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Rating Action:

Moody's changes rating outlook on Salton Sea to negative from stable; affirms Baa3 rating

16 May 2014

Approximately $86.5 million (originally $295 million) of debt securities outstanding

New York, May 16, 2014 -- Moody's Investors Service today revised the rating outlook on the debt at Salton Sea Funding Corporation's (Salton Sea) to negative from stable. Concurrent with this rating action, Moody's affirmed the Baa3 rating assigned to Salton Sea's senior secured bonds due 2018.

RATINGS RATIONALE

The negative outlook reflects the continuation of weaker than expected financial performance over the next year reflecting primarily the challenging operating conditions at Salton Sea. The negative rating outlook further reflects the execution risk associated with a multi-year capital expenditure program intended to restore generation production levels at the geothermal projects to historical levels in order to achieve financial results in line with the current investment grade rating. During 2013, the overall capacity factor for the Salton Sea projects improved slightly to 82.8% from 81.3% in 2012, but remains well below historical levels of 90% and higher. Similarly, Salton Sea's debt service coverage ratio (DSCR) improved to 1.89x during 2013, a significant improvement over the 1.27x DSCR recorded in 2012; however, this improvement was attributable to a decision to delay 2013 capital expenditures and push them out into 2014 and beyond. We expect capital expenditures to average about $50 million per year over the next few years in order to lift production levels and maintain generation, and this program includes spending for additional well drilling, production equipment improvements, and pipeline enhancements.

Recent financial results have also been negatively influenced by the 2012 shift from a fixed Short Run Avoided Costs (SRAC) tariff to a variable SRAC tariff on 6.5 of the 8 geothermal assets which have power purchase agreements with Southern California Edison Company (A2 stable). Under the variable SRAC formula, energy margins are highly influenced by changes in the price of natural gas. With low natural prices persisting during 2012 and 2013, SRAC energy prices declined to an average of 3.87 cents per kWh in 2013 and 4.15 cents per kWh in 2012, both of which are substantially lower than the 6.16 cents per kWh price (escalated at 1% annually) that existed from May 2008 through May 2012. The combination of the lower SRAC energy price and the lower production have severely weakened financial performance during the last two years. While 2014 DSCR is forecasted to be below 1.0x, we anticipate Salton Sea's DSCR to recover in 2015 assuming the capital investment program outlined above increases production levels. As such, material execution risk exists with this planned program. That said, the project management and its sponsors have a track record of improving production levels at Salton Sea. Several years ago there was a production shortfall due to higher than expected operating and maintenance costs associated with the costs of geothermal gathering systems and the disposal costs associated with brine and solids management. After significant sponsor funded capital expenditures were incurred to install new equipment that was more resistant to brine corrosion, the negative trend reversed itself, and Salton Sea's production returned to historic levels, with its DSCR exceeding 2.0x.

In that vein, the Baa3 rating affirmation captures management's track record and the substantial degree of consistent sponsor financial support for the project. For 2014, our assumption of specific sponsor support includes planned capital infusions to fund required shortfalls related to the payment of debt service and to fund any remaining funding needs under the capital expenditure program. While Salton Sea has a sponsor provided one-year debt service reserve, we expect that current plans will not contemplate any draws against this reserve. Salton Sea's parent, CE Generation LLC (CE Gen) is indirectly owned by a joint venture between Berkshire Hathaway Energy Company (formerly, MidAmerican Energy Holdings) (BHE: A3 stable) and TransAlta Corporation (TAC:Baa3 negative). The co-owners together injected $34 million of equity into CE Gen in 2013 to support debt service at both Salton Sea and CE Gen. Moreover, on February 20, 2014, TAC announced that it had agreed to sell its 50% stake in CE Gen to BHE for $180.0 million. The sale is anticipated to close by the end of the second quarter of this year, and once completed, BHE will own 100% of CE Gen and Salton Sea. In our view, this transaction simplifies and strengthens the degree of sponsor commitment to this project given the benefits to the project of sole ownership (versus multiple ownership) coupled with BHE's track record of providing consistent sponsor level support.

Outlook

The negative outlook recognizes that the project will produce DSCR metrics that are below 1.0x this year and incorporates the uncertainty related to the timeline for improved financial metrics as the project implements efforts to enhance production and restore operating performance in line with historical expectations

What Could Move the Rating -- Up

In light of the negative outlook, limited prospects exist for a rating upgrade in the next year. The outlook could stabilize if the company's financial performance improves to levels at or above Salton Sea's historical performance and the project achieves the higher production levels from the planned increased capex spending. Moreover, the current Baa3 rating incorporates the benefits of the ownership and support of BHE.

What Could Move the Rating - Down

The rating could be downgraded if poor financial performance persists, even after the significant amount of capital is employed, such that key credit metrics do not return to levels on par with an investment grade rating. At a minimum, the failure to return Salton's Sea DSCR to a level comfortably above 1.50x, the minimum DCSR for its restricted payments test, will likely result in a downgrade.

The principal methodology used in this rating was Power Generation Projects published in December 2012. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

Salton Sea Funding Corporation is a wholly-owned subsidiary of CE Generation LLC, which in turn, is jointly-owned by Berkshire Hathaway Energy Company. Salton Sea is the funding vehicle for ten California-based geothermal projects representing an aggregate net ownership interest of 327MW of electrical generating capacity. Eight of the ten geothermal projects have long-term PPAs with SCE the majority of which matures after the final November maturity of the bonds. The remaining two plants are also fully contracted with other utilities.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Richard Donner
VP - Senior Credit Officer
Project Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Chee Mee Hu
MD - Project Finance
Project Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's changes rating outlook on Salton Sea to negative from stable; affirms Baa3 rating
No Related Data.
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