Fitch Affirms Kleen Energy Systems, LLC's Ratings at 'BB'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed at 'BB' the ratings for Kleen Energy Systems, LLC's (Kleen) $435 million ($108.1 million outstanding) term loan A due 2018 and $295 million ($250.9 million outstanding) term loan B due 2024. The Rating Outlook is Stable.

KEY RATING DRIVERS

The ratings reflect Kleen's stable base of capacity payments under a long-term contract with a strong, investment-grade offtaker and the facility's uncertain competitiveness in a merchant environment. The reduced debt service burden after 2017 should substantially mitigate operating risks, though the level of financial cushion will depend upon Kleen's profitability as a merchant generator. The Stable Outlook is supported by Kleen's consistent operational performance and improved cost visibility over the past two years.

Fitch estimates that Kleen achieved a debt service coverage ratio (DSCR) of 1.29x in 2015 and expects the DSCR will improve to 1.37x in 2016. In the near term, Fitch believes that DSCRs are unlikely to fall below 1.30x absent significant departure from recent operating performance. After the tolling agreement expires in 2017, capacity payments alone should be adequate to support an average DSCR of 1.44x.

Revenue Risk: Midrange

Fixed price agreements: Kleen's revenues are currently derived from fixed-price tolling and capacity agreements with investment-grade counterparties, partially mitigating price risks through 2017. The project remains subject to replacement power costs in the event of a forced outage under the tolling agreement. Kleen is vulnerable to margin risks during the post-2017 merchant period but is not entirely dependent on market-based revenues, as capacity payments alone should be sufficient to meet debt service requirements.

Operation Risk: Weaker

Kleen has not yet established an extensive history of cost stability or consistent operating performance. Actual costs have exceeded original projections by a wide margin and demonstrated considerable volatility. Kleen's ability to meet target availability requirements under the capacity agreement remains uncertain based on Kleen's history of forced outages. Kleen otherwise benefits from commercially proven technology operated and maintained by experienced O&M providers.

Supply Risk: Midrange

Low Supply Risk: Volumetric risks are minimal, as the project is situated in a highly liquid and competitive natural gas market. The tolling counterparty bears natural gas supply risks in the short term, and Kleen's dual-fuel capability protects against temporary supply disruptions.

Debt Structure: Midrange

Mitigated Refinancing Risk: Fitch believes Kleen will likely fully prepay the term loan A balloon payment prior to maturity if the facility continues to maintain a high level of operational performance. The supplemental amortization mechanism relies upon contracted revenues during the tolling period, and catch-up provisions provide some protection against temporary interruptions in cash flow.

Near-Term Financial Vulnerability: The expected 2017 DSCR of 1.40x provides Kleen with limited financial cushion to protect against variable cost risk and market-based contractual penalties under the tolling agreement. The potential for a missed target amortization payment is therefore greatest prior to 2018, when the tolling agreement is no longer in effect. Fitch-projected DSCRs generally range between 1.40x and 1.45x during the merchant period based solely on contractual capacity revenues, which could be consistent with higher credit quality.

Peer Comparison: Kleen's credit quality is consistent with other thermal projects in the 'BB' rating category. Lea Power Partners, LLC (rated 'BB+', Stable Outlook) has stabilized its operating costs, and cash flows are sufficient to support a higher average rating case DSCR of 1.37x. Conversely, CE Generation LLC (rated 'BB-', Stable Outlook) is exposed to a greater degree of price risk with rating case DSCRs that fall below breakeven, such that the project is reliant upon sponsor support.

RATING SENSITIVITIES

Negative - Further increases in costs would heighten the project's vulnerability to operating event risks.

Negative - Persistently low availability, repeated forced outages, or an accelerated degradation in heat rates could reduce revenue and subject the project to contractual penalties.

Negative - In the event that an outstanding balance remains on the term loan A at maturity, market conditions and/or project-specific factors could prevent Kleen from refinancing.

Positive - Kleen's financial profile could improve if the project enters the merchant period with a stable operational profile and a favorable competitive position.

