NEW YORK--()--Fitch Ratings has downgraded the rating on $165 million ($76.5 million outstanding) senior notes due 2020 of OrCal Geothermal LLC (OrCal) to 'BB' from 'BBB-'. The ratings downgrade reflects OrCal's exposure to depressed Short Run Avoided Cost (SRAC) energy prices through debt maturity, and revenue contract renewal risk for 50% of capacity after 2015.
The Rating Outlook has been revised to Negative from Stable reflecting uncertainty regarding achievement of production increases and contract prices that must be realized to maintain debt service coverage consistent with the current rating.
KEY RATING DRIVERS
--Revenue Contract Prices Uncertain: Energy revenues are materially exposed to variable SRAC pricing and negatively impacted by SRAC's correlation with natural gas prices. Uncertainty about new contract prices for 50% of capacity after 2015 and potentially low SRAC prices for 33% of capacity through maturity significantly weaken the revenue profile.
--Output Requires Active Management: OrCal continues to actively manage the geothermal resource. However, increases in output in 2012 were adversely affected by delays in installation of new wells and equipment. Planned capacity increases expected by 2014 are likely to occur.
--Expenses Remain Stable: Total expense reductions have benefited the project since 2010, and are expected to be sustained.
--Projected Metrics Below Investment Grade: Fitch calculated debt service coverage of 1.31x was well below Fitch's projections of 1.70x in 2012. Under the Fitch rating case, the debt service coverage ratios (DSCRs) average 1.35x with a minimum of 1.20x through 2020, which is not consistent with an investment grade rating for a partially contracted thermal project that is subject to substantial price risk, and the inability to absorb modest cost stresses.
--Failure to realize production increases by 2014, as projected and funded by the sponsor.
--Natural gas prices below current Fitch forecasts.
--Operating cost profile materially different from current levels.
--Material reduction in exposure to variable energy pricing.
The senior notes are collateralized by a first priority lien on the accounts, revenues, project agreements, real and personal property or OrCal, and all the equity interests in the project.
As anticipated, 85% of OrCal's energy revenues converted to variable SRAC pricing when fixed rates under contract ended in May 2012. Based on SRAC's correlation with natural gas prices, the current and persistent low-priced gas environment has considerably impacted existing and forecasted revenues.
Fitch considers the risk low that the project would not sign a new revenue contract to replace the contract expiring in 2015 based on the demand for renewable base-load power in California. However, there is uncertainty about new contract prices. As a result, Fitch assumes a minimum contract price for this production through debt maturity.
A surviving SRAC contract through debt maturity for 33% of output capacity weakens the revenue profile. Fitch stressed the variable pricing under this contract to simulate sustained low natural gas prices through 2020 under the rating case.
Recent declines in production performance in 2012 also highlight OrCal's output variability. A major capital improvement plan at Heber 1, slated for 2012 and unexpectedly delayed, was a major contributor to availability declines at the plant. The remainder of the capital plan for Heber 1 is expected to occur in 2014, a year behind schedule. Fitch believes the improvements could boost capacity.
Favorably, funding for the capital plan comes from the sponsor, Ormat Nevada, Inc., under a subordinated loan agreement that Fitch considers comparable to equity contributions. Therefore, funding for capital enhancements does not reduce cash available for debt service.
The rating case also includes gas hedges that provide a floor on SRAC prices through 2015. Thereafter, Fitch uses the agency's low gas price deck to determine SRAC prices through maturity, reflecting gas below $4.50 per MMBTU. As discussed, Fitch assumes a minimum price under a new revenue contract after 2015 for 50% of capacity through debt maturity, and excludes a cost stress that would further erode margins. Under the Fitch rating case, the DSCRs average 1.35x through 2020, which is not consistent with an investment-grade rating.
OrCal is a special-purpose company created to acquire the Heber 1 and Heber 2 geothermal power facilities (the Heber power plants) located in Imperial County, CA. The Heber power plants sell electric energy and capacity to Southern California Edison (SCE; 'A-' / Stable) under two separate Standard Offer No. 4 PPAs expiring 2015 and 2023.
OrCal also owns the Gould 1 and Gould 2 plants which consist of a series of upgrades designed to enhance production and operating efficiency at the Heber power plants. The Heber South power plant, which became operational in 2008, supplies energy to Southern California Public Power Authority ('A'/Outlook Stable) under a separate fixed-price PPA.
OrCal is jointly owned by a tax-equity investor and Ormat Nevada Inc. Ormat Nevada is a subsidiary of Ormat Technologies, Inc., a vertically integrated owner and developer of geothermal and other recovered energy projects.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Rating Criteria for Infrastructure and Project Finance' (July 11, 2012);
--'Rating Criteria for Thermal Power Projects' (June 18, 2012).
Applicable Criteria and Related Research
Rating Criteria for Infrastructure and Project Finance
Rating Criteria for Thermal Power Projects