Power Project Requiem
The US electric generation industry has changed. There is more deal
flow for banks in financing acquisitions than in start-ups ? and
more in bankrolling portfolio deals than in single asset
transactions. In amortising lender, legal and ratings agencies'
fees over a portfolio of companies, per unit costs are lower for
borrowers. And while there is intense competition among banks for
single asset transactions, bankers maintain that the ardour is as
much driven by building a relationship for future multiple deals as
it is for the actual financing of a single asset.
A New York-based banker laments, ?It's going to be a lot tougher for start-ups and independents today than it was 10 years ago because of deregulation. Adding to the problems of potential start-ups is that rates charged to customers are being shaved to the bone as new entrants and established energy seeking to buy greater market share cut prices to retail customers. I can't even guess what the US market will look like three or four years from now ? except that there will be a number of casualties along the way.?
No one has summoned clergy to lead a requiem mass for project finance. But even die-hard project finance fans recognise that the structure harbours some vestiges of a bygone era. Bankers tied to project finance rather than financing projects may find themselves employed in the fast foods industry.
Financing schemes have evolved and become more sophisticated. Transition contracts have benefited the financing of plants sold by utilities in the US. These transition contracts ? usually two to five years long ? provide predictable cash flow for a period, and some comfort for lenders. Over the last few years, electricity markets have changed dramatically. Power plants in developed countries are now sold or built almost exclusively without the security of long term power purchase agreements. Instead, merchant plants sell directly into wholesale power markets. The power sector also has been marked by a declining number of one-off acquisitions in favour of portfolio acquisitions. The move toward portfolio acquisition represents a huge change for project finance banks and the bankers making the deals.
?The mindset seems to be that you can't live by one unit alone. The days of individual players are pretty well gone,? according to Fitch Managing Director Alan Spen. Portfolio acquisition allows for multiple revenue streams, reduced legal and ratings fees, and the ability for an acquirer to add or sell assets to correspond with corporate strategy. ?While we may end up with 10 big companies because of rampant consolidation, ratings agencies still look at how good individual projects or properties are,? adds Spen, Gencos benefit from cash flow diversification, and if assets are geographically diverse, the downside effect of overbuilding in a single region is minimised.
Calpine is at the forefront of changes in the way deals are structured and financed. The California-based company recently announced plans to acquire Northbrook, Illinois-based SkyGen Energy from Michael Polsky and from Wisvest Corporation, a Wisconsin Energy Corp affiliate, for $450 million, plus the assumption of $122 million of SkyGen Energy debt obligations. To fund the SkyGen Energy and other recently announced acquisitions, Calpine has obtained a $1 billion six-month credit facility with Bank of Nova Scotia, Credit Suisse First Boston (CSFB) and CIBC World Markets. The company expects to refinance this facility in the capital markets.
To pay down the bridge facility, Calpine will issue a mix of common equity, convertible preferred and debt securities from a soon to be filed $2 billion shelf registration that will effectively pre-fund Calpine's future equity commitment for announced plants under development. For its requirements over the next four years, Calpine is finalising a construction revolver in the $2 billion to $2.5 billion range. Calpine is expected to refinance this facility after the plants move from development to commercial operation.
As part of the SkyGen acquisition, Michael Polsky, who founded the company in 1991, will receive approximately 1.1 million shares of Calpine common stock. In addition, Calpine will make contingent payments for completion of certain project development milestones. Goldman Sachs acted as financial advisor to SkyGen Energy, with Credit Suisse First Boston serving as Calpine's advisor. SkyGen will continue to develop its portfolio of development projects as a wholly owned subsidiary of Calpine.
At the same time, Calpine announced that it had secured rights to develop, build, own and operate a 600MW natural gas-fired electricity generating facility near the town of Thermal in Riverside County, California through a development agreement with Adair International Oil and Gas. The $275 million Teayawa Energy Center will be sited on the Torres Martinez Desert Cahuilla Indians' land through a long-term lease agreement between Calpine and the Torres Martinez. Construction of the project may begin as soon as mid-2001, with commercial operation beginning in late 2003. The venture will not be project financed. Output from the project will be sold into California's competitive electric power market.
As the power project is located on Native American land, the lead permitting agency under the National Environmental Policy Act is the federal Bureau of Indian Affairs (BIA). Additionally, BIA approval is necessary to ensure that the Teayawa Energy Center appropriately meets the cultural, environmental and economic considerations of the Torres Martinez.
Calpine will manage all aspects of project development for the Teayawa Energy Center, including engineering and design, construction, fuel supply, and power marketing. The project will interconnect with an existing transmission line adjacent to the property.
Bob Kelly, senior vice-president for finance at Calpine, says, ?Calpine's new plants generally are not project financed unless it's a partnership agreement and part of negotiations for varying reasons. And it's very rare for us to make a one-off acquisition unless there is a partner involved.? Kelly notes that changes in the power market ? such as short-term power contracts ? are not compatible with traditional project finance.
?We just acquired SkyGen Energy. They are a very good project developer. But they were creating a structure to satisfy project finance bankers. As a result, they were giving too much to the customer to appease the lender. The problem with project finance bankers is that they have not evolved from the long-term power contract concept to understanding the pricing of power over time.? Kelly asserted that most bankers have adapted to changes in other industries ? such as pulp and paper as well as chemicals and aircraft ? but not power. ?We were the first company to finance an acquisition using a revolving credit facility. We find that moving away from project finance gives us flexibility.?
Adebayo Ogunlesi, head of global energy and the project finance group at CSFB, notes: ?When you try to operate your business on a system-wide basis like Calpine, traditional project finance ? designed for a single plant with a long-term power contract ? is dead.? He adds that for a company with a lot of debt which finances single projects ? such as Edