory changes connected with the gas industry restructuring is expected to result in lighter-handed regulation and the potential to improve earnings. MichCon is positioning itself to respond to changes in regulation and increased competition by reducing its cost of operations while maintaining a high level of customer satisfaction. MichCon remains focused on these goals in 1997 and beyond.
MichCon continues to take steps to become the preferred provider of natural gas and high-value energy services within Michigan and to maintain strong returns. To accomplish this, MichCon will increase penetration of existing markets by focusing on meeting the needs of customers and the marketplace, will increase efforts to reduce cost of gas and operating costs, and will take advantage of growth opportunities to expand to new geographic areas.
MichCon is continually assessing ways to improve cost competitiveness. Among other cost saving initiatives, MichCon and The Detroit Edison Company are exploring opportunities to share the cost of common, duplicative functions, including billing, meter reading, payment processing and excavation.
Significant cost savings could be achieved, given that approximately 60% of MichCon's 1.2 million customers are also customers of Detroit Edison.
Cost of gas sold increased in 1996 as a result of significantly higher spot market prices paid for natural gas purchases and higher gas sales volumes due to colder weather. Cost of gas sold per Mcf for 1996 was $2.92, an increase of $.56 (24%). MichCon still retained a significant cost advantage over competing fuels. Lower natural gas prices, partially offset by higher gas sales volumes, resulted in the 1995 decrease in cost of gas sold. Cost of gas sold per Mcf for 1995 decreased from 1994 by $.31 (12%).
MichCon's Market Expansion Program is intended to spur demand for natural gas in areas currently not served. The program is primarily targeted at residential and small-volume commercial markets. By financing the cost of main extensions, this program makes it easier for users of other, higher-cost fuels, such as propane and fuel oil, to consider using natural gas for space heat and other applications. The Market Expansion Program, which reaches rural and developing areas not currently using natural gas, has contributed to the 10,532, 17,677 and 12,047 net increases in customers in 1996, 1995 and 1994, respectively. In 1996, 11 new areas of Michigan were served by MichCon, bringing to 128 the total number of new areas added since 1984.
MichCon's market share for residential heating customers in the communities in which it serves is approximately 85%. While this saturation rate is high, significant growth opportunities exist through conversion of existing homes as well as from new construction. MichCon also promotes expanded natural gas usage through programs designed to increase non-heating applications, including gas ranges, clothes dryers, grills, fireplace logs and lighting. MichCon continues to expand the industrial and commercial markets by aggressively facilitating the use of existing gas technologies and equipment.
END USER TRANSPORTATION: End user transportation deliveries increased in 1996 due to a higher level of usage by large-volume commercial and industrial customers. Additional deliveries to gas cogeneration facilities and colder weather also contributed to the increased deliveries. In 1996, this market accounted for 16% of total gas deliveries and produced approximately 14% of MichCon's Gross Profit Margin.
At December 31, 1996, MichCon had end user transportation agreements representing annual volumes of 146 Bcf. Approximately 65% of these volumes are under contracts that extend to 1998 or beyond and include the majority of the large, and most price-sensitive, customers. Contracts for the remaining volumes are typically one-year contracts that expire at various times during 1997 and relate to a large number of low volume users with relatively low price sensitivity. Negotiations have commenced with customers whose contracts expire in 1997.
Through technical and financial assistance, customers have been encouraged to increase the use of natural gas in their industrial and commercial facilities. Gas-fueled power generation has been an expanding market for natural gas. In 1996, this market accounted for approximately 31 Bcf of gas deliveries. Air compressors and other small engines in certain commercial applications also provide possibilities for conversion to natural gas-powered equipment. The efficiencies and price competitiveness of natural gas can significantly reduce operating costs for customers, even though a higher initial outlay for gas-burning equipment may be required.
The primary focus of competition in this market is total cost of fuel. Some large commercial and industrial customers have the capacity to switch to alternative fuel sources including coal, electricity, oil and steam. In addition, some of these customers could bypass MichCon's distribution system and obtain
service directly from a pipeline company. However, cost differentials must be sufficient to offset the substantial investment costs and risks associated with fuel switching or bypass. MichCon competes against alternative fuel sources by providing competitive pricing and reliable supply through the use of the company's extensive storage capacity and multiple supply sources. Almost all significant customers that are in proximity to pipeline facilities are under long-term contracts.
In the past several years, MichCon has been successful in converting many customers' facilities to natural gas from alternative fuels and in retaining those customers after conversion. Also, in the past several years, MichCon has not experienced fuel switching of any significance by its customers. In 1996, approximately 22 Bcf of MichCon's transportation deliveries were to customers who displaced coal with natural gas.
INTERMEDIATE TRANSPORTATION: This service accounts for 59% of total gas volumes, but, due to the lower rate charged for the service, represents only 8% of MichCon's Gross Profit Margin. The increases in intermediate transportation deliveries in 1996 and 1995 are due primarily to additional volumes transported for two major fixed-fee customers and increased transportation of Antrim gas for Michigan gas producers and brokers.
MichCon's extensive transmission pipeline system has enabled it to increase the volumes transported for Michigan gas producers, ANR Pipeline Company (ANR) and other shippers. MichCon operates in a pivotal geographic location with links to major interstate pipelines that reach markets elsewhere in the Midwest, the eastern United States and eastern Canada.
MichCon, through its subsidiary MichCon Pipeline Company (MichCon Pipeline), is involved in ventures that transport natural gas and natural gas liquids from east-central Michigan gas fields to processing plants in the northern part of the state. During 1996, MichCon Pipeline transported an average of 551 MMcf/d of natural gas and related liquids. In January 1996, the transportation rate of one customer on the Saginaw Bay Pipeline decreased 40% in accordance with the terms of a 15-year contract that reduces the transportation rate for the last 10 years of the agreement. However, in December 1996, the contract was renegotiated, thus eliminating the 40% decrease. This contract expires in December 1997. Negotiations are currently underway to extend this contract. Moreover, all transportation contracts relating to the Saginaw Bay Pipeline are being negotiated to raise the transportation rate to the maximum authorized rate. MichCon will continue to look at new sources of volume and revenue to increase the profitability of this asset.
There has been a significant increase in Michigan Antrim gas production over the past several years, resulting in a growing demand by gas producers and brokers for intermediate transportation services. In order to meet the increased demand, MichCon expanded the transportation capacity of its northern Michigan gathering system in 1996. The expansion enabled MichCon to transport an additional 75 Bcf in 1996.
In January 1997, MichCon completed construction of a 59-mile loop of its existing Milford to Belle River Pipeline at a cost of approximately $85 million. The pipeline will improve the overall reliability and efficiency of MichCon's gas storage and transmission system by serving as a back-up means of transportation in the event of disruption in the operation of the existing pipeline or other facilities used to supply gas to MichCon's system.
In 1997, MichCon will exercise its option to purchase a 50% interest in an additional pipeline under the St. Clair River to link MichCon's system with Consumers Gas of Toronto's pipeline. When placed
into service during 1997, this project will enhance MichCon's ability to transport gas bound for both Canadian and Northeast U.S. markets.
ENERGY ASSISTANCE AND CONSERVATION PROGRAMS
Energy assistance programs funded by the federal government and the State of Michigan, including the Home Heating Credit for low-income customers and the Department of Social Services' (DSS) Heating Assistance Program, remain critical to MichCon's ability to control its uncollectible expenses. MichCon has historically obtained favorable regulatory treatment of its uncollectible costs, including those related to these energy assistance programs.
MichCon receives a significant amount of its heating assistance funding from the federal Low-Income Home Energy Assistance Program (LIHEAP). During 1995, Congress reduced a substantial portion of the program's funding for the 1996 fiscal year. The state of Michigan's share of federal LIHEAP funds was reduced from $78 million in fiscal year 1995 to $47.5 million in 1996. Uncollectible gas accounts were further impacted by the late receipt of fiscal year 1996 funding by the state of Michigan. Due to this delay, many of MichCon's customers who were eligible for assistance did not file to receive such funds. During 1996 and 1995, $10.1 million and $27.3 million in federal LIHEAP funds assisted approximately 74,000 and 112,000 MichCon customers, respectively, in making their gas payments. During October 1996, President Clinton signed an Omnibus Spending Bill passed by Congress that provided for $1 billion in federal LIHEAP funding for 1997, an increase of $100 million over 1996 levels. During February 1997, the President released his proposed budget which provides for federal LIHEAP funding at $1 billion annually through fiscal year 2002. Receipt of this funding is not expected to be delayed in 1997. A portion of any future increase or decrease in funding may impact uncollectible gas accounts.
