Nevada Geothermal closed a $180 million long-term construction loan for its Blue Mountain I geothermal project with TCW on 4 September. The financing carried a hefty 14% interest rate, and indicates the difficulties that geothermal developers face in syndicating their debt to inexperienced banks in difficult market conditions.

Nevada Geothermal, listed on Toronto's TSX Venture Exchange and New York's over-the-counter market, is headquartered in Vancouver but has four geothermal properties in the US under development. Blue Mountain, in Humboldt County, in the Northwestern part of Nevada, is its most advanced prospect.

Until 2007, the developer financed development and exploration work on the portfolio, which it says has a potential total capacity of between 150MW and 200MW, through the issue of equity. In September 2005, for instance, it issued C$10 million ($9.3 million at today's rates) in equity through Dundee Securities, and issued another C$15 million through the same underwriter in May of this year.

In August 2006, it agreed a 20-year power purchase agreement (PPA) for 35MW of Blue Mountain's capacity with Nevada Power, a subsidiary of Sierra Pacific Resources and the local utility. This provides the most important underpinning to the financing, and Nevada Power, while not investment grade, has been the counterparty to the majority of geothermal financings in the US in recent years.

But greenfield geothermal assets have often been difficult to finance in the bank market. Ormat, the US industry leader, has financed development prospects using either balance sheet funds or high-yield bank debt. It then typically refinances these with either 144A bond debt, or, more recently, using unlevered tax equity.

This shift in Ormat's financing strategy results from geothermal power's recent eligibility for the production tax credit (PTC). The production tax credit is not strictly necessary to allow geothermal projects to break even, as it is for solar and, arguably, for wind. But it was extended to geothermal in an attempt to spur capacity additions.

But the production tax credit only kicks in when projects are operational, tax equity investors will only provide financing once a plant is on-line, and smaller developers still need a way to bring plants to completion. Nevada Geothermal had hired Ormat, which is an equipment supplier and construction contractor, as well as developer, to build Blue Mountain I. The engineering, procurement and construction (EPC) contract, which includes the provision of three of Ormat's 16.5MW converter units, was executed in April 2008.

The developer had mandated Glitnir Bank, an Icelandic institution known for a specialisation in geothermal power (along with shipping and fisheries) to provide a $20 million bridge loan in November 2007. But allowing Ormat to start work on its full $76 million contract would require Nevada Geothermal to close a full construction financing.

At the same time as the EPC contract signing, it mandated Glitnir and Morgan Stanley as joint lead arrangers, although Glitnir's role was primarily to provide a $145 million construction loan, and Morgan Stanley's role was to refinance that loan with $140 million in tax equity. The two had assembled a bank syndicate, and the developer hoped to close by 30 April but had not formerly signed them in.

The missing element for Nevada Geothermal was a set of definitive drilling results. Geothermal financing shares similar qualities to mining finance or reserves-based lending. Geology plays a huge factor, and few banks have personnel to assess early-stage resource reports properly. Glitnir, which does, has been buffeted by the credit crunch, and like any other project finance bank in the current market, would not provide a sole underwriting commitment.

While the developer was prevailed upon to raise additional credit enhancements, in the form of letters of credit and contingent equity commitments, the two leads were unable to keep the bank syndicate in place. For Nevada Geothermal, plan B was to raise high-yield bridge financing, much as Ormat turned to Beal Bank to finance its asset acquisitions.

For the lucky provider, TCW, the terms are very attractive. Blue Mountain's debt financing requirement has been increased to $180 million, to take account of higher financing, interest and construction costs. TCW gets a 200bp upfront fee for its 15-year debt commitment and the all-in pricing of 14% on undrawn amounts.

But the hardest cut of all was TCW's insistence on receiving a 7.5% interest in the project, a stake that the developer promises to buy back in 15 years. For a small developer that has struggled to remain independent while bringing the project to fruition, the dilution is a difficult one to bear. Moreover, even if the developer manages to refinance the financing, it must keep $70 million of the TCW debt outstanding.

Nevertheless, as soon as Nevada Geothermal can produce comprehensive drilling reports, and complete the procurement process for a 34km transmission line to Sierra Pacific's grid, it will look to refinance the debt. If it cannot do so before completion, a tax equity commitment might refinance the TCW debt directly. But the primary objective, avoiding having to renegotiate the Ormat EPC contract at a higher price, has been met.

The developer can now reasonably hope to have the plant online by the end of 2009. Its PPA, fortunately enough, includes a provision that the tariff that the utility pays would be higher in the event that the PTC does not cover the project, and both sides would probably agree to move the plant's operational date into 2010 if this allowed it to receive tax benefits.

But the outcome illustrates starkly how ill-prepared to assist in geothermal financings the commercial bank sector is, and how few alternative options there are. TCW operates an extremely lucrative niche, but would not have the resources to bankroll an entire sector. Google's noisy commitment to invest in geothermal might have captured the headlines, but Blue Mountain provides a welcome dose of reality.

NGP Blue Mountain Holdco LLC
Status: Closed 4 September 2008
Location: Humboldt County, Nevada
Description: 49.5MW geothermal power project
Sponsor: Nevada Geothermal
Debt: $180 million
Provider: TCW
Arrangers: Morgan Stanley, Glitnir Bank
Offtaker: Sierra Pacific Resources
EPC contractor: Ormat
Resource consultant: GeothermEx
Independent engineer: Luminate
Drilling: ThermaSource
Sponsor legal: Latham & Watkins
Arranger legal: Chadbourne & Parke; Skadden Arps