MOODY'S ASSIGNS Baa3 RATING TO CE GENERATION LLC PROJECT FINANCE BONDS
Moody's Investors Service assigns a Baa3 rating to the $400 million bonds to be issued by CE Generation LLC.
SUMMARY OPINION OF CREDIT CONCERNS
Moody's has assigned a Baa3 to the U.S. bonds to be issued by CE Generation LLC (CEG), a newly formed generating company consisting of geothermal electric generating assets and natural gas fired electric generating assets. The company is being formed from the qualifying facilities (QF's) of CalEnergy which are being divested in conjunction with CalEnergy's merger with MidAmerican Energy Company (MEC) located in Iowa. At closing, CalEnergy will own 100% of CE Generation, but it is expected that CalEnergy will sell 50% to a unaffiliated third party prior to closing its merger with MidAmerican.
The Baa3 rating is supported by the quality of the assets, strength of power purchase contracts, resilient project economics and limited construction risk. Key credit concerns include: the high degree of leverage, exposure to commodity price risk, the risk of contract renegotiation and limited geographic and offtaker diversification.
CEG will consist of a portfolio of fourteen (14) projects located in California, Arizona, Texas and New York totaling 826 MW of net-owned capacity. The portfolio cash flow is 51 % from geothermal assets and 49 % from natural gas fired assets. The weighted average availability for the last three years is 97% with an average capacity factor over the same period of 94%. All projects are qualifying facilities (QF's) and operate under contracts. The geothermal projects are 9 separate units in the Imperial Valley in southern California selling to Southern California Edison (SCE). The project-related debt for these assets was issued by Salton Sea Funding Corporation which is rated Baa2 by Moody's. There are four natural gas fired combined-cycle cogeneration plants: Saranac Power Partners, a 240 MW facility located in Plattsburgh, New York; Power Resources Inc.(PRI), a 200 MW facility located near Big Springs, Texas; NorCon Power Partners, a 80 MW facility located in North East, Pennsylvania; and, Yuma Cogeneration Associates, a 50 MW facility located in Yuma, Arizona.
PROVISIONAL RATING ONLY:
Moody's is issuing this provisional rating in advance of the final sale of the bonds described in this rating release based on information and documentation received as of February 22, 1999.
ANALYSIS OF KEY CREDIT RISKS:
Market Price Risk Exposure:
Base case coverage ratios are robust: 2.50x (Minimum)/ 3.11x (Average). Coverage ratios withstand various sensitivity tests:
Scenario DSCR (Min./Avg.)
Base Case 2.50x/3.11x
Higher O& M 2.35x/2.84x
Increased Heat Rate 2.40x/3.05x
Reduced Availability 2.06x/2.77x
Low Power Price 1 (10 % reduction) 2.40x/2.96x
Low Power Price 2 (15% reduction) 2.32x/2.80x
A significant portion of the revenues to CEG are exposed to market price risk due to the contractual provisions of the purchase power agreements which allow for energy pricing to follow the Short Run Avoided Costs (SRAC) of the offtaker utility. In the California market, the CPUC has indicated that the SRAC formulas now in place will be replaced by the Power Exchange (PX) once it is "fully functioning". It is estimated by Henwood Services, a market consultant, that the PX price will replace SRAC in 2000. We note that over the 20 year life of the debt of CEG, revenues determined by a "market price" whether SRAC or PX price range from 23% to 53% of the total revenues to CEG. Given the relative newness of the California PX and the volatility seen to-date, Moody's sees this as a significant risk to creditors of CEG.
Mitigating our concerns are the "must take" position of the assets as Qualifying Facilities which eliminates concerns about sales volumes assuming the future operating performance is predicted by the past operating performance. Equally important, is the low break-even prices relative to the market forecast. In Moody's analysis, CEG's break-even electricity price ranges from 31% to 87% below the forecast for off-peak marginal cost prices. While we believe actual prices may be lower than the forecast the low break-even prices for CEG allow the project to absorb substantial price volatility.
We note that the analysis includes no revenues from the natural gas projects after their contractual periods expire. Furthermore, during each year a portion of the revenues are fixed under a contract.
In addition to the strong coverage provided by the assets' distributions, CEG demonstrates a strong portfolio effect with the ability to continue to service debt with the elimination of cash flow from it two largest projects, Salton Sea IV and Saranac. Furthermore, any combination of two projects eliminated yields coverage ratios in excess of 1.0 times at the minimum and 2.0 times on average.
Risk of Contract Renegotiation/Loss of QF Status:
The Salton Sea assets enjoy the benefit of lucrative purchase power agreements with Southern California Edison with an average cost in 1998 of 11 cents per kwh compared to a PX average on-peak price ranging from 1.7 cents per kwh to 5.4 cents per kwh. In addition, much of the cost of the PPA's is in the form of a capacity payment which is a fixed cost purchasers will wish to avoid in the future. The high cost of the contracts relative to the spot market price creates an incentive to renegotiate. However, a market for "green power" in California is emerging, studies of which suggest that customers are willing to pay a 0.7 cents per kwh to 3.0 cents per kwh premium for environmentally-friendly power like geothermal. In addition the competitive transition charges provided in the California restructuring legislation make the likelihood of a concerted effort to renegotiate the contracts low. Finally, the age of the contracts and legal precedence would suggest they would withstand challenges.
While the QF status of the geothermal plants is relatively easy to assure, the gas plants must keep their steam host in order to meet the requirements of a cogeneration asset. The loss of QF status for the projects would be devastating as , in most cases, the lucrative PPA's would terminate as would the must-take designation of the plants; however, the risk seems remote under historical conditions and current expectations. The strong portfolio effects of the CEG assets also mitigates the loss of a single QF designation.
The structural risks stem from the prior claims of other creditors to the cash flows of the underlying projects providing cash flow to CEG. As always in financings of this type, the CEG debt is structurally subordinated to the debt at the project level. In the case of the Imperial Valley ( Salton Sea) assets the "project" debt lies at the Salton Sea Funding Corporation with the gas projects having debt at the level of the asset. So while there is legal and financial complexity within the structure there is only one level of structural subordination.
CEG is a shell company set up to house the ownership of the 14 projects. Its only assets are its interests in the equity distributions from the projects it owns. In addition to its debt service reserve CEG has a dividend trap mechanism to trap cash flow a coverage levels below 1.5 times and features a Loan Life Coverage Ratio ( LLCR) in the case of default at a project. The LLCR is calculated after a project default and captures long term impairments in cash flow.
Construction risk is limited to the new Salton Sea V unit and the Brine Processing Facilities for Salton Sea Region II. Independent assessments indicate that the technology used and the plans made are achievable for those facilities. While there are maintenance expenditures required for the continued smooth operation of the assets the budgets appear reasonable and complete, based on expert review.
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