CE Generation receives affirmation of BBB- rating for secured bonds

CalEnergy Unit 5, Imperial Valley/ California (source: landmark-ca.com)

Alexander Richter 8 May 2010

Reported from the U.S., “Fitch Ratings has affirmed the ‘BBB-‘ rating for CE Generation LLC’s (CE Gen) $400 million secured bonds (the secured bonds) due 2018, with $219 million currently outstanding.

The affirmation reflects CE Gen’s long-term credit profile in which most of its cash flows derive from 10 well maintained and operated geothermal projects in the Imperial Valley of California (the Imperial Valley Projects). The affirmation follows reductions in total scheduled debt service, and the conclusion of a large capital improvement program in 2010 that is expected to reduce geothermal operating costs going forward. Credit concerns include structural subordination of the secured bonds to debt at CE Gen’s portfolio of projects, future migration of fixed price to variable price power sales at the Imperial Valley Projects, and the potential for expected geothermal cost savings to be lower than expected. The Rating Outlook remains Stable.

Supporting the current rating is the stability of cash flows at the Imperial Valley Projects. Geothermal output is contracted under nine investment grade power purchase agreements (PPAs), of which eight are with the highly rated utility, Southern California Edison (rated ‘A-‘/Stable Outlook), and one with Arizona Public Service (rated ‘BBB-‘/Stable Outlook). The output is 100% contracted through 2016 and 87% contracted through 2018. Fitch expects the geothermal projects will be able to renew the expiring PPAs with Southern California Edison (SCE) due to existing Renewable Portfolio Standards that require utilities in California to procure 20% of their power from renewable sources by 2010, and targets 33% by 2020. Geothermal power does not create greenhouse gases, and qualifies as clean, renewable energy. In addition, the Imperial Valley Projects are well run by an affiliate of CE Gen and have shown strong performance over the last eight years at a combined capacity factor of 92% or greater. The projects are sited on a proven geothermal resource base with a projected life beyond 2029.

Of concern is the structural subordination of the secured bonds to the debt at the portfolio projects. Cash flow to CE Gen is only available after debt service at the project level, and distributions are subject to a relatively high distribution threshold. Fitch evaluates CE Gen’s debt coverage on a consolidated basis, assessing total cash available for debt service across all projects, against total debt service for the secured bonds and all project level debt. In the Fitch combined stress rating case, the consolidated debt service coverage ratio is expected be 1.55 times (x) average and 1.35x minimum through the term of the secured bonds. The minimum consolidated coverage level is not expected to persist as indicated by the higher average, and project level coverage is expected to remain significantly higher than the distribution threshold. The consolidated coverage profile in the rating case is consistent with the assigned rating.

Going forward, the primary risks to CE Gen’s financial performance are market-based price exposure under its geothermal PPAs, and possible shortfalls in its projected cost savings at the Imperial Valley Projects. After 2012, the eight PPAs with SCE will convert from current fixed prices to SCE’s Short-Run Avoided Cost (SRAC) which is highly correlated with natural gas prices. An extended low gas price environment could therefore adversely affect cash flows. In addition, the Imperial Valley Projects are finishing a three-year capital improvement plan in 2010. The investments in production piping are expected to result in significantly fewer outages and overall lower maintenance costs beyond 2018. The projected level of cost reduction remains unproven, however, and might yield lower savings than estimated. These risks were taken into account in Fitch’s combined stress case.

Finally, as expected, CE Gen’s cash flow profile substantially changed at the end of 2009 from relying on the Imperial Valley Projects for 37% and on three gas-fired plants for 63% of cash flows, to relying on the Imperial Valley Projects for over 90% and on the gas plants for 5%-10% of cash flows. Historically, gas projects Saranac and Power Resources provided the majority of CE Gen’s cash flow under various PPAs that expired in 2009, and now sell peaking output under short-term tolling agreements. CE Gen’s smallest gas fired project, Yuma, continues to sell 100% of its output to strong investment grade utility San Diego Gas & Electric (rated ‘A-‘/Stable Outlook) through 2024. Fitch projects the reduction in cash flows from the gas assets can be absorbed by the Imperial Valley Projects because of significant reductions in scheduled senior debt service at the geothermal plants themselves, which allows more cash flow to be up-streamed to CE Gen, additional scheduled reductions in secured bond debt service at CE Gen, and improved cost savings reaped from the extensive geothermal production pipeline replacement program. Additional cash flow from the gas assets above current projections could only enhance CE Gen’s financial performance.

CE Gen is a special purpose holding company created solely to issue the secured bonds and hold the equity interests in 13 generating assets with an aggregate net ownership interest of 770 MWs. CE Gen’s 10 geothermal facilities (the Imperial Valley Projects) are located in Calipatria, California, and its three gas fired facilities are located in Plattsburg, New York (Saranac); Big Springs, Texas (Power Resources); and Yuma, Arizona (Yuma), respectively. CE Gen is owned 50% by U.S based MidAmerican Energy Holdings Company (rated ‘BBB+/Stable Outlook) and 50% by Canadian based TransAlta USA Inc.”

Source: Business Wire