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Global Credit Research - 05 Nov 2010
$347 million debt affected
New York, November 05, 2010 -- Moody's has downgraded the rating on AES Red Oak's $347
million of senior secured bonds outstanding to B2 from B1 and revised
the outlook to stable from negative. The downgrade reflects the
company's limited financial flexibility and liquidity constraints,
notwithstanding the high degree of cash flow stability provided by its
tolling agreement. The company's tenuous financial condition
is largely the result of significant penalties assessed on the plant due
to its continuing inability to meet the aggressive heat rate and dispatchable
capacity guarantees in the tolling agreement.
..Issuer: AES Red Oak, L.L.C.
....Senior Secured Regular Bond/Debenture,
Downgraded to B2 from B1
..Issuer: AES Red Oak, L.L.C.
....Outlook, Changed To Stable From
The company resolved the pressing liquidity concerns that resulted in
the last year's revision of the outlook to negative by executing
a new $8 million subordinated loan agreement in January with AES
Corp., which replaced the previous $3 million loan
agreement with Corp. and the $5 million working capital
facility with Union Bank of California, both of which expired last
year. The new agreement expires in 2015. However,
its liquidity position remains very narrow. The company is heavily
reliant on its external lines of credit because of the seasonality of
its cash flows and the narrowness of its financial margins, coupled
with a lack of significant unrestricted internal sources of liquidity.
Over 50% of the capacity payments under its tolling agreement are
received in just four months, between July and October. As
of June 30, the company's annual cash low point, it
had no unrestricted cash and just $1.7 million in its revenue
account, and it had drawn $7.5 million under the loan
agreement. Though it also had $8 million in cash restricted
for its upcoming debt service payment and $22 million in cash in
its debt service reserve fund, equal to six months principal and
interest, the $500,000 of excess borrowing availability
it had would not have been sufficient to cover even a relatively small
increase in operating and maintenance costs or capex. (As of November
1, it had repaid all but $1.5 million of the loan
agreement draw.) While AES Corp. could choose to provide
the project with additional funds if necessary, and in fact the
subordinated loan agreement provides for up to an additional $8
million at AES Corp.'s discretion, there is no assurance
that they would be willing to do so given the project's marginal
Senior coverage (excluding opening cash balances and availability under
lines of credit) declined to 1.04x in 2009 from 1.3x in
each of the two prior years because of increases in both capex and debt
service, though it is expected to rebound to 1.2x in 2010
as a result of a reduction in both net capex and debt service.
However, after the payment of subordinated management fees to AES
Corp. and fuel conversion volume rebates and non-dispatch
penalties to the project's offtaker, TAQA Gen X, net
coverage is projected to be approximately 20 bps lower. As a result,
the company is not projected to generate any excess cash flow.
In fact, since its first full year of operations in 2003,
it has never generated a significant amount of excess cash flow,
with net debt service coverages never exceeding 1.1x.
As a result of the company's poor financial performance in 2009,
it deferred the $1.8 million in subordinated management
fees payable to AES Corp. However, it did make the $7.3
million in fuel conversion volume rebates and non-dispatch penalties.
It paid the deferred management fees earlier this year along with 40%
of the 2010 management fees, and it currently expects to pay the
full amount of this year's fuel conversion volume rebates and non-dispatch
penalties prior to year end. Moody's notes that the rebates
are payable quarterly after debt service. This limits any benefit
the company might derive from deferring these payments in our opinion,
particularly in light of the seasonality of the company's cash flows.
Furthermore, we believe that failure to pay fuel conversion volume
rebates in a timely manner could potentially constitute an event of default
under the tolling agreement, which would permit the offtaker to
terminate the agreement if it so chose, though we note that it would
be unlikely to do so under current market conditions.
Gross capex is expected to increase to $13.5 million in
2010 from $10.7 million in 2009. However, $7.3
million of this amount was related to a heat rate improvement project
and was funded with proceeds from a 2007 settlement with Raytheon,
the project's EPC contractor, that had been restricted for
this purpose. 2010 capex was also reduced thanks to a provision
in the project's new Term Warranty Agreement with Siemens contract
that permitted the deferral of the initial true-up outage fee under
the contract. The $2.9 million in deferred costs
will be payable over 48 months beginning in April 2011 and is expected
to help levelize the payments due under the contract. Were it not
for this deferral, however, the company would likely have
been forced instead to defer its management fees again in addition to
a portion of the fuel conversion volume rebates.
