ArcLight is close to completing a bond financing for its $460 million Hobbs Power project. The deal, led by Calyon and Lehman Brothers, is an extremely rare example of a bond financing for an entirely greenfield power project.

Lea Power is a CCGT power project located to the west of Hobbs, New Mexico. It is positioned to supply both that state's power market and that of West Texas. It is located at the site of the Maddox and Cunningham plants, whose owner is Xcel Energy. It has a capacity of 604MW during the winter and nearer 504MW in summer, because it uses air cooling technology, that reduces the project's water consumption but is more sensitive to ambient temperatures than a water-cooled facility.

The location is not a coincidence. The project is being developed in response to a request for proposals from Xcel subsidiary Southwestern Public Service Company. SPSC issued the RFP in April 2006, attracted a swarm of developers, including Black Hills Corporation, Invenergy, LS Power and Kinder Morgan.

But the winner was a joint venture of Genova Power Solutions, a six-year old developer, and Centennial Power, then a subsidiary of MDU Resources, a utility, construction and oil and gas group. The joint venture made the shortlist on 26 June, and was selected on 31 October.

At the same time that Xcel selected the winners, the winners selected ArcLight as equity provider for the project. ArcLight Energy Partners Fund III is the owner of project company Lea Power Partners, and provides all of its equity funding. This arrangement is not the first for a power fund, although few have the patience to provide such early-stage development equity.

The winning bid was premised on a combination of long-term low-cost financing and low-cost equipment. Genova's principals, with a long background in project development, managed to salvage equipment from other producers that had not obtained suitable locations or power purchase agreements.

The developer secured grey market equipment from a variety of sources. From the site of the abandoned McAdams power project in Mississippi, the developer secured a GE steam turbine/generator and two Aalborg heat recovery steam generators. The McAdams project, with which Genova was familiar, was a former TECO property on which the Florida utility had ceased construction.

The developer then secured two Mitsubishi 501F turbines from Tenaska, which had in turn bought them from AES' stock of unused turbines. All of this equipment, as well as a water use reduction system from SPX, and a boiler from CMI, benefit from manufacturers' warranties.

The engineering, procurement and construction contractor is Centennial Power's sister company, Colorado Energy Services (CES). The contractor has roughly five projects under its belt, but is a less well-known name than many of its peers, a fact that could cause lenders discomfort.

Moreover, as the debt of project company Lea Power partners went to market, MDU announced plans to sell both Centennial Power and CES to a joint venture of Natural Gas Partners VIII fund. MDU's rating is currently BBB+/A3 (S&P/Moody's), while the rating of the Centennial/CES acquisition vehicle is currently the subject of discussions between the new owners and their lenders, Goldman Sachs and Barclays.

The construction risk profile is thus in need of enhancement, and Calyon is providing a letter of credit to support this. The developers had originally intended that the plant be constructed using a bank facility, but ArcLight decided that the enhancements, necessary to make the project bankable, would also make the project a suitable subject of a bond financing.

In this analysis, the power purchase agreement is key. The PPA has a term of 25 years, and provides for fixed capacity payments to the projects so long as it is available and ready to dispatch. The project is not exposed to volume, price, or commodity risk. The offtaker is rated BBB/Baa1 (S&P/Moody's), and is a familiar credit to bank lenders, particularly through its wind power purchases.

The financing breaks down into a prospective $327 million, 30-year 144A bond issue, and roughly $120 million in equity, backed by a $20 million equity letter of credit. Construction started in late 2006, so some of this has already been spent, and ArcLight is providing roughly $13 million in additional contingent equity commitments, for the benefit of prospective bondholders. The bonds have received a preliminary rating of BBB- from S&P.

Letters of credit amount to $428.6 million, of which the most important is a $307 million construction letter of credit, priced at 162.5bp over Libor. This is designed to carry the project and its bondholders, through to completion, and will eventually fall away. Additional letters of credit include a $75.5 million performance letter of credit, $15.5 million debt service letter of credit, $15.6 million interconnection letter of credit, and $15 million working capital letter of credit.

The project's debt service burden during construction will be relatively high, but gas-fired plants can be completed in a relatively short period. The plant should be operational by the middle of 2008, and a negative carry period of this length is surmountable. The bonds should have a maturity of 2024, just one year less than the PPA, so the benefits are considerable, especially if a developer takes the view that underlying rates are set to rise.

The bonds are set to close by the end of the month, providing enough banks sign up to the letter of credit, and Calyon can persuade the ratings agencies of the efficacy of its construction wrap, among other elements. The deal, though, is a one-off. Although other utilities, especially in the southwestern US, are looking to contract for power, few will sign a PPA with the same length.

Nor are there the same numbers of cheap parts available. Jeff Shroeter, managing director for Genova, estimates that following the developer's example, the overhang in the supply of boilers and turbines has been eliminated in the last 6-8 months. Copycats will have to pay list prices, and raise money from the B loan market to pay for them, if they want to compete for similar opportunities.

Lea Power Partners
Status: Letters of credit in syndication, bond financing set to launch shortly
Size: $460 million
Location: Hobbs, New Mexico
Description: 550MW gas-fired power project
Developers: Genova Power Solutions, Centennial Power
Equity provider and owner: ArcLight Energy Partners Fund III
Debt: $334 million in 144A bonds, backed by $430 million in letters of credit
Arrangers and bookrunners: Calyon and Lehman Brothers
Independent engineer: E3 Consulting
Owner's engineer: Burns & Roe
Environmental consultant: CH2M Hill
Project company legal: Paul Hastings