SUMMARY OF CREDIT

Fitch believes that Kleen's financial profile has stabilized, as the project has recorded more than two consecutive years of improved operating results and recently resolved outstanding disputes with its offtakers that should improve revenues going forward. Kleen achieved a DSCR of 1.29x in 2015, and the 2016 DSCR is expected to further improve to 1.37x based on operational cash flows. The project is now current on target amortization payments and continues to rapidly deleverage as the maturity of the term loan A approaches in June 2018.

Kleen has maintained availability of more than 98% with stable heat rates below 7,100 btu/kWh. This positive trend follows a severe outage in January 2014 that had a major impact on revenues. The two-year average capacity factor of 80% suggests that tolling agreement is economic for the offtaker, though Kleen's competitiveness in a merchant environment remains untested. Certain unreimbursed variable expenses, such as Regional Greenhouse Gas Initiative (RGGI) costs and the Connecticut Gross Receipts Tax, have eroded margins.

The recovery of Kleen's financial profile has tracked the improvement in operational performance. Fitch projects a year-end (YE) 2016 DSCR of 1.37x excluding extraordinary items related to the settlement of disputes with insurers and contractual offtakers. The estimated 2016 DSCR exceeds the 1.34x Fitch base case DSCR. Marginally increased revenues, lower RGGI costs, and reduced legal fees are the primary drivers of financial performance for 2016.

Fitch believes there is now greater visibility regarding Kleen's operating expenses. Fitch estimates that 2016 expenses have returned to pre-2015 levels of approximately $33 million to $34 million. RGGI costs have eroded Kleen's financial profile but should not significantly contribute to cost volatility in the near term, as Kleen entered into a forward contract to purchase RGGI allowances through 2017. Kleen also expects to incur lower legal expenses following the 2016 settlements.

Kleen's post-2017 cost profile will primarily depend upon the facility's competitiveness as a merchant generator. Many of the unanticipated costs that Kleen has incurred, such as RGGI allowances and the Connecticut Gross Receipts Tax, largely reflect Kleen's lack of dispatch control. A prudently run merchant facility would only incur these costs if the market price of electricity justified the all-in cost of dispatch.

Fitch expects that the 2017 DSCR should reach 1.4x based on a cost profile grounded in the past two years of relatively stable operations. Financial performance after 2017 will depend upon Kleen's prospects as a merchant facility. Fitch estimates that DSCRs would average 1.44x, assuming only the receipt of contractual capacity payments.

Fitch believes that this scenario represents a highly conservative view of projected financial performance, given the current level of natural gas prices and the position of Kleen within the dispatch stack. Projected financial performance could potentially support credit quality above the current rating once the tolling period expires and the outstanding balance of the term loan A is largely repaid.

Kleen is a special-purpose company created to own and operate the project, which consists of a 620-megawatt combined-cycle electric generating facility located near Middletown, CT. Kleen sells capacity under a 15-year agreement with Connecticut Light & Power (IDR 'A-', Stable Outlook). Exelon Generation Company (ExGen; IDR 'BBB', Stable Outlook) purchases the facility's energy output under a seven-year tolling agreement. Exelon Corp. (IDR 'BBB', Stable Outlook), ExGen's parent, has partially guaranteed ExGen's contractual obligations.

SECURITY

The collateral includes a first-priority security interest in the ownership interests in Kleen, all real and personal property, including Kleen's rights under the project documents, the project accounts, and all revenues.

Additional information is available on www.fitchratings.com

Applicable Criteria

Rating Criteria for Infrastructure and Project Finance (pub. 08 Jul 2016)

https://www.fitchratings.com/site/re/882594

Rating Criteria for Thermal Power Projects (pub. 28 Jun 2016)

https://www.fitchratings.com/site/re/883254

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1014669

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014669

Endorsement Policy

https://www.fitchratings.com/regulatory

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+1-312-368-3166
Fitch Ratings, Inc.
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or
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+1-415-732-5622
or
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or
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Contacts

Fitch Ratings
Primary Analyst
Christopher Joassin
Director
+1-312-368-3166
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Andrew Joynt
Associate Director
+1-415-732-5622
or
Committee Chairperson
Gregory Remec
Senior Director
+1-312-606-2339
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com