Project leasing has long been suggested as a way to increase the sources of capital available to sponsors who want to take solid assets off balance sheet. It is also prized for its ability to create tax and accounting benefits for plants' former owners. It is probably the second factor that explains why the method does not always get the analysis that it deserves ? cutting-edge instruments are not what a nervous market desires right now. Dynegy's Project Alpha is described by its creator as tax-driven, but suggestions that the series of transactions inflated revenue have hurt the Dynegy share price hard.

Kinder Morgan's $194.3 million AlphaGen financing, therefore, is described by most parties to the deal as fairly simple and even vanilla, in recognition of the fact that innovation carries little kudos amongst arrangers or sponsors. A look at the deal's structure suggests, however, that the financing brings together several elements that could add to the energy player's capacity base if other avenues remain closed. This is, after all, a rare deal without recourse to its sponsor that features several structural enhancements to maximise potential returns to Kinder Morgan.

AlphaGen is the lessor of a 535MW combined-cycle plant, in Jackson, Michigan (known as Triton). Triton's developer, contractor and sponsor is Kinder Morgan Power. The facility has signed a 16-year tolling agreement with Williams Energy Trading and Marketing, owned and guaranteed by the Williams Companies. The 22-year financing therefore features a six-year merchant tail.

The most interesting technical aspect of the plant is that it uses a proprietary turbine configuration, dubbed Orion, possibly after the now Reliant-owned champions of managed power solutions, Orion Power. The configuration's chief benefit is that it enables the plant to start up extremely quickly and without undue stress to components, and to maintain a consistent heat rate. The turbines used are six GE LM6000 turbines and one GE Frame 7EA, as well as two steam turbines.

Given the speed with which the plant can be started up, it may be able to realise substantial premiums for providing rapid-response, yet cost-effective power. It also explains why Kinder Morgan is managing the construction process, which is over 90% complete. Subcontractors on the plant, which has experienced some overruns, include Kvaerner Songer. Structures designed to deal with such issues, as well as the potential for a declining sponsor or offtaker credit, are among the chief innovations on the financial side.

Until now, and certainly for the last three years, leveraged leasing has been the province of the acquired facility. Several large generation company (genco) financings, starting with AES' Eastern assets, have used it. Edison Mission, Mirant (then Southern Energy) and Reliant Resources (then Reliant Energy) have since followed suit, on Commonwealth Edison, Sithe and Pepco assets, respectively. This last target, however, was financed on a non-recourse basis, and was priced far wide of the others. Others have typically carried a corporate guarantee on lease payments, which figures more prominently on accounts.

AlphaGen's guarantees, on the other hand, are far more piecemeal, which means, combined with the assumption of limited construction risk by lenders, that the deal is the closest on offer to a pure project lease. AlphaGen is a special purpose entity effectively owned by CIT and leased to Triton Power Michigan for 40 years. CIT, alongside Investment Management Holdings, has put up $58 million in lease equity, with the headline $194.3 million provided by nameless institutional investors, described by those close to the deal as being largely similar to the project finance debt providing community.

The unique part of the structure, however, is that it includes five additional tranches of equity, of which one is common equity of $3.1 million. This piece is designed to satisfy an outside ownership requirement of 3%, probably for the benefit of the lease equity providers' balance sheets. More important to the deal's economics, however, are the four contingent equity pieces.

Class A and B are $89.2 million funding, of which $24 million is committed. These classes are designed to protect bondholders during the merchant tail of the deal. Whilst designed to boost cashflow and cover debt service, they are available if the plant is not at Williams' disposal by 1 July 2003. Class C is an initial commitment of $5.2 million, and $2.6 million per year (up to $41.6 million) to cover operations and maintenance difficulties, but not shortfalls under the tolling agreement. Class D covers payments required through overruns with the EPC contract (guaranteed by Kinder Morgan). Williams has the option to buy into the B and C classes, although common equity may be required to be boosted the outside ownership level above 3%.

These equity cushions enable the project to subsist on a 1.4x coverage ratio for the tolled period and 1.7x thereafter. In the event of a downgrade of either Williams or Kinder Morgan to below BB, distributions are stopped until these portions are cash-reserved, but the effects of a downgrade would have broader effects on the project's profile, as a report from Standard & Poor's notes. S&P gave the deal a BBB- rating, a notch below Williams' BBB level.

Analysts are fortunate in that it is possible to analyse the probable operational profile of the plant on the basis of the five-year history of the 272MW Fort Lupton facility, which uses a similar turbine configuration. Crucially, it has met the availability requirements demanded of Triton to gain its fixed capacity payments. Moreover, the plant has been tested against the past history of a comparative baseload-dominated market ? PJM ? and has been found to be robust.

The debt was initially sized at around $201 million, but was later decreased to maintain debt service coverage ratios at a high 9.019% interest rate. The placement agent, Citigroup/Salomon Smith Barney, has declined to comment on the pricing of the issue, but if it is high enough to force a lowering of debt size, then market reluctance to assume non-recourse lease debt without adequate reward is undimmed. Nevertheless, the deal adds considerably to the lessee's arsenal and probably stretches the industry envelope a little wider, even if the participants would not care to admit this.

AlphaGen LLC

Status: closed 24 April 2002

Size: $364.1 million

Location: Jackson, Michigan, USA

Description: Leveraged lease financing of 534MW combined cycle plant with innovative turbine configuration

Sponsor: Kinder Morgan Power

Debt: $194.3 million

Placement agent: Citigroup

Lease equity: $58.5 million

Equity providers: CIT and Investment Management Holdings