SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed the rating of Midland Cogeneration Venture LP's (MCV) combined $741.25 million ($666.7 million outstanding) senior secured notes due 2025 at 'BBB-'. The Rating Outlook is revised to Stable from Negative.
KEY RATING DRIVERS
The Outlook revision to Stable from Negative and rating affirmation reflects the expectation that the near-term weakness in MCV's financial profile will not extend beyond 2016. Debt service coverage has improved due to positive adjustments to the fixed energy rate (FER) component of MCV's power purchase agreement (PPA), and updated DSCR projections suggest there is adequate cushion for the project to absorb operational stresses or extreme market pricing conditions. The rating affirmation reflects Fitch's expectation that the forecasted FER along with continued stable operating performance will maintain the project's financial profile at a level consistent with an investment grade rating.
Contracted Cash Flow with Volume and Price Risk [Revenue Risk: Midrange]
Over 90% of MCV's fixed and variable revenues are derived from contracted power and steam sales to investment grade offtakers. The Consumers Energy Co. (Consumers, 'BBB'/Stable Outlook) PPA passes through most of the fuel, operations and maintenance (O&M) and emission costs through capacity and energy payments. However, project revenues are partially exposed to volume and price risk through the PPA fixed energy rate, market gas and power pricing, and PPA dispatch.
Proven Operating History [Operation Risk: Midrange]
The facility has historical PPA availability exceeding 98% since its completion in 1990, supported by excess capacity and redundant equipment. The operations and maintenance profile, along with the long-term service agreement (LTSA) is expected to support PPA requirements through 2025.
Limited Fuel Risk [Supply Risk: Midrange]
The abundance of fuel management suppliers mitigates the risk of MCV's expiring contract with Shell Energy. Additionally, fuel costs are a pass-through under the off-take agreements or hedged with forward contracts, mitigating the price risk with contract extension or replacement.
Fully Amortizing Debt Structure [Debt Structure: Midrange]
MCV's debt is fixed and fully amortizes over the next 10 years. The structure contains typical project finance features, such as a six-month debt service reserve and 12 months forward and backward-looking distribution test of 1.20x DSCR.
Improving Financial Profile
Debt service coverage in 2016 is expected to dip from 2015 levels to below typical coverage for investment grade thermal projects. However, the financial profile strengthens beyond 2016 with rating case DSCRs averaging 1.45x through the remaining debt term.
Peer Comparison
MCV's high proportion of contracted cash flow and midrange debt structure and DSCR profile are consistent with other single-site investment grade cogeneration peers. However, MCVs volume and fuel price risk is a significant exposure, unlike peer Orange Cogen ('BBB+', Stable Outlook). Other cogeneration peers similarly exposed to partial price and volume risk have lower projected margins that are not consistent with investment grade ratings.
RATING SENSITIVITIES
Negative: Debt service coverage remains materially lower than the Fitch rating case;
Positive: Fixed energy component of the PPA adjusts to a higher than expected rate with forecasted DSCRs above Fitch's base case projections.
SECURITY
Collateral includes a first lien security interest for the benefit of all senior secured note holders, 100% of the assets of the issuer (MCV); 100% of the sponsors' equity interests in the issuer; all material project documents and agreements; the funds of collateral accounts and all permitted investments; all insurance and reinsurance and condemnation awards; and all revenues. Shell Energy also holds a $100 million pari passu lien for the above assets and interests as collateral under the obligation of the secured commodity agreement.
CREDIT UPDATE
The revision of MCV's Outlook to Stable from Negative reflects upward adjustments of the FER in addition to continued stable operations. The FER, a key component in the calculation of MCV's energy revenues, is indexed to the cost of generation from Consumers' coal-fired fleet. During the last FER adjustment, MCV's management discovered incorrect calculations by Consumers resulting in a lower rate than was actually due. As a result, in July 2015, Consumers made a payment of $9.9 million to MCV for current and past adjusted FER plus $1 million in interest. The current year FER increased by 9% and forecasts were revised upward to reflect the corrected operating costs of the indexed coal plants.
Changes in the FER are largely beyond MCV's control, representing a potentially substantial price risk under the PPA. The FER index historically grew 5% per year, however, beginning with the April 2014 FER adjustment, the rate declined by 14% due primarily to lower O&M costs among seven coal units in the Consumers fleet scheduled for retirement. The lower rate (even after the recent upward adjustment) will persist until these units are finally shut down in 2016 and removed from the FER calculation.
Through the second quarter of 2015 operations were in line with MCVs forecasts and improved from the same period last year. In February 2015, the upper Midwest experienced a record cold month, but market prices remained relatively stable as gas industry were better prepared for winter demand. MCV continues to maintain high availability exceeding 98% and in line with historical averages. The low gas prices and supportive off-peak power prices have allowed the project to operate more often in combined cycle mode, limiting the use of their auxiliary boilers, and resulting in favorable volume and efficiency variance compared to the same period last year where the project experienced more volatile pricing movements. Additionally the configurations allow for more off-peak merchant sales while limiting the cycling of the gas turbines. The redundancy of the components allows the project to maintain high PPA availability in addition to operating at optimized configurations based on market pricing for gas and energy. The DSCR for 2015 is expected to be over 1.45x
Fitch's rating case contemplates debt service coverage under stressed market conditions aimed to capture the potential downside of MCV's volume and price risk. FER projections are based on a detailed analysis of expected coal generation and O&M costs of the remaining units. These projections are incorporated under Fitch's various gas/power pricing scenarios to assess the potential variability of this index under shifting market conditions. Debt service coverage in 2016 will be 1.20x in the Fitch rating case. Over the full remaining debt term, rating case DSCRs average 1.45x, with a minimum of 1.20x (2016). The profile strengthens in the outer years and DSCRs are in line with an investment grade rating.
TRANSACTION SUMMARY
MCV was formed in 1987 as a limited partnership to convert a portion of an uncompleted nuclear power plant owned by Consumers into a 1,633-MW natural gas-fired, combined cycle, cogeneration facility. MCV issued series A notes in 2011 and series B notes in 2013. The series are pari-passu, are secured by a typical pledge of project assets and contracts, and fully amortize in March 2025 via semi-annual payments of principal and interest.
Additional information is available on www.fitchratings.com
Applicable Criteria
Rating Criteria for Infrastructure and Project Finance (pub. 12 Jul 2012)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=682867
Rating Criteria for Thermal Power Projects (pub. 23 Jun 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=867314
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