The company renegotiated its maintenance parts and services agreement
with Siemens earlier this year, replacing it with a new Term Warranty
Agreement, in the course of which a number of disputes between the
parties were settled. The payments due Siemens under the new agreement
will be slightly higher than those under the old agreement, but
more costs will reportedly be covered, including many potential
unforeseen costs, and the company will receive a number of fringe
benefits according to management. The new agreement will remain
in place for up to 15 years depending upon the plant's dispatch
profile. Capex is expected to equal roughly $8-11
million annually going forward under the new agreement with Siemens.
Historically, the company's capital expenditures have averaged
about $7 million a year. The higher projected capex will
put further pressure on the company's financial flexibility and
liquidity position going forward.
However, the increased capex may be at least partially offset by
higher revenues resulting from the recent capital improvements and higher
plant capacity factors. The heat rate improvement project has reportedly
resulted in a reduction in the plant's heat rate of up to 80 points
(though the plant's heat rate remains 130 points above the guaranteed
heat rate in its offtake contract notwithstanding the improvement) or
an increase in capacity of up to 20 MWs. This additional capacity
is expected to result in an increase in the fixed payments due from the
offtaker of as much as $500,000, as well as an increased
variable O&M payment. The company also expects to receive increased
heat rate bonuses and be charged lower heat rate penalties. Further
improvement in heat rate of up to 30 points is expected following next
year's scheduled major outage on the third unit. It will
not be possible to quantify the precise financial impact of the improvements
until next year's outage has been completed, but based upon
current expectations for capacity factors and gas prices, management
hopes to see an improvement in cash flows of $1-1.5
million a year.
While there are certain other potential sources of improved cash flows
as well related in particular to the terms of the tolling agreement,
in Moody's opinion the plant's financial performance is likely
to remain marginal for the foreseeable future barring a significant additional
investment by AES to address the heat rate issue. At this point,
Moody's in unaware of any plans to undertake this investment.
Any decision to do so would probably depend on the plant's longer
term economic prospects once the tolling agreement expires. Moody's
notes that the debt has a seven-year merchant tail. Though
the project's capacity factors have improved considerably in recent
years, it is not clear to what extent this reflects increased demand
and a corresponding improvement in the long-term prospects for
the project, and to what extent it is due to the decline in gas
prices, which has resulted in gas-fired generation displacing
less efficient coal-fired generation in the dispatch stack.
The stable outlook reflects Moody's expectation that barring any
unexpected operational problems, the project should continue to
generate sufficient cash flows to cover its costs, including subordinated
costs. The rating could face upward pressure if the project can
demonstrate its ability to achieve net debt service coverages of at least
1.15x on a sustainable basis and as a result, is less dependent
on external liquidity. The rating could be downgraded further if
the project's financial performance deteriorates further and it
is forced to defer subordinated payments to its offtaker and/or draw on
the debt service reserve fund.
The principal methodology used in this rating was Power Generation Projects
published in December 2008.
AES Red Oak is an 830 megawatt (MW) gas-fired electric generating
project located in Sayreville, New Jersey. The project,
which is owned by AES Corp., currently sells all of its capacity
to TAQA Gen X LP pursuant to a tolling agreement expiring in 2022.
Information sources used to prepare the credit rating are the following:
parties involved in the ratings, parties not involved in the ratings.
Moody's Investors Service considers the quality of information available
on the issuer or obligation satisfactory for the purposes of assigning
a credit rating.
Moody's adopts all necessary measures so that the information it uses
in assigning a credit rating is of sufficient quality and from sources
Moody's considers to be reliable including, when appropriate,
independent third-party sources. However, Moody's
is not an auditor and cannot in every instance independently verify or
validate information received in the rating process.
Please see ratings tab on the issuer/entity page on Moodys.com
for the last rating action and the rating history.
The date on which some Credit Ratings were first released goes back to
a time before Moody's Investors Service's Credit Ratings were fully digitized
and accurate data may not be available. Consequently, Moody's
Investors Service provides a date that it believes is the most reliable
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Please see the ratings disclosure page on our website www.moodys.com
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MD-CCO Pub, Proj and Infra Fin
Financial Institutions Group
Moody's Investors Service
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service
Moody's Investors Service
Moody's downgrades AES Red Oak's rating to B2; outlook revised to stable
250 Greenwich Street
New York, NY 10007
No Related Data.
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