GAS SUPPLY
MichCon obtains its natural gas supply from various sources in different geographic areas under agreements that vary in both pricing and terms. This geographic and contractual diversity of supply ensures that MichCon will be able to meet the requirements of its present and future customers with reliable supplies of natural gas at competitive, market responsive prices. The company's objective is to rank in the lowest quartile for cost of gas in Michigan as well as neighboring states. Although MichCon's gas costs rose 24% during the year to $2.92 per Mcf, they remained in the lowest quartile among a group of 22 utilities in the region, having decreased 32% over the last 10 years. Under its gas cost recovery mechanism, MichCon expects to continue to collect all of its prudently incurred gas costs.
Gas Supply Purchases(Bcf) - -------------------------------------------------------------------------------
MichCon purchased 38% of its 1996 supply from Michigan producers, 46% from producers in the southern and midcontinent regions of the United States and 16% from Canadian producers. These
supplies are complemented by 130 Bcf of working storage capacity from storage fields owned and operated in Michigan.
MichCon has in place long-term firm transportation agreements with ANR and Great Lakes Gas Transmission Limited Partnership (Great Lakes). ANR is obligated to transport approximately 375 MMcf/d of supply during the summer months and 310 MMcf/d of supply during the winter months for MichCon under these agreements, while Great Lakes is obligated to transport 30 MMcf/d. These transportation contracts expire on various dates between 1999 and 2011.
MichCon also has contracts with independent Michigan producers that expire on various dates through 2011. MichCon continues its supply strategy of purchasing gas under contracts that tie purchase prices to spot market prices. To mitigate risk related to spot market prices, MichCon has filed a proposal with the MPSC to change its supply strategy to purchase approximately two-thirds of its gas under contracts that tie purchase prices to spot market prices and to acquire the remainder under fixed price contracts. MichCon expects approval of this proposal during the second quarter of 1997.
In 1993, Panhandle Eastern Pipe Line Company (Panhandle) refunded to MichCon the costs of certain direct billings totaling $5.4 million plus interest of $4.4 million in compliance with a FERC order. During 1994, the FERC issued an order permitting Panhandle to seek reimbursement of the $4.4 million in interest from MichCon. MichCon's request for rehearing of the 1994 order was denied. MichCon appealed the issue to the District of Columbia (D.C.) Circuit Court. In February 1996, the U.S. District Court Eastern District of Michigan ruled that the FERC orders were final for purposes of requiring MichCon to pay Panhandle's invoice for the $4.4 million in interest. MichCon satisfied the judgment. In September 1996, the D.C. Circuit Court upheld the FERC's previous orders. MichCon has filed for recovery of these costs through its 1996 GCR reconciliation case.
At December 31, 1996, MichCon owned and operated five natural gas storage fields in Michigan with a working storage capacity of approximately 130 Bcf. These facilities play an important role in providing reliable and cost-effective service. MichCon uses its storage capacity to supplement its supply during the winter months, replacing the gas in April through October when demand is at its lowest. The use of this storage capacity also allows MichCon to lower its peak-day entitlement, thereby reducing interstate pipeline costs. During 1996, MichCon's maximum one-day sendout exceeded 2.4 Bcf, of which approximately 70% came from its underground storage fields. MichCon's gas distribution system has a maximum daily sendout capability of 2.8 Bcf, with approximately 70% coming from underground storage. MichCon also sells a portion of its natural gas storage capacity to an affiliated company and third parties.
REGULATION AND RATES
MichCon is subject to the jurisdiction of the MPSC as to various phases of its operations, including gas sales rates, service and accounting. MichCon is also subject to the requirements of other regulatory agencies with respect to safety, the environment and health.
Michigan offers an environment of progressive and reasonable rate regulation. This is evident by the efforts underway to change the current form of regulation. The MPSC is reviewing various plans to reform Michigan's gas utility regulatory process to give all customers added choices and to increase competition. One such plan is MichCon's Pilot Transportation Program being offered to 47,000 small-volume residential and commercial customers, discussed previously. MichCon is positioning itself to respond to changes in regulation and increased competition by successfully reducing its cost of operations while maintaining a high level of customer satisfaction. As the MPSC evaluates expanded competition for the electric and natural gas industries within the state, MichCon will continue its active involvement.
GENERAL RATE PROCEEDINGS: MichCon received authorization to defer manufactured gas plant (MGP) investigation and remediation costs in excess of the $11.7 million previously reserved by MichCon. The remaining balance of this initial reserve at December 31, 1996 is approximately $2.6 million. Any excess costs are to be amortized over a 10 year period beginning in the year subsequent to the year environmental investigation and remediation costs are paid. The recovery of any remediation costs incurred will be reviewed in a future rate case.
In June 1994, the MPSC approved the property tax stipulation and settlement agreement, which addresses the treatment of reduced state property tax and increased state sales tax and federal income tax. The estimated net decrease in MichCon's operating expense was approximately $4.0 million for 1994 and $6.2 million annually thereafter. The agreement allows MichCon to accelerate the amortization of its 1993 deferred costs associated with the implementation of Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," by the net decreased tax expense.
MichCon filed an application with the MPSC in October requesting authority to decrease depreciation rates from the existing 4.09% to 3.44%. Based on December 1996 plant balances, depreciation expense would have effectively decreased by approximately $11.2 million. The final determination of MichCon's depreciation rate reduction is subject to an MPSC order. An MPSC order is expected by December 1997.
GAS COST RECOVERY: The GCR process allows MichCon to recover its cost of gas sold if the MPSC determines that such costs are reasonable and prudent. This determination includes an annual Gas Supply and Cost Review, in which the MPSC approves maximum monthly GCR factors. A subsequent annual GCR reconciliation proceeding provides a review of gas costs incurred during the year, determines whether approved gas costs have been overcollected or undercollected and, as a result, whether a refund or surcharge, including interest, is required to be returned to or collected from GCR customers using the rolled-in prospective refunding methodology approved by the MPSC on June 30, 1994.
In February 1995, MichCon filed its 1994 GCR reconciliation case indicating an over-recovery of $19 million, including interest. In February 1996, the MPSC issued an order finding that all of MichCon's 1994 gas costs were reasonable and prudent, and made no disallowance of gas costs as a result of MichCon fixing gas prices on a portion of its gas purchases.
In February 1996, MichCon filed its 1995 GCR reconciliation case indicating an under-recovery of less than $0.1 million, including interest, which will be collected from GCR customers using the new rolled-in prospective refunding methodology. In February 1997, the MPSC issued an order finding that all of MichCon's 1995 gas costs were reasonable and prudent.
In February 1997, MichCon filed its 1996 GCR reconciliation case indicating a net under-recovery of approximately $28 million, including interest. An MPSC order is expected in December 1997. In July 1996, MichCon filed its 1997 GCR plan case. An MPSC order is expected in May 1997.
ENVIRONMENTAL MATTERS
MANUFACTURED GAS PLANTS: Prior to the construction of major natural gas pipelines, gas for heating and other uses was manufactured from processes involving coal, coke or oil. MichCon owns, or previously owned, 16 former manufactured gas plant (MGP) sites.
During the mid-1980s, MichCon conducted preliminary environmental investigations at former MGP sites, and some contamination related to the byproducts of gas manufacturing was discovered at each site. The existence of these sites and the results of the environmental investigations have been reported to the Michigan Department of Environmental Quality. None of these former MGP sites are on the National Priorities List prepared by the U.S. Environmental Protection Agency.
MichCon is not involved in any administrative proceedings regarding these former MGP sites but is currently remediating one of these sites. The remedy consists of limited excavation and disposal of soils, a new soil cover and long-term groundwater monitoring. More extensive investigations are under way at seven other sites.
In 1984, MichCon established an $11.7 million reserve for environmental investigation and remediation. During 1993, MichCon received MPSC approval of a cost deferral and rate recovery mechanism for investigation and remediation costs incurred at former MGP sites in excess of this reserve.
MichCon employed outside consultants to evaluate remediation alternatives for these sites, to assist in estimating its potential liabilities and to review its archived insurance polices. MichCon notified more than 40 current and former insurance carriers of the environmental conditions at these former MGP sites. In 1996, MichCon received payments from certain carriers and expects additional insurance recoveries over the next several years. The findings of these investigations indicate that the estimated total expenditures for investigation and remediation activities for these sites could range from $30 million to $170 million based on undiscounted 1995 costs. As a result of these studies, MichCon accrued an additional liability and a corresponding regulatory asset of approximately $32 million during 1995.
During 1996, 1995 and 1994, MichCon spent $0.9 million, $2.1 million and $0.6 million, respectively, investigating these former MGP sites. At December 31, 1996, the reserve balance was $34.6 million, of which $2.6 million was classified as current. Any significant change in assumptions, such as remediation techniques, nature and extent of contamination and regulatory requirements, could impact the estimate of remedial action costs for the sites and, therefore, have an effect on MichCon's financial position and cash flows. However, management believes insurance coverage and the cost deferral and rate recovery mechanism approved by the MPSC will prevent environmental costs from having a material adverse impact on MichCon's results of operations.
FRANCHISES
MichCon operates in numerous cities, villages and townships under franchises or permits that typically are revocable at will and have a 30-year maximum duration. In Grand Rapids and a number of other municipalities where a significant part of MichCon's service is furnished, MichCon's operations originated under franchises that have since expired. In 1993, MichCon began renewing or re-establishing formal franchises in those municipalities in order to avoid uncertainty with regard to MichCon's ability to continue and expand service in those areas. Regarding the franchises that have not been renewed, MichCon's gas distribution systems are rightfully occupying the streets with the consent or acquiescence of the municipalities. While MichCon could be ordered by any municipality in which its franchise has
expired to remove its property, it could be deprived of ownership only by its consent and the payment of an agreed upon price, or by condemnation and the payment of the fair value of such property. Should any of these municipalities seek to terminate MichCon's operations therein and substitute another gas utility operation, publicly or privately owned, the municipality must either (i) acquire and operate MichCon's system, (ii) construct a new system or (iii) grant a franchise to another privately owned utility to construct or acquire its own distribution system.
During 1996, MichCon gained six franchises with aggregate gas sales volumes of approximately 0.4 Bcf annually. Approximately 40 major franchises have been renewed in 1996, which account for gas sales volumes of approximately 18 Bcf annually.
Public utility franchises in Michigan are non-exclusive. Construction under a second franchise granted to another public utility requires authorization by the MPSC, which must consider, among other things, the service rendered by the existing utility, the investment by such utility, and the benefit, if any, to the public of having a second utility serve in the area. In one township where MichCon formerly served approximately 450 residential customers (representing 78,400 Mcf annually) under an expired franchise, and upon the suit of a competing utility with a franchise overlapping the area, a local circuit judge entered an order to enjoin MichCon from expanding its service in that township. However, the Michigan Court of Appeals reversed that decision. This matter is pending before the Michigan Supreme Court. On October 1, 1994, MichCon sold its distribution facilities in that township to the competing utility. Management expects that issues involving franchise rights will continue to be actively pursued in judicial and regulatory proceedings but are not expected to have a significant impact on its business.
ITEM 2.

ITEM 2. PROPERTIES
MichCon operates natural gas distribution, transmission and storage facilities in the state of Michigan. At December 31, 1996, MichCon's distribution system included 16,257 miles of distribution mains, 1,065,233 service lines and 1,185,445 active meters. MichCon owns 2,509 miles of transmission and production lines that deliver natural gas to the distribution districts and interconnect its storage fields with the sources of supply and the market areas. MichCon also owns properties relating to five underground storage fields with an aggregate storage capacity of approximately 130 Bcf. Additionally, MichCon owns district office buildings, service buildings and gas receiving and metering stations. MichCon occupies its principal office buildings, located in Detroit and Grand Rapids, under long-term leases. Portions of these buildings are subleased to affiliates and others.
Most of MichCon's properties are held in fee, by easement, or under lease agreements expiring at various dates to 2006, with renewal options extending beyond that date. The principal plants and properties of MichCon are held subject to the lien of MichCon's Indenture of Mortgage and Deed of Trust under which MichCon's First Mortgage Bonds are issued. Some existing properties are being fully utilized and new properties are being added to meet the requirements of expansion into new areas. MichCon's capital expenditures for 1996 totaled $212.7 million. MichCon's capital requirements for 1997 are anticipated to be approximately $175 million for capital investments.
The Saginaw Bay Pipeline Company, a wholly owned subsidiary of MichCon Pipeline Co., owns a 66 2/3% interest in the Saginaw Bay Area Limited Partnership, which owns substantially all of the properties used in the conduct of its business, primarily a 126-mile major gathering line. The Saginaw Bay Lateral Company, a wholly owned subsidiary of MichCon Pipeline Co., owns a 46% interest in the Saginaw Bay Lateral Limited Partnership, which owns substantially all of the properties used in the conduct of its business, primarily lateral lines related to the Saginaw Bay major gathering line. Westside
Pipeline Company, a wholly owned subsidiary of MichCon Pipeline Co., owns an 82.62% interest in Jordan Valley Pipeline, an 14-mile major gathering line and the Terra-Hayes Pipeline, a 18-mile major gathering line.
MichCon Gathering Company, a wholly owned subsidiary of MichCon Pipeline Co., owns substantially all of the properties used in the conduct of its business, including 44.7-mile, 8.6-mile and 11-mile major gathering lines and a 2400 horsepower compressor station.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
In addition to the regulatory proceedings and other matters described in Item 1, "Business," MichCon is also involved in a number of lawsuits and administrative proceedings in the ordinary course of business with respect to taxes, environmental matters, contracts, personal injury, property damage claims and other matters.
ENVIRONMENTAL
In 1994, MichCon received a general notice of liability letter from the U.S. Environmental Protection Agency (USEPA) stating that it was one of two potentially responsible parties at the Lower Ecorse Creek Superfund site in Wyandotte, Michigan. USEPA requested that MichCon conduct a remedial investigation and feasibility study at that site. MichCon investigated its prior activities in the area and USEPA's bases for its conclusion, and concluded that it was not responsible for contamination discovered at that site. MichCon informed USEPA of this belief and did not undertake the requested activities.
In September 1996, USEPA sent MichCon a second general notice of liability letter for the site and demanded reimbursement of approximately $2.3 million in past costs, plus interest. USEPA then issued MichCon and the other potentially responsible party a unilateral administrative order under section 106 of the Comprehensive Environmental Response Compensation and Liability Act to implement the remedy. USEPA estimates the cost of the remedy to be approximately $650,000. MichCon again reviewed USEPA's bases for determining that it is a potentially responsible party and concluded again that it was not responsible for contamination discovered at that site and informed USEPA of its decision. USEPA has not subsequently contacted MichCon about this response. USEPA may sue MichCon to force compliance with the order or may implement the remedy and then sue MichCon for recovery of all incurred costs. If USEPA institutes and prevails in such a suit and if the court determines that MichCon did not have sufficient cause not to comply with the order, the court may impose civil penalties and punitive damages. Management believes MichCon was not responsible for contamination at the site and has sufficient cause not to comply with this order and that the resolution of this matter will not have a material adverse effect on MichCon's financial statements.
ENERGY CONSERVATION PROGRAMS
In December 1994, a suit was filed against MichCon in Wayne County Michigan Circuit Court by six customers who had participated in one of three energy conservation programs sponsored by MichCon. Under these programs, which had been approved by the MPSC and operated from 1990 to 1996, MichCon offered low-interest loans, rebates and other arrangements to assist approximately 46,000 qualified residential customers in purchasing high-efficiency furnaces. MichCon did not manufacture, sell or install any of the furnaces. The complaint alleged that MichCon induced the purchase of these furnaces through its conservation programs and that it had a duty to, but failed to, warn its customers that harmful levels of carbon monoxide could backdraft if a chimney was not properly sized and a chimney
liner installed. No personal injuries were claimed. Plaintiffs sought injunctive relief, unspecified monetary damages and class action certification. The trial court denied such certification on two separate occasions; the Michigan Court of Appeals denied plaintiffs' request for an appeal of those rulings.
MichCon impleaded, as third-party defendants, all of the manufacturers, contractors and installers of the plaintiffs' furnaces. On September 13, 1996, plaintiffs' third motion to certify the lawsuit as a class action was granted. MichCon appealed the granting of certification and on December 2, 1996, the Michigan Court of Appeals granted MichCon's Motion for Immediate Consideration and stayed all further proceedings until the Court issues its decision. MichCon believes that the plaintiffs' allegations are without merit and will continue to defend the case vigorously.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Omitted per general instruction I (2) (c) of Form 10-K for wholly-owned subsidiaries (reduced disclosure format).
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
All of the 10,300,000 issued and outstanding shares of common stock of MichCon, par value $1 per share, are owned by MCN and constitute 100% of the voting securities of MichCon. Therefore, no market exists for MichCon common stock. On January 31, 1996, MichCon called for redemption the remaining 104,732 shares of its redeemable cumulative preferred stock.
MichCon paid cash dividends of $11.3 million in 1996, $6.5 million in 1995 and $8.5 million in 1994 on its common stock.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA (UNAUDITED)
ITEM 7.

ITEM 7. MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Earnings for 1996 were $79.8 million, an increase of $8.3 million over 1995. Similarly, earnings for 1995 increased by $12.1 million over 1994. These improvements are due primarily to increased gross margins resulting from higher gas sales and transportation deliveries.
GROSS MARGIN
Gross margin (operating revenues less cost of gas) increased in 1996 and 1995 reflecting higher gas sales and end user transportation due primarily to colder weather. Additionally, gross margins were favorably affected by the continued growth in intermediate transportation services.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Operating Revenues
1996 1995 1994 ---- ---- ---- Gas Markets (Bcf) Gas Sales ........................... 217.7 206.9 201.4 End User Transportation ............. 146.7 145.3 139.8 Intermediate Transportation.......... 527.5 341.6 303.6 ----- ----- ----- 891.9 693.8 644.8 ===== ===== =====
Gas sales and end user transportation revenues increased $170.5 million in 1996 and decreased $33.4 million in 1995. Revenues were affected by increases in gas sales and end user transportation deliveries which increased 12.2 Bcf and 11 Bcf in 1996 and 1995 respectively. The increases were due primarily to colder weather as well as marketing initiatives that expanded gas markets. The decline in gas sales revenues during 1995 reflects lower gas costs as subsequently discussed. MichCon continues to enter into multi-year competitively priced transportation agreements with large-volume users, thereby maintaining these gas markets over the long term.
Gas sales and gross margins have also been affected by variations in revenues associated with lost gas costs. Gas sales rates are set to recover lost gas costs using an averaging method based on historical lost gas experience. Prior to 1993, MichCon deferred or accrued revenues for differences between historical average lost gas amounts and the actual amount experienced. However, as a result of an October 1993 order issued in MichCon's last general rate case, MichCon no longer defers or accrues revenues for these differences in lost gas amounts. Amortization of previously deferred amounts was completed in 1995 and increased revenues by $3.4 million and $3.1 million in 1995 and 1994 respectively. As discussed in the "Cost of Gas" section that follows, gross margins have also been impacted by variations in lost gas costs.
The increases in intermediate transportation deliveries in both 1996 and 1995 periods are due primarily to additional volumes transported for two major fixed-fee customers and increased transportation of Antrim gas for Michigan gas producers and brokers. There has been a significant increase in Michigan Antrim production over the past several years, resulting in a growing demand by gas producers and brokers for intermediate transportation services. In order to meet the increased demand, MichCon expanded the transportation capacity of its northern Michigan gathering system. The expansion enabled MichCon to transport an additional 75 Bcf during 1996.
In January 1996, MCN transferred its Michigan pipeline operations to MichCon in order to consolidate MCN's Michigan gathering pipeline activities within one business unit. The pipeline operation contributed 54.5 Bcf in volumes transported during 1996. Profit margins on intermediate transportation services are considerably less than margins on gas sales or for end user transportation markets.
Other operating revenue decreased primarily due to a $16.1 million decrease in conservation revenue resulting from the discontinuation of MichCon's conservation programs. As discussed in the "Operation and Maintenance" section that follows, this decrease in revenue is offset by a corresponding decrease in expenses related to the conservation programs. This decrease is offset by a $5.5 million increase in gas processing revenues generated from the Michigan pipeline operations which were transferred from MCN to MichCon at the beginning of 1996.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Cost of Gas
Cost of gas is affected by variations in sales volumes and cost of gas rates. Through the Gas Cost Recovery (GCR) mechanism, MichCon is allowed timely recovery of 100% of its reasonably and prudently incurred cost of gas sold. Therefore, fluctuations in cost of gas sold have little or no effect on gross margins.
Cost of gas sold increased in 1996 as a result of significantly higher spot market prices paid for natural gas purchased and higher gas sales volumes due to colder weather. Cost of gas sold per thousand cubic feet for 1996 was $2.92, an increase of $.56 (24%). Lower natural gas prices, partially offset by higher gas sales volumes, resulted in the 1995 decrease in cost of gas sold. Cost of gas sold per thousand cubic feet for 1995 decreased from 1994 by $.31 (12%). MichCon continues its supply strategy of purchasing gas under contracts that tie purchase prices to spot market prices. To mitigate risk related to spot market prices, MichCon has filed a proposal with the MPSC to change its supply strategy to purchase approximately two-thirds of its gas under contracts that tie purchase prices to spot market prices and to purchase the remainder under fixed price contracts. MichCon expects approval of this proposal during the second quarter of 1997.
As previously discussed, cost of gas is affected by variations in lost gas amounts. Lost gas costs for 1996 and 1995 increased by $6.6 million and $8.5 million respectively.
OPERATION AND MAINTENANCE
Operation and maintenance expenses for 1996 declined slightly from 1995. Increased uncollectible gas accounts expense of $13.6 million combined with additional expenses related to the transfer of the Michigan pipeline operations from MCN to MichCon were offset by decreased benefit costs, primarily pension and retiree health care costs, of $6.8 million and a decrease of $16.1 million in expense related to the conservation program, which was discontinued as noted above in "Other Operating Revenues." Uncollectible gas accounts were driven higher by last winter's colder temperatures and rising gas prices which significantly increased customers' heating bills. The impact of higher heating bills was worsened by a reduction and delay in the home heating assistance funding obtained by low-income customers. Operation and maintenance expenses decreased during 1995 due to lower benefit costs, primarily pension and retiree health care costs, combined with management's efforts to reduce operating costs.
MichCon receives a significant amount of its heating assistance funding from the federal Low-Income Home Energy Assistance Program (LIHEAP). During 1995, Congress reduced a substantial portion of the program's funding for the 1996 fiscal year and had proposed to eliminate all funding in future years. The State of Michigan's share of LIHEAP funds was reduced from $78 million in fiscal year 1995 to $47.5 million in 1996. The problem was further impacted by the late receipt of funding by the State of Michigan. Due to this delay, many of MichCon's customers who would have been eligible for assistance did not file. During 1996 and 1995, $10.1 million and $27.3 million in LIHEAP funds assisted approximately 74,000 and 112,000 MichCon customers, respectively. During October 1996, the President signed an Omnibus Spending Bill passed by Congress that provided for $1 billion in federal LIHEAP funding for 1997, an increase of $100 million over 1996 levels. During February 1997, the President released his proposed budget which provides for federal LIHEAP funding at $1 billion annually through fiscal year 2002. A portion of any future increase or decrease in funding may impact MichCon's uncollectible accounts. MichCon is currently working with federal and state officials to identify ways to obtain energy assistance for low-income customers from other venues, and is taking actions to minimize the impact a reduction in LIHEAP funds would have on MichCon's financial statements.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
DEPRECIATION AND DEPLETION
The increases in depreciation and depletion in both 1996 and 1995 are due to higher plant balances reflecting capital expenditures of $593.9 million over the past three years. Depreciation and depletion expenses are expected to increase in future years due to additional capital investments. MichCon has filed an application with the MPSC to lower its depreciation rates which could partially offset the anticipated increase in depreciation expense in 1997 and future years.
PROPERTY AND OTHER TAXES
Property and other taxes increased in 1996 reflecting an increase in property taxes due to higher property balances. The decrease in 1995 was due mainly to a decrease in Michigan single business taxes, resulting from favorable amendments to the Michigan tax law.
OTHER INCOME AND DEDUCTIONS
Interest on long-term debt increased in 1996 and 1995 as a result of the average amount of long-term debt outstanding increasing $72.6 million and $95.7 million respectively. The increase in interest on long-term debt in 1996 was offset by a slight decrease in the weighted average interest rate. The increases in long-term debt outstanding were the result of issuing first mortgage bonds in the aggregate of $70 million in both 1996 and 1995, and $80 million in 1994.
The decrease in 1996 other deductions is primarily due to an increase in the capitalization of the cost of funds used during construction resulting from higher construction balances.
INCOME TAX PROVISION
Income taxes for 1996 remained consistent with 1995 despite the increase in earnings due to a decrease in excess book depreciation over tax depreciation and an increase in the favorable resolution of prior year tax issues. Income taxes increased in 1995 primarily as a result of earnings. In addition, excess book depreciation over tax depreciation rose in 1995 contributing to the increase in 1995 income taxes. Income taxes were reduced by $3.4 million, $1.3 million and $3.9 million during 1996, 1995 and 1994, respectively, due to the favorable resolution of prior years' tax issues.
ENVIRONMENTAL MATTERS
Prior to the construction of major natural gas pipelines, gas for heating and other uses was manufactured from processes involving coal, coke or oil. MichCon owns or previously owned 16 such former manufactured gas plant (MGP) sites.
During the mid-1980's, MichCon conducted preliminary environmental investigations at these former MGP sites, and some contamination related to the byproducts of gas manufacturing was discovered at each site. The existence of these sites and the results of the environmental investigations have been reported to the Michigan Department of Environmental Quality. None of these former MGP sites are on the National Priorities List prepared by the U.S. Environmental Protection Agency.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
MichCon is not involved in any administrative proceedings regarding these former MGP sites, but is currently remediating one of these sites. The remedy consists of limited excavation and disposal of soils, a new soil cover and long-term ground water monitoring. More extensive investigations are underway at seven sites.
In 1984, MichCon established an $11.7 million reserve for environmental investigation and remediation. During 1993, MichCon received MPSC approval of a cost deferral and rate recovery mechanism for investigation and remediation costs incurred at former MGP sites in excess of this reserve.
MichCon employed outside consultants to evaluate remediation alternatives for these sites, to assist in estimating its potential liabilities and to review its archived insurance policies. MichCon has notified more than 40 current and former insurance carriers of the environmental conditions at these former MGP sites, and is pursuing its claims against these carriers. In 1996, MichCon received payments from certain insurance carriers and expects additional insurance recoveries over the next several years. The findings of these investigations indicate that the estimated total expenditures for investigation and remedial activities at all 16 former MGP sites will be between $30 million and $170 million based on undiscounted 1995 costs. As a result of these studies, MichCon accrued an additional liability and a corresponding regulatory asset of $32 million during 1995.
During 1996, 1995 and 1994, MichCon spent $0.9 million, $2.1 million and $0.6 million, respectively, investigating these former MGP sites. At December 31 1996, the reserve balance is $34.6 million, of which $2.6 million is classified as current. Any significant change in assumptions, such as remediation techniques, nature and extent of contamination and regulatory requirements, could impact the estimate of remedial actions costs and, therefore, have an effect on MichCon's financial position and cash flows. However, management believes that insurance coverage and the cost deferral and rate recovery mechanism approved by the MPSC will prevent environmental costs from having a material adverse impact on MichCon's results of operations.
CAPITAL RESOURCES AND LIQUIDITY
OPERATING ACTIVITIES
MichCon's cash flow from operating activities decreased $56.5 million in 1996 from 1995 and decreased $15.9 million in 1995 compared to 1994. These decreases were due primarily to higher working capital requirements, partially offset by higher net income, after adjusting for depreciation and deferred taxes. Operating cash flows were sufficient for the payment of cash dividends on common and preferred stock and a portion of capital investments.
FINANCING ACTIVITIES
During the latter part of the year, short-term debt is generally incurred to finance increases in gas inventories and customer accounts receivable. Short-term debt is normally reduced in the first part of each year as gas inventories are depleted and funds are received from winter heating sales. To meet its seasonal short-term borrowing needs, MichCon normally issues commercial paper which is backed by credit lines with several banks. MichCon has established credit lines to allow for borrowings of up to $150 million under a 364-day revolving credit facility and up to $150 million under a three-year revolving credit facility. Commercial paper of $238.3 million was outstanding as of December 31, 1996.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
In May 1996, MichCon issued first mortgage bonds totaling $70 million under its existing shelf registration. The proceeds were used to repay short-term obligations, finance MichCon capital expenditures and for general corporate purposes. During the fourth quarter of 1996, MichCon filed a shelf registration with the Securities and Exchange Commission for the issuance of up to $260 million which will allow it to issue, in conjunction with its remaining existing shelf registration, up to $300 million of debt securities over the next several years. MichCon's capital requirements and general market conditions will affect the timing and amount of future issuances.
MichCon issued $70 million and $80 million of first mortgage bonds in 1995 and 1994, respectively. The 1995 proceeds were used to repay short-term obligations, to finance capital expenditures and for general corporate purposes. The 1994 proceeds were used to repay short-term obligations and for general corporate purposes.
During 1996, MichCon renewed its Trust Demand Note program which allows it to borrow up to $25 million through March 1997. Borrowings of $25 million were outstanding as of December 31, 1996.
The following table sets forth the ratings for securities issued by MichCon:
These ratings are considered investment grade by each rating agency.
MichCon's capitalization objective is to maintain a ratio of approximately 50% debt and 50% equity. At December 31, 1996, the common equity ratio was 51.2% of total capitalization.
INVESTING ACTIVITIES
MichCon's capital expenditures for 1996 totaled $212.7 million. This amount represents a decrease of $23.1 million compared to 1995. Capital expenditures in 1995 increased by $90.4 million over 1994. Capital expenditures primarily represent the construction of transportation pipelines, the construction of new distribution lines to reach communities not previously served by MichCon, and improvements to existing storage and transmission systems.
MichCon's capital requirements for 1997 are anticipated to be approximately $175 million for capital investments. These investments will be made to add new customers, develop new gas transportation markets, make improvements to existing storage and transmission systems and to improve its information systems. These capital requirements and general financial market conditions will affect the timing and amount of future debt issuances.
In January 1996, MichCon began construction of a 59-mile loop of its existing Milford to Belle River Pipeline. The pipeline was completed in January 1997 at a cost of approximately $85 million. The pipeline will improve the overall reliability and efficiency of MichCon's gas storage and transmission system by serving as a back-up means of transportation in the event of disruption in the operation of the existing pipeline or other facilities used to supply gas to MichCon's system.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
It is management's opinion that MichCon will have sufficient capital resources, both internal and external, to meet anticipated capital requirements.
OUTLOOK
The statements contained in this Outlook are based on current expectations. These statements are forward looking, and actual results may differ materially.
MichCon's strategy is to become the dominant provider of natural gas and high-value energy services within Michigan. Accordingly, MichCon's objectives are to increase revenues and reduce its costs in order to maintain strong returns and provide customers with high-quality service at competitive prices. Revenue growth will be achieved through the expansion of MichCon's 1.2 million residential, commercial and industrial customer base. MichCon expects to provide natural gas to approximately 23,000 new customers in 1997. MichCon's market share for residential heating customers in the communities in which it serves is approximately 85%. While this saturation rate is high, significant opportunities exist through conversion of existing homes as well as from new construction. MichCon continues to expand the industrial and commercial markets by aggressively facilitating the use of existing gas technologies and equipment as well as by developing new natural gas technologies.
Management is continually assessing ways to improve cost competitiveness. Among other cost saving initiatives, MichCon and The Detroit Edison Company are exploring opportunities to share the cost of common, duplicative functions, including billing, meter reading, payment processing and underground facilities locating.
MichCon continues to focus on challenges and opportunities resulting from increased competition with other natural gas distribution companies and other energy providers. The MPSC is reviewing various plans which outline major reforms to Michigan's utility regulatory process aimed at giving all customers added choices and thereby increasing competition. MichCon and other Michigan gas utilities will implement pilot transportation service programs in 1997 for small commercial and residential customers. Under MichCon's two-year program, 47,000 customers in the pilot territory will have the opportunity to select alternative natural gas suppliers beginning in April 1997. This option has been available to MichCon's larger commercial customers for several years. MichCon currently generates its earnings on delivery related services, and generally generates no earnings on the gas-supply portion of operations. Therefore, a customer's selection of an alternative supplier is expected to be essentially earnings-neutral. However, the overall package of regulatory changes connected with the gas industry restructuring will not be earnings-neutral, but is expected to generate additional revenue opportunities as the restructuring advances. MichCon is positioning itself to respond to changes in regulation and increased competition by reducing its cost of operations while maintaining a high level of customer satisfaction. MichCon remains focused on these goals in 1997 and beyond.
As described in Note 7 to the consolidated financial statements, MichCon complies with the provisions of Statement of Financial Accounting Standards, No. 71 (SFAS 71), "Accounting for the Effects of Certain Types of Regulation." In the event MichCon determines it no longer meets the criteria for following SFAS No. 71, the accounting impact would be an extraordinary, non-cash increase to net income of approximately $50 million. Criteria that give rise to the discontinuance of SFAS 71 include (1) increasing competition that restricts MichCon's ability to establish prices to recover specific costs, and (2) a significant change in the manner in which rates are set by regulators from cost-based regulation to another form of regulation. MichCon periodically reviews these criteria to ensure that the continuing
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
application of SFAS No. 71 is appropriate. Based on a current evaluation of the various factors and conditions that are expected to impact future cost recovery, MichCon believes that its regulatory assets are probable of future recovery.
NEW ACCOUNTING PRONOUNCEMENTS
During 1996, the Financial Accounting Standards Board issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." Although certain aspects of SFAS 125 have been delayed, the effective date for most of its provisions remains January 1, 1997. MichCon has analyzed the impacts of adopting SFAS 125 and expects that it will have no impact on MichCon's financial statements.
During 1996 the American Institute of Certified Public Accountants issued Statement of Position (SOP) 96-1, "Environmental Remediation Liabilities" which provides guidance on the issues present in the recognition, measurement, display and disclosure of environmental remediation liabilities. MichCon does not expect the 1997 adoption of this pronouncement to have a material impact on MichCon's financial statements.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME
The notes to the consolidated financial statements are an integral part of this statement.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF FINANCIAL POSITION
The notes to the consolidated financial statements are an integral part of this statement.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CAPITALIZATION
The notes to the consolidated financial statements are an integral part of this statement.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS
The notes to the consolidated financial statements are an integral part of this statement.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF ACCOUNTING POLICIES
NATURE OF OPERATIONS
MichCon is a public utility engaged in the distribution and transmission of natural gas in the state of Michigan. MichCon is subject to the accounting requirements of and rate regulation by the Michigan Public Service Commission (MPSC) with respect to the distribution and intrastate transportation of natural gas. The major services provided by MichCon are gas sales, end user transportation, and intermediate transportation. MichCon serves more than 1.2 million residential, commercial and industrial customers. The Company is not dependent upon any one customer or group of customers. Its principle markets are located in the Detroit, Grand Rapids, Ann Arbor, Traverse City, and Muskegon metropolitan areas. MichCon's non-utility operations are insignificant.
Forty-six percent of MichCon's labor force is covered by collective bargaining agreements, with the earliest agreements set to expire in December 1997. Twenty-eight percent of the Company's labor force is covered under the earlier agreements.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of MichCon and all of its subsidiaries. Investments in 50% or less owned entities have been accounted for under the equity method because MichCon has significant but not controlling influence over these entities.
BASIS OF PRESENTATION
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Certain reclassifications have been made to prior years' statements to conform with the 1996 presentation.
REVENUES AND COST OF GAS
MichCon accrues revenues for gas service provided but unbilled at month end. Annual gas cost recovery (GCR) proceedings before the MPSC permit MichCon to recover the prudent and reasonable cost of gas sold. Any overcollection or undercollection of costs, including interest, will be reflected in future rates.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at cost and includes amounts for labor, materials, overhead and an allowance for funds used during construction. Upon retirement, the cost of property, plant and equipment and net removal costs are charged to accumulated depreciation.
ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION
MichCon capitalizes an allowance for both debt and equity funds used during construction in the cost of major additions to utility plant. The total amount capitalized was $5,233,000, $1,644,000 and $839,000 in 1996, 1995 and 1994, respectively.
DEPRECIATION AND DEPLETION
MichCon provides depreciation for a major portion of its property, plant and equipment on the basis of straight-line rates prescribed by the MPSC. Unit of production depreciation and depletion is used for certain production and transmission property. Depreciation rates vary by class of property. The ratio of the provision for depreciation to the average cost of depreciable property was 4.4% in 1996 and 1995, and 4.5% in 1994.
FINANCIAL INSTRUMENTS
In order to manage interest rate exposure, MichCon and its subsidiaries engage in interest rate swap agreements that exchange fixed and variable rate interest payment obligations over the life of the agreements without the exchange of the underlying principal amounts. The difference to be paid or received on these swaps is accrued and recorded as an adjustment to interest expense over the life of the agreements.
DEFERRED DEBT COSTS
In accordance with MPSC regulations, MichCon defers reacquisition and unamortized issuance costs of reacquired long-term debt when such debt is refinanced. These costs are amortized over the term of the replacement debt.
INCOME TAXES AND INVESTMENT TAX CREDIT
Tax benefits amortizable to customers represents the net revenue equivalent of the difference in property-related accumulated deferred income taxes computed in accordance with SFAS No. 109, "Accounting for Income Taxes," as compared to the amounts previously reflected in setting utility rates. This amount is primarily due to current tax rates being lower than the rates in effect when the original deferred taxes were recorded and because of temporary differences, including accumulated investment tax credits, for which deferred income taxes were not previously recorded in setting utility rates. These net tax benefits are being amortized in accordance with the regulatory treatment over the life of the related plant, as the temporary differences reverse.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
CONSOLIDATED STATEMENT OF CASH FLOWS
MichCon considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.
STOCK-BASED COMPENSATION
In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation." This statement requires expanded disclosures about stock-based employee compensation and encourages a fair value based method of accounting for such compensation for fiscal years beginning after December 15, 1995. The statement supersedes Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees," but allows continued application of the intrinsic value based method of accounting prescribed by APB 25. During the fourth quarter of 1996, MichCon adopted the recommended fair value based method of accounting for its stock-based compensation plans, effective January 1, 1996. Due to the immaterial effect of adoption, prior periods have not been restated.
2. GAS IN INVENTORY
Inventory gas is priced on a last-in, first-out (LIFO) basis. At December 31, 1996, the replacement cost exceeded the $67,910,000 LIFO cost by $240,442,000 and at December 31, 1995, the replacement cost exceeded the $40,191,000 LIFO cost by $135,635,000. MichCon's current GCR tariff provisions prevent MichCon from retaining any benefits from a lower cost of gas sold resulting from liquidating its LIFO inventory. MichCon's LIFO inventory balance was 73.6 Bcf and 64.2 Bcf as of December 31, 1996 and 1995, respectively.
A portion of gas in underground storage used as a pressure base is included in "Property, Plant and Equipment" in the amount of $32,792,000 at December 31, 1996 and 1995.
3. CAPITALIZATION
A. LONG-TERM DEBT
Substantially all of the net properties of MichCon in the approximate amount of $1,100,000,000 are pledged as security for the payment of outstanding first mortgage bonds.
MichCon has a variable interest rate swap agreement through April 2000 on $12,000,000 of unsecured notes which has effectively reduced the cost of this debt from 9.8% to 5.7% for the year ended December 31, 1996. A subsidiary of MichCon has an interest rate swap agreement on the $17,600,000 outstanding balance of its project loan agreement at December 31, 1996, which effectively fixes the interest rate at 7.5% through February 2003.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Maturities and sinking fund requirements during the next five years for long-term debt outstanding at December 31, 1996, are $51,821,000 in 1997, $21,823,000 in 1998, $51,825,000 in 1999, $33,827,000 in 2000, and $21,829,000 in 2001.
B. REDEEMABLE CUMULATIVE PREFERRED STOCK
At December 31, 1995, 104,732 shares of Redeemable Cumulative Preferred Stock, $2.05 Series were outstanding. During January 1996, MichCon redeemed all outstanding shares at the sinking fund redemption price of $25 per share.
C. ADDITIONAL CAPITAL
During 1995, MCN Corporation, doing business as MCN Energy Group Inc. (MCN), invested $7,000,000 in MichCon as a capital contribution.
4. CREDIT FACILITIES AND SHORT-TERM BORROWINGS
During 1996, MichCon increased its credit lines by $50,000,000 to allow for borrowings of up to $150,000,000 under a 364-day revolving credit facility and up to $150,000,000 under a three-year revolving credit facility. MichCon usually issues commercial paper in lieu of an equivalent amount of borrowings under these lines of credit. Commercial paper outstanding at December 31, 1996 and 1995, totaled $238,251,000 and $194,760,000, respectively, at weighted average interest rates of 5.5% and 5.7%, respectively. This debt is classified as short-term based upon management's intent to repay it within one year. Fees are paid to compensate banks for lines of credit.
During 1996, MichCon renewed its Trust Demand Note program which allows MichCon to borrow up to $25,000,000 through March 1997. At December 31, 1996, borrowings of $25,000,000 were outstanding under this program at an interest rate of 5.9%. No borrowings were outstanding at December 31, 1995.
5. TRANSFER OF SUBSIDIARIES
In January 1996, MCN's Michigan pipeline operations were transferred, at book value, to MichCon in order to consolidate MCN's Michigan gathering pipeline activities within one business unit. Net assets transferred to MichCon totaled approximately $18,622,000 including cash of $1,614,000 and long-term debt of $17,600,000. The contribution from these pipeline operations to MichCon's consolidated net income was approximately $626,000 for the year ended 1996. The pipeline operations have investments in certain partnerships. Outside partners have interests in these partnerships ranging from 17% to 54%.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
6. COMMITMENTS AND CONTINGENCIES
A. GUARANTY
A subsidiary of MichCon and an unaffiliated corporation have formed a series of partnerships which are engaged in the construction and development of a residential community on the Detroit riverfront (Harbortown). One of the partnerships obtained $12,000,000 of tax-exempt financing due June 2004 through the Michigan State Housing Development Authority. Both partners and their parent corporations have issued guaranties for the full amount of this financing and each parent corporation has agreed to reimburse the other for 50% of any payments made as a result of these guaranties.
B. ENVIRONMENTAL MATTERS
Prior to the construction of major natural gas pipelines, gas for heating and other uses was manufactured from processes involving coal, coke or oil. MichCon owns or previously owned 16 such former manufactured gas plant (MGP) sites.
During the mid-1980's, MichCon conducted preliminary environmental investigations at these former MGP sites, and some contamination related to the byproducts of gas manufacturing was discovered at each site. The existence of these sites and the results of the environmental investigations have been reported to the Michigan Department of Environmental Quality. None of these former MGP sites are on the National Priorities List prepared by the U.S. Environmental Protection Agency.
MichCon is not involved in any administrative proceedings regarding these former MGP sites, but is currently remediating one of these sites. The remedy consists of limited excavation and disposal of soils, a new soil cover and long-term ground water monitoring. More extensive investigations are underway at seven sites.
In 1984, MichCon established an $11,700,000 reserve for environmental investigation and remediation. During 1993, MichCon received MPSC approval of a cost deferral and rate recovery mechanism for investigation and remediation costs incurred at former MGP sites in excess of this reserve.
MichCon employed outside consultants to evaluate remediation alternatives for these sites, to assist in estimating its potential liabilities and to review its archived insurance policies. MichCon notified more than 40 current and former insurance carriers of the environmental conditions at these former MGP sites and is pursuing its claims against these carriers. In 1996, MichCon received payments from certain insurance carriers and expects additional insurance recoveries over the next several years. The findings of these investigations indicate that the estimated total expenditures for investigation and remedial activities at all 16 former MGP sites will be between $30,000,000 to $170,000,000 based on undiscounted 1995 costs. As a result of these studies, MichCon accrued an additional liability and a corresponding regulatory asset of $32,000,000 during 1995.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
During 1996, 1995, and 1994, MichCon spent $900,000, $2,100,000 and $600,000, respectively, investigating and remediating these former MGP sites. At December 31, 1996, the reserve balance is approximately $34,576,000, of which $2,576,000 is classified as current. Any significant change in assumptions, such as remediation techniques, nature and extent of contamination and regulatory requirements, could impact the estimate of remedial action costs for the sites and, therefore, have an effect on MichCon's financial position and cash flows. However, management believes that insurance coverage and the cost deferral and rate recovery mechanism approved by the MPSC will prevent environmental costs from having a material adverse impact on MichCon's results of operations.
C. COMMITMENTS
MichCon has entered into long-term purchase and transportation contracts with various suppliers and producers. In general, purchase prices under these contracts are determined by formulas based on market prices. In 1997, MichCon has firm purchase commitments for approximately 132 Bcf of gas. The Company expects that sales will exceed its minimum purchase commitments. To ensure that there is sufficient flexibility to obtain the lowest cost natural gas supplies in the future, MichCon continues its policy of reducing the length of its gas purchase contracts to no more than one year. This will ensure that MichCon's supply portfolio is compatible with the market at any point in time. MichCon has long-term transportation contracts with various interstate pipeline companies which expire on various dates through the year 2011. The Company is committed to pay demand charges of approximately $56,000,000 during 1997 related to firm purchase and transportation agreements. These demand charges are recoverable through the GCR mechanism.
Capital investments for 1997 are estimated to be $175,000,000 and certain commitments have been made in connection therewith.
D. OTHER
MichCon receives a significant amount of heating assistance funding from the federal Low-Income Home Energy Assistance Program (LIHEAP). During 1995, Congress reduced a substantial portion of the program's funding for the 1996 fiscal year and had proposed to eliminate all funding in future years. The State of Michigan's share of LIHEAP funds was reduced from $78,000,000 in fiscal year 1995 to $47,500,000 in 1996. During October 1996, the President signed an Omnibus Spending Bill passed by Congress that provided for $1,000,000,000 in federal LIHEAP funding for 1997, an increase of $100,000,000 over 1996 levels. During February 1997, the President released his proposed budget which provides for federal LIHEAP funding at $1,000,000,000 annually through fiscal year 2002. A portion of any future increase or decrease in funding may impact MichCon's uncollectible accounts.
MichCon is involved in certain legal and administrative proceedings before various courts and governmental agencies concerning claims arising in the ordinary course of business. Management cannot predict the final disposition of such proceedings, but believes that adequate provision has been made for probable losses. It is management's belief, after discussion with legal counsel, that the ultimate resolution of those proceedings still pending will not have a material adverse effect on MichCon's financial statements.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
7. REGULATORY MATTERS
REGULATORY ASSETS AND LIABILITIES
MichCon's operations are subject to the provisions SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation." As a result, several regulatory assets and liabilities are recorded in MichCon's financial statements. Regulatory assets represent costs which will be recovered from customers through the ratemaking process. Regulatory liabilities represent benefits which will flow through to customers as refunds or reduced rates. The following regulatory assets and liabilities were reflected in the Consolidated Statement of Financial Position as of December 31:
MichCon currently has regulatory precedents and orders in effect which provide for the probable recovery or refund of its regulatory assets and liabilities. Future regulatory changes or changes in the competitive environment could result in MichCon discontinuing the application of SFAS No. 71 for all or part of its business and require the write-off of the portion of any regulatory asset or liability which was no longer probable of recovery or refund. If MichCon were to have discontinued the application of SFAS No. 71 as of December 31, 1996, it would have had an extraordinary, non-cash increase to net income of approximately $50,000,000. Management believes that evidence currently available supports the continued application of SFAS No. 71.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
8. CAPITAL AND OPERATING LEASES
MichCon leases certain property (principally an office building, a warehouse and a parking structure) under lease arrangements expiring at various dates to 2006, with renewal options extending beyond that date. Portions of the office building and parking structure are subleased to various tenants.
The gross amount of assets recorded under capital leases and the related accumulated depreciation at December 31, 1996, are $26,887,000 and $11,719,000, respectively. The gross amount of assets and related accumulated depreciation at December 31, 1995, were $26,887,000 and $10,429,000, respectively.
Minimum rental commitments under noncancelable leases at December 31, 1996 are as follows:
Total minimum lease payments for capital and operating leases have not been reduced by future minimum sublease receipts of $8,793,000 under noncancelable subleases.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Capital and operating lease payments for the years ended December 31 consist of the following:
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9. RETIREMENT BENEFITS
A. PENSION PLAN BENEFITS
MichCon participates in separate defined benefit retirement plans for union and nonunion employees. The plans are noncontributory, cover substantially all employees and provide for normal retirement at age 65, but with the option to retire earlier or later under certain conditions. The plans provide pension benefits that are based on the employee's compensation and years of credited service. MichCon's funding policy is to fund each year's actuarially determined funding requirements of the plans, subject to regulations issued by the Internal Revenue Service. Currently, these plans meet the full funding limitations of the Internal Revenue Code. Accordingly, no contributions for the 1996, 1995 or 1994 plan years were made and none are expected to be made for the 1997 plan year.
Net pension cost for these plans included the following components:
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MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The following table sets forth a reconciliation of the funded status of the plans and the amounts recorded as prepaid pension cost in the Consolidated Statement of Financial Position:
In determining the actuarial present value of the projected benefit obligation, the weighted average discount rate was 8.0% for 1996 and 7.5% for 1995. The rate of increase in future compensation levels used was 5.0% for 1996 and 1995. The expected long-term rate of return on plan assets, which are invested primarily in equity and fixed income securities, was 9.25%, 9.0% and 7.5% for 1996, 1995 and 1994, respectively.
MichCon also sponsors several defined contribution pension plans. Participation in one of these plans is available to substantially all union and non-union employees. Company contributions to these plans are based upon salary and the matching of employee contributions up to certain predefined limits. The cost of these plans was $5,300,000 in 1996, $5,200,000 in 1995, and $5,100,000 in 1994.
B. OTHER POSTRETIREMENT BENEFITS
MichCon provides certain health care and life insurance benefits for retired employees who may become eligible for these benefits if they reach retirement age while working for MichCon. Upon adoption in 1993 of SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," MichCon deferred postretirement costs in excess of claims paid (including the amortization of the initial transition obligation) until January 1994 when new rates to recover such costs became effective. The deferred costs are being amortized over 1994 through 1997.
MichCon's policy is to fund its postretirement benefit costs to the extent such amounts are recoverable in rates. Separate qualified Voluntary Employees' Beneficiary Association (VEBA)
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
trusts exist for union and nonunion employees. Funding to the VEBA trusts totaled $41,600,000, $27,300,000 and $8,300,000 in 1996, 1995 and 1994, respectively. The expected weighted average long-term rate of return on plan assets, which are invested in life insurance policies, equity securities and fixed income securities, was 9.1% for 1996 and 8.9% for 1995.
Net postretirement cost for the years ended December 31, includes the following components:
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MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The following table sets forth a reconciliation of the funded status of the plans and the amounts recorded as accrued postretirement cost in the Consolidated Statement of Financial Position:
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The rate at which health care costs are assumed to increase is the most significant factor in establishing MichCon's postretirement benefit obligation. MichCon used a rate of 7% in 1996, and a rate that gradually declines each year until it stabilizes at 5% in 2003. A one percentage point increase in the assumed rate would increase the accumulated postretirement benefit obligation at December 31, 1996 by 9% and increase the sum of the service cost and interest cost by 8% for the year then ended. The discount rate used in determining the accumulated postretirement benefit obligation was 8% and 7.5% for 1996 and 1995, respectively.
10. FINANCIAL INSTRUMENTS
MichCon has estimated the fair value of its financial instruments using available market information and appropriate valuation methodologies. Considerable judgment is required in developing the estimates of fair value presented herein; therefore, the values are not necessarily indicative of the amounts that MichCon could realize in a current market exchange. The carrying amounts of certain financial instruments such as customer deposits, notes payable and notes receivable and advances are assumed to approximate the fair value due to the short-term nature of these items.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The carrying amount and the estimated fair value of other financial instruments consist of the following:
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Long-term debt - interest rates available to MichCon for issuance of debt with similar terms and remaining maturities.
Redeemable cumulative preferred stock - quoted market price on the New York Stock Exchange.
Interest rate swap - the estimated amount that MichCon would receive or pay to terminate the swap agreements, taking into account current interest rates and the creditworthiness of the swap counterparties and the fact that there is no similar market for the instrument.
Guaranty - management is unable to practicably estimate the fair value of the Harbortown guaranty (Note 6a) due to the nature of the related party transaction and the fact there is no similar market for the instrument.
The fair value estimates presented herein are based on information available to management as of December 31, 1996 and 1995. Management is not aware of any subsequent factors that would significantly affect the estimated fair value amounts.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
11. RELATED PARTY TRANSACTIONS
MichCon enters into transactions with affiliated companies to sell transportation and storage services. MichCon purchased computer operations services from Genix, which was an affiliate until it was sold in June 1996. Under a service agreement with its parent company, MichCon receives various tax, financial and legal services. The following is a summary of transactions with the affiliated companies:
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12. SUMMARY OF INCOME TAXES
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MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Deferred tax assets and liabilities are recognized for the estimated future tax effect of temporary differences between the tax basis of assets or liabilities and the reported amounts in the financial statements. Deferred tax assets and liabilities are classified as current or noncurrent according to the classification of the related assets or liabilities. The tax effect of temporary differences that gave rise to MichCon's deferred tax assets and liabilities consisted of the following:
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MichCon is part of the consolidated federal income tax return of MCN. The federal income tax expense for MichCon and its subsidiaries is determined on an individual company basis with no allocation of tax benefits or expenses from other affiliates of MCN.
13. STOCK INCENTIVE PLAN
MCN's Stock Incentive Plan authorizes the use of performance units, restricted stock or other stock-related awards to key employees, primarily management. MichCon's current policy is to issue performance units which encourage a strategic focus on long-term performance and have a high employee retention value. The performance units are denominated in shares of MCN common stock and issued to employees based on total shareholder return over a six year period, as compared to a group of peer companies. The initial number of performance units granted is based on total shareholder return during the previous three year period. Participants receive dividend equivalents on the units granted. The initial grants will be adjusted upward or downward based on total shareholder return for the subsequent three-year period. The final awards are then payable in shares of MCN common stock, 50% of which must be retained by the recipient while employed by MichCon.
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (CONCLUDED)
During February 1996, MichCon granted 122,669 performance units with a weighted-average grant date fair value of $24.625 per unit. During February 1995 and 1994, MichCon granted 191,500 and 94,700 performance units, respectively. In May 1996, MichCon modified its 1995 and 1994 performance units granted to allow limited acceleration in the vesting for a portion of the awards. As a result, the 1995 and 1994 awards also have been accounted for under the recognition provisions of SFAS No. 123 from the date of modification. The weighted average modification date fair value for both 1995 and 1994 awards was $24.875 per unit. Stock-based compensation cost recognized during 1996, 1995 and 1994 for all awards outstanding totaled $6,885,000, $7,919,000, and $4,101,000, respectively. At December 31, 1996, there were 2,773,788 MCN shares available to be issued under the Stock Incentive Plan.
INDEPENDENT AUDITORS' REPORT
Michigan Consolidated Gas Company:
We have audited the accompanying consolidated statements of financial position of Michigan Consolidated Gas Company and subsidiaries (the "Company") as of December 31, 1996 and 1995, and the related consolidated statements of income, cash flows and capitalization for each of the three years in the period ended December 31, 1996. Our audits also included the consolidated financial statement schedule listed in Item 8. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Michigan Consolidated Gas Company and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. Also, in our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information shown therein.
As discussed in Note 13 to the consolidated financial statements, in 1996 the Company adopted Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation."
DELOITTE & TOUCHE LLP Detroit, Michigan February 7, 1997
MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDARIES SUPPLEMENTARY FINANCIAL INFORMATION
Quarterly Operating Results (Unaudited)
Due to the seasonal nature of MichCon's business, revenues and net income tend to be higher in the first and fourth quarters of the calendar year.
SCHEDULE II MICHIGAN CONSOLIDATED GAS COMPANY AND SUBSIDIARIES SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS (Thousands of Dollars)
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Omitted per general instruction I (2) (c) of Form 10-K for wholly-owned subsidiaries (reduced disclosure format).
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
Omitted per general instruction I (2) (c) of Form 10-K for wholly-owned subsidiaries (reduced disclosure format).
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Omitted per general instruction I (2) (c) of Form 10-K for wholly-owned subsidiaries (reduced disclosure format).
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Omitted per general instruction I (2) (c) of Form 10-K for wholly-owned subsidiaries (reduced disclosure format).
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 10-K
(A) LIST OF DOCUMENTS FILED AS PART OF THE REPORT:
1. For a list of the financial statements included herein, see the section titled "Financial Statements and Supplementary Data", page 21 in Part II, Item 8 of this Report.
2. For the financial statement schedule included herein, see the section titled "Financial Statements and Supplementary Data", page 21 in Part II, Item 8 of this Report.
Schedules other than those referred to above are omitted as not applicable or not required, or the required information is shown in the financial statements or notes thereto.
3. Exhibits, including those incorporated by reference:
(B) REPORTS ON FORM 8-K:
None.
* Indicates document filed herewith.
References are to MichCon (File No. 1-7310) for MichCon documents incorporated by reference. References are to MCN (File No. 1-10070) for MCN documents incorporated by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.
MICHIGAN CONSOLIDATED GAS COMPANY (Registrant)
By: /s/ David R. Nowakowski -------------------------------------- David R. Nowakowski VICE PRESIDENT, CONTROLLER, TREASURER AND CHIEF ACCOUNTING OFFICER FEBRUARY 28, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the date indicated.
EXHIBIT INDEX
(B) REPORTS ON FORM 8-K:
None.
* Indicates document filed herewith.
References are to MichCon (File No. 1-7310) for MichCon documents incorporated by reference. References are to MCN (File No. 1-10070) for MCN documents incorporated by reference.