10-K 1 aes10k2001.txt FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------- FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 Commission file number 333-89725 AES Eastern Energy, L.P. (Exact name of registrant as specified in its charter) Delaware 54-1920088 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1001 North 19th Street Arlington, Virginia 22209 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 703-522-1315 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None (Title of each class) --------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ---- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [] --------------- Registrant is a wholly owned subsidiary of The AES Corporation. Registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is filing this Annual Report on Form 10-K with the reduced disclosure format authorized by General Instruction I. DOCUMENTS INCORPORATED BY REFERENCE None Item 1. Business (a) General Development of Business Our company is a Delaware limited partnership. Our company was formed on December 2, 1998 as an indirect wholly owned subsidiary of The AES Corporation to take part in the acquisition by subsidiaries of The AES Corporation of six coal-fired electricity generating stations and related assets located in the western and west central part of New York State. AES NY, L.L.C. is the sole general partner of our company and AES NY2, L.L.C. is the sole limited partner of our company. The AES Corporation owns indirectly all of the member interests in both AES NY, L.L.C. and AES NY2, L.L.C. The mailing address of our principal executive offices is 1001 North 19th Street, Arlington, Virginia 22209, telephone no. (703) 522-1315. New York State Electric & Gas Corporation and its affiliate NGE Generation, Inc. (whom we refer to collectively as "NYSEG") sold these six electricity generating stations and related assets as part of NYSEG's overall plan to divest itself of its coal-fired electricity generating assets. On May 14, 1999, twelve special purpose business trusts formed by three institutional investors that are not affiliated with us or with The AES Corporation acquired from NYSEG and leased to us the assets constituting the Somerset Generating Station ("Somerset")(formerly known as the Kintigh Generating Station) and the Cayuga Generating Station ("Cayuga")(formerly known as the Milliken Generating Station), excluding the real property on which they are located. On that date, we acquired from NYSEG the real property on which Somerset and Cayuga are located and two additional coal-fired electricity generating stations, the Westover Generating Station ("Westover")(formerly known as the Goudey Generating Station) and the Greenidge Generating Station ("Greenidge")(together with the real property upon which they are located). We leased a portion of the real property on which Somerset and Cayuga are located and a selective catalytic reduction system ("SCR"), which reduces emissions of nitrogen oxides, that was then being installed at Somerset to the special purpose business trusts, which subleased them back to us. As part of the transaction, AES NY3,L.L.C., an indirect wholly owned subsidiary of The AES Corporation that we do not control, acquired the stock of the Somerset Railroad Corporation, which owns short line railroad assets used to transport coal to Somerset. Somerset Railroad entered into a coal hauling agreement with us to transport coal. AES Creative Resources, L.P., an indirect wholly owned subsidiary of The AES Corporation that we do not control, acquired the balance of the assets that were purchased from NYSEG, consisting of two older, coal-fired electricity generating stations, the Jennison Generating Station and the Hickling Generating Station. We operate our electricity generating stations through our wholly owned subsidiaries. Westover and Greenidge are owned by our wholly owned subsidiary, AEE2, L.L.C. Our other subsidiaries do not own any of our electricity generating stations but operate them pursuant to operations and maintenance agreements with us. The agreements governing the leases of Somerset and Cayuga and our working capital credit facility impose severe restrictions on our ability to make distributions of cash or other assets to our owners and on the ability of our owners to withdraw cash or other assets from us. These restrictions are intended to assure that we have paid all of our operating and maintenance expenses and all of our obligations under our leases and under our working capital credit facility before any assets are distributed to or withdrawn by our owners. We may make a distribution to our owners on or within ten business days after a rent payment date for the Somerset and Cayuga leases so long as the following conditions are satisfied: (1) all rent under the leases for Somerset and Cayuga including deferrable payments, must have been paid to date; (2) amounts on deposit or deemed on deposit in the rent reserve account and the additional liquidity account established in connection with the pass through trust certificates issued to finance the acquisition of Somerset and Cayuga must be equal to or greater than the rent reserve account required balance or the additional liquidity required balance, as applicable; (3) no lease material default, lease event of default or event of default under any permitted indebtedness shall have occurred and be then continuing; (4) no amounts may be outstanding under the working capital credit facility; (5) we have no indemnity currently due and payable under specified provisions of the participation agreements relating to the Somerset and Cayuga leases or any other operative document or any obligation to fund the indemnity accounts (as defined in the leases) under the leases; (6) the coverage ratios for each of the two semiannual rent payment periods immediately preceding the rent payment date (based on actual operating history) must be equal to or greater than the required coverage ratio and the pro forma coverage ratios for each of the four semiannual periods immediately succeeding this rent payment date must be equal to or greater than the required coverage ratio; (7) with respect to the Somerset Railroad credit facility or any replacement facility, no event of default shall have occurred and be then continuing under the facilities and the remaining term of the Somerset Railroad credit facility or any replacement facility shall not be less than 30 days. On February 19, 2002, The AES Corporation announced that it intends to reposition itself in the electric business by fully contracting or divesting its merchant generation businesses. The AES Corporation said that it made this decision to reduce earnings volatility and strengthen its balance sheet. We are one of the merchant generating businesses. Our business could be fully contracted if we were to sign one or more long-term power sales agreements for the output of our electricity generating stations. As of the date of this Annual Report on Form 10-K, no specific proposal to fully contract or divest our operations is under consideration. We are adopting a policy of not commenting on proposed transactions and we disclaim any obligation to provide information with respect to proposed transactions until a definitive agreement has been reached. We wish to caution readers that our business and operations involve risks and uncertainties, including the following important factors. These factors should be considered when reviewing our business, financial condition, results of operations and future prospects, and are relied upon by us in issuing any forward-looking statements. Such factors could affect our actual operating results and cause such results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, us. Some or all of these factors may apply to our business as currently conducted or as we intend to conduct it. o The market in which our business is concentrated has been recently deregulated and there is no long-term historical price data that shows we will be able to sell our electric energy, installed capacity and ancillary services at prices that will permit us to pay our expenses. o We will be required to make substantial payments under our leases and other contracts and we may have difficulty responding to unforeseen requirements. o We may have difficulty meeting our payment obligations if our operations are not as successful as we have projected. o Operation of our electricity generating stations might be disrupted by: interruptions in fuel supply; disruptions in electrical transmission; facility shutdown due to breakdowns or failures of equipment or processes, violations of permit requirements, operator error or terrorist activity or other catastrophic events; or labor disputes. o Our electricity generating stations are not new and will require careful maintenance if they are to operate efficiently. o We may have trouble meeting our obligations if our electricity generating stations are not dispatched nearly continually. o The perception of the public and government officials in the markets we serve and in other deregulated markets that deregulated prices for electric energy are higher than expected may result in some degree of re-regulation of the markets in which we sell our electric energy, installed capacity and ancillary services. This re-regulation might take the form, for example, of lowering of caps on wholesale electric 2 energy prices during periods of peak demand. o The addition of new generating capacity in the New York region in excess of the amount required to meet increased demand could result in the reduction of market clearing prices in periods of peak demand, which would reduce the profitability of our operations. o An increase in the real price of coal may negatively affect our operating results. o We have only a limited operating history and we have not demonstrated that we can operate our electricity generating stations in a profitable manner on a long-term basis. o Our business is extensively regulated and new regulations may impose requirements that we are unable to meet or that require us to make additional expenditures. o We have responsibility for environmental liabilities that existed prior to our ownership of our electricity generating stations and we will incur expenses as a result. These expenses may exceed our estimates. o We may be subject to significant new restrictions on emissions which may force us to restrict our operations or incur significant expenses. o Under the Asset Purchase Agreement with NYSEG relating to the acquisition of our electricity generating stations, we have assumed liabilities of NYSEG that could result in unexpected expenses and we have given up the right to make claims for problems we may discover later. o We are controlled by The AES Corporation and The AES Corporation may pursue its own interests to the detriment of our creditors and holders of pass through trust certificates issued to finance the acquisition of Somerset and Cayuga. o The AES Corporation is not obligated to provide further funding to us if we are unable to pay our obligations. o We expect that two senior members of our management team, Dan Rothaupt and John Ruggerillo, will devote a portion of their time to other projects for The AES Corporation. o In the future we might compete with other electricity generating stations owned by The AES Corporation. (b) Financial Information About Industry Segments We operate in only one business segment, electrical generation. (c) Narrative Description of Business A diagram of the corporate structure of The AES Corporation as it relates to our company is included below: 3 The AES Corporation------------- | | AES New York AES Odyssey, L.L.C. Funding, L.L.C. | AES NY Holdings, L.L.C. | --------------------------------------------------------------- | | | | | | AES NY2, L.L.C. AES NY, L.L.C. AES, NY3, (Limited Partner) (General Partner) L.L.C. | | | | | | ------------------------------------------------- | | | | | | | | | | AES Eastern AES Creative Somerset Energy, L.P. Resources, L.P. Railroad | | Corp. | | -------------------------------- --------------- | | | | | | | | | | AES AES AEE 2, AES AES Somerset, Cayuga, L.L.C. Jennison, Hickling, L.L.C. L.L.C. | L.L.C. L.L.C. (Somerset) (Cayuga) | | ------------ | | | | AES AES Westover, Greenidge, L.L.C. L.L.C. (Westover) (Greenidge) The AES Corporation The AES Corporation, was incorporated under the laws of Delaware in 1981 and is headquartered in Arlington, Virginia. The AES Corporation is a leading global power company. Its mission is to help serve the world's need for electricity. The AES Corporation is dedicated to providing electricity worldwide in a socially responsible way. The AES Corporation is a leading global power company comprised of competitive generation, distribution, and retail supply businesses in Argentina, Australia, Bangladesh, Brazil, Canada, China, Dominican Republic, El Salvador, Georgia, Hungary, Kazakhstan, the Netherlands, Mexico, Pakistan, Panama, the United Kingdom, the United States, and Venezuela. The AES Corporation's generating assets include interests in one hundred and twenty-eight facilities totaling over 44 gigawatts of capacity. The AES Corporation's electricity distribution network has over 954,000 km of conductor and associated rights of way and sells over 114,000 gigawatt hours per year to over 15 million end-use customers. In addition, through its various retail electricity supply businesses, The AES Corporation sells electricity to over 154,000 end-use customers. The AES Corporation and its affiliates, other than our company, will not be liable for any of our obligations, including our obligations under the leases for Somerset and Cayuga. The AES Corporation and its affiliates also will not be liable for any obligations under the pass through trust certificates issued to finance the acquisition of Somerset and Cayuga or the secured lease obligation notes issued by the special purpose business trusts that own those electricity generating stations. 4 The AES Corporation's Corporate Culture A core part of The AES Corporation's corporate culture is a commitment to "shared principles." These principles describe how The AES Corporation people endeavor to behave, recognizing that they don't always live up to these standards. The principles are: Integrity--The AES Corporation strives to act with integrity, or "wholeness." The AES Corporation seeks to honor its commitments. The goal is that the things The AES Corporation people say and do in all parts of The AES Corporation should fit together with truth and consistency. Fairness--The AES Corporation wants to treat fairly its people, its customers, its suppliers, its stockholders, governments and the communities in which it operates. Defining what is fair is often difficult, but The AES Corporation believes it is helpful to routinely question the relative fairness of alternative courses of action. Fun--The AES Corporation desires that people employed by The AES Corporation and those people with whom The AES Corporation interacts have fun in their work. The AES Corporation's goal has been to create and maintain an environment in which each person can flourish in the use of his or her gifts and skills and thereby enjoy the time spent at The AES Corporation. Social Responsibility--The AES Corporation believes that it has a responsibility to be involved in projects that provide social benefits, such as lower costs to customers, a high degree of safety and reliability, increased employment and a cleaner environment. The AES Corporation recognizes that most companies have standards and ethics by which they operate and that business decisions are based, at least in part, on these principles. The AES Corporation believes that an explicit commitment to a particular set of standards is a useful way to encourage ownership of those values among its people. While the people at The AES Corporation acknowledge that they won't always live up to these standards, they believe that being held accountable to these shared values will help them behave more consistently with these principles. The AES Corporation makes an effort to support these principles in ways that acknowledge a strong corporate commitment and encourage people to act accordingly. For example, The AES Corporation conducts annual surveys, both company-wide and at each location, designed to measure how well its people are doing in supporting these principles--through interactions within The AES Corporation and with people outside The AES Corporation. These surveys are perhaps most useful in revealing failures, and helping to deal with those failures. The AES Corporation's principles are relevant because they help explain how The AES Corporation people approach The AES Corporation's business. The AES Corporation seeks to adhere to these principles, not as a means to achieve economic success but because adherence is a worthwhile goal in and of itself. In order to create a fun working environment for its people and implement its strategy of operational excellence, The AES Corporation has adopted decentralized organizational principles and practices. For example, The AES Corporation works to minimize the number of supervisory layers in its organization. Most of The AES Corporation's plants operate without shift supervisors. The project subsidiaries are responsible for all major facility-specific business functions, including financing and capital expenditures. The AES Corporation's criteria for hiring new people include a person's willingness to accept responsibility and The AES Corporation's principles as well as a person's experience and expertise. The AES Corporation has generally organized itself into multi-skilled teams to develop projects, rather than forming "staff" groups (such as a human resources department or an engineering staff) to carry out specialized functions. 5 New York Power Market The New York Independent System Operator ("ISO") commenced operations in November 1999 and consists of the ISO and the New York State Reliability Council. The ISO is a non-profit New York corporation under the Federal Energy Regulatory Commission's jurisdiction. It is governed by a board of directors with 10 members and three committees, the management committee, the operating committee, and the business issues committee, which are composed of representatives from all market participants, including buyers of power, sellers of power, consumer groups and transmission owners. The New York State Reliability Council has the primary responsibility to preserve the reliability of electricity service on the bulk power system within New York State and sets the reliability standards to be used by the ISO. The ISO operates a two-settlement system for calculating Location-Based Marginal Prices ("LBMP") of electric energy. The first settlement system is a financially binding market for delivery of electric energy on the following day and the second settlement system is the balancing market for immediate delivery of electric energy. LBMP is the incremental cost to supply load at a specific location in the grid. Locational energy price differentials represent the opportunity cost for transmission between specific locations in the grid. In July 2001, the Federal Energy Regulatory Commission directed the New York ISO and adjacent power market operators to engage in a 45-day mediation process to form one regional transmission organization for the northeastern region. The participants released a business plan on September 17, 2001. On January 28, 2002 the New York ISO and ISO New England entered into an agreement to develop a plan to establish a common market design for a regional transmission organization. We cannot predict if or when these initiatives will actually result in the creation of a regional transmission organization or what effect the creation of such an organization might have on the markets in which we do business. The New York power market is interconnected with ISO New England to the northeast, Hydro Quebec and Ontario Hydro to the north, and PJM (Pennsylvania-New Jersey-Maryland) Interconnection to the south. The transmission of electricity between states and between regions within New York State is constrained by physical limits on transmission capacity and limits on the amount of electricity that may be imported into a power pool imposed by power pools to enhance reliability. Therefore, the purchasers of generating assets in any given region have a competitive advantage in that region over generators not in the region. There is an existing natural market for the installed capacity and the electric energy of our electricity generating stations in Western New York, which includes the retail service territories of NYSEG, Niagara Mohawk Power Corporation and Rochester Gas & Electric Corporation. The existing transmission infrastructure also permits us to access neighboring markets. However, our ability to sell electric energy into neighboring markets is limited by constraints imposed by transmission capacity limitations and limits on imported electricity imposed by power pools in those markets for reliability considerations. Until April 30, 2008, our ability to sell electric energy into neighboring markets is also limited because we are required to offer to sell our electric energy in the New York market for the delivery of electric energy on the following day because we have entered into bilateral contracts for the sale of a substantial portion of our unforced capacity to load serving entities, i.e., an entity selling electric energy to consumers of electric energy, including regulated distribution utilities, municipalities and energy supply companies, in New York. At the time we acquired our electricity generating stations, we entered into a two-year agreement for energy marketing services with Merchant Energy Group of the Americas, Inc. ("MEGA"), then an Annapolis, Maryland-based subsidiary of Gener S.A. MEGA has since been sold by Gener S.A., which is now a wholly owned subsidiary of The AES Corporation. MEGA was responsible for marketing our electric energy, installed capacity and ancillary services in the deregulated New York power market. The marketing agreement between us and MEGA was terminated effective November 26, 2000. We have paid MEGA $1.6 million and made the first of an additional four payments of $225,000 each from 2002 to 2005 as part of the termination of our agreement with MEGA. We entered into an arrangement with AES Odyssey, L.L.C. ("Odyssey"), a direct wholly-owned subsidiary of The AES Corporation. This agreement commenced on November 27, 2000 and is for a term of three years. Odyssey provides data management, marketing, scheduling, invoicing and risk management services for a fee of $300,000 per month. Odyssey acts as agent on behalf of us in the over-the-counter and New York ISO markets. 6 As agent, Odyssey manages all energy transactions under our name including (i) preparing confirmations for us and approving confirmations with counter-parties, (ii) conducting monthly check-outs with counter-parties as appropriate before the preparation of invoices, (iii) invoicing counter-parties for the term of the transactions and (iv) otherwise managing and executing the terms of the transactions in accordance with their provisions. Odyssey provides data management for us by maintaining databases of pricing, load, transmission, weather and generation data to aid in analysis to optimize the value of our assets. Odyssey maintains a transaction management system to manage day-ahead commitments with the New York ISO and swap and physical values with counter-parties and to provide daily financial reporting and end of day budget variance, forward mark-to-market and commercially accepted risk analysis. New York Wholesale Electric Energy Market. Electric energy generators may sell electric energy, installed capacity and ancillary services at the wholesale level to regulated distribution utilities, municipalities and energy supply companies. Electric energy generators may also sell electric energy, installed capacity and ancillary services in the centralized wholesale market coordinated by the ISO. Competition in wholesale and retail markets has led to unbundling of and distinct markets for electric energy, installed capacity and ancillary services. Electric Energy Markets. Any generator in New York State can sell its output of electric energy to any wholesale customer statewide including utilities, municipalities, and energy supply companies. Generators can sell electric energy under bilateral contracts, with pricing and other provisions determined by two-party negotiation, or they can bid into either or both of two centralized settlement systems for electric energy, a market for delivery on the following day or a market for delivery on an immediate basis, which is intended primarily to balance actual loads and resources. The system pricing is based upon market clearing price, which is the price at which sufficient electric energy is supplied to satisfy all demand for which bids have been submitted. If a generator's bid is equal to or less than the market clearing price, the generator will be paid the market clearing price, rather than its bid price, at the point it supplies electric energy to the system and the purchaser will pay the market clearing price at the point it receives electric energy from the system. If a generator's bid exceeds the market clearing price, the generator will not be dispatched. In general, we sell the electric energy generated by our electricity generating stations directly into the spot market. On occasion, we enter into bilateral sales contracts for our electricity generating stations' electric energy. Unforced Capacity Market. A market in which electricity generators can sell commitments of their unforced generating capacity has been established to ensure there is enough generation capacity available to produce sufficient electric energy to meet retail demand and ancillary service requirements. Any load serving entity is required to procure capacity commitments sufficient to meet its capacity requirements based on its forecasted annual electric energy requirements at times of maximum usage plus a reserve requirement. Initially, each load serving entity is required to purchase unforced capacity commitments equal to 118% of its forecasted annual maximum usage (which translates into a 22% control area reserve margin). The load serving entity can secure these capacity commitments through a bilateral contract or through unforced capacity auctions. Any capacity commitment which is not procured locally needs to satisfy the requirement that, as an import, it does not violate transmission constraints. Starting with the 2001 - 2002 Winter Capability Period, the ISO implemented a revised capacity market design in the New York control area that employs unforced capacity as the measure of the capacity of a generator rather than the old measure of installed capacity. Unforced capacity factors in the probability that a generator will be available to serve load. Unforced capacity is the demonstrated maximum output of a generator(installed capacity) with a formula applied that takes into account a generator's forced outage rate over a defined period of time. 7 Suppliers of unforced capacity are not required to supply the associated electric energy to the load serving entity with whom they have a contract to provide unforced capacity. For reliability reasons, the New York ISO requires that electricity generators that sell unforced capacity into New York must make their electric energy available in the event of a system emergency. This prevents generators from entering into firm contracts to sell electric energy into one market and unforced capacity into another. If the unforced capacity supplier's offer in the electric energy market for delivery on the following day is not accepted, the unforced capacity supplier, for the next day, will be free either to offer to sell its electric energy in the market for delivery on an immediate basis or to sell electric energy to any customer, including out-of-state customers. AES NY, L.L.C. and New York State Electric & Gas Corporation entered into a New York Transition Agreement, dated as of August 3, 1998, to ease the transition of New York State Electric & Gas Corporation's native load customers' installed capacity requirements. Under this agreement, New York State Electric & Gas Corporation agreed to purchase, and AES NY, L.L.C. agreed to sell, installed capacity in the amount of 1,424MW (which is the aggregate capacity of all of the generating assets included in the assets acquired from NYSEG) for the term of the agreement. AES NY, L.L.C. assigned this agreement to us insofar as it related to our electricity generating stations. The parties performance under the agreement commenced on May 14, 1999 and terminated on April 30, 2001. Since this agreement terminated, we have entered into bilateral contracts with a number of parties for the substantial portion of our unforced capacity through April 30, 2008. Ancillary Services Market. The ISO will procure various ancillary services required for reliability from generators as needed. Services to be procured on a market basis include operating reserves and regulation and frequency support. Generators will be compensated for other services, including voltage support and black start capability, on a cost basis. OTC Swap Market. A fairly liquid over-the-counter swap market has developed in several of the ISO Zones, (1) West or Zone A, (2) East or Zone G, and (3) New York City or Zone J. A zone is a defined portion of the New York electric system that encompasses a set of load and generation buses. Each Zone has an associated zonal price that is calculated as a weighted average price. Currently New York State is divided into eleven zones, corresponding to ten major transmission interfaces that can become congested. The swaps settle against the Day Ahead LBMP for Zone A. Our plant prices are highly correlated to the Zone A price and the swaps are highly effective products for managing our price risk. Transmission System Market. Transmission lines in New York are controlled by the ISO. Transmission access is available to all market participants on a comparable and non-discriminatory basis. A party transmitting electric energy through or out of New York State pays the ISO a transmission service charge to cover the revenue requirements of the transmission owner. Electric energy sold under a bilateral contract is subject to a congestion charge. The congestion charge reflects the differences between the LBMP at the source and destination on the transmission system. Parties can hedge their exposure to congestion charges through transmission congestion contracts which are auctioned biannually. Regions. New York State has regional transmission constraints which divide the state's power market into distinct regions. The most significant transmission constraints impede the transmission of electricity going west to east. As a result, the most significant regional differences in the power market are between the western and eastern regions. The eastern region includes the service areas of the Long Island Power Authority, Key Span Energy Corporation, Consolidated Edison Company of New York, Inc., Orange & Rockland Utilities, Inc. and Central Hudson Gas & Electric Corporation. The western region includes service areas of Niagara Mohawk Power Corporation, Rochester Gas & Electric Corporation, the New York Power Authority and most of NYSEG. The western region is dominated by low cost nuclear and coal and hydro facilities which, together with non-utility generators that must be permitted to run under their power purchase agreements with local utilities, form 83% of installed capacity. The eastern region has a predominance of facilities which are economically viable only at periods of peak demand, which form 80% of its installed capacity. Even though the western region has only 40% of the New York power market's generation capacity, power normally flows from the west into the east. The flow of power from the lower priced western region to the higher priced eastern region is limited to approximately 5,000MW by transmission limits and reliability considerations. When this limit is reached, higher cost units in the New York City area are directed to run even when lower cost units in the western region are available. 8 Interconnection. Western and central New York are relatively unattractive markets for the transmission of imported power due to the low generation costs of existing facilities and low on-peak electric energy prices relative to the area's adjacent markets, ISO New England, PJM (Pennsylvania-New Jersey-Maryland) Interconnection and eastern New York. On the export side, ISO New England and PJM Interconnection forecast higher demand growth for their markets. Furthermore, the existing transmission infrastructure permits us to access these neighboring markets, subject to constraints imposed by capacity limitations and reliability considerations and subject to our obligation to offer to sell our electric energy in the New York market for the delivery of electric energy on the following day to the extent that we have sold our installed capacity to a load serving entity in New York in accordance with the rules of the New York ISO. Fuel Supply Our electricity generating stations are located in close proximity to important coal producers. In addition, both Somerset and Cayuga are equipped with flue gas desulfurization("FGD") systems allow the plant to burn less expensive medium- and high-sulfur coal while staying within sulfur dioxide ("SO2") emission regulation requirements. Coal mines in the Pittsburgh Seam coal formation near our electricity generating stations include some of the lowest cost coal supply sources producing at volume. Although more expensive low-sulfur coals are available for units without FGD systems, the high sulfur content of the coals from the Pittsburgh Seam have historically made coal-fired generating stations equipped with FGD systems the primary market for Pittsburgh Seam producers. Since both Somerset and Cayuga have installed FGD systems and are capable of burning higher sulfur coals, we expect to maintain a fuel cost advantage over competitors without FGD systems. Approximately 66% of Somerset's and approximately 50% of Cayuga's coal requirements are supplied under a contract with Consolidation Coal Company ("Consol"), under which Consol will provide coal at least through 2002. The agreement terminates on December 31, 2003 unless extended by the parties. Greenidge and Westover rely on shorter term contracts to purchase their medium-sulfur coal. The Electricity Generating Stations We believe that our two principal coal-fired electricity generating stations, Somerset and Cayuga, are operated currently at or near operating costs at which they can be run economically even at times of minimum demand for electric energy, and we expect them to be fully dispatched when available in the deregulated and competitive New York power market. As a means of further enhancing the competitive position of our electricity generating stations in the New York power market, we expect to use expertise gained by The AES Corporation as a major operator of coal-fired facilities on a worldwide basis. We also intend to make appropriate investments of capital to maintain our electricity generating stations. Somerset, Cayuga, Westover and Greenidge have an aggregate net generating capacity of 1,268MW. The Somerset Generating Station Somerset is the largest and newest of our electricity generating stations and is located northeast of Niagara Falls, alongside the southern shore of Lake Ontario near Barker, New York. There is a single operating unit, which began generating electricity in 1984. The maximum net generating capacity of Somerset is 675MW. Somerset currently operates at operating costs at which it can be run economically even at times of minimum demand for electric energy. Somerset also is capable of burning low cost medium- and high-sulfur coal as a result of being equipped with a FGD system and a selective catalytic reduction ("SCR") system. When Somerset is not being dispatched at maximum load, its periodic load can be varied to meet both system load demand and provide transmission system support and the plant can provide both operating reserves that are available immediately or on ten minutes notice. 9 The Cayuga Generating Station Cayuga is located alongside the east shore of Cayuga Lake, near the town of Lansing, New York. There are two operating units at Cayuga, Unit 1 and Unit 2, which began generating electricity in 1955 and 1958, respectively. The maximum aggregate net generating capacity of the two units is 306MW. Cayuga Unit 1 currently has a net generating capacity of 150MW. Unit 2 currently has a net generating capacity of 156MW. Cayuga historically has been operated at operating costs at which it can be run economically even at times of minimum demand for electric energy. Cayuga also is capable of burning low cost medium- and high-sulfur coal as a result of being equipped with a FGD system. When Cayuga is not being dispatched at maximum load, its periodic load can be varied to meet both system load demand and provide transmission system support, and the plant can provide both operating reserves that are available immediately or on ten minutes notice. The plant is also equipped with Automatic Generation Controls enabling it to provide regulation and frequency support. During 2001, we installed a SCR system on Unit 1, which became operational on June 7, 2001. Westover Generating Station Westover is located alongside the Susquehanna River near Johnson City, New York, and began generating electricity in the early 1900's. Units 1 through 6 have been retired and physically removed. ___ Westover presently consists of two units, Unit 7 and Unit 8, with a combined maximum net generating capacity of 126MW. Westover is capable of providing both operating reserves that are available immediately or on ten minutes notice. The station is equipped with Automatic Generation Controls, which connect it to the New York ISO power control center and enable it to provide regulation, frequency support, and when directed by the ISO, voltage support. Greenidge Generating Station Greenidge is located on the west shore of Seneca Lake adjacent to the village of Dresden, New York, and began generating electricity in 1938. Units 1 and 2 have been retired and physically removed. Greenidge presently consists of two units, Unit 3 and Unit 4, with a combined maximum net generating capacity of 161MW. Greenidge is capable of providing both operating reserves available immediately and on ten minutes notice. The station is equipped with Automatic Generating Controls, which connect it to the New York ISO power control center and enable it to provide regulation, frequency support, and, when directed by the ISO, voltage support. Regulation Energy Regulatory Matters General We and our ownership and operation of our electricity generating stations are regulated under numerous federal, state and local statutes and regulations. Among other aspects of electric generation, these statutes and regulations govern the rates that we may charge for the output of our electricity generating stations, establish in certain instances the operating parameters of our electricity generating stations, and define standards for ownership of our electricity generating stations. While there exists a strong interest at both the federal and state level to deregulate certain aspects of the electric generation industry, we currently remain subject to extensive regulation. 10 Federal Energy Regulation Federal Power Act. Under the Federal Power Act, the Federal Energy Regulatory Commission possesses exclusive rate-making jurisdiction over wholesale sales of electricity and transmission in interstate commerce. FERC regulates the owners of facilities used for the wholesale sale of electricity and transmission in interstate commerce as "public utilities" under the Federal Power Act. Pursuant to the Federal Power Act, all public utilities subject to FERC's jurisdiction are required to obtain FERC's acceptance of their rate schedules in connection with the wholesale sale of electricity. Our rate schedule was approved by FERC as a market-based rate schedule and, accordingly, FERC granted us waivers of the principal accounting, record-keeping and reporting requirements that otherwise are imposed on utilities with a cost-based rate schedule. Public Utility Holding Company Act. The Public Utility Holding Company Act ("PUHCA") provides that any corporation, partnership or other entity or organized group that owns, controls or holds power to vote 10% or more of the outstanding voting securities of a "public utility company" or a company that is a "holding company" of a public utility company is subject to regulation under PUHCA, unless an exemption is established or an order is issued by the SEC declaring it not to be a holding company. Registered holding companies under PUHCA are required to limit their utility operations to a single integrated utility system and to divest any other operations not functionally related to the operation of the utility system. In addition, a public utility company that is a subsidiary of a registered holding company under PUHCA is subject to financial and organizational regulation, including approval by the SEC of certain of its financing transactions. However, under the Energy Policy Act of 1992, a company engaged exclusively in the business of owning and/or operating a facility used for the generation of electric energy exclusively for sale at wholesale may be exempted from PUHCA regulation as an "exempt wholesale generator." On February 5, 1999, we received exempt wholesale generator status from FERC for our ownership and operation of generation and associated facilities. If, after having received this status, there is a "material change" in facts that might affect our continued eligibility for exempt wholesale generator status, within 60 days of this material change, we must (a) file a written explanation of why the material change does not affect our exempt wholesale generator status, (b) file a new application for exempt wholesale generator status or (c) notify FERC that we no longer wish to maintain exempt wholesale generator status. However, if we should lose exempt wholesale generator status, then we would either have to restructure ourselves or risk subjecting ourselves and our affiliates to PUHCA regulation. State Regulation. In New York State, recent legislation has significantly deregulated the rate setting aspects of the industry. However, significant risks remain, including, but not limited to, the potential that the state deregulation initiatives are not implemented in the manner anticipated by us or that they could be reversed or nullified. We obtained authorization from the New York State Public Service Commission for the issuance of the pass through trust certificates and the incurrence of debt pursuant to the terminated working capital credit facility with Union Bank of California, N.A. In April 2001, we have received approval of our current working capital facility. Lease Transactions Filings and Approvals. As conditions to completion of the lease transactions relating to Somerset and Cayuga, we and the appropriate financial participants in the lease transactions were required to obtain certain approvals from FERC. We obtained all of our approvals, including authorization to sell wholesale electric energy under our market-based rate schedule and related waivers and blanket authorization. We believe that the special purpose business trusts have obtained all energy-related approvals required to be obtained by them. The special purpose business trusts have been included in the approval by FERC of the transfer of jurisdictional facilities and the acquisition and leaseback of FERC-jurisdictional facilities, and FERC has granted a disclaimer of jurisdiction over each of the institutional investors and the special purpose business trusts and the trustees of those trusts as public utilities under Part II or III of the Federal Power Act. The special purpose business trusts have received determinations from FERC that they are exempt wholesale generators. The special purpose business trusts obtained a no-action letter from the SEC staff that no enforcement action would be recommended against them under PUHCA if they proceeded with the lease transactions prior to obtaining exempt wholesale generation determinations from FERC. 11 Environmental Regulatory Matters General As is typical for electric generators, our electricity generating stations are required to comply with federal, state and local environmental regulations relating to the safety and health of personnel and the public, including o the identification, generation, storage, handling, transportation, disposal, record-keeping, labeling, reporting of and emergency response in connection with hazardous and toxic materials associated with our electricity generating stations; o limits on noise emissions from our electricity generating stations; o safety and health standards, practices and procedures applicable to the operation of our electricity generating stations; and o environmental protection requirements, including standards and limitations relating to the discharge of air and water pollutants. Failure to comply with any of these statutes or regulations could have material adverse effects on us, including the imposition of criminal or civil liability by regulatory agencies or civil fines and liability to private parties, and the required expenditure of funds to bring our electricity generating stations into compliance. In addition, pursuant to the Asset Purchase Agreement with NYSEG, we (as assignee of AES NY, L.L.C.) have, with a few exceptions, agreed to indemnify NYSEG against the consequences of NYSEG's handling, storage or emission of hazardous and toxic materials on any of the sites of our electricity generating stations and the Lockwood off-site ash disposal site and for NYSEG's past non-compliance, if any, with environmental requirements. It is likely that the stringency of environmental regulations affecting us and our operations will increase in the future. In the meantime, we will monitor potential regulatory developments that may impact our operations and we will participate in rulemaking proceedings applicable to our operations when we consider it advisable to do so. We do not expect any proposed regulations to have a material adverse effect on our operations or our financial condition. On February 14, 2002, the Bush Administration issued its multi-pollutant proposal called "Clear Skies". This proposal would regulate the emission of SO2, NOx and mercury. We have not determined the effect of the Clear Skies or the other pending regulation or legislation. Expenditures. Compliance with environmental standards will continue to be reflected in our capital expenditures and operating costs. Based on the current status of regulatory requirements and other than the expenditures for the Somerset SCR system, including the construction of new landfill space to manage ash from SCR system operations, and the construction of a SCR system on Cayuga Unit 1, which became operational on June 7, 2001, and expenditures for possible installation of a SCR system on Cayuga Unit 2, the U.S. Department of Energy Power Plant Improvement project on Greenidge Unit 4 and the Westover Overfire Air Project, we do not anticipate that any capital expenditures or operating expenses associated with our compliance with current laws and regulations will have a material effect on our operations or our financial condition. See "Air Emissions--Nitrogen Oxides." Air Emissions The federal Clean Air Act and many state laws, including the laws of the State of New York, require significant reductions in utility SO2 and nitrogen oxides ("NOx") emissions that result from burning fossil fuels in order to reduce acid rain and ground-level ozone (smog). Sulfur Dioxide (SO2). SO2 emissions are regulated under Title IV of the federal Clean Air Act Amendments and by the New York Acid Deposition Control Act. One of the primary goals of Title IV of the Amendments was to reduce SO2 emissions by 10 million tons from 1980 levels. The SO2 emission reduction requirements generally apply to almost all fossil-fuel fired electric generating units producing electricity for sale. Power plants subject to Title IV are required to obtain acid rain permits, to hold sufficient emission allowances to cover their SO2 emissions, and 12 to comply with various monitoring and record-keeping requirements. The federal SO2 requirements were implemented in two phases--Phase I applies to the 110 plants listed in section 404 of the Act and Phase II generally affects all other fossil-fuel fired electric generating plants selling over 25MW to the electricity distribution grid. Phase I of the federal Clean Air Act Amendments SO2 program went into effect January 1, 1995, with Cayuga Unit 1 and Unit 2 and Greenidge Unit 4 falling under the program. Phase II went into effect January 1, 2000 and affects all the units. FGD systems are operated at both Somerset and Cayuga to reduce total SO2 emissions from these plants to quantities substantially below the Title IV SO2 "allowance" allocations for the units at these plants. An allowance is a freely transferable right to emit one ton of a substance, in this case, SO2. The excess allowances are accumulated and can either be used for our other electricity generating stations or sold to provide liquidity to us. We may sell SO2 allowances rather than save them for Phase II of Title IV of the federal Clean Air Act Amendments. During Phase II, we may need to purchase SO2 allowances to cover SO2 emissions for Greenidge and Westover. Market prices for SO2 allowances currently range from $157 to $175 per ton. We were self sufficient with respect to SO2 allowances in 2001, however it is expected that we may have a shortfall of approximately 10,000 to 13,000 SO2 allowances in 2002 assuming the units are operated at capacities similar to 2001. At current market prices, the cost could range from $1.7 million to $2.2 million to purchase sufficient SO2 allowances for 2002. On October 14, 1999, New York Governor Pataki announced a new initiative which directs the New York State Department of Environmental Conservation ("NYSDEC")to issue regulations requiring electric generators to reduce SO2 emissions by another 50% below Phase II standards. The NYSDEC issued proposed regulations in February 2002. The proposed regulations call for the new SO2 reduction regulations to be phased in starting on January 1, 2005 with implementation completed by January 1, 2008. If adopted, the proposed regulations will require further SO2 reductions at our electric generating stations and may necessitate that either additional SO2 emission controls be installed, lower sulfur coal be utilized or surplus SO2 allowances be purchased. We are not currently in a position to quantify the potential costs of complying with the proposed regulations; however, the costs of compliance could be substantial. In addition, we received an information request letter dated October 12, 1999 from the New York Attorney General which sought detailed operating and maintenance history for Westover and Greenidge. On January 13, 2000, we received a subpoena from the NYSDEC seeking similar operating and maintenance history for all four of our electricity generating stations. We have provided materials responding to the requests from the Attorney General and the NYSDEC. This information was sought in connection with the Attorney General's and the NYSDEC's investigations of several electric generation stations in New York which are suspected of undertaking modifications in the past (from as far back as 1977) without undergoing an air permitting review. Both the proposed regulations and the Attorney General's and the NYSDEC's investigations have the potential of triggering further emission reductions at our plants and possibly resulting in the necessity of installing additional emissions control equipment. On April 14, 2000 we received a request for information pursuant to Section 114 of the Clean Air Act from the United States Environmental Protection Agency ("EPA") seeking detailed operating and maintenance history data for Cayuga and Somerset. EPA has commenced an industry-wide investigation of coal-fired electric power generators to determine compliance with environmental requirements under the Clean Air Act associated with repairs, maintenance, modifications and operational changes made to coal-fired facilities over the years. The EPA's focus is on whether the changes were subject to new source review or new source performance standards, and whether best available control technology was or should have been used. We have provided the requested documentation and the EPA is currently evaluating the materials. By letter dated May 25, 2000, the NYSDEC issued a Notice of Violation (NOV) to NYSEG for violations of the Clean Air Act and the Environmental Conservation Law at Greenidge and Westover related to NYSEG's alleged failure to obtain an air permitting review for repairs and improvements made during the 1980s and 1990s, which was prior to the acquisition of the electricity generating stations by us. Pursuant to the Asset Purchase Agreement relating to the acquisition of the electricity generating stations from NYSEG, we agreed to assume responsibility for environmental liabilities that arose while NYSEG owned the electricity generating stations. On September 12, 2000, we agreed with NYSEG that we will assume the defense of and responsibility for the NOV, subject to a reservation of our right to assert applicable exceptions to our contractual undertaking to assume preexisting environmental liabilities. The financial and operational effect of this NOV is still being discussed with the DEC. We are unable to estimate the effect of this 13 NOV on our financial condition or results of future operations. It is possible that the NYSDEC NOV and other potential enforcement actions arising out of the Attorney General, NYSDEC, and EPA investigations may result in penalties and the potential requirement to install additional air pollution control equipment and could require us to make substantial expenditures. Nitrogen Oxides (NOx). New York State and the other states in the Mid-Atlantic and Northeast region are classified as the Ozone Transport Region in the federal Clean Air Act, which designates the Ozone Transport Region as being not in compliance with the ozone National Ambient Air Quality Standard. The states in the Ozone Transport Region have agreed to implement a three-phase process to reduce NOx emissions in the region in order to comply with the federal Clean Air Act Title I requirements for ozone non-compliance areas. NYSEG complied with Phase I through operational modifications to reduce NOx emissions, reduction of electric output from selected generating units to reduce emissions to cap levels, and installation of NOx reduction equipment on selected generating units. The Phase I regulations require facilities in New York State to implement NOx control requirements based on reasonably available control technology. Somerset, Cayuga, Greenidge and Westover operate under a common averaging plan, whereby the stations that emit well below the system-wide limit reduce the overall average for electricity generating stations that emit in excess of the system-wide limit. Implementation of the Phase II emission rules commenced on May 1, 1999. The Phase II NOx regulations set forth a NOx allowance allocation program which gives us 6,292 NOx emission allowances annually through 2002. Each allowance authorizes us to emit one ton of NOx during the ozone season (May 1 to September 30), beginning in 1999. To comply with the stricter emissions regulations beginning in 1999, we installed a SCR system at Somerset which became operational in June 1999. During 2001, we installed a SCR system on Unit 1 of Cayuga, which became operational on June 7, 2001. Somerset generated 2,633, 2,516 and 2,345 excess allowances in 2001, 2000 and 1999, respectively, and should continue to generate excess allowances in 2002. Cayuga accumulated approximately 600 excess allowances on Unit 1 during the 2001 ozone season. We expect that it will accumulate an equal number of excess allowances during the 2002 ozone season. A portion of our compliance strategy involves potential installation of additional NOx control technology at our electricity generating stations, and/or the selling/buying or trading of allowances. This includes trades between our electricity generating stations as needed to offset NOx emissions. During 2001, we were a net seller of NOx allowances. The current allowance allocations will allow each of our electricity generating stations to run at their planned capacity factors through 2003, when the more stringent Phase III NOX regulations are imposed. Since the final Phase III allowance allocations have not been made, it is difficult for us to predict the size of the allowance shortfall, if any, that may exist at that time. We may decide to install a second SCR system at Cayuga in order to continue operation of each of our electricity generating stations at full planned capacity factors during Phase III. We are also considering other compliance strategies and control technologies. New York Governor Pataki's October 14, 1999 initiative also directs the NYSDEC to issue regulations requiring electric generators to impose stringent NOx reduction requirements during the seven months not covered by the summertime ozone season. The NYSDEC issued proposed regulations in February 2002. The proposed regulations call for implementation the new NOx regulations to be in effect starting on October 1, 2004. If adopted, the proposed regulations have the potential to require further NOx emission reductions at our electricity generating stations and may necessitate the installation of additional emissions control equipment at certain stations. We are not currently in a position to quantify the potential costs of complying with the NOx requirements of the proposed regulations; however, the costs of compliance could be substantial. The capital cost of the Somerset SCR was $31 million. We expect that the system will operate for 20 years at which time we will need to replace the catalyst approximately every three years at an estimated cost of $4.5 million in 1999 dollars. The capital cost of the Cayuga SCR on Unit 1 was $11.2 million and it was operational on June 7, 2001. We expect that the system will operate for 20 years with catalyst replacement capital costs of $325,000 (in 2001 dollars) every four years. 14 Our electricity generating stations have generally achieved continuous compliance with the current NOx reduction requirements with the exception of a one-time violation of the facility-wide NOx emission cap in May 1998. We believe that, under the Asset Purchase Agreement with NYSEG, any penalty assessed for that exceedence would be the responsibility of NGE Generation, Inc. On October 16, 2001 Greenidge was awarded a Federal Clean Coal Grant that will fund 50% of the capital costs and 30% of the operations and maintenance costs for backend technology. This technology will include a single bed, in-duct SCR unit in combination with low-NOX combustion technology, on Greenidge Unit 4 firing on coal and biomass. It will also include a Circulating Dry Scrubber for SO2, mercury and acid gas removal. AES Greenidge L.L.C.'s share of the costs for the 54-month project will be approximately $9.8 million. Westover is also in the process of installing overfire air to control NOx. Particulates and Opacity. Each of our electricity generating stations is currently in compliance with particulate emission limits. Each of our electricity generating stations is required to meet an opacity limit. In the past, several of the plants exceeded these limits. This was a common problem at coal-fired electricity generating plants, and the New York State Department of Environmental Conservation has initiated an enforcement action against several utilities, including NYSEG. Potential fines and required actions cannot be divulged to the public until a final settlement is reached. Nevertheless, it would appear that any consent order will likely require continued operation at the current level of opacity compliance that has been achieved over the past year. In January 2000, we received a draft consent order from the NYSDEC that alleges violations of the opacity emission limitations in the air permits for Cayuga, Westover, and Greenidge occurring since our electricity generating stations were purchased from NYSEG. The draft consent order would require us to prepare an opacity compliance plan and would impose penalties for opacity violations occurring after May 14, 1999, the date of the acquisition. We expect to enter a final consent order with the NYSDEC in 2002. AES NY, L.L.C. also received notice from NYSEG that NYSEG has received a draft consent order from the NYSDEC seeking penalties primarily for opacity violations occurring prior to May 14, 1999. In the notice, NYSEG asserts that it will seek indemnification from AES NY, L.L.C. for any penalties, attorney fees, and related costs that it incurs in connection with the consent order. We and AES NY, L.L.C. have denied liability for the pre-closing violations and intend to vigorously defend this claim if NYSEG pursues litigation or arbitration. Mercury. In 2000, the EPA determined that regulation of mercury emissions from the nation's coal-fired power plants is necessary. The regulations will be developed over the coming years, with a final rule scheduled to be promulgated in December 2004, and compliance under the new rule expected for December 2007. At this point we cannot determine what the costs would be to comply with mercury control regulations. Carbon Dioxide (CO2). Environmental concerns related to the impacts of greenhouse gases (e.g., carbon dioxide, "CO2") led to the adoption in 1992 of the United Nations-sponsored Framework Convention, which was ratified by over 150 countries, including the United States. In 1993, President Clinton committed the United States to limit CO2 and other climate-altering gas emissions to their 1990 levels by the year 2000. However, it became apparent that this goal was unlikely to be met by most industrialized nations. The Kyoto Conference was called in December 1997 to expedite a global climate treaty supported by the United States. If adopted by the participating nations, any legally binding global climate treaty will have significant economic consequences for all U.S. industries, including the electricity generating industry. The Bush Administration has indicated that the United States will not implement the Kyoto Protocol. On February 14, 2002, President Bush announced his Global Climate Change Initiative which calls on U.S. industry to commit to voluntary greenhouse gas emission reductions and will directs the U.S. Department of Energy to implement an improved verifiability system for the existing voluntary emission reductions registry and the development of transferable credits for verifiable reductions. 15 Water Issues The federal Clean Water Act prohibits the discharge of any pollutant (including heat), except in compliance with a discharge permit issued by the states or the federal Environmental Protection Agency for a term of no more than five years. There is potential uncertainty with permitting issues in the future, but much of the uncertainty on these issues is industry-wide because of new regulatory requirements for cooling water discharges under the National Pollutant Discharge Elimination System program. On February 28, 2002, EPA Administrator Whitman signed a proposed rule that would impose new requirements on cooling water intake systems for existing power plants. If promulgated, the regulations could require upgrades to the cooling water intake system at one or more of our electricity generating stations to meet technology-based standards that are intended to reduce the impact on aquatic life from impingement on intake structure screens and entrainment in the intake system. We are not currently in a position to quantify the potential costs of complying with the proposed rule; however, the costs could be substantial. Our electricity generating stations and their ash disposal sites have been designed and are operated to comply with strict water and wastewater compliance standards. Groundwater protection measures include coal pile liners at all stations, lined active ash disposal sites, no active fly ash settling ponds, and a network of groundwater monitoring wells. New York State has not only technology-based effluent limitations for surface water discharges, but is one of the first states in the nation to impose more restrictive limits on wastewater discharges to ensure that very protective water quality-based standards are maintained. Our electricity generating stations have numerous wastewater treatment facilities in order to ensure compliance with these restrictive discharge limits. In addition, Somerset normally operates in a zero process wastewater discharge mode, reusing wastewater for various plant processes. Similarly, the ash disposal sites must comply with both technology and water quality-based discharge limits. Where necessary, lime treatment is employed to remove metals from ash site wastewater prior to discharge. Hazardous Material and Wastes The electric utility industry typically uses and/or generates in its operations a range of potentially hazardous products and by-products. We have identified a number of site remediation issues at our electricity generating stations. Under the terms of the Asset Purchase Agreement, NYSEG will retain pre-closing off-site environmental liabilities associated with our electricity generating stations (other than liabilities arising from the Weber and Lockwood ash disposal sites), but we will assume responsibility for contamination at our electricity generating stations and at the Lockwood ash disposal site. We have budgeted $9.8 million for the cost for environmental liabilities at our electricity generating stations (excluding closure and post-closure costs for the Weber and Lockwood ash disposal sites), based on estimates of environmental consultants retained by NYSEG and The AES Corporation. We have budgeted approximately $6 million for closure and post-closure (monitoring and maintenance) expenses for the Lockwood ash disposal site, based solely on amounts previously budgeted for these activities by NYSEG. AES Creative Resources, L.P. assumed responsibility for the Weber ash disposal site. Our subsidiary, AEE2, L.L.C., has contributed one-half of the closure costs for the Weber ash disposal site based on the amount of ash disposed at the site from Westover and Greenidge, which are owned by AEE2, L.L.C., compared to the amount disposed from the Hickling Generating Station("Hickling") and the Jennison Generating Station("Jennison"), which were acquired by AES Creative Resources, L.P. In October 1999, AES Creative Resources, L.P. entered into a consent order with the NYSDEC to resolve alleged violations of the water quality standards in the groundwater downgradient of the Weber ash disposal site. The consent order included a suspended $5,000 civil penalty and a requirement to submit a work plan to initiate closure of the landfill by October 8, 2000. The consent order also called for a site investigation, which was conducted and indicated that there is a possibility that some groundwater remediation at the site may be required. Further compliance with this order included a Closure Investigation Report which was submitted to the NYSDEC in the spring of 2000, and a Closure Plan which was submitted to the NYSDEC in January 2001. 16 The Closure Plan was implemented in December 2001 when capping of the site was completed. Minor site maintenance will be required in the spring of 2002. AEE2, L.L.C. contributed one-half of the costs to close the landfill, which were approximately $2 million, and it will contribute additional costs for long-term groundwater monitoring. Nevertheless, if a groundwater remediation is required, these costs have not been budgeted, and AEE2, L.L.C. may be responsible for a portion of such costs. These projected environmental cost estimates are not a guarantee that additional environmental liabilities will not be incurred, and it is possible that the actual costs could be significantly higher. In addition, it is possible that previously unknown environmental conditions will be discovered in the future. We expect to develop a new area, Area 3, of the on-site landfill located at Somerset to contain ammonia-contaminated fly ash produced during operation of the SCR system and stabilized sludge produced during simultaneous operation of the FGD system. As designed, Area 3 will comply with modern landfill design and performance standards. On April 26, 1999, the New York State Board on Electric Generation Siting and the Environment approved the plan to use Area 3, subject to approval by the NYSDEC of more detailed design submissions. The NYSDEC has defined non-ammoniated waste material to contain less than 0.5 parts per million of ammonia. Most of the fly ash generated during operation of the SCR at Somerset qualifies as non-ammoniated. The NYSDEC approved disposal of non-ammoniated waste material generated during the operation of the SCR system in an existing area of the landfill, Area 1. We are working with the NYSDEC to complete an approved design for the Area 3 expansion. The existing Cayuga on-site landfill currently complies with modern landfill design and performance standards and will receive any ammonia-contaminated fly ash or ammoniated sludge produced during operation of the SCR system on Unit 1. The Somerset landfill is under the jurisdiction of the Public Service Commission. NYSEG's original compliance filing with the Public Service Commission in 1983 provided that the landfill would be constructed in a 200 acre section of the site, which NYSEG divided into three areas (Areas 1, 2, and 3). The landfill was designed to comply with the then-existing solid waste landfill standards of the NYSDEC. Each area was to receive a separate landfill unit lined with a low permeability material, usually clay. However, the first 17-acre section of Area 1 of the landfill was lined with compacted soil only. Only Area 1 was used by NYSEG. The Area 1 landfill has been expanded seven times during the years since 1983. When a portion of Area 1 reaches the maximum allowable elevation (130 feet), it is "capped" by adding compacted soil and planting ground cover. The entire process is meant to be self-implementing, with little input from the Public Service Commission unless there is a problem or a change in design or operation. In the period since the original approval of the Somerset landfill, the NYSDEC has modified its solid waste landfill regulations extensively. As a result of these changes, these regulations currently allow construction or expansion of landfills only with low permeability liners and sophisticated leachate collection systems, and impose higher standards for capping and closing solid waste facilities. Natural groundwater conditions present at the Somerset site make it very difficult to distinguish between landfill leachate and naturally occurring substances in the groundwater. Substances that are typically considered indicators of leachate infiltration into groundwater from ash monofill operations, namely sulfates, iron and manganese, are also naturally occurring in the groundwater around and beneath Area 1. NYSEG commissioned independent consultants to perform groundwater testing using sophisticated geochemical fingerprinting techniques, which distinguish the major ions of a water sample. NYSEG's consultants have shown, to the satisfaction of the Public Service Commission, that there has been no material release of leachate from Area 1 into the groundwater. In April 1999, the NYSDEC and the Public Service Commission negotiated a Memorandum of Understanding that clarifies their respective roles with respect to the regulation of the Somerset landfill. According to the Memorandum of Understanding, the Public Service Commission's decisions will continue to control all aspects of Areas 1 and 2 of the landfill, but the Public Service Commission must defer to current and future NYSDEC regulations, standards and policies with respect to the development, use and closure of Area 3. The Memorandum of Understanding was approved by the New York State Board on Electric Generation Siting and the Environment and was incorporated as part of the April 26, 1999 amendment to the Certificate of Environmental Compatibility for Somerset that we received in connection with installation of the SCR. 17 Factors which could cause actual costs of disposal in Areas 1, 2 and 3 to vary include, but are not limited to, adoption of more stringent solid waste landfill regulations by the NYSDEC, the discovery of groundwater contamination from Area 1, and escalation of the costs of landfill development. Exceedences of state groundwater standards at Cayuga were reported in the vicinity of the coal pile area, the coal pile runoff pond, and the ash disposal site. In 1997, a new liner was installed under the coal pile, which brought Cayuga within state groundwater standards. In an area adjacent to the Lockwood ash disposal site, our environmental consultant reported that approximately 500 to 700 drums of abrasives were disposed in the early 1970s and covered with ash. We have budgeted $520,000 to conduct a site investigation and remove the drums. In addition, groundwater sampling in this area and around the Lockwood ash disposal site indicates that some monitoring wells have parameters which exceed state regulatory limits. As noted above, we have budgeted $6 million in closure and post-closure (monitoring and maintenance) costs for the Lockwood ash disposal site. In 2000, the EPA confirmed that ash disposed of in landfills should be regulated as non-hazardous waste. Nevertheless, the EPA determined that additional solid waste regulations will be developed for coal ash disposal in landfills and surface impoundments. At this point, we cannot determine whether such new regulations will have an impact on our ash disposal practices. Noise Noise emissions from our electricity generating stations are regulated pursuant to New York law which establishes different acceptable noise levels based upon the nature of the neighboring property uses, with the lowest being noise standards that must be met at residential properties. In general, compliance with noise standards is not a material concern with respect to our electricity generating stations. The Certificate of Environmental Compatibility that was issued to NYSEG in 1978 for the development and operation of Somerset contains a number of requirements for mitigating environmental impacts from the facility, including noise impacts. Among the noise requirements was an obligation to obtain noise easements from neighboring landowners or, as subsequently approved by the Public Service Commission, to purchase their property in a buffer zone where noncompliance with noise standards was expected to occur. Subsequent analyses predicted that these exceedences would occur only in connection with ash disposal operations when Area 2 of the Somerset landfill was constructed. Prior to the acquisition of our electricity generating stations, NYSEG had purchased neighboring properties for a combined cost totaling approximately $1.5 million and had a standing offer to purchase the remainder. We obtained an appraisal of the remaining properties which places their aggregate current value at approximately $3.1 million. We have not budgeted any amount for the acquisition of these properties. The Public Service Commission has also required that a noise mitigation plan be developed and submitted for Public Service Commission approval at least one year prior to commencement of Area 2 development. The Public Service Commission could require additional noise control measures at that time. We do not expect that the noise compliance costs we may incur, including as a result of taking over the land purchase program, will be material. People As of December 2001, we employed 259 people who operate our electricity generating stations. The International Brotherhood of Electrical Workers (the "IBEW") represents hourly labor at Somerset, Cayuga, Westover and Greenidge. The IBEW represents approximately 240 workers. We have negotiated collective bargaining agreements with respect to each electricity generating station, on an individual electricity generating station basis. This gives us continuing labor harmony and encourages the adoption of The AES Corporation's culture by emphasizing individual businesses with responsibility and ownership of local issues. We believe that relations with the people employed at our electricity generating stations are satisfactory. 18 Item 2. Properties The following table shows the material properties which we or our subsidiaries own or lease. See "Business--The Electricity Generating Stations" for more information about these properties.

------------------------ * We own all of the land on which Somerset and Cayuga are located and we lease the portion on which the facilities of those stations are located to the special purpose business trusts that own those facilities. We lease the facilities of those stations and sublease the land on which they are located from the special purpose business trusts. Item 3. Legal Proceedings We received an information request letter dated October 12, 1999 from the New York Attorney General which sought detailed operating and maintenance history for Westover and Greenidge. On January 13, 2000, we received a subpoena from the NYSDEC seeking similar operating and maintenance history for all four of our electricity generating stations. We have provided materials responding to the requests from the Attorney General and the Department of Environmental Conservation. This information was sought in connection with the Attorney General's and the Department of Environmental Conservation's investigations of several electricity generating stations in New York which are suspected of undertaking modifications in the past (from as far back as 1977) without undergoing an air permitting review. On April 14, 2000 we received a request for information pursuant to Section 114 of the Clean Air Act from the EPA seeking detailed operating and maintenance history data for Cayuga and Somerset. The EPA has commenced an industry-wide investigation of coal-fired electric power generators to determine compliance with environmental requirements under the Clean Air Act associated with repairs, maintenance, modifications and operational changes made to coal-fired facilities over the years. The EPA's focus is on whether the changes were subject to new source review or new source performance standards, and whether best available control technology was or should have been used. We have provided the requested documentation and the EPA is currently evaluating the materials. By letter dated May 25, 2000, the NYSDEC issued a Notice of Violation (NOV) to NYSEG for violations of the Clean Air Act and the Environmental Conservation Law at Greenidge and Westover related to NYSEG's alleged failure to obtain an air permitting review for repairs and improvements made during the 1980s and 1990s, which was prior to the acquisition of the electricity generating stations by us. Pursuant to the Asset Purchase Agreement relating to the acquisition of the electricity generating stations from NYSEG, we agreed to assume responsibility for environmental liabilities that arose while NYSEG owned the electricity generating stations. On September 12, 2000, we agreed with NYSEG that we will assume the defense of and responsibility for the NOV, subject to a reservation of our right to assert applicable exceptions to our contractual undertaking to assume preexisting environmental liabilities. The financial and operational effect of this NOV is still being discussed with the NYSDEC. We are unable to estimate the effect of this NOV on our financial condition or results of future operations. 19 It is possible that the NYSDEC NOV and other potential enforcement actions arising out of the Attorney General, NYSDEC, and EPA investigations may result in penalties and the potential requirement to install additional air pollution control equipment and could require us to make substantial expenditures. In January 2000, we received a draft consent order from the NYSDEC that alleges violations of the opacity emission limitations in the air permits for Cayuga, Westover, and Greenidge occurring since we acquired our electricity generating stations from NYSEG. The draft consent order would require us to prepare an opacity compliance plan and would impose penalties for opacity violations occurring after May 14, 1999, the date of the acquisition. We expect to enter a final consent order with the NYSDEC in 2002. AES NY, L.L.C. also received notice from NYSEG that NYSEG has received a draft consent order from the NYSDEC seeking penalties primarily for opacity violations occurring prior to May 14, 1999. In the notice, NYSEG asserts that it will seek indemnification from AES NY, L.L.C. for any penalties, attorney fees, and related costs that it incurs in connection with the consent order. We and AES NY, L.L.C. have denied liability for the pre-closing violations and intend to vigorously defend this claim if NYSEG pursues litigation or arbitration. Item 4. Submission of Matters to a Vote of Security Holders Not applicable. 20 PART II Item 5. Market for our Company's Common Equity and Related Stockholder Matters All outstanding equity interests in our company are owned indirectly by The AES Corporation. Item 6. Selected Financial Data

SELECTED QUARTERLY FINANCIAL DATA The following table summarizes the quarterly consolidated statements of income (in thousands):

21 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations General The information in this Management's Discussion and Analysis should be read in conjunction with the accompanying consolidated financial statements, the related Notes to the Financial Statements and the selected financial data. Forward looking statements in this Management's Discussion and Analysis are qualified by the cautionary statement in the Forward Looking Statements section of the Management's Discussion and Analysis. All four of our electricity generating stations operate as merchant plants, which means that we will sell their output in power pool spot market transactions or in transactions negotiated from time to time directly with another party rather than selling the output under a long-term power sales contract. As merchant plants, our electricity generating stations generally will be dispatched, that is, they will supply electricity, whenever the market price of electricity exceeds their variable cost of generating electricity. Our revenue and income will be directly affected by the price of electricity, which is usually highest during the summer and winter peak seasons. On February 19, 2002, The AES Corporation announced that it intends to reposition itself in the electric business by fully contracting or divesting its merchant generation businesses. The AES Corporation stated that it made this decision to reduce earnings volatility and strengthen its balance sheet. We are one of the merchant generating businesses. Our business could be fully contracted if we were to sign one or more long-term power sales agreements for the output of our electricity generating stations. As of the date of this Annual Report on Form 10-K, no specific proposal to fully contract or divest our operations is under consideration. We are adopting a policy of not commenting on proposed transactions and we disclaim any obligation to provide information with respect to proposed transactions until a definitive agreement has been reached. The economics of any electric power facility are primarily a function of the price of electricity, the quantity of electricity which is purchased and the level of operating expenses. The greater the percentage of time a unit is dispatched, the greater the revenues associated with that unit. The markets for wholesale electric energy, unforced capacity and ancillary services in the New York power market were largely deregulated in November 1999. In a competitive market where the order in which electricity generating plants are dispatched will be based on bids for the sale of electric energy by the generating assets in the region, we expect that the lower marginal cost facilities will bid lower prices and therefore those facilities will be dispatched more often than higher marginal cost facilities. We believe that our electricity generating stations are among the lowest variable cost facilities in the New York power market. We also believe that our electricity generating stations are among the most efficient coal units in the region. We expect that our electricity generating stations will almost always be dispatched. The efficiency of our electricity generating stations provides several important advantages: a stable pricing structure, the ability to benefit from energy price spikes in the market and relatively little risk that our electricity generating stations will be idle while other generating stations are directed to run. Our electricity generating stations have historically been available to run a high percentage of the time due to the regulated utility-grade nature of their design and construction. In 2001, 2000 and 1999, the stations had a weighted average (based on capacity) equivalent availability factor of 96%, 94% and 97%, respectively (excluding the outages at the Somerset and Cayuga from May to June 1999 and from April to June 2001, respectively). Based upon the historical experience of The AES Corporation, we believe that we can maintain or improve the availability of our electricity generating stations. We believe that we will also have opportunities to derive revenue from sales of unforced capacity and ancillary services. Under the terms of the capacity purchase agreement with NYSEG, NYSEG purchased all of our 1,268MW of installed capacity at a price of $68 per MW-day through April 30, 2001. During the term of the capacity purchase agreement, the rules of the New York ISO system required us to offer to sell our electric energy in the New York market for delivery of electric energy on the following day. Since termination of the capacity purchase agreement with NYSEG on April 30, 2001, we are permitted to sell electric energy and unforced capacity into other markets. See "Business--New York Power Market." 22 NYSEG has brought a proceeding to obtain a refund of real estate taxes it paid in connection with Somerset while NYSEG owned it. NYSEG had little incentive to contest the tax valuation of its electricity generating stations while it owned them because the real property taxes it paid were included among the expenses it was permitted to recover through regulated electricity rates and were therefore passed along to its customers. We had identified real estate taxes as a potential area for cost savings. If NYSEG is successful in obtaining substantial refunds of prior real estate taxes, our potential savings may be to some extent nullified because the local governments may be forced to raise real estate tax rates to bring revenues into balance with expenditures. It is too early to tell what impact, if any, this will have on our financial condition and results of operations. Significant Accounting Policies General We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The significant accounting policies which we believe are most critical to understanding and evaluating our reported financial results include the following: Revenue Recognition; Property, Plant and Equipment, Contingencies and Derivatives. Revenue Recognition Revenues from the sale of electricity are recorded based upon output delivered and rates specified under contract terms. Revenues generated from commodity forwards, swaps and options, which are entered into for the hedging of forecasted sales, are recorded based on settlement accounting with the net amount received recognized as revenue. Revenues for ancillary and other services are recorded when the services are rendered. Property, Plant and Equipment Electric generation assets that existed at the date of acquisition (see Note 3) are recorded at fair market value. Somerset and Cayuga, which represent $650 million of the electric generation assets, are subject to a leasing arrangement accounted for as a financing (see Note 6). Additions or improvements thereafter are recorded at cost. Depreciation is computed using the straight-line method over the 34-year and 28-year lease terms for Somerset and Cayuga, respectively, and over the estimated useful lives for the other fixed assets, which range from 7 to 35 years. A significant decrease in the estimated useful life of a material amount of our property, plant or equipment could have a material adverse impact on our operating results in the period in which the estimate is revised and subsequent periods. Maintenance and repairs are charged to expense as incurred. Contingencies We accrue for loss contingencies when the amount of the loss is probable and estimable. We are subject to various environmental regulations, and we are involved in certain legal proceedings. If our actual environmental and/or legal obligations are materially different from our estimates, the recognition of the actual amounts may have a material impact on our operating results and financial condition. Derivatives On January 1, 2001, we adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which, as amended, established new accounting and reporting standards for derivative instruments and hedging activities. SFAS 133 requires that all derivatives (including derivatives embedded in other contracts) be recorded as either assets or liabilities at fair value on the balance sheet. Changes in the derivative's fair value are to be recognized in earnings in the period of change, unless hedge accounting criteria are met. Hedge accounting allows the derivative's gains or losses in fair value to offset the related results of the hedged item. We utilize derivative financial instruments to manage commodity price risk. Although the 23 majority of our derivative instruments qualify for hedge accounting, the adoption of SFAS No. 133 will result in more variation to our results of operations from changes in commodity prices. For the year ended December 31, 2001, we recognized $29.5 million of losses pursuant to SFAS No. 133 related to derivatives which did not qualify for hedge accounting. See Note 7 to the consolidated financial statements for a more complete discussion of the accounting for derivatives under SFAS No. 133. Results of Operations --------------------- (Amounts in Millions)

The increase in Energy Revenues from 2000 to 2001 is primarily due to higher market prices in the first half of the year and higher operating levels during that time. These were offset by a major maintenance outage at Cayuga of approximately 45 days for Unit 1 in 2001. We scheduled this outage to avoid expected seasonal peaks in demand for electric energy. The increase in Energy Revenue in the year ended December 31, 2000 compared to the period from May 14, 1999 (inception) to December 31, 1999 was primarily due to a full year of operations combined with higher energy prices. The decrease in Capacity Revenue from 2000 to 2001 is primarily due to the expiration of a long term capacity purchase agreement with NYSEG in April 2001. Capacity sales on the open market for the remainder of the 2001 period were at lower rates. The increase in Capacity Revenue in the year ended December 31, 2000 compared to the period from May 14, 1999 (inception) to December 31, 1999 was due to a full year of operations. The Transmission Congestion Contract is essentially a swap between the congestion component of the locational prices posted by the New York ISO in western New York and the more populated areas in eastern New York. The Transmission Congestion Contract became effective on November 1, 2000 and terminates on October 1, 2004. We entered into this agreement because it provided a reasonable settlement for resolving a FERC dispute between us and Niagara Mohawk Power Corporation. This contract is not deemed to be a hedge based on the definitions in SFAS 133. Therefore, this contract is marked to market at the end of every period. The mark-to-market value is computed based on a regression of historical eastern and western locational prices. This regression is used with forecasted eastern and western locational prices to calculate the forward congestion for the remainder of the contract term. This accounting treatment contributes to the income statement volatility of this contract.

24 The increase in Operating Expenses from 2000 to 2001 is primarily due to higher operating levels in the first half of the year, which necessitated greater coal usage, greater coal purchases on the spot market and higher operating and maintenance expenditures. These increases were partially offset by the decrease in general and administrative expenses. The increase in Operating Expenses in the year ended December 31, 2000 and the period from May 14, 1999 (inception) to December 31, 1999 was due to a full year of operations. In addition, Somerset incurred fixed charges during 2000 with respect to the Niagara Mohawk Power Corporation transmission agreement of $6.1 million.

As a result of our failure to complete an exchange offer for the pass through trust certificates on or prior to November 10, 1999, the pass through trust certificates accrued additional interest at the rate of 0.50% per annum from November 10, 1999 until March 27, 2000, when we completed an exchange offer for the pass through trust certificates. We paid approximately $229,000 additional interest per month until we completed the exchange offer on March 27, 2000. Liquidity and Capital Resources The leases for Somerset and Cayuga require that we make fixed semiannual payments of rent on each January 2 and July 2 during the terms of the leases commencing on January 2, 2000 in amounts calculated to be sufficient (1) to pay principal and interest when due on the secured lease obligation notes issued by the special purpose business trusts that own and lease to us Somerset and Cayuga and (2) to pay the economic return of the institutional investors that formed the special purpose business trusts. Our minimum rent obligation under the leases is $62.6 million for 2002, $57.6 million for 2003, $63.5 million for 2004, $59.5 million for 2005, $61.6 million for 2006 and a total of $1,314.7 million for the years thereafter. For purposes of the minimum rent obligations described in the preceding sentence, we treated the semiannual rent payments that are due on January 2 of each year as though they would be paid in the preceding year. You can find information concerning our minimum rental obligations that treats rent payments as obligations for the years in which they are due in note 6 of our audited financial statements which are included in this Annual Report on Form 10-K. Through January 2, 2017 and so long as no lease event of default exists, we may defer payment of rent obligations under each lease in excess of the amount required to pay principal and interest on the secured lease obligation notes until after the final scheduled payment date of the secured lease obligation notes. In addition, we are required to maintain a rent reserve account equal to the maximum semiannual payment with respect to the sum of basic rent (other than deferrable basic rent) and fixed charges expected to become due on any one basic rent payment date in the immediately succeeding three-year period. At December 31, 2001, 2000 and 1999, the amounts deposited in the rent reserve account were $31.7 million, $31.0 million and $29.5 million, respectively. We will also be obligated to make payments under the coal hauling agreement with Somerset Railroad in an amount sufficient, when added to funds available from other sources, to enable Somerset Railroad to pay, when due, all of its operating expenses and other expenses, including interest on and principal of outstanding indebtedness. On August 14, 2000, Somerset Railroad entered into a $26 million credit facility with Fortis Capital Corp. which replaced in its entirety a credit facility for the same amount previously provided to Somerset Railroad by an affiliate of CIBC World Markets. The new credit facility provided by Fortis Capital Corp. consists of a 14-year term note (maturing on May 6, 2014), with principal and interest payments due quarterly. As a result of these obligations, we must dedicate a substantial portion of our cash flow from operations to payments of rent under the leases, payments under our working capital facility and payments under the coal hauling agreement with Somerset Railroad, which in turn allow Somerset Railroad to pay principal and interest under its credit facility with Fortis Capital Corp. 25 We incurred approximately $17.1 million, $20.7 million and $64.2 million in capital expenditures with regard to our assets for the years ended December 31, 2001, 2000 and 1999, respectively. These amounts include approximately $11.2 million for a SCR system to reduce NOx emissions at Cayuga which was operational June 7, 2001. We will make capital expenditures thereafter according to the maintenance program for our electricity generating stations. In addition to capital requirements associated with the ownership and operation of our electricity generating stations, we will have significant fixed charge obligations in the future, principally with respect to the leases. Compliance with environmental standards will continue to be reflected in our capital expenditures and operating costs. Based on the current status of regulatory requirements and, other than the expenditures for the SCRs at Somerset and Cayuga, including the construction of new landfill space to manage ash from Somerset's SCR system operations, and the construction of a SCR system on Cayuga Unit 1, which became operational on June 7, 2001, and expenditures for possible installation of a SCR system on Cayuga Unit 2, the U.S. Department of Energy Power Plant Improvement project on Greenridge Unit 4 and the Westover Overfire Air Project, we do not anticipate that any capital expenditures or operating expenses associated with our compliance with current laws and regulations will have a material effect on our results of operations or our financial condition. See "Business--Regulation--Environmental Regulatory Matters." Our net working capital at December 31, 2001, 2000 and 1999 was $80.0 million, $84.2 million and $46.8 million, respectively. During 1999 and 2000, we made two borrowings under a Credit Suisse First Boston working capital credit facility. The first borrowing was from August 25, 1999 to September 13, 1999 in the amount of $5 million and bore interest at the rate of 9.25% per annum. The second borrowing was from July 18, 2000 to July 25, 2000 in the amount of $8 million and bore interest at the rate of 8.375% per annum. At March 9, 2001, our $20 million Credit Suisse First Boston working capital credit facility was terminated. In April 2001, we entered into a $35 million secured revolving working capital and letter of credit facility with Union Bank of California, N.A. This facility has a term of approximately twenty-one months. We can borrow up to $35 million for working capital purposes under this facility. In addition, we can have letters of credit issued under this facility up to $25 million, provided that the total amount of working capital borrowings and letters of credit issuances may not exceed the $35 million limit on the entire facility. Since the new facility was signed there have been two borrowings. The first borrowing was for $7 million on July 13, 2001 at an interest rate of 8.125%. The borrowing was repaid on July 31, 2001. The second borrowing was for $8.5 million on January 11, 2002 at an interest rate of 6.125%. The borrowing was repaid in full on February 28, 2002. The outage at Cayuga for almost the entire period from March 31, 2001 to June 4, 2001 did not impair our ability to meet our obligations during this period. Similarly, the outage at Somerset for almost the entire period from May 14, 1999 to June 30, 1999 did not impair our ability to meet our obligations during this period. Subsequent to these outages, our four electricity generating stations are all available for service and are being dispatched to generate electricity when market conditions warrant. Cash flow from our operations was sufficient to cover aggregate rental payments under the leases for Somerset and Cayuga on the rent payment dates of January 2, 2000, July 2, 2000, January 2 2001, July 2, 2001 and January 2, 2002. We believe that cash flow from our operations will be sufficient to cover aggregate rental payments on each rent payment date thereafter. We also believe that our cash flow from operations, together with amounts we can borrow under our $35 million working capital and letter of credit facility with Union Bank of California, N.A., will be sufficient to cover expected capital requirements over the terms of the leases. If we are required to make unanticipated capital expenditures, our cash flow from operations and operating income in the period incurred might be reduced. Our future ability to obtain additional debt financing for working capital, capital expenditures or other purposes is limited by financial covenants restricting our ability to incur debt and liens contained in the agreements governing the leases of Somerset and Cayuga. With certain exceptions, these agreements limit us to a maximum of $100,000,000 of indebtedness, including no more than $25,000,000 of indebtedness for purposes other than to provide working capital. 26 Our ability to make distributions to the partners of our company is restricted by the terms of the agreements governing the leases for Somerset and Cayuga. We may make distributions only on or within ten days after a semiannual rent payment date and only if all rent on the leases has been paid, the reserve accounts for lease payments that we are required to maintain are fully funded and other conditions are satisfied. See "Business--General Development of Business." The AES Corporation contributed approximately $9.3 million to us in 2001. The contribution was accounted for as a partner's contribution and was related to the construction of the SCR on Unit 1 of Cayuga, which became operational on June 7, 2001. Credit Rating Discussion Credit ratings affect our ability to execute our commercial strategies in a cost-effective manner. In determining our credit rating, the rating agencies consider a number of factors. Quantitative factors that appear to have significant weight include, among other things, earnings before interest, taxes and depreciation and amortization ("EBITDA"); operating cash flow; total debt outstanding; fixed charges such as interest expense, lease payments; liquidity needs and availability and various ratios calculated from these factors. Qualitative factors appear to include, among other things, predictability of cash flows, business strategy, industry position and contingencies. Trigger Events Our commercial agreements typically include adequate assurance provisions relating to trade credit and some agreements have credit rating triggers. These trigger events typically would give counterparties the right to suspend or terminate credit if our credit ratings were downgraded. Under such circumstances, we would need to post collateral to continue transacting risk-management business with many of our counterparties under either adequate assurance or specific credit rating trigger clauses. The cost of posting collateral would have a negative effect on our profitability. If such collateral was not posted, our ability to continue transacting business as before the downgrade would be impaired. Forward-looking Statements Certain statements contained in this Annual Report on Form 10-K are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements speak only as of the date hereof. Forward-looking statements can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "intends," "will," "should" or "anticipates" or the negative forms or other variations of these terms or comparable terminology, or by discussions of strategy. Future results covered by the forward-looking statements may not be achieved. Forward-looking statements are subject to risks, uncertainties and other factors which could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. The most significant risks, uncertainties and other factors are discussed under the heading "Business--General Development of Business" in this Annual Report on Form 10-K, and you are urged to consider carefully such factors. 27 Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks associated with commodity prices. We often utilize financial instruments to hedge against such fluctuations. We utilize financial and commodity derivatives for the purpose of hedging exposures to market risk. We generally do not enter into derivative instruments for trading or speculative purposes. We are exposed to the impact of market fluctuations in the price of electricity and coal. Our current and expected future revenues are derived from wholesale energy sales without significant long-term revenue or supply contracts. Our results of operations are subject to the volatility of electricity and coal prices in competitive markets. We hedge certain aspects of our "net open" positions. We have used a hedging strategy, where appropriate, to hedge our financial performance against the effects of fluctuations in energy commodity prices. The implementation of this strategy involves the use of commodity forward contracts, swaps and options. In 2000, we adopted a value at risk (VaR) approach to assess and manage risk. VaR measures the potential loss in a portfolio's value due to market volatility, over a specified time horizon, stated with a specific degree of probability. The quantification of market risk using VaR provides a consistent measure of risk across diverse markets and instruments. The VaR approach was adopted because we feel that statistical models of risk measurement, such as VaR, provide an objective, independent assessment of our risk exposure. The use of VaR requires a number of key assumptions, including the selection of a confidence level for expected losses, the holding period for liquidation and the treatment of risks outside the VaR methodology, including liquidity risk and event risk. VaR, therefore, is not necessarily indicative of actual results that may occur. The use of VaR allows us to compare risk on a consistent basis and identify the drivers of risk. Because of the inherent limitations of VaR, including those specific to the variance/covariance approach, specifically the assumption that values or returns are normally distributed, we rely on VaR as only one component in our risk assessment process. In addition to using VaR measures, we perform stress and scenario analyses to estimate the economic impact of market changes on the value of our portfolios. These results are used to supplement the VaR methodology. We perform our VaR calculation using a model based on the variance/covariance methodology with a delta gamma model for optionality. We express VaR as a dollar amount of the potential loss in the fair value of our portfolio based on a 95% confidence level and a one-day holding period. Our daily VaR for commodity price sensitive instruments as of December 31, 2001, 2000 and 1999 was $6.2 million, $5.5 million and $2.4 million, respectively. These amounts include the financial instruments that serve as hedges and do not include the underlying physical assets. During 2001, the daily VaR amount was greater than the year-end amount on June 29, 2001 and September 28, 2001. At no date during 2000 or 1999 was the daily VaR amount greater than it was at year-end. Item 8. Financial Statements and Supplementary Data The following financial statements are attached to this Annual Report on Form 10-K following the signature page: AES EASTERN ENERGY, L.P. Independent Auditors' Report Financial Statements: Consolidated Balance Sheets as of December 31, 2001 and 2000 Consolidated Statements of Income for the years ended December 31, 2001 and 2000 and for the period from May 14, 1999 (inception) through December 31, 1999 Consolidated Statements of Changes in Partners' Capital for the years ended December 31, 2001 and 2000 and for the period from May 14, 1999 (inception) through December 31, 1999 Consolidated Statements of Cash Flows for the years ended December 31, 2001 and 2000 and for the period from May 14, 1999 (inception) through December 31, 1999 Notes to Consolidated Financial Statements 28 AES NY, L.L.C. (General Partner of AES Eastern Energy, L.P.)* Independent Auditors' Report Financial Statements: Consolidated Balance Sheets as of December 31, 2001 and 2000 Notes to Consolidated Balance Sheets * The Consolidated Balance Sheets of AES NY, L.L.C. contained in this Annual Report on Form 10-K should be considered only in connection with its status as the general partner of AES Eastern Energy, L.P. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. PART III Item 10. Directors and Executive Officers of Our Company We are a Delaware limited partnership. Under the Delaware Revised Uniform Limited Partnership Act and our Agreement of Limited Partnership, the general partner of our company, AES NY, L.L.C., manages our business and affairs. Our managers are appointed by AES NY, L.L.C., as general partner of our company. Our managers may be appointed from time to time by AES NY, L.L.C. and hold their positions at the discretion of AES NY, L.L.C. AES NY, L.L.C. may elect to appoint additional managers from time to time. The AES Corporation indirectly owns all member interests in and controls AES NY, L.L.C. The following table sets forth certain information concerning our management team as of March 28, 2002. Name Age Position Dan Rothaupt 50 General Manager John Ruggirello 51 Assistant General Manager Richard Santoroski 37 Manager of Marketing Kevin Pierce 44 Somerset Plant Manager Jerry Goodenough 37 Cayuga Plant Manager James Mulligan 53 Westover Plant Manager Douglas Roll 46 Greenidge Plant Manager Dan Rothaupt, our management team leader, is a Vice President of The AES Corporation and is a former plant manager for AES Thames, a coal-fired facility located in the New England power pool region. Mr. Rothaupt has been with The AES Corporation for 11 years. In addition to AES Thames, he has managed a number of complex operations including the startup of The AES Corporation's business in Hawaii with its coal-fired Barbers Point facility. Mr. Rothaupt has a proven track record of reducing costs while organizing The AES Corporation's businesses at various locations in the United States and has 25 years experience working in various aspects of power systems. Mr. Rothaupt is General Manager of our company. Mr. Rothaupt has a Bachelor of Science degree in Mechanical Engineering from the United States Coast Guard Academy. John Ruggirello is a Vice President of The AES Corporation and has over 22 years of industry experience. Mr. Ruggirello also serves as a board member of NIGEN, Ltd., a joint venture of The AES Corporation which acquired 760MW of coal-fired generating assets from the government of Northern Ireland, including a 45-year-old plant which had an availability of 100% in 1998. Mr. Ruggirello heads a group within The AES Corporation responsible for project development, construction and plant operations in much of the eastern United States and Canada. He served as President of AES Beaver Valley from 1990 to 1996. Mr. Ruggirello is Assistant General Manager of our Company. He has a Bachelor of Science degree in Mechanical Engineering from the New Jersey Institute of Technology. 29 Richard Santoroski worked for NYSEG for 13 years prior to May 14, 1999 primarily in engineering positions in the system protection and control group (relay) and in field distribution offices. Mr. Santoroski was formerly the lead engineer in the electric resource planning group. Mr. Santoroski has extensive experience in power marketing, including trading physical power options, swaps and forwards, developing and marketing structured products in the New York power pool, the New England power pool and the Pennsylvania-New Jersey-Maryland power pool and overseeing NYSEG's trading, risk management and billing. Mr. Santoroski is the Manager of Power Marketing of our company. Mr. Santoroski has a Bachelor of Science degree in Electrical Engineering from Pennsylvania State University and a Master of Science degree in Electrical Engineering and a Master of Business Administration, both from Syracuse University. Kevin Pierce has over 21 years experience in power operations and has worked for The AES Corporation for 13 years. Mr. Pierce was formerly the plant manager for AES Hawaii, which reliably supplies twenty percent of the electric demand for the island of Oahu and was involved with the start-up and operations of the AES Thames plant. Mr. Pierce is the plant manager of Somerset. Mr. Pierce has a Bachelor of Science degree in Marine Engineering from Maine Maritime Academy. Jerry Goodenough has worked for The AES Corporation for three years. Prior to that time he worked for NYSEG for ten years in engineering and supervisory roles in the generation engineering group and at Cayuga. Mr. Goodenough is the plant manager of Cayuga. Mr. Goodenough holds a Bachelor of Arts degree in Physics from Ithaca College and a Master of Science degree in Electrical Engineering from the State University of New York at Binghamton. James Mulligan has over 26 years experience in the power generation business including design and management of utility plants. Mr. Mulligan was formerly employed by NYSEG as the plant manager at Cayuga. Prior to that, he was responsible for NYSEG's four central area plants, which achieved the lowest production costs and highest availabilities in their operating history during his tenure. Mr. Mulligan is the plant manager of Westover. Mr. Mulligan has a Bachelor of Science degree in Mechanical Engineering from the New York Institute of Technology. Douglas J. Roll has over 18 years experience in the power generation business in areas of plant management, engineering, design, construction and start-up of fossil fuel-fired power plants. Mr. Roll was formerly the Station Manager at NYSEG's Greenidge Station where he directed the efforts of the station's staff to the lowest production cost and heat rate and highest reliability and availability in 25 years. Prior to that, Mr. Roll was the Manager of Mechanical Engineering in NYSEG's Generation Department, responsible for directing the engineering, design, construction and start-up of large scale capital projects at NYSEG's coal fired power plants. Mr. Roll is the Plant Manager of Greenidge. Mr. Roll holds a Bachelor of Science degree in Mechanical Engineering from Cornell University and a Bachelor of Arts degree in Biology from Queens College of the City University of New York. Mr. Roll is a registered Professional Engineer in the State of New York. Management of AES NY, L.L.C., the General Partner of Our Company AES NY, L.L.C., the general partner of our company, is a Delaware limited liability company managed by managers who are designated as directors. The Board of Directors of AES NY, L.L.C. comprises two classes of directors, the Class A Directors and the Class B Director. There are three Class A Directors, Roger Naill, Barry J. Sharp and Dan Rothaupt, each elected by the members of the limited liability company. The business and affairs of AES NY, L.L.C. are managed by the Class A Directors. The Class B Director's only participation in the management of AES NY, L.L.C. is in matters of bankruptcy or related matters. Mr. Rothaupt is also the President of AES NY, L.L.C. Dr. Roger F. Naill, 53 years old, has been Vice President for Planning at The AES Corporation since 1981. Prior to joining The AES Corporation, Dr. Naill was Director of the Office of Analytical Services at the U.S. Department of Energy. Barry J. Sharp, 42 years old, was appointed Chief Operating Officer of The AES Corporation in February 2002 and oversees the finance function at The AES Corporation as well as the large utilities business segment. He was appointed Executive Vice President of The AES Corporation in February 2001. Mr. Sharp was appointed Senior Vice President and Chief Financial Officer of The AES Corporation effective January 1998 and had been Vice President and Chief Financial Officer of The AES Corporation since 1987. He also served as Secretary of The AES Corporation until February 1996. From 1986 to 1987, he served as The AES Corporation's Director of Finance and Administration. Mr. Sharp is a certified public accountant. 30 Item 11. Executive Compensation Not Applicable. Item 12. Security Ownership of Certain Beneficial Owners and Management Not Applicable. Item 13. Certain Relationships and Related Transactions Not Applicable. PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) Financial Statements, Financial Statement Schedules and Exhibits. (1) The following financial statements are attached to this Annual Report on Form 10-K following the signature page: AES EASTERN ENERGY, L.P. Independent Auditors' Report Financial Statements: Consolidated Balance Sheets as of December 31, 2001 and 2000 Consolidated Statements of Income for the years ended December 31, 2001 and 2000 and the period from May 14, 1999 (inception) through December 31, 1999 Consolidated Statements of Changes in Partners' Capital for the years ended December 31, 2001 and 2000 and the period from May 14, 1999 (inception) through December 31, 1999 Consolidated Statements of Cash Flows for the years ended December 31, 2001 and 2000 and the period from May 14, 1999 (inception) through December 31, 1999 Notes to Consolidated Financial Statements AES NY, L.L.C. (General Partner of AES Eastern Energy, L.P.)* Independent Auditors' Report Financial Statements: Consolidated Balance Sheets as of December 31, 2001 and 2000 Notes to Consolidated Balance Sheets * The Consolidated Balance Sheets of AES NY, L.L.C. contained in this Annual Report on Form 10-K should be considered only in connection with its status as the general partner of AES Eastern Energy, L.P. (2) Financial Statement Schedules Schedules are omitted as the information is either not applicable, not required or has been furnished in the financial statements or notes thereto included in this Annual Report on Form 10-K. 31 (3) Exhibits Exhibit No. Description ---------- ----------- 3.1 Certificate of Limited Partnership of AES Eastern Energy, L.P.* 3.2 Agreement of Limited Partnership of AES Eastern Energy, L.P., dated as of May 4, 1999* 4.1 Form of 9.0% Series 1999-A Pass Through Certificate* 4.2 Form of 9.67% Series 1999-B Pass Through Certificate* 4.3a Pass Through Trust Agreement A, dated as of May 1, 1999, between AES Eastern Energy, L.P. and Bankers Trust Company, as Pass Through Trustee, made with respect to the formation of the Pass Through Trust, Series 1999-A and the issuance of 9.0% Pass Through Certificates, Series 1999-A* 4.3b Schedule identifying substantially identical agreement to Pass Through Trust Agreement constituting Exhibit 4.3a hereto* 4.4a Participation Agreement (Kintigh A-1), among AES Eastern Energy, L.P., as Lessee, Kintigh Facility Trust A-1, as Owner Trust, DCC Project Finance Fourteen, Inc., as Owner Participant, Bankers Trust Company, as Indenture Trustee, and Bankers Trust Company, as Pass Through Trustee, dated as of May 1, 1999* 4.4b Schedule identifying substantially identical agreement to Participation Agreement constituting Exhibit 4.4a hereto* 4.5a Participation Agreement (Milliken A-1), among AES Eastern Energy, L.P., as Lessee, Milliken Facility Trust A-1, as Owner Trust, DCC Project Finance Fourteen, Inc., as Owner Participant, Bankers Trust Company, as Indenture Trustee, and Bankers Trust Company, as Pass Through Trustee, dated as of May 1, 1999* 4.5b Schedule identifying substantially identical agreement to Participation Agreement constituting Exhibit 4.5a hereto* 4.6a Facility Lease Agreement (Kintigh A-1), between Kintigh Facility Trust A-1, as Lessor, and AES Eastern Energy, L.P., as Lessee, dated as of May 1, 1999* 4.6b Schedule identifying substantially identical agreements to Facility Lease Agreement constituting Exhibit 4.6a hereto* 4.7a Facility Lease Agreement (Milliken A-1), between Milliken Facility Trust A-1, as Lessor, and AES Eastern Energy, L.P., as Lessee, dated as of May 1, 1999* 32 4.7b Schedule identifying substantially identical agreements to Facility Lease Agreement constituting Exhibit 4.7a hereto* 4.8a Indenture of Trust and Security Agreement (Kintigh A-1), between Kintigh Facility Trust A-1, as Owner Trust, and Bankers Trust Company, as Indenture Trustee, dated as of May 1, 1999* 4.8b Schedule identifying substantially identical agreements to Indenture of Trust and Security Agreement constituting Exhibit 4.8a hereto* 4.9a Indenture of Trust and Security Agreement (Milliken A-1), between Milliken Facility Trust A-1, as Owner Trust, and Bankers Trust Company, as Indenture Trustee, dated as of May 1, 1999* 4.9b Schedule identifying substantially identical agreements to Indenture of Trust and Security Agreement constituting Exhibit 4.9a hereto* 4.10 [Reserved] 4.11 Registration Rights Agreement, between AES Eastern Energy, L.P., and Morgan Stanley & Co. Inc., Credit Suisse First Boston Corp. and CIBC World Markets Corp., dated as of May 11, 1999* 4.12 [Reserved] 4.13 [Reserved] 10.1 Asset Purchase Agreement, among NGE Generation, Inc., New York State Electric & Gas Corporation ("NYSEG"), and AES NY, L.L.C. ("AES NY"), dated as of August 3, 1998, (incorporated herein by reference to exhibit 10.2 of the Annual Report on Form 10-K of Energy East Corp. for the year ended December 31, 1998 filed on March 29, 1999, SEC file #001-14766) 10.2a Milliken Operating Agreement, between AES NY and NYSEG, dated as of August 3, 1998* 10.2b Amendment No. 1 to the Milliken Operating Agreement, dated as of May 6, 1999* 10.3a Interconnection Agreement, between AES NY and NYSEG, dated as of August 3, 1998* 10.3b Amendment No. 1 to the Interconnection Agreement, dated as of May 6, 1999* 10.4 Interconnection Implementation Agreement, between NYSEG and AES NY, dated as of May 6, 1999* 10.5 Standard Bilateral Power Sales Agreement and Transaction Agreement, between AES Eastern Energy and NYSEG Solutions, Inc., dated as of May 14, 1999* 10.6 Scheduling and Settlement Agreement, among NYSEG, 33 AES Creative Resources, L.P., AES Eastern Energy and EME Homer City Generation, dated as of March 18, 1999* 10.7 Agreement to Assign Transmission Rights and Obligations, between AES NY and NYSEG, dated as of August 3, 1998* 10.8 New York Transition Agreement, between AES NY and NYSEG, dated as of August 3, 1998* 10.9a Reciprocal Easement Agreement (Kintigh Station), between AES NY and NYSEG, dated as of August 3, 1998* 10.9b Reciprocal Easement Agreement (Milliken Station), between AES NY and NYSEG, dated as of August 3, 1998* 10.9c Reciprocal Easement Agreement (Greenidge Station), between AES NY and NYSEG, dated as of August 3, 1998* 10.9d Reciprocal Easement Agreement (Goudey Station), between AES NY and NYSEG, dated as of August 3, 1998* 10.10 Coal Sales Agreement, among NYSEG, Consolidation Coal Company, CONSOL Pennsylvania Coal Company, Nineveh Coal Company, Greenon Coal Company, McElroy Coal Company and Quarto Mining Company, dated as of November 1, 1983* 10.11a Coal Supply Agreement, between NYSEG and United Eastern Coal Sales Corporation, dated as of January 12, 1998* 10.11b Amendment No. 1 to Coal Sales Agreement, dated as of February 20, 1998* 10.12 Coal Supply Agreement, between NYSEG and Eastern Associated Coal Corporation, dated as of July 1, 1994* 10.13 Coal Hauling Agreement, among Somerset Railroad Corporation, AES NY3, L.L.C., and AES Eastern Energy L.P., dated as of May 6, 1999* 10.14 Scheduling and Settlement Agreement, among CSX Transportation, Inc., Norfolk Southern Corporation, Norfolk Southern Railway Company and NYSEG, dated as of February 20, 1998* 10.15 [Reserved] 10.16 Kintigh Turbine Agreement among NGE, NYSEG and AES Eastern Energy L.P. dated April 13, 1999* 10.17 Omnibus Agreement, between NYSEG and AES NY, dated as of May 7, 1999* 10.18 Assignment and Assumption Agreement, among NGE, NYSEG and AES NY, dated as of May 14, 1999* 34 10.19 Amended and Restated Deposit and Disbursement Agreement among AEE, Union Bank of California, N.A., as Agent under the Working Capital Facility, as Working Capital Provider, and Bankers Trust Company, as Depositary Agent, et al., dated as of April 10, 2001.** 10.20 [Reserved] 10.21a Omnibus Amendment to Kintigh A-1 Transaction Documents dated as of December 1, 2000 10.21b Schedule identifying substantially identical agreements to Omnibus Agreement constituting Exhibit 10.21a hereto 10.22a Omnibus Amendment to Milliken A-1 Transaction Documents dated as of December 1, 2000 10.22b Schedule identifying substantially identical agreements to Omnibus Agreement constituting Exhibit 10.22a hereto 10.23a Agreement and Appendix A dated as of April 10, 2001** 10.23b Schedule identifying substantially identical agreements to Second Amendment constituting Exhibit 10.23a hereto** 10.24a Second Amendment to Milliken A-1 Participation Agreement and Appendix A dated as of April 10, 2001** 10.24b Schedule identifying substantially identical agreements to Second Amendment constituting Exhibit 10.24a hereto** 10.25a $35,000,000 Credit Agreement dated as of April 10, 2001 among AEE and Union Bank of California, N.A., as Agent** 10.25b Amendment No. 1 and Waiver dated as of August 31, 2001 to $35,000,000 Credit Agreement dated as of April 10, 2001 among AEE and Union Bank of California, N.A., as Agent** 12.1 Statement regarding ratio of earnings to fixed charges 21.1 Subsidiaries Schedule* 24.1 Power of Attorney ------------------------------ * Incorporated herein by reference to similarly numbered exhibit to the Registration Statement on Form S-4 of AES Eastern Energy, L.P. (Reg. No. 333-89725), filed with the Securities and Exchange Commission on October 26, 1999. ** Incorporated herein by reference to similarly numbered exhibit to the Quarterly Report of AES Eastern Energy, L.P. (Reg. No. 333-89725) for the quarterly period ended September 30, 2001, filed with the Securities and Exchange Commission on November 14, 2001. 35 (b) Reports on Form 8-K. No reports on Form 8-K have been filed during the last quarter of our fiscal year ended December 31, 2001. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, AES Eastern Energy, L.P. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 29, 2002 AES EASTERN ENERGY, L.P. By: AES NY, L.L.C., as General Partner By: /s/ Dan Rothaupt ------------------------- Dan Rothaupt President Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons in the capacities and on the dates indicated. Signature Title Date --------------------- -------------------------------------- --------------- /s/ Dan Rothaupt President (chief executive officer) March 29, 2002 --------------------- and Class A Director of AES NY, L.L.C. Dan Rothaupt /s/ Barry J. Sharp Class A Director of AES NY, L.L.C. March 29, 2002 --------------------- Barry J. Sharp /s/ Roger F. Naill --------------------- Roger F. Naill Class A Director of AES NY, L.L.C. March 29, 2002 /s/ Amy Conley Vice President and Treasurer March 29, 2002 --------------------- (principal financial officer) Amy Conley of AES NY, L.L.C. Supplemental Information to Be Furnished With Reports Filed Pursuant to Section 15(d) of the Act by Registrants Which Have Not Registered Securities Pursuant to Section 12 of the Act We did not, and do not intend to, send to security holders an annual report covering our last fiscal year (other than this Annual Report on Form 10-K) or a proxy statement with respect to an annual or other meeting of security holders. 36 Index to Financial Statements Page AES EASTERN ENERGY, L.P. Independent Auditors' Report ........................................ 1 Financial Statements: Consolidated Balance Sheets....................................... 2 Consolidated Statements of Income................................. 3 Consolidated Statements of Changes in Partners' Capital........... 4 Consolidated Statements of Cash Flows............................. 5 Notes to Consolidated Financial Statements ....................... 6 AES NY, L.L.C. (General Partner of AES Eastern Energy, L.P.)* Independent Auditors' Report ........................................ 18 Financial Statements: Consolidated Balance Sheets........................................ 19 Notes to Consolidated Balance Sheets............................... 20 *The Consolidated Balance Sheets of AES NY, L.L.C. contained in this Form 10-K should be considered only in connection with its status as the general partner of AES Eastern Energy, L.P. The pass through trust certificates do not represent an interest in or an obligation of AES NY, L.L.C. INDEPENDENT AUDITORS' REPORT To the Partners of AES Eastern Energy, L.P. We have audited the accompanying consolidated balance sheets of AES Eastern Energy, L.P. (an indirect wholly owned subsidiary of The AES Corporation) and subsidiaries (the Partnership) as of December 31, 2001 and 2000, and the related consolidated statements of income, changes in partners' capital, and cash flows for the years then ended and the period from May 14, 1999 (inception) through December 31, 1999. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform our audits 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, such consolidated financial statements present fairly, in all material respects, the financial position of AES Eastern Energy, L.P., and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for the years ended December 31, 2001 and 2000, and the period from May 14, 1999 (inception) through December 31, 1999, in conformity with accounting principles generally accepted in the United States of America. /s/Deloitte & Touche LLP McLean, Virginia February 19, 2002 AES EASTERN ENERGY, L.P. CONSOLIDATED BALANCE SHEETS, DECEMBER 31, 2001 and DECEMBER 31, 2000

The notes are an integral part of the consolidated financial statements 2 AES EASTERN ENERGY, L.P. CONSOLIDATED STATEMENTS OF INCOME YEAR ENDED DECEMBER 31, 2001, YEAR ENDED DECEMBER 31, 2000, AND THE PERIOD FROM MAY 14, 1999 (INCEPTION) THROUGH DECEMBER 31, 1999

The notes are an integral part of the consolidated financial statements 3 AES EASTERN ENERGY, L.P. CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL YEAR ENDED DECEMBER 31, 2001, YEAR ENDED DECEMBER 31, 2000, AND THE PERIOD FROM MAY 14, 1999 (INCEPTION) THROUGH DECEMBER 31, 1999

The notes are an integral part of the consolidated financial statements. 4 AES EASTERN ENERGY, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS YEAR ENDED DECEMBER 31, 2001, YEAR ENDED DECEMBER 31, 2000, AND THE PERIOD FROM MAY 14, 1999 (INCEPTION) THROUGH DECEMBER 31, 1999

The notes are an integral part of the consolidated financial statements. 5 AES EASTERN ENERGY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED DECEMBER 31, 2001, YEAR ENDED DECEMBER 31, 2000, AND THE PERIOD FROM MAY 14, 1999 (INCEPTION) THROUGH DECEMBER 31, 1999 ================================================================================ 1. GENERAL AES Eastern Energy, L.P. (the Partnership), a Delaware limited partnership, was formed on December 2, 1998. The Partnership's wholly owned subsidiaries are AES Somerset, L.L.C., AES Cayuga, L.L.C., and AEE2, L.L.C., (which wholly owns AES Westover, L.L.C. and AES Greenidge, L.L.C.). The Partnership began operations on May 14, 1999 (see Note 3). Prior to that date, the Partnership had no operations. The Partnership is an indirect wholly owned subsidiary of The AES Corporation (AES). The Partnership has adopted December 31 as its fiscal year end. The Partnership was established for the purpose of owning and operating four coal-fired electric generating stations (the Plants) with a total combined capacity of 1,268 MW. The partners of the Partnership are comprised of AES NY, L.L.C. (the General Partner) and AES NY2, L.L.C. (the Limited Partner) both of which are indirect wholly owned subsidiaries of AES. The Plants are owned or leased by the Partnership (see Note 3) and are operated by the Partnership's wholly owned subsidiaries in the State of New York, pursuant to operation and maintenance agreements with the Partnership. The Plants sell generated electricity, as well as unforced capacity and ancillary services, directly into the markets operated by the New York Independent System Operator (ISO) system, PJM (Pennsylvania, New Jersey, Maryland) Interconnection and ISO New England. For Federal regulatory purposes, the Partnership is an exempt wholesale generator (EWG). As an EWG, the Partnership cannot make retail sales of electricity and can only make wholesale sales of electricity, installed capacity, and ancillary services into wholesale power markets. At the time the Partnership acquired the Plants, the Partnership had entered into a two-year agreement for energy marketing services with Merchant Energy Group of the Americas, Inc. (MEGA), which was then an Annapolis, Maryland-based subsidiary of Gener S.A., but which has since been sold. MEGA was responsible for marketing the Partnership's electric energy, installed capacity, and ancillary services in the deregulated New York power market. The marketing agreement between the Partnership and MEGA was terminated effective November 26, 2000. The Partnership has paid MEGA $1.6 million and made the first of four additional payments of $225,000 each, from 2002 to 2005, as part of the termination of the agreement with MEGA. Gener S.A. subsequently became a direct wholly owned subsidiary of AES. The Partnership entered into an arrangement with AES Odyssey, L.L.C.(Odyssey), a direct wholly owned subsidiary of AES. This agreement commenced on November 27, 2000 and is for a term of three years. Odyssey will provide data management, marketing, scheduling, invoicing and risk management services for a fee of $300,000 per month (see note 8). 2. SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation - The consolidated financial statements include the accounts of the Partnership, AES Somerset, L.L.C., AES Cayuga, L.L.C., and AEE2, L.L.C. (which includes its subsidiaries, AES Westover, L.L.C., and AES Greenidge, L.L.C.). All material intercompany transactions have been eliminated. Restricted Cash - Under the terms of the deposit and disbursement agreement entered into in connection with the lease of two plants (see Note 6), all revenues of the Partnership and its subsidiaries are deposited into a revenue account administered by Bankers Trust Company, as depositary agent. On request of the Partnership and in accordance with the terms of the deposit and disbursement agreement, funds are transferred from the revenue account to other operating accounts administered by the depositary agent for payment of operating and maintenance costs, lease obligations, debt service, reserve requirements, and distributions. Payment of operating and maintenance costs (other than actual fuel costs) in excess of 125% of the annual operating budget is not permitted under the terms of the lease documents. Amendments, modifications or reallocations of the annual operating budget that result in changes of 25% (positive or negative) in the amounts set forth in the annual operating budget require confirmation from an independent engineer that such payment is based on reasonable assumptions. 6 Inventory - Inventory is valued at the lower of cost (average cost basis) or market, and consists of coal and other raw materials used in generating electricity, and spare parts, materials, and supplies. Inventory, as of December 31 consisted of the following (in thousands): 2001 2000 ---------- ---------- Coal and other raw materials $ 13,488 $ 7,353 Spare parts, materials, and supplies 16,127 15,955 ---------- ---------- Total $ 29,615 $ 23,308 ========== ========== Property, Plant, Equipment, and Related Assets - Electric generation assets that existed at the date of acquisition (see Note 3) are recorded at fair market value. The Somerset (formerly known as Kintigh) and Cayuga (formerly known as Milliken) Plants, which represent $650 million of the electric generation assets, are subject to a leasing arrangement accounted for as a financing (see Note 6). Additions or improvements thereafter are recorded at cost. Depreciation is computed using the straight-line method over the 34-year and 28- year lease terms for the Somerset and Cayuga Plants, respectively, and over the estimated useful lives for the other fixed assets, which range from 7 to 35 years. Maintenance and repairs are charged to expense as incurred. Electric generation assets as of December 31 consisted of the following (in thousands): 2001 2000 -------- -------- Electric generation tangible assets $794,901 $777,658 Other intangible assets 245,805 244,753 Accumulated depreciation and amortization (82,564) (49,022) -------- -------- Total $958,142 $973,389 ======== ======== Other intangible assets represent assets that were identified and valued in an independent appraisal and that are directly related to the physical assets of the Plants. These include trading benefits derived from the ability of the Partnership to enter new deregulated markets through sale of the output of the Plants, potential revenues from ancillary services, and mitigation of environmental risk due to the advanced emissions control equipment that has already been installed at the principal Plants. Trading benefits provide both the Plants and the Partnership the ability to arbitrage electricity generation and installed capacity in order to capture the most lucrative prices in available markets. Ancillary services include voltage support, spinning reserves, and other activities that enhance the stability and reliability of the transmission system. These services will be purchased by the organizations that manage power systems rather than wholesale electricity customers. Mitigation of environmental risk reflects the Partnership's ability, created by pollution control devices, to effectively use lower cost and lower grade coal to provide the same electricity output as its competitors. Amortization is computed on the same basis as the related assets (28 to 34 years). Rent Reserve Account - As part of the Partnership's lease obligation (see Note 6), the Partnership is required to maintain a rent reserve account equal to the maximum semiannual payment with respect to the sum of basic rent (other than deferrable payments) and fixed charges expected to become due on any one basic rent payment date in the immediately succeeding three-year period. As of December 31, 2001 and 2000, the Partnership had fulfilled this obligation by entering into a Payment Undertaking Agreement, dated as of May 1, 1999, among the Partnership, each Owner Trust (see Note 3) and Morgan Guaranty Trust Company of New York (the Payment Undertaking Agreement). On May 14, 1999, the Partnership deposited with Morgan Guaranty Trust Company of New York approximately $28.7 million pursuant to the Payment Undertaking Agreement. The accreted value of the Payment Undertaking Agreement at any time includes interest earned thereunder at an interest rate of 4.79% per annum. Interest earnings as of December 31, 2001, 2000, and 1999 were approximately $1.5 million, $1.4 million and $870,000, respectively, and are included in the rent reserve account balance. At December 31, 2001 and 2000, the accreted value of the Payment Undertaking Agreement exceeded the required balance of the rent reserve account. This amount is being accounted for as a restricted cash balance and is included within the rent reserve account on the accompanying balance sheets, as it can only be utilized to satisfy lease obligations. 7 In the future, the Partnership may fulfill its obligation to maintain the required balance of the rent reserve account either by deposits into the rent reserve account or by making amounts available under the Payment Undertaking Agreement, such that the aggregate amount of such deposits in the rent reserve account and amounts available to be paid under the Payment Undertaking Agreement are equal to the required balance of the rent reserve account. New York Transition Agreement - As the New York ISO system represents a deregulated environment, the ISO attempts to ensure stability of the power grid in New York by requiring each entity engaged in retail sales of electricity to obtain unforced capacity commitments from generators in an amount equal to the entity's forecasted peak load plus a reserve margin. This requirement is intended to ensure that an adequate supply of electricity is always available. The General Partner entered into a two-year transition agreement with New York State Electric & Gas Corporation (NYSEG) pursuant to which the Partnership sold its installed capacity to NYSEG in order to permit NYSEG to comply with ISO standards for system stability. The transition agreement was assumed by the Partnership on the date of acquisition of the Plants. The Partnership recognized revenue under this contract as it was earned, which was $68 per MW per day for installed capacity made available. This agreement expired on April 30, 2001. Income Taxes - A provision for Federal and state income taxes has not been made in the accompanying financial statements since the Partnership does not pay income taxes but rather allocates its revenues and expenses to the individual partners. Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Partnership to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Comprehensive Income - In 1999, the Partnership adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income", which establishes rules for the reporting of comprehensive income and its components. As of December 31, 2001, the Partnership has recorded $28.5 million of other comprehensive income due to the adoption of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". In the years prior to the adoption of SFAS No. 133, the Partnership did not have any items of other comprehensive income. New Accounting Pronouncements - On January 1, 2001, the Partnership adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which, as amended, established new accounting and reporting standards for derivative instruments and hedging activities. The Statement requires that the Partnership recognize all derivatives, as defined in the Statement, on the balance sheet at fair value. Derivatives, or any portion thereof, that are not effective hedges are adjusted to fair value through income. Derivatives that are effective hedges are recognized in other comprehensive income (loss) until the hedged items are recognized in earnings. The adoption of SFAS No. 133 on January 1, 2001, resulted in a cumulative reduction of Other Comprehensive Income in Partner's Capital of $66.3 million. The Partnership utilizes derivative financial instruments to hedge commodity price risk. The Partnership utilizes electric derivative instruments, including swaps and forwards, to hedge the risk related to forecasted electricity sales over the next four years. The majority of the Partnership's electric derivatives are designated and qualify as cash flow hedges. No hedges were derecognized or discontinued during the year ended December 31, 2001. No significant amounts of hedge ineffectiveness were recognized in earnings during the year ended December 31, 2001. 8 Gains and losses on derivatives reported in accumulated other comprehensive income are reclassified into earnings when the hedged forecasted sale occurs. Approximately, $15.7 million of other comprehensive income is expected to be recognized as a reduction to earnings over the next twelve months. Amounts recorded in Other Comprehensive Income during the year ended December 31, 2001, were as follows (in millions): Transition adjustment on January 1, 2001 $(66.3) Reclassified to earnings 12.2 Change in fair value 82.6 ------ Balance, December 31, 2001 $ 28.5 ====== In addition to the electric derivatives classified as cash flow hedge contracts, the Partnership has a Transmission Congestion Contract that is a derivative under the definition of SFAS No.133, but does not qualify for hedge accounting. This contract is recorded at fair value on the balance sheet with changes in the fair value recognized through earnings. In 2000, this contract was also recorded at fair value with changes in fair value recorded through income under the requirements of Emerging Issues Task Force (EITF) No. 98-10, Accounting for Contracts Involved in Energy Trading and Risk Management Activities. Revenue Recognition - Revenues from the sale of electricity are recorded based upon output delivered and rates specified under contract terms. Revenues generated from commodity forwards, swaps and options, which are entered into for the hedging of forecasted sales, are recorded based on settlement accounting with the net amount received recognized as revenue for 1999 and 2000. In 2001, such contracts were accounted for in accordance with SFAS No. 133. Revenues for ancillary and other services are recorded when the services are rendered. In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets". This standard eliminates the amortization of goodwill, and requires goodwill to be reviewed periodically for impairment. This standard also requires the useful lives of previously recognized assets to be adjusted accordingly. This standard is effective for fiscal years beginning after December 15, 2001, for all goodwill and other intangible assets recognized on the Partnership's balance sheet at that date, regardless of when the assets were initially recognized. The Partnership has not determined the effects of this standard on its financial reporting. In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". This standard is effective for fiscal years beginning after June 15, 2002, and provides accounting requirements for asset retirement obligations associated with tangible long- lived assets. The Partnership has not determined the effects of this standard on its financial reporting. Reclassifications - Certain prior year and prior period amounts have been reclassified on the consolidated financial statements to conform with the 2001 presentation. 3. ACQUISITION On May 14, 1999, the Partnership's four Plants were acquired from NYSEG for approximately $914 million. The Partnership acquired ownership of two of the Plants, Westover (formerly known as Goudey) and Greenidge. The other two Plants, Somerset and Cayuga, were acquired for $650 million by twelve unrelated third-party owner trusts (collectively, the Owner Trusts) organized by three unrelated institutional investors. Simultaneously, the Partnership entered into separate leasing agreements for the Somerset and Cayuga Plants with the Owner Trusts. The Partnership accounts for these leases as a financing (see Note 6). The acquisition was financed by capital contributions from the General Partner and the Limited Partner in an aggregate amount equal to the purchase price for the Plants, certain associated costs and expenses, and certain amounts for working capital less the net proceeds from the leasing transactions with respect to the Somerset and Cayuga Plants described above. The acquisition has been accounted for as an asset purchase. In connection with the acquisition, NYSEG engaged an environmental consulting firm to perform an environmental analysis of the potential required remediations for soil and ground water contamination. The Partnership engaged another environmental consulting firm to evaluate the costs estimated by NYSEG's consultants. The environmental analysis and the Partnership's estimate of other environmental remediation costs indicated that there existed a range of potential remediation costs of between $8.5 million and $19.7 million, with a 9 most probable liability of approximately $12 million. The Partnership recorded $12 million as an undiscounted liability under purchase accounting for the projected remediation cost. As of December 31, 2001, $155,000 was classified as a current liability. Also in connection with the acquisition, the General Partner entered into an agreement for the construction of a selective catalytic reduction (SCR) facility at the Somerset Plant. The SCR facility is designed to significantly reduce the amount of nitrogen oxide emissions from the burning of coal fuel at the Somerset Plant. The Partnership acquired the SCR work in progress from the General Partner on May 14, 1999, for approximately $31 million, which was the contract price for the SCR. Construction of this asset began prior to the acquisition of the Plants. On the acquisition date, the Somerset Plant was shut down to complete construction and make other improvements. The outage lasted until late June 1999. All costs associated with the installation of the SCR, including construction and engineering costs, wages of people involved in the construction, and interest expense during the period were capitalized. The Somerset Plant was placed back in service on June 28, 1999. The Partnership received payments for installed capacity under the New York Transition Agreement while it was in effect (see Note 2). Payments received while the Somerset Plant was out of service, of approximately $2.1 million, reduced the total amount of capitalized costs. Total costs capitalized during construction were approximately $52 million, which included approximately $5.2 million in capitalized interest. The purchase agreement with NYSEG relating to the acquisition of the Plants provided for a post-closing adjustment of the purchase price to reflect the actual book value of inventories and a pro rata allocation of various expenses as of the acquisition date. As a result of this adjustment and to settle other contractual obligations, NYSEG returned approximately $1.6 million to the Partnership in 2000. 4. PARTNERSHIP AGREEMENT The Partnership was capitalized with an initial contribution of $10 from the General Partner and $990 from the Limited Partner. Subsequently, the General Partner and the Limited Partner contributed $354 million to the Partnership (see Note 5). The General Partner is responsible for the day-to-day management of the Partnership and its operations and affairs, and is responsible for all liabilities and obligations of the Partnership. Under the terms of the Partnership Agreement, the Limited Partner is not liable for any obligations, liabilities, debts, or contracts of the Partnership and is only responsible to make capital contributions when required under the Partnership Agreement. All distributions, profits, and losses of the Partnership are allocated among the partners based on their ownership interests, currently 1% for the General Partner and 99% for the Limited Partner. 5. CAPITALIZATION The Partnership is indirectly owned by AES New York Funding, L.L.C. (AES Funding), which is a special purpose financing vehicle established to raise a portion of the capital contributed to the Partnership through the General Partner and the Limited Partner. AES Funding is a direct wholly owned subsidiary of AES. On May 11, 1999, AES Funding entered into a three-year loan agreement with a syndicate of banks, with Morgan Guaranty Trust Company of New York as Agent, in the amount of $300 million. AES Funding contributed 1% of this amount to the General Partner and 99% of this amount to the Limited Partner which, in turn, made an aggregate capital contribution of $300 million to the Partnership. AES also contributed capital in the amount of approximately $54 million through AES Funding, which subsequently contributed this amount to the General Partner and the Limited Partner which, in turn, made a capital contribution of approximately $54 million to the Partnership. On November 30, 2001, AES Funding entered into a thirty-nine month loan agreement with a syndicate of financial institutions and institutional lenders, with Citibank, N.A. as Agent, in the amount of $300 million. The proceeds were used to refinance in full the debt outstanding under the Loan Agreement dated May 11, 1999. Collateral for the loan consists of a pledge of the membership interests of AES New York Holdings, L.L.C., a direct wholly owned subsidiary of AES Funding, which is the 100% direct owner of both the General Partner and the Limited Partner. 10 AES Funding is dependent upon the residual cash flows from the Partnership received in the form of dividends to service its debt. The loan is payable on February 28, 2005, and bears interest at a variable rate based on the terms of the loan agreement, which was 6.875% as of December 31, 2001. The Partnership has no obligation to repay this loan. If AES Funding were unable to repay this loan, one of the remedies available to the lenders would be to seek to sell the membership interests in AES New York Holdings, L.L.C., which would divest AES of control of the Partnership. 6. LEASE FINANCING The Partnership's leases for the Somerset and Cayuga Plants are accounted for as a financing (see Note 3). Minimum lease payments and the present value of the lease obligations are as follows (in thousands):

Through January 2, 2020, and so long as no lease event of default exists, a portion of the rent payable under each lease may be deferred until after the final scheduled payment of the debt incurred by the Owner Trusts to acquire the Somerset and Cayuga Plants. As of December 31, 2001, the Partnership has not deferred any portion of the lease obligations. The lease obligations are payable to the Owner Trusts. These obligations bear imputed interest at 9.252% and 9.024% for the Somerset and Cayuga Plants, respectively. Total assets under the leases of these two Plants were $650 million at December 31, 2001. These amounts are included in electric generation assets. The related accumulated depreciation, combined for both leased Plants, as of December 31, 2001 and 2000, was approximately $52.1 million and $31.5 million, respectively. The agreements governing the leases restrict the Partnership's ability to incur additional indebtedness, engage in other businesses, sell its assets, or merge with another entity. The ability of the Partnership to make distributions to its partners is restricted unless certain covenants, including the maintenance of certain coverage ratios, are met. In connection with the lease agreements, the Partnership is required to maintain an additional liquidity account. The required balance in the additional liquidity account was initially equal to the greater of $65 million less the balance in the rent reserve account on May 14, 1999 (see Note 2) or $29 million. As of December 31, 2001, the Partnership had fulfilled its obligation to fund the additional liquidity account by establishing a letter of credit, issued by BankBoston, dated May 14, 1999, in the stated amount of approximately $36 million (the Additional Liquidity Letter of Credit). This letter of credit was established by AES for the benefit of the Partnership. However, the Partnership is obligated to replenish or replace this letter of credit in the event it is drawn upon or needs to be replaced. An aggregate amount in excess of $65 million is available to be drawn under the Payment Undertaking Agreement (see Note 2) and the Additional Liquidity Letter of Credit for making rental payments. In the event sufficient amounts to make rental payments are not available from other sources, a withdrawal from the additional liquidity account (which may include making a drawing under the Additional Liquidity Letter of Credit) and from the rent reserve account (which may include making a demand under the Payment Undertaking Agreement) may be made for rental payments. 11 7. COMMITMENTS AND CONTINGENCIES Coal Purchases - In connection with the acquisition of the Partnership's four Plants, the Partnership assumed from NYSEG an agreement to purchase the coal required by the Somerset and Cayuga Plants. Each year either party can request renegotiation of the price of one-third of the coal supplied pursuant to this agreement. During 2001 the coal suppliers were committed to sell and the Partnership was committed to purchase all three lots of coal for the Somerset Plant as well as 70% of the anticipated coal purchases for the Cayuga Plant. The supplier requested renegotiation during 2001 for the 2002 lot but the parties failed to reach agreement. Therefore, the parties have current commitments with respect to only two lots in 2002 and 50% of the anticipated coal purchases at the Cayuga Plant. Either party may request renegotiation during 2002 on the third lot, and a request could be made to renegotiate the lot for which an agreement was not reached in the prior year. Therefore, the commitment of the Partnership for 2003 that is not subject to renegotiation and possible cancellation is one lot plus 50% of the estimated coal usage for the Cayuga Plant. The termination date for the contract is December 31, 2003. No later than June 30, 2003, the parties shall meet to determine if the agreement is to be extended under mutually agreeable terms and conditions. If the agreement were not extended, the Partnership would seek a new coal supplier. As of the acquisition date of the Plants, the contract prices for the coal purchased through 2002 were above the market price, and the Partnership recorded a purchase accounting liability for approximately $15.7 million related to the fulfillment of its obligation to purchase coal under this agreement. The purchase accounting liability is amortized as a reduction to coal expense over the life of the contract. As of December 31, 2001, the remaining liability was approximately $3.3 million. Based on the coal purchase commitments for 2002 and 2003, the Partnership has expected coal purchases ranging between $100.0 and $130.0 million and between $20.7 and $24.7 million, respectively. Transmission Agreements - On August 3, 1998, the General Partner entered into an agreement for the purpose of transferring certain rights and obligations from NYSEG to the General Partner under an existing transmission agreement among Niagara Mohawk Power Corporation (NIMO), the New York Power Authority, NYSEG, and Rochester Gas & Electric Corporation, and an existing transmission agreement between NYSEG and NIMO. This agreement provides for the assignment of rights to transmit energy from the Somerset Plant and other sources to remote load areas and other delivery points, and was assumed by the Partnership on the date of acquisition of the Plants. In accordance with its plan, as of the acquisition date, the Partnership discontinued using this service. The Partnership did not intend to transmit over these lines and was required to pay the current fees until the effective cancellation date, November 19, 1999. These fees aggregated approximately $3.4 million over the six months ended December 31, 1999, and were recorded as a purchase accounting liability. Because the Partnership did not use the lines during this period, the Partnership received no economic benefit subsequent to the acquisition. The Partnership was informed by NIMO that the Partnership would be responsible for the monthly fees of $500,640 under the existing transmission agreement to the originally scheduled termination date of October 1, 2004. On October 5, 1999, the Partnership filed a complaint against NIMO alleging that the Partnership has a right to non-firm transmission service upon six months prior notice without payment of $500,640 in monthly fees subsequent to the cancellation date of November 19, 1999. On March 9, 2000, a settlement was reached between the Partnership and NIMO, which was subsequently approved by the Federal Energy Regulatory Commission (FERC). According to the settlement, the Partnership will continue to pay NIMO a fixed rate of $500,640 per month during the period of November 20, 1999 to October 1, 2004, and in turn, will receive a form of transmission service commencing on May 1, 2000, which the Partnership believes will provide an economic benefit over the period of May 1, 2000 to October 1, 2004. The Partnership has the right under a Remote Load Wheeling Agreement (RLWA) to transmit 298 MW over firm transmission lines from the Somerset Plant. The Partnership has the right to designate alternate points of delivery on NIMO's transmission system provided that the Partnership is not entitled to receive any transmission service charge credit on the NIMO system. 12 On November 1, 2000, the effective date of the final settlement, the transmission contract was classified as an energy-trading contract as defined in EITF No. 98-10, Accounting for Contracts Involved in Energy Trading and Risk Management Activities. From January 1, 2001 the contract was accounted for as a derivative under SFAS No. 133. The transmission contract was entered into because it provided a reasonable settlement for resolving a FERC issue. The agreement is essentially a swap between the congestion component of the locational prices posted daily by the New York ISO in western New York and the more heavily populated areas in eastern New York. The agreement is a financially settled contract since there is no requirement to flow power under this agreement. The agreement generates gains or losses from exposure to shifts or changes in market prices. The Partnership recorded a loss of approximately $29.4 million for the year ended December 31, 2001 related to this contract. Line of Credit Agreement - On May 14, 1999, the Partnership established a three-year revolving working capital credit facility of up to $50 million for the purpose of making funds available to pay for certain operating and maintenance costs. This facility was terminated as of March 9, 2001. In April 2001, the Partnership entered into a $35 million secured revolving working capital and letter of credit facility with Union Bank of California, N.A. This facility has a term of approximately twenty-one months. The Partnership can borrow up to $35 million for working capital purposes under this facility. In addition, the Partnership can have letters of credit issued under this facility up to $25 million, provided that the total amount of working capital borrowings and letters of credit issuances may not exceed the $35 million limit on the entire facility. During 2001, there was one draw. That draw was for $7 million on July 13, 2001 at an interest rate of 8.125%. That draw was repaid on July 31, 2001. Environmental - The Partnership has recorded a liability for environmental remediation associated with the acquisition of the Plants (see Note 3). On an ongoing basis, the Partnership monitors its compliance with environmental laws. Because of the uncertainties associated with environmental compliance and remediation activities, future costs of compliance or remediation could be higher or lower than the amount currently accrued. The Partnership received an information request letter dated October 12, 1999 from the New York Attorney General, which seeks detailed operating and maintenance history for the Westover and Greenidge Plants. On January 13, 2000, the Partnership received a subpoena from New York State Department of Environmental Conservation (DEC) seeking similar operating and maintenance history from the Plants. This information is being sought in connection with the Attorney General's and the DEC's investigations of several electricity generating stations in New York that are suspected of undertaking modifications in the past without undergoing an air permitting review. If the Attorney General or the DEC does file an enforcement action against the Somerset, Cayuga, Westover, or Greenidge Plants, then penalties may be imposed and further emission reductions might be necessary at these Plants. The Partnership is unable to estimate the impact, if any, of these investigations on its financial condition or results of future operations. On April 14, 2000, the Partnership received a request for information pursuant to Section 114 of the Clean Air Act from the U.S. Environmental Protection Agency (EPA) seeking detailed operating and maintenance history data for the Cayuga and Somerset Plants. The EPA has commenced an industry-wide investigation of coal-fired electric power generators to determine compliance with environmental requirements under the Clean Air Act associated with repairs, maintenance, modifications and operational changes made to coal-fired facilities over the years. The EPA's focus is on whether the changes were subject to new source review or new source performance standards, and whether best available control technology was or should have been used. The Partnership has provided the requested documentation and the EPA is currently evaluating the materials. The Partnership is unable to estimate the impact, if any, of this investigation on its financial condition or results of future operations. By letter dated May 25, 2000, the DEC issued a Notice of Violation (NOV) to NYSEG for violations of the Clean Air Act and the Environmental Conservation Law at the Greenidge and Westover Plants related to NYSEG's alleged failure to obtain an air permitting review for repairs and improvements made during the 1980s and 1990s, which was prior to the acquisition of the Plants by the Partnership. Pursuant to the purchase agreement relating to the acquisition of the Plants from NYSEG, the Partnership agreed to assume responsibility for environmental liabilities that arose while NYSEG owned the Plants. On September 12, 2000, the Partnership agreed with NYSEG that the Partnership will assume the defense of and responsibility for the NOV, subject to a reservation of its right to assert applicable exceptions to its contractual undertaking to assume preexisting environmental liabilities. The financial and operational effect of this NOV is still being discussed with the DEC. The Partnership is unable to estimate the effect of this NOV on its financial condition or results of future operations. 13 It is possible that the DEC NOV and other potential enforcement actions arising out of the Attorney General, DEC, and EPA investigations may result in penalties and the potential requirement to install additional air pollution control equipment and could require the Partnership to make substantial expenditures. Nitrogen Oxide and Sulfur Dioxide Emission Allowances - The Plants emit nitrogen oxide (NOx) and sulfur dioxide (SO2) as a result of burning coal to produce electricity. The Plants have been allocated allowances by the DEC to emit NOx during the ozone season, which runs from May 1 to September 30. Each NOx allowance authorizes the emission of one ton of NOx during the ozone season. The Plants are also subject to SO2 emission allowance requirements imposed by the EPA. Each SO2 allowance authorizes the emission of one ton of SO2 during the calendar year. Both NOx and SO2 allowances may be bought, sold, or traded. If NOx and/or SO2 emissions exceed the allowance amounts allocated to the Plants, then the Partnership may need to purchase additional allowances on the open market or otherwise reduce its production of electricity to stay within the allocated amounts. On October 16, 2001 AES Greenidge, L.L.C. was awarded a Federal Clean Coal Grant that will fund 50% of the capital costs and 30% of the operations and maintenance costs for backend technology. This technology will include a single bed, in-duct Selective Catalytic Reduction (SCR) unit in combination with low-NOx combustion technology, on Greenidge Unit 4 firing on coal and biomass. It will also include a Circulating Dry Scrubber for SO2, mercury and acid gas removal. AES Greenidge L.L.C.'s share of the costs for the 54-month project will be approximately $9.8 million. 8. RELATED PARTY TRANSACTIONS The Partnership has entered into a contract with Somerset Railroad Corporation (SRC), a wholly owned subsidiary of AES NY3, L.L.C., which is an indirect wholly owned subsidiary of AES, pursuant to which SRC will haul coal and limestone to the Somerset Plant and make its rail cars available to transport coal to the Cayuga Plant. The Partnership will pay amounts sufficient to enable SRC to pay all of its operating and other expenses, including all out-of-pocket expenses, taxes, interest on and principal of SRC's outstanding indebtedness, and all capital expenditures necessary to permit SRC to continue to provide rail service to the Somerset and Cayuga Plants. As of December 31, 2001, 2000 and 1999, $4.2 million, $4.6 million and $2.4 million, respectively, has been recorded by the Partnership as operating expenses and other accrued liabilities under this agreement. On August 14, 2000, SRC entered into a $26 million credit facility with Fortis Capital Corp. which replaced in its entirety a credit facility for the same amount previously provided to SRC by an affiliate of CIBC World Markets. The new credit facility provided by Fortis Capital Corp. consists of a 14-year term note (maturing on May 6, 2014), with principal and interest payments due quarterly. From August 14, 2000 to August 13, 2002, the interest rate on the loans under this credit facility is equal to a Base Rate plus 0.625% for the Base Rate loans and LIBOR plus 1.375% for LIBOR loans. From August 14, 2002 to August 13, 2005, the interest rate on the loans under this credit facility is equal to a Base Rate plus 0.750% for the Base Rate loans and LIBOR plus 1.500% for LIBOR loans. From August 14, 2005 to August 13, 2008, the interest rate on the loans under this credit facility is equal to a Base Rate plus 0.875% for the Base Rate loans and LIBOR plus 1.625% for LIBOR loans. From August 14, 2012 to August 13, 2014, the interest rate on the loans under this credit facility is equal to a Base Rate plus 1.125% for the Base Rate loans and LIBOR plus 1.875% for LIBOR loans. From August 14, 2008 to August 13, 2012, the interest rate on the loans under this credit facility is equal to a Base Rate plus 1.375% for the Base Rate loans and LIBOR plus 2.125% for LIBOR loans. The principal amount of SRC's outstanding indebtedness under this credit facility was approximately $23.2 million as of December 31, 2001. In November 2000, the Partnership entered into a three-year agreement for energy marketing services with Odyssey, a wholly owned subsidiary of AES. Odyssey is responsible for marketing the Partnership's electric energy, unforced capacity, and ancillary services. The Partnership will pay Odyssey $300,000 per month over the term of the agreement. Odyssey acts as agent on behalf of the Partnership in the over-the-counter and New York ISO markets. As agent, Odyssey manages all energy transactions under the Partnership name including (i) preparing confirmations for the Partnership and approving confirmations with counter-parties, (ii) conducting monthly check-outs with counter-parties as appropriate before the preparation of invoices, (iii) invoicing counter-parties for the term of the transactions and (iv) otherwise managing and executing the terms of the transactions in accordance with their provisions. 14 Odyssey provides data management services for the Partnership by maintaining databases of pricing, load, transmission, weather and generation data to aid in analysis to optimize the value of the Partnership's assets. Odyssey maintains a transaction management system to manage day-ahead commitments with the New York ISO and swap and physical values with counter-parties and to provide daily financial reporting and end of day budget variance, forward mark to market and commercially accepted risk analysis. In 2001, the Partnership entered into bilateral contract transactions with AES New Energy, a wholly owned subsidiary of AES. These transactions include forward sales of electric energy and unforced capacity at market based rates. For the year ended December 31, 2001, the Partnership recognized revenues of approximately $11.7 million related to the physical delivery of electricity or unforced capacity and the subsequent change in the market value of these contracts. As of December 31, 2001 the related account receivable - trade between AES New Energy and the Partnership was $2.6 million. The exposure at December 31, 2001 related to these contract transactions is less than 10% of the Partnership's estimated cash revenues for the year 2001. Prior to June 30, 1999, AES paid approximately $3.2 million in costs related to the acquisition of the NYSEG plants, which are to be reimbursed by the Partnership. Of the $3.2 million, approximately $1.1 million was for internal costs incurred by AES, and was treated as a reduction of contributed capital. AES contributed approximately $9.4 million to the Partnership in 2001, related to the construction of the SCR on Unit 1 of the Cayuga Plant, which became operational on June 7, 2001. 9. BENEFIT PLANS Effective May 14, 1999, the Partnership adopted The Retirement Plan for Employees of AES NY, L.L.C. (the Plan), a defined benefit pension plan. The Plan covers people employed both under collectively bargained and non-collectively bargained arrangements. Certain people formerly employed by NYSEG (the Transferred Persons) receive credit under the Plan for compensation and service earned while employed by NYSEG. The amount of any benefit payable under the Plan to a Transferred Person will be offset by the amount of any benefit payable to such Transferred Person under the Retirement Plan for Employees of NYSEG. Effective May 29, 1999, the ability to commence participation in the Plan and the accrual of benefits under the Plan ceased with respect to non-collectively bargained people and the accrued benefits of any such participant was fixed as of such date. As of December 31, 2001, the Plan was funded to the extent required by Internal Revenue Code (IRC) Section 412 minimum funding and the requirement of IRC Section 404, maximum contribution limits. The Partnership will make the required minimum contribution within the Employee Retirement Income Security Act (ERISA) guidelines. Pension benefits are based on years of credited service, age of the participant, and average earnings. During 2000 and 2001, collectively bargained people were offered the opportunity to freeze their accrued benefit payable under the Plan and opt into the AES Profit Sharing and Stock Ownership Plans. Significant assumptions used in the calculations of the net benefit cost and projected benefit obligation for the periods ending December 31, 2001, 2000 and 1999 are as follows: Discount rate 6.25% Rate of compensation increase 4.75% Expected long-term rate of return on plan assets 8.00% 15 Net benefit cost for the period ended December 31, 2001, 2000 and 1999 includes the following components (in thousands):

The projected benefit obligation of the Plan as of May 14, 1999, as actuarially determined, was recorded by the Partnership as a purchase accounting liability (see Note 3) under Accounting Principles Board Opinion (APB) No. 16, Business Combinations. The accumulated benefit obligation was approximately $16.7 million, $15.5 million and $11.2 million as of December 31, 2001, 2000 and 1999, respectively. During 2000, 137 participants of the Plan opted out and either joined an AES Plan, retired, or became terminated. This resulted in a curtailment gain to the Plan of approximately $ 5.3 million and is included within other income in the statement of income. As of December 31, 2001, the Plan had 101 active participants. Additionally, people of the Partnership and its subsidiaries participate in the AES Profit Sharing and Stock Ownership Plans. The plans provide Partnership matching contributions. Participants are fully vested in their own contributions and the Partnership's matching contributions. 10. LONG-TERM INCENTIVE PROGRAM Stock Option Plan - Employees of the Partnership participate in the AES Stock Option Plan (the SOP) that provides for grants of stock options to eligible participants. The following disclosures relate to the Partnership employees' share of benefits under the SOP. Options granted during 2001 and 2000 of 469,899 and 12,756, respectively, had weighted average fair value of approximately $13.52 and $22.50, respectively, using the Black-Scholes valuation method. Significant assumptions used in the Black-Scholes valuation method for shares granted in 2001 and 2000 were: expected stock price volatility 16 of 86% and 48% respectively; expected dividend yield of 0% and 0%, respectively; risk-free interest rate of 4.8% and 5.1%, respectively; and an expected life of 8 years and 7 years, respectively. No options were granted during 1999. Outstanding stock options become exercisable on a cumulative basis commencing two years from the date of grant and expire ten years after the date of grant. As permitted under SFAS No. 123,"Accounting for Stock-Based Compensation", AES applies APB Opinion No. 25 in accounting for the SOP. As the exercise price of all stock options are equal to their fair market value at the time the options are granted, the Partnership did not recognize any compensation expense related to the SOP using the intrinsic value based method. Had compensation expense been recognized using the fair value based method under SFAS No. 123, the Partnership's consolidated earnings would have decreased by $6,117,979 and $273,368 in 2001 and 2000, respectively. 11. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of the Partnership's current financial assets and liabilities approximate their carrying values. The fair value estimates are based on pertinent information available as of December 31, 2001. The Partnership is not aware of any factors that would significantly affect the estimated fair value amounts since that date. 12. SEGMENT INFORMATION Under the provisions of SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information", the Partnership's business is expected to be operated as one reportable segment, with operating income or loss being the measure of performance measured by the chief operating decision-maker. 13. RESTRICTIONS ON DISTRIBUTIONS TO PARTNERS The Partnership's ability to make distributions to its partners is restricted by the terms of the agreements governing the leases of the Somerset and Cayuga Plants. The Partnership may make a distribution to its partners only on or within ten business days after a semiannual rent payment date (commencing with the rent payment date occurring on July 2, 2000), so long as the conditions as specified in the agreements have been met. The Partnership has made four distributions to its partners to date: July 11, 2000, in the amount of $35 million; January 12, 2001, in the amount of $32.5 million; July 12, 2001, in the amount of $65.7 million; and January 9, 2002, in the amount of $32.6 million. 14. SUBSEQUENT EVENTS AES contributed approximately $1.2 million to the Partnership in January 2002, related to the construction of the SCR on Unit 1 of Cayuga, which became operational on June 7, 2001. On February 19, 2002, AES announced that it intends to reposition itself in the electric business by fully contracting or divesting its merchant generation businesses. AES stated that it made this decision to reduce earnings volatility and strengthen its balance sheet. The Partnership is one of the merchant generating businesses. The Partnership's business could be fully contracted if it were to sign one or more long-term power sales agreements for the output of the Plants. As of the date of this Annual Report on Form 10-K, no specific proposal to fully contract or divest the Partnership's operations is under consideration. The Partnership is adopting a policy of not commenting on proposed transactions and we disclaim any obligation to provide information with respect to proposed transactions until a definitive agreement has been reached. 17 INDEPENDENT AUDITORS' REPORT To the Member of AES NY, L.L.C. We have audited the accompanying consolidated balance sheets of AES NY, L.L.C. (an indirect wholly owned subsidiary of The AES Corporation) and subsidiaries (the Company) as of December 31, 2001 and 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform our audits 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, such consolidated balance sheets present fairly, in all material respects, the financial position of AES NY, L.L.C. and subsidiaries as of December 31, 2001 and 2000, in conformity with accounting principles generally accepted in the United States of America. /s/Deloitte & Touche LLP McLean, Virginia February 19, 2002 18 AES NY, L.L.C. CONSOLIDATED BALANCE SHEETS, DECEMBER 31, 2001 and DECEMBER 31, 2000

The notes are an integral part of the consolidated Balance Sheets 19 AES NY, L.L.C. NOTES TO CONSOLIDATED BALANCE SHEETS, YEAR ENDED DECEMBER 31, 2001 AND YEAR ENDED DECEMBER 31, 2000 ================================================================================ 1. GENERAL AES NY, L.L.C. (the Company), a Delaware limited liability company, was formed on August 2, 1998. The Company is the sole general partner of AES Eastern Energy, L.P. (AEE), owning a one percent interest in AEE. The Company is also the sole general partner of AES Creative Resources, L.P. (ACR), owning a one percent interest in ACR. AES NY Holdings, L.L.C. is the sole member of the Company. The Company is an indirect wholly owned subsidiary of The AES Corporation (AES). The Company began operations on May 14, 1999. Prior to that date, the Company had no operations. The Company was established for the purpose of acting as the general partner of both AEE and ACR. In this capacity, the Company is responsible for the day-to-day management of AEE and ACR and their operations and affairs, and is responsible for all liabilities and obligations of both entities. AEE, a Delaware limited partnership, was formed on December 2, 1998. AEE's wholly owned subsidiaries are AES Somerset, L.L.C., AES Cayuga, L.L.C., and AEE2, L.L.C., (which wholly owns AES Westover, L.L.C. and AES Greenidge, L.L.C.). AEE began operations on May 14, 1999. Prior to that date, AEE had no operations. AEE was established for the purpose of owning and operating four coal-fired electric generating stations (the AEE Plants) with a total combined capacity of 1,268 MW. Two of the plants are owned by AEE and two of the plants are leased by AEE (see Note 5), and are operated by AEE's wholly owned subsidiaries in the State of New York, pursuant to operation and maintenance agreements with AEE. The limited partner of AEE is AES NY 2, L.L.C. (the Limited Partner), which is also an indirect wholly owned subsidiary of AES. ACR, a Delaware limited partnership, was formed on December 3, 1998. ACR's wholly owned subsidiaries are AES Jennison, L.L.C. and AES Hickling, L.L.C., which each owns a coal-fired electric generating station (the ACR Plants) with a combined capacity of 156 MW. ACR began operations on May 14, 1999. Prior to that date ACR had no operations. The limited partner of ACR is AES NY 2, L.L.C. The AEE Plants and the ACR Plants are hereinafter referred to collectively as "the Plants." At the time that AEE and ACR acquired the Plants, AEE and ACR entered into two-year agreements for energy marketing services with Merchant Energy Group of the Americas, Inc. (MEGA), which was then an Annapolis, Maryland-based subsidiary of Gener S.A., but which has since been sold. MEGA was responsible for marketing AEE's and ACR's electric energy, installed capacity, and ancillary services in the deregulated New York power market. The marketing agreements between AEE and ACR and MEGA were terminated effective November 26, 2000. AEE has paid MEGA $1.6 million and made the first of four additional payments from 2002 to 2005 of $225,000 each, as part of the termination of the agreement with MEGA. Gener S.A. subsequently became a direct wholly owned subsidiary of AES. AEE and ACR entered into arrangements with AES Odyssey, L.L.C.(Odyssey), a direct wholly owned subsidiary of AES. These agreements commenced on November 27, 2000 and are for a term of three years. Odyssey will provide data management, marketing, scheduling, invoicing and risk management services for a fee of $300,000 per month (see note 8). The AEE Plants sell generated electricity, as well as unforced capacity and ancillary services, directly into the markets operated by the New York Independent System Operator (ISO) system, PJM (Pennsylvania, New Jersey, Maryland) Interconnection and ISO New England. For Federal regulatory purposes, AEE and ACR are exempt wholesale generators (EWGs). As EWGs, AEE and ACR cannot make retail sales of electricity, and can only make wholesale sales of electricity, installed capacity, and ancillary services into wholesale power markets. 20 During the fourth quarter of 2000, ACR placed the ACR Plants on long-term cold standby. The long-term cold standby designation means that these plants require more than 14 days to be brought on-line. The Company is currently evaluating the future of these plants. 2. SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation - The consolidated financial statement includes the accounts of the Company, AEE and ACR (including all subsidiaries). The financial statement is presented on a consolidated basis because the Company, as general partner, controls the operations of AEE and ACR (Note 1). All material intercompany transactions have been eliminated. The 99% limited partner ownerships of AEE and ACR are presented as minority interest. The assets of the Company on a stand-alone basis at December 31, 2001 and 2000 (using the equity method of accounting) consist only of the 1% ownership interest in AEE ($4,330,000 and $4,414,000, respectively) and the 1% ownership interest in ACR ($32,000 and $64,000, respectively). The Company had no liabilities as of December 31, 2001 and 2000, other than liabilities of AEE and ACR for which it is responsible as General Partner of AEE and ACR. Restricted Cash - Under the terms of the deposit and disbursement agreement entered into by AEE in connection with the lease of two AEE Plants (see Note 5), all revenues of AEE and its subsidiaries are deposited into a revenue account administered by Bankers Trust Company, as depositary agent. On request of AEE and in accordance with the terms of the deposit and disbursement agreement, funds are transferred from the revenue account to other operating accounts administered by the depositary agent for payment of operating and maintenance costs, lease obligations, debt service, reserve requirements and distributions. Payment of operating and maintenance costs (other than actual fuel costs) in excess of 125% of the annual operating budget is not permitted under the terms of the lease documents. Amendments, modifications or reallocations of the annual operating budget that result in changes of 25% (positive or negative) in the amounts set forth in the annual operating budget require confirmation from an independent engineer that such payment is based on reasonable assumptions. Inventory - Inventory valued at the lower of cost (average cost basis) or market, consists of coal and other raw materials used in generating electricity, spare parts, materials, and supplies. Inventory, as of December 31 consisted of the following (in thousands): 2001 2000 ---------- ---------- Coal and other raw materials $ 13,488 $ 7,487 Spare parts, materials, and supplies 16,127 17,664 ---------- ---------- Total $ 29,615 $ 25,151 ========== ========== Property, Plant, Equipment, and Related Assets - Electric generation assets that existed at the date of acquisition (see Note 3) are recorded at fair market value. The Somerset (formerly known as Kintigh) and Cayuga (formerly known as Milliken) Plants, which represent $650 million of the electric generation assets, are subject to a leasing arrangement accounted for as a financing (see Note 5). Additions or improvements thereafter are recorded at cost. Depreciation is computed using the straight-line method over the 34-year and 28-year lease terms for the Somerset and Cayuga Plants, respectively, and over the estimated useful lives for the other AEE fixed assets, which range from 7 to 35 years. Maintenance and repairs are charged to expense as incurred. 21 The Company is currently evaluating the future of the Jennison and Hickling plants and may dispose or shut down these plants. As such, the electric generation assets of these two plants are being depreciated over two years using the straight-line method. Maintenance and repairs are charged to expense as incurred. During the fourth quarter of 2000, ACR placed the ACR Plants on long-term cold standby. The long-term cold standby designation means that these plants require more than 14 days to be brought on-line. The ACR Plants continue to generate revenue from the sales of environmental allowances which they receive from regulatory authorities. Electric generation assets as of December 31 consisted of the following (in thousands):

Other intangible assets represent assets recorded by AEE that were identified and valued in an independent appraisal and that are directly related to the physical assets of the AEE Plants. These include trading benefits derived from the ability of AEE to enter new deregulated markets through sale of the output of the AEE Plants, potential revenues from ancillary services, and mitigation of environmental risk due to the advanced emissions control equipment that has already been installed at the principal AEE Plants. Trading benefits provide both the AEE Plants and AEE the ability to arbitrage electricity generation and installed capacity in order to capture the most lucrative prices in available markets. Ancillary services include voltage support, spinning reserves, and other activities that enhance the stability and reliability of the transmission system. These services will be purchased by the organizations that manage power systems rather than wholesale electricity customers. Mitigation of environmental risk reflects AEE's ability, created by pollution control devices, to effectively use lower cost and lower grade coal to provide the same electricity output as its competitors. Amortization is computed on the same basis as the related assets (28 to 34 years). Rent Reserve Account - As part of AEE's lease obligation (see Note 5), AEE is required to maintain a rent reserve account equal to the maximum semiannual payment with respect to the sum of basic rent (other than deferrable payments) and fixed charges expected to become due on any one basic rent payment date in the immediately succeeding three-year period. As of December 31, 2001 and 2000, AEE had fulfilled this obligation by entering into a Payment Undertaking Agreement, dated as of May 1, 1999, among AEE, each Owner Trust (see Note 3) and Morgan Guaranty Trust Company of New York (the Payment Undertaking Agreement). On May 14, 1999, AEE deposited with Morgan Guaranty Trust Company of New York approximately $28.7 million pursuant to the Payment Undertaking Agreement. The accreted value of the Payment Undertaking Agreement at any time includes interest earned thereunder at an interest rate of 4.79% per annum. Interest earnings as of December 31, 2001, 2000, and 1999 were approximately $1.5 million, $1.4 million and $870,000, respectively, and are included in the rent reserve account balance. At December 31, 2001 and 2000, the accreted value of the Payment Undertaking Agreement exceeded the required balance of the rent reserve account. This amount 22 is being accounted for as a restricted cash balance and is included within the rent reserve account on the accompanying balance sheets, as it can only be utilized to satisfy lease obligations. In the future, AEE may fulfill its obligation to maintain the required balance of the rent reserve account either by deposits into the rent reserve account or by making amounts available under the Payment Undertaking Agreement, such that the aggregate amount of such deposits in the rent reserve account and amounts available to be paid under the Payment Undertaking Agreement are equal to the required balance of the rent reserve account. New York Transition Agreement - As the New York ISO system represents a deregulated environment, the ISO attempts to ensure stability of the power grid in New York by requiring each entity engaged in retail sales of electricity to obtain installed capacity commitments from generators in an amount equal to the entity's forecasted peak load plus a reserve margin. This requirement is intended to ensure that an adequate supply of electricity is always available. The Company entered into a two-year transition agreement with New York State Electric & Gas Corporation (NYSEG) pursuant to which AEE and ACR sold their installed capacity to NYSEG in order to permit NYSEG to comply with ISO standards for system stability. The transition agreement was assumed by AEE and ACR on the date of acquisition of the AEE and the ACR Plants. The Company recognized revenue under this contract as it was earned, which was $68 per MW per day for installed capacity made available. This agreement expired on April 30, 2001. Income Taxes - A provision for Federal and state income taxes has not been made in the accompanying financial statements since the Company, AEE and ACR do not pay income taxes but rather allocate their revenues and expenses to their member or partners. Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Comprehensive Income - In 1999 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income", which establishes rules for the reporting of comprehensive income and its components. As of December 31, 2001, the Company has recorded $28.5 million of other comprehensive income due to the adoption of SFAS No. 133. In the years prior to the adoption of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", the Company did not have any items of other comprehensive income. New Accounting Pronouncements - On January 1, 2001, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which, as amended, established new accounting and reporting standards for derivative instruments and hedging activities. The Statement requires that the Company recognize all derivatives, as defined in the Statement, on the balance sheet at fair value. Derivatives, or any portion thereof, that are not effective, hedges are adjusted to fair value through income. Derivatives that are effective hedges are recognized in other comprehensive income (loss) until the hedged items are recognized in earnings. The adoption of SFAS No. 133 on January 1, 2001, resulted in a cumulative reduction of Other Comprehensive Income in member's equity of $66.3 million. AEE utilizes derivative financial instruments to hedge commodity price risk. AEE utilizes electric derivative instruments, including swaps and forwards, to hedge the risk related to forecasted electricity sales over the next four years. The majority of AEE's electric derivatives are designated and qualify as cash flow hedges. No hedges were derecognized or discontinued during the year ended December 31, 2001. No significant amounts of hedge ineffectiveness were recognized in earnings during the year ended December 31, 2001. 23 Gains and losses on derivatives reported in accumulated other comprehensive income are reclassified into earnings when the hedged forecasted sale occurs. Approximately, $15.7 million of other comprehensive income is expected to be recognized as a reduction to earnings over the next twelve months. Amounts recorded in Other Comprehensive Income during the year ended December 31, 2001, were as follows (in millions): Transition adjustment on January 1, 2001 $(66.3) Reclassified to earnings 12.2 Change in fair value 82.6 ------ Balance, December 31, 2001 $ 28.5 ====== In addition to the electric derivatives classified as cash flow hedge contracts, AEE has a Transmission Congestion Contract that is a derivative under the definition of SFAS No. 133, but does not qualify for hedge accounting. This contract is recorded at fair value on the balance sheet with changes in the fair value recognized through earnings. In 2000, this contract was also recorded at fair value with changes in fair value recorded through income under the requirements of Emerging Issues Task Force (EITF) No. 98-10, Accounting for Contracts Involved in Energy Trading and Risk Management Activities. Revenue Recognition - Revenues from the sale of electricity are recorded based upon output delivered and rates specified under contract terms. Revenues generated from commodity forwards, swaps and options, which are entered into for the hedging of forecasted sales, are recorded based on settlement accounting with the net amount received recognized as revenue for 1999 and 2000. In 2001 such contracts were accounted for in accordance with SFAS No. 133. Revenues for ancillary and other services are recorded when the services are rendered. In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets". This standard eliminates the amortization of goodwill, and requires goodwill to be reviewed periodically for impairment. This standard also requires the useful lives of previously recognized assets to be adjusted accordingly. This standard is effective for fiscal years beginning after December 15, 2001, for all goodwill and other intangible assets recognized on the Company's balance sheet at that date, regardless of when the assets were initially recognized. The Company has not determined the effects of this standard on its financial reporting. In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". This standard is effective for fiscal years beginning after June 15, 2002, and provides accounting requirements for asset retirement obligations associated with tangible long-lived assets. The Company has not determined the effects of this standard on its financial reporting. In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets". The provisions of this statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and address reporting for the impairment or disposal of long-lived assets. SFAS No. 144 provides guidance for developing estimates of future cash flows used to test assets for recoverability and requires that assets to be disposed of be classified as held for sale when certain criteria are met. The statement also extends the reporting of discontinued operations to all components of an entity and provides guidance for recognition of a liability for obligations associated with disposal activity. The Company believes that the initial adoption of the provisions of SFAS No. 144 will not have any material impact on its financial position or results of operations. Reclassifications - Certain prior year and prior period amounts have been reclassified on the consolidated financial statements to conform with the 2001 presentation. 3. ACQUISITION On May 14, 1999, the AEE Plants were acquired from NYSEG for approximately $914 million. AEE acquired ownership of two of the Plants, Westover (formerly known as Goudey) and Greenidge. The other two Plants, Somerset and Cayuga, were acquired for $650 million by twelve unrelated third-party owner trusts (collectively, the Owner Trusts) organized by three unrelated institutional investors. Simultaneously, AEE entered into separate leasing 24 agreements for the Somerset and Cayuga Plants with the Owner Trusts. The Company accounts for these leases as financing leases. The acquisition of the AEE Plants was financed by capital contributions from the Company and the Limited Partner in an aggregate amount equal to the purchase price for the Plants, certain associated costs and expenses, and certain amounts for working capital less the net proceeds from the leasing transactions with respect to the Somerset and Cayuga Plants described above. The acquisition has been accounted for as an asset purchase. In connection with the acquisition of the AEE Plants, NYSEG engaged an environmental consulting firm to perform an environmental analysis of the potential required remediations for soil and ground water contamination. AEE engaged another environmental consulting firm to evaluate the costs estimated by NYSEG's consultants. The environmental analysis and AEE's estimate of other environmental remediation costs indicated that there existed a range of potential remediation costs of between $8.5 million and $19.7 million, with a most probable liability of approximately $12 million. AEE recorded $12 million as an undiscounted liability under purchase accounting for the projected remediation cost at the acquisition date. As of December 31, 2001, $155,000 was classified as a current liability. Also in connection with the acquisition, the Company entered into an agreement for the construction of a selective catalytic reduction (SCR) facility at the Somerset Plant. The SCR facility is designed to significantly reduce the amount of nitrogen oxide emissions from the burning of coal fuel at the Somerset Plant. AEE acquired the SCR work in progress from the Company on May 14, 1999, for approximately $31 million, which was the contract price for the SCR. Construction of this asset began prior to the acquisition of the AEE Plants. On the acquisition date, the Somerset Plant was shut down to complete construction and make other improvements. The outage lasted until late June 1999. All costs associated with the installation of the SCR, including construction and engineering costs, wages of people involved in the construction, and interest expense during the period were capitalized by AEE. The Somerset Plant was placed back in service on June 28, 1999. AEE received payments for installed capacity under the New York Transition Agreement while it was in effect (see Note 2). Payments received while the Somerset Plant was out of service, of approximately $2.1 million, reduced the total amount of capitalized costs. Total costs capitalized during construction were approximately $52 million, which included approximately $5.2 million in capitalized interest. The purchase agreement with NYSEG relating to the acquisition of the AEE Plants provided for a post-closing adjustment of the purchase price to reflect the actual value of inventories and a pro rata allocation of various expenses as of the acquisition date. As a result of this adjustment and to settle other contractual obligations, NYSEG returned approximately $1.6 million to AEE in 2000. Also, in connection with this transaction, ACR acquired from NYSEG two older coal-fired plants, Jennison and Hickling (Note 1). An environmental liability of $2.6 million was recorded in connection with this acquisition, which represented the most probable liability based on a range calculated by NYSEG's environmental consultants and reviewed by other environmental consultants hired by ACR. During the fourth quarter of 2000, ACR placed the ACR Plants on long-term cold standby. The long-term cold standby designation means that these plants require more than 14 days to be brought on-line. The Company is currently evaluating the future of these plants. The ACR plants continue to generate revenue from the sales of environmental allowances which they receive from regulatory authorities. 25 4. CAPITALIZATION The Company is indirectly owned by AES NY Funding, L.L.C. (AES Funding), which is a special purpose financing vehicle established to raise a portion of the capital contributed to AEE and ACR through the Company and AES NY 2, L.L.C, the limited partner of AEE and ACR. AES Funding is a direct wholly owned subsidiary of AES. On May 11, 1999, AES Funding entered into a three-year loan agreement with a syndicate of banks, with Morgan Guaranty Trust Company of New York as Agent, in the amount of $300 million. AES Funding contributed 1% of this amount to the Company and 99% of this amount to AES NY 2, L.L.C. which, in turn, made an aggregate capital contribution of $300 million to AEE. AES also contributed capital in the amount of approximately $57 million through AES Funding, which subsequently contributed this amount to the Company and AES NY 2, L.L.C. which, in turn, made a capital contribution of approximately $54 million to AEE and approximately $3 million to ACR. On November 30, 2001, AES Funding entered into a thirty-nine month loan agreement with a syndicate of financial institutions and institutional lenders, with Citibank, N.A. as Agent, in the amount of $300 million. The proceeds were used to refinance in full the debt outstanding under the Loan Agreement dated May 11, 1999. Collateral for the loan consists of a pledge of the membership interests of AES NY Holdings, L.L.C., a direct wholly owned subsidiary of AES Funding, which is the 100% direct owner of both the Company and AES NY 2, L.L.C. AES Funding is dependent upon the residual cash flows from AEE and ACR received in the form of dividends to service its debt. The loan is payable on February 28, 2005, and bears interest at a variable rate based on the terms of the loan agreement, which was 6.875% as of December 31, 2001. If AES Funding were unable to repay this loan, one of the remedies available to the lenders would be to seek to sell the membership interests in AES NY Holdings, L.L.C., which would divest AES of control of the Company, AEE, and ACR. 5. LEASE FINANCING AEE's leases for the Somerset and Cayuga Plants are accounted for as a financing (see Note 3). Minimum lease payments and the present value of the lease obligations are as follows (in thousands): Principal Imputed Lease Fiscal Years Ending December 31, Portion Interest Payments 2002 $ 6,223 $ 56,354 $ 62,577 2003 1,665 55,885 57,550 2004 7,846 55,604 63,450 2005 4,411 55,039 59,450 2006 6,898 54,652 61,550 Thereafter 618,506 696,161 1,314,667 ------- --------- ----------- Total minimum lease payments 645,549 973,695 1,619,244 Less imputed interest (973,695) ----------- Present value of minimum lease payments 645,549 Less current portion 6,223 ----------- Lease financing - long term 639,326 =========== Through January 2, 2020, and so long as no lease event of default exists, a portion of the rent payable under each lease may be deferred until after 26 the final scheduled payment of the debt incurred by the Owner Trusts to acquire the Somerset and Cayuga Plants. The lease obligations are payable to the Owner Trusts. These obligations bear imputed interest at 9.252% and 9.024% for the Somerset and Cayuga Plants, respectively. Total assets under the leases of these two Plants were $650 million at December 31, 2001. These amounts are included in electric generation assets. The related accumulated depreciation, combined for both leased Plants, as of December 31, 2001 and 2000, was approximately $52.1 million and $31.5 million, respectively. The agreements governing the leases restrict AEE's ability to incur additional indebtedness, engage in other businesses, sell its assets, or merge with another entity. AEE's ability to make distributions to its partners is restricted by the terms of the agreements governing the leases of the Somerset and Cayuga Plants. The ability of AEE to make distributions to its partners is restricted unless certain covenants, including the maintenance of certain coverage ratios, are met. In addition, AEE may make a distribution to its partners only on or within ten business days after a semiannual rent payment date (commencing with the rent payment date occurring on July 2, 2000) so long as the conditions as specified in the agreements have been met. AEE has made four distributions to its partners to date: July 11, 2000, in the amount of $35 million; January 12, 2001, in the amount of $32.5 million; July 12, 2001, in the amount of $65.7 million; and January 9, 2002, in the amount of $32.6 million. In connection with the lease agreements, AEE is required to maintain an additional liquidity account. The required balance in the additional liquidity account was initially equal to the greater of $65 million less the balance in the rent reserve account on May 14, 1999 (see Note 2) or $29 million. As of December 31, 2001, AEE had fulfilled its obligation to fund the additional liquidity account by establishing a letter of credit, issued by BankBoston, dated May 14, 1999, in the stated amount of approximately $36 million (the Additional Liquidity Letter of Credit). This letter of credit was established by AES for the benefit of AEE. However, AEE is obligated to replenish or replace this letter of credit in the event it is drawn upon or needs to be replaced. An aggregate amount in excess of $65 million is available to be drawn under the Payment Undertaking Agreement (see Note 2) and the Additional Liquidity Letter of Credit for making rental payments. In the event sufficient amounts to make rental payments are not available from other sources, a withdrawal from the additional liquidity account (which may include making a drawing under the Additional Liquidity Letter of Credit) and from the rent reserve account (which may include making a demand under the Payment Undertaking Agreement) may be made for rental payments. 6. COMMITMENTS AND CONTINGENCIES Coal Purchases - In connection with the acquisition by AEE of its four Plants, AEE assumed from NYSEG an agreement to purchase the coal required by the Somerset and Cayuga Plants. Each year either party can request renegotiation of the price of one-third of the coal supplied pursuant to this agreement. During 2001 the coal suppliers were committed to sell and AEE was committed to purchase all three lots of coal for Somerset as well as 70% of the anticipated coal purchases for the Cayuga Plant. The supplier requested renegotiation during 2001 for the 2002 lot but the parties failed to reach agreement. Therefore, the parties have current commitments with respect to only two lots in 2002 and 50% of the anticipated coal purchases at the Cayuga Plant. Either party may request renegotiation during 2002 on the third lot, and a request could be made to renegotiate the lot for which an agreement was not reached in the prior year. Therefore, the commitment of AEE for 2003 that is not subject to renegotiation and possible cancellation is one lot plus 50% of the estimated coal usage for Cayuga. The termination date for the contract is the end of 2003. No later than June 30, 2003, the parties shall meet to determine if the agreement is to be extended under mutually agreeable terms and conditions. If the agreement were not extended, AEE would seek 27 a new coal supplier. As of the acquisition date of the Plants, the contract prices for the coal purchased through 2002 were above the market price, and AEE recorded a purchase accounting liability for approximately $15.7 million related to the fulfillment of its obligation to purchase coal under this agreement. The purchase accounting liability is amortized as a reduction to coal expense over the life of the contract. As of December 31, 2001, the remaining liability was approximately $3.3 million. Based on the coal purchase commitments for 2002 and 2003, AEE has expected coal purchases ranging between $100.0 and $130.0 million and between $20.7 and $24.7 million, respectively. Transmission Agreements - On August 3, 1998, the Company entered into an agreement for the purpose of transferring certain rights and obligations from NYSEG to the Company under an existing transmission agreement among Niagara Mohawk Power Corporation (NIMO), the New York Power Authority, NYSEG, and Rochester Gas & Electric Corporation, and an existing transmission agreement between NYSEG and NIMO. This agreement provides for the assignment of rights to transmit energy from the Somerset Plant and other sources to remote load areas and other delivery points, and was assumed by AEE on the date of acquisition of the Plants. In accordance with its plan, as of the acquisition date, AEE discontinued using this service. AEE did not intend to transmit over these lines and was required to pay the current fees until the effective cancellation date, November 19, 1999. These fees aggregated approximately $3.4 million over the six months ended December 31, 1999, and were recorded as a purchase accounting liability. Because AEE did not use the lines during this period, AEE received no economic benefit subsequent to the acquisition. AEE was informed by NIMO that AEE would be responsible for the monthly fees of $500,640 under the existing transmission agreement to the originally scheduled termination date of October 1, 2004. On October 5, 1999, AEE filed a complaint against NIMO alleging that AEE has a right to non-firm transmission service upon six months prior notice without payment of $500,640 in monthly fees subsequent to the cancellation date of November 19, 1999. On March 9, 2000, a settlement was reached between AEE and NIMO, which was subsequently approved by the Federal Energy Regulatory Commission (FERC). According to the settlement, AEE will continue to pay NIMO a fixed rate of $500,640 per month during the period of November 20, 1999, to October 1, 2004 and in turn, will receive a form of transmission service commencing on May 1, 2000, which AEE believes will provide an economic benefit over the period of May 1, 2000 to October 1, 2004. AEE has the right under a Remote Load Wheeling Agreement ("RLWA") to transmit 298 MW over firm transmission lines from the Somerset Plant. AEE has the right to designate alternate points of delivery on NIMO's transmission system provided that AEE is not entitled to receive any transmission service charge credit on the NIMO system. On November 1, 2000, the effective date of the final settlement, the transmission contract was classified as an energy-trading contract as defined in EITF No. 98-10, Accounting for Contracts Involved in Energy Trading and Risk Management Activities. From January 1, 2001 the contract was accounted for as a derivative under SFAS No. 133. The transmission contract was entered into because it provided a reasonable settlement for resolving a FERC issue. The agreement is essentially a swap between the congestion component of the locational prices posted daily by the New York ISO in western New York and the more heavily populated areas in eastern New York. The agreement is a financially settled contract since there is no requirement to flow power under this agreement. The agreement generates gains or losses from exposure to shifts or changes in market prices. AEE recorded a loss of approximately $29.4 million for the year ended December 31, 2001 related to this contract. Line of Credit Agreement - On May 14, 1999, AEE established a three-year revolving working capital credit facility of up to $50 million for the purpose of making funds available to pay for certain operating and maintenance costs. This facility was terminated as of March 9, 2001. In April 2001, AEE entered into a $35 million secured revolving working capital and letter of credit facility with Union Bank of California, N.A. This facility has a term of approximately twenty-one months. AEE can borrow up to $35 million for working capital purposes under this facility. In addition, AEE can have letters of credit issued under this facility up to $25 million, provided that the total amount of working capital borrowings and letters of credit issuances may not exceed the $35 million limit on the entire facility. During 2001, there was one draw. That draw was for $7 million on July 13, 2001 at an interest rate of 8.125%. That draw was repaid on July 31, 2001. Environmental - The Company has recorded a liability for environmental remediation associated with the acquisition of the AEE Plants and the ACR Plants (see Note 3). On an ongoing basis, the Company monitors its compliance with environmental laws. Because of the uncertainties associated with environmental compliance and remediation activities, future costs of compliance or remediation could 28 be higher or lower than the amount currently accrued. AEE received an information request letter dated October 12, 1999 from the New York Attorney General, which seeks detailed operating and maintenance history for the Westover and Greenidge Plants. On January 13, 2000, the Company received a subpoena from the New York State Department of Environmental Conservation (DEC) seeking similar operating and maintenance history from the AEE and ACR Plants. This information is being sought in connection with the Attorney General's and the DEC's investigations of several electricity generating stations in New York that are suspected of undertaking modifications in the past without undergoing an air permitting review. If the Attorney General or the DEC does file an enforcement action against the Somerset, Cayuga, Westover, or Greenidge Plants, then penalties might be imposed and further emission reductions may be necessary at these Plants. The Company is unable to estimate the impact, if any, of these investigations on its financial condition or results of operations. On April 14, 2000, AEE received a request for information pursuant to Section 114 of the Clean Air Act from the U.S. Environmental Protection Agency (EPA) seeking detailed operating and maintenance history data for the Cayuga and Somerset Plants. The EPA has commenced an industry-wide investigation of coal- fired electric power generators to determine compliance with environmental requirements under the Clean Air Act associated with repairs, maintenance, modifications and operational changes made to coal-fired facilities over the years. The EPA's focus is on whether the changes were subject to new source review or new source performance standards, and whether best available control technology was or should have been used. AEE has provided the requested documentation and the EPA is currently evaluating the materials. The Company is unable to estimate the impact, if any, of this investigation on its financial condition or results of future operations. By letter dated May 25, 2000, the DEC issued a Notice of Violation (NOV) to NYSEG for violations of the Clean Air Act and the Environmental Conservation Law at the Greenidge and Westover Plants related to NYSEG's alleged failure to obtain an air permitting review for repairs and improvements made during the 1980s and 1990s, which was prior to the acquisition of the Plants by AEE. Pursuant to the purchase agreement relating to the acquisition of the Plants from NYSEG, AEE agreed to assume responsibility for environmental liabilities that arose while NYSEG owned the Plants. On September 12, 2000, AEE agreed with NYSEG that AEE will assume the defense of and responsibility for the NOV, subject to a reservation of its right to assert applicable exceptions to its contractual undertaking to assume preexisting environmental liabilities. The financial and operational effect of this NOV is still being discussed with the DEC. The Company is unable to estimate the effect of this NOV on its financial condition or results of future operations. It is possible that the DEC NOV and other potential enforcement actions arising out of the Attorney General, DEC, and EPA investigations may result in penalties and the potential requirement to install additional air pollution control equipment and could require the Company to make substantial expenditures. Nitrogen Oxide and Sulfur Dioxide Emission Allowances - The AEE Plants and the ACR Plants emit nitrogen oxide (NOx) and sulfur dioxide (SO2) as a result of burning coal to produce electricity. The six Plants have been allocated allowances by the DEC to emit NOx during the ozone season, which runs from May 1 to September 30. Each NOx allowance authorizes the emission of one ton of NOx during the ozone season. The six Plants are also subject to SO2 emission allowance requirements imposed by the EPA. Each SO2 allowance authorizes the emission of one ton of SO2 during the calendar year. Both NOx and SO2 allowances may be bought, sold, or traded. If NOx and/or SO2 emissions exceed the allowance amounts allocated to the six Plants, then the Company may need to purchase additional allowances on the open market or otherwise reduce its production of electricity to stay within the allocated amounts. On October 16, 2001 AES Greenidge, L.L.C. was awarded a Federal Clean Coal Grant that will fund 50% of the capital costs and 30% of the operations and maintenance costs for backend technology. This technology will include a single bed, in-duct 29 Selective Catalytic Reduction (SCR) unit in combination with low-NOX combustion technology, on Greenidge Unit 4 firing on coal and biomass. It will also include a Circulating Dry Scrubber for SO2, mercury and acid gas removal. AES Greenidge L.L.C.'s share of the costs for the 54-month project will be approximately $9.8 million. In October 1999, ACR entered into a consent order with the DEC to resolve alleged violations of the water quality standards in the groundwater downgradient of an ash disposal site. The consent order includes a suspended $5,000 civil penalty and a requirement to submit a work plan to initiate closure of the landfill by October 8, 2000. The consent order also called for a site investigation, which was conducted and indicated that there is a possibility that some groundwater remediation at the site may be required. AEE2, L.L.C. contributed one-half of the costs to close the landfill, which were approximately $2 million, and will contribute additional costs for long term groundwater monitoring. While the actual closure costs may exceed $1.6 million, which is included in the environmental remediation liability (see Note 3), management does not expect any added closure costs to be material. ACR has recently reported that concentrations of a number of chemicals in a few groundwater wells increased in the year ending December 31, 2001, since the Jennison and Hickling Plants were placed on long term cold standby. ACR has notified the NYSDEC and anticipates determining what remediation is needed, if any. Until ACR develops a plan with the NYSDEC, the Company cannot estimate if this will have a material effect of its operations. 7. RELATED PARTY TRANSACTIONS AEE has entered into a contract with Somerset Railroad Corporation (SRC), a wholly owned subsidiary of AES NY 3, L.L.C., which is an indirect wholly owned subsidiary of AES, pursuant to which SRC will haul coal and limestone to the Somerset Plant and make its rail cars available to transport coal to the Cayuga Plant. AEE will pay amounts sufficient to enable SRC to pay all of its operating and other expenses, including all out-of-pocket expenses, taxes, interest on and principal of SRC's outstanding indebtedness, and all capital expenditures necessary to permit SRC to continue to provide rail service to the Somerset and Cayuga Plants. On August 14, 2000, SRC entered into a $26 million credit facility with Fortis Capital Corp. which replaced in its entirety a credit facility for the same amount previously provided to SRC by an affiliate of CIBC World Markets. The new credit facility provided by Fortis Capital Corp. consists of a 14-year term note (maturing on May 6, 2014), with principal and interest payments due quarterly. From August 14, 2000 to August 13, 2002, the interest rate on the loans under this credit facility is equal to a Base Rate plus 0.625% for the Base Rate loans and LIBOR plus 1.375% for LIBOR loans. From August 14, 2002 to August 13, 2005, the interest rate on the loans under this credit facility is equal to a Base Rate plus 0.750% for the Base Rate loans and LIBOR plus 1.500% for LIBOR loans. From August 14, 2005 to August 13, 2008, the interest rate on the loans under this credit facility is equal to a Base Rate plus 0.875% for the Base Rate loans and LIBOR plus 1.625% for LIBOR loans. From August 14, 2012 to August 13, 2014, the interest rate on the loans under this credit facility is equal to a Base Rate plus 1.125% for the Base Rate loans and LIBOR plus 1.875% for LIBOR loans. From August 14, 2008 to August 13, 2012, the interest rate on the loans under this credit facility is equal to a Base Rate plus 1.375% for the Base Rate loans and LIBOR plus 2.125% for LIBOR loans. The principal amount of SRC's outstanding indebtedness under this credit facility was approximately $23.2 million as of December 31, 2001. In November 2000, AEE entered into a three-year agreement for energy marketing services with Odyssey, a wholly owned subsidiary of AES. Odyssey is responsible for marketing AEE's electric energy, unforced capacity, and ancillary services. AEE will pay Odyssey $300,000 per month over the term of the agreement. 30 Odyssey acts as agent on behalf of AEE in the over-the-counter and New York ISO markets. As agent, Odyssey manages all energy transactions under AEE's name including (i) preparing confirmations for AEE and approving confirmations with counter-parties, (ii) conducting monthly check-outs with counter-parties as appropriate before the preparation of invoices, (iii) invoicing counter-parties for the term of the transactions and (iv) otherwise managing and executing the terms of the transactions in accordance with their provisions. Odyssey provides data management services for AEE by maintaining databases of pricing, load, transmission, weather and generation data to aid in analysis to optimize the value of AEE's assets. Odyssey maintains a transaction management system to manage day-ahead commitments with the New York ISO and swap and physical values with counter-parties and to provide daily financial reporting and end-of-day budget variance, forward mark to market and commercially accepted risk analysis. In 2001, AEE entered into derivative transactions with AES New Energy, a wholly owned subsidiary of AES. These transactions include the forward sales of electric energy and unforced capacity. For the year ended December 31, 2001, AEE recognized revenues of approximately $11.7 million related to the physical delivery of electricity or unforced capacity and the subsequent change in the market value of these contracts. As of December 31, 2001 the related account receivable - trade between AES New Energy and AEE was $2.6 million. The exposure at December 31, 2001 related to these contract transactions is less than 10% of AEE's estimated cash revenues for the year 2001. Prior to June 30, 1999, AES paid approximately $3.2 million in costs related to the acquisition of the NYSEG plants, which are to be reimbursed by AEE. Of the $3.2 million, approximately $1.1 million was for internal costs incurred by AES, and was treated as a reduction of contributed capital. AES contributed approximately $9.4 million to AEE in 2001, related to the construction of the SCR on Unit 1 of the Cayuga Plant, which became operational on June 7, 2001. 8. BENEFIT PLANS Effective May 14, 1999, the Company adopted The Retirement Plan for Employees of AES NY, L.L.C. (the Plan), a defined benefit pension plan. The Plan covers people employed both under collectively bargained and non-collectively bargained arrangements. Certain people formerly employed by NYSEG (the Transferred Persons) receive credit under the Plan for compensation and service earned while employed by NYSEG. The amount of any benefit payable under the Plan to a Transferred Person will be offset by the amount of any benefit payable to such Transferred Person under the Retirement Plan for Employees of NYSEG. Effective May 29, 1999, the ability to commence participation in the Plan and the accrual of benefits under the Plan ceased with respect to non-collectively bargained people and the accrued benefits of any such participant was fixed as of such date. As of December 31, 2001, the Plan was funded to the extent required by Internal Revenue Code (IRC) Section 412 minimum funding and the requirement of IRC Section 404, maximum contribution limits. The Company will make the required minimum contribution within the Employee Retirement Income Security Act (ERISA) guidelines. Pension benefits are based on years of credited service, age of the participant, and average earnings. During 2000 and 2001, collectively bargained people were offered the opportunity to freeze their accrued benefit payable under the Plan and opt into the AES Profit Sharing and Stock Ownership Plans. Significant assumptions used in the calculations of projected benefit obligation are as follows: Discount Rate 6.25% Rate of compensation increase 4.75% Expected long-term rate of return on plan assets 8.00% 31

The projected benefit obligation of the Plan as of May 14, 1999, as actuarially determined, was recorded by the Company as a purchase accounting liability (see Note 3) under Accounting Principles Board Opinion (APB) No. 16, Business Combinations. The accumulated benefit obligation was approximately $16.7 million and $17.4 million as of December 31, 2001 and 2000, respectively. During 2000, 137 participants of the Plan opted out and either joined an AES Plan, retired, or became terminated. This resulted in a curtailment gain to the Plan of approximately $5.3 million. Due to the ACR long-term standby status on its Plants, the number of active participants at the Jennison and Hickling Plants went from 55 at December 31, 1999 to zero at December 31, 2000 and remains zero at December 31, 2001. This resulted in a curtailment gain to the Plan of approximately $ 1.9 million. As of December 31, 2001, the Plan had 101 active participants. Additionally, employees of the Company and its subsidiaries participate in the AES Profit Sharing and Stock Ownership Plans. The plans provide for Company matching contributions. Participants are fully vested in their own contributions and the Company's matching contributions. 32 9. LONG-TERM INCENTIVE PROGRAM Stock Option Plan - Employees of the Company participate in the AES Stock Option Plan (the SOP) that provides for grants of stock options to eligible participants. The following disclosures relate to the Company employees' share of benefits under the SOP. Options granted during 2001 and 2000 of 469,899 and 12,756, respectively, had weighted average fair value of approximately $13.52 and $22.50, respectively, using the Black- Scholes valuation method. Significant assumptions used in the Black-Scholes valuation method for shares granted in 2001 and 2000 were: expected stock price volatility of 86% and 48% respectively; expected dividend yield of 0% and 0%, respectively; risk-free interest rate of 4.8% and 5.1%, respectively; and an expected life of 8 years and 7 years, respectively. No options were granted during 1999. Outstanding stock options become exercisable on a cumulative basis commencing two years from the date of grant and expire ten years after the date of grant. As permitted under SFAS No. 123, "Accounting for Stock-Based Compensation", AES applies APB Opinion No. 25 in accounting for the SOP. As the exercise price of all stock options are equal to their fair market value at the time the options are granted, the Company did not recognize any compensation expense related to the SOP using the intrinsic value based method. Had compensation expense been recognized using the fair value based method under SFAS No. 123, the Company's consolidated earnings would have decreased by $6,117,979 and $273,368 in 2001 and 2000, respectively. 10. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of the Company's current financial assets and liabilities approximate their carrying values. The fair value estimates are based on pertinent information available as of December 31, 2001. The Company is not aware of any factors that would significantly affect the estimated fair value amounts since that date. 11. SEGMENT INFORMATION Under the provisions of SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information", the Company's business is expected to be operated as one reportable segment, with operating income or loss being the measure of performance measured by the chief operating decision-maker. 12. SUBSEQUENT EVENTS AES contributed approximately $1.2 million to AEE in January 2002, related to the construction of the SCR on Unit 1 of Cayuga, which became operational on June 7, 2001. On February 19, 2002, AES announced that it intends to reposition itself in the electric business by fully contracting or divesting its merchant generation businesses. AES stated that it made this decision to reduce earnings volatility and strengthen its balance sheet. The Company is one of the merchant generating businesses. The Company's business could be fully contracted if we were to sign one or more long-term power sales agreements for the output of its Plants. As of the date of this Annual Report on Form 10-K, no specific proposal to fully contract or divest the Company's operations is under consideration. The Company is adopting a policy of not commenting on proposed transactions and it disclaims any obligation to provide information with respect to proposed transactions until a definitive agreement has been reached. 33 Exhibit 12.1 AES Eastern Energy, L.P. Statements Regarding Ratio of Earnings to Fixed Charges YEAR ENDED DECEMBER 31, 2001, YEAR ENDED DECEMBER 31, 2000, AND THE PERIOD FROM MAY 14, 1999 (INCEPTION) THROUGH DECEMBER 31, 1999 (Amounts in Thousands, Except Ratio Amounts)

34 Exhibit 24.1 POWER OF ATTORNEY The undersigned, acting in the capacity or capacities stated opposite their respective names below, hereby severally constitute and appoint Jennifer Lowry, William R. Luraschi and Peter K. Ingerman and each of them with full power to act alone, our true and lawful attorneys and agents to do any and all acts and things and to execute any and all instruments which they deem necessary or advisable for AES NY, L.L.C., a Delaware limited liability company ("AES NY"), acting in its capacity as general partner of AES Eastern Energy, L.P., a Delaware limited partnership ("AES Eastern"), to enable AES Eastern to comply with the Securities Exchange Act of 1934, as amended, in connection with the execution and filing of the Annual Report on Form 10-K of AES Eastern for the year ended December 31, 2001 and any related registration statements, amendments, post-effective amendments or supplements thereto, including specifically, but without limiting the generality of the foregoing, the power and authority to sign the name of the AES NY, for itself or as general partner of AES Eastern, and the names of the undersigned directors and officers in the capacities indicated below. This Power of Attorney may be executed in counterparts, which together shall constitute one and the same instrument. Signature Title Date ------------------- ------------------------------------------ --------------- /s/ Dan Rothaupt President (chief executive officer) and March 29, 2002 ------------------- Class A Director of AES NY, L.L.C. Dan Rothaupt /s/ Barry J. Sharp Class A Director of AES NY, L.L.C. March 29, 2002 ------------------- Barry J. Sharp /s/ Roger F. Naill Class A Director of AES, NY, L.L.C. March 29, 2002 ------------------- Roger F. Naill /s/ Amy Conley Vice President and Treasurer March 29, 2002 -------------------- (principal financial officer) Amy Conley of AES NY, L.L.C. 35

AES EASTERN ENERGY LP 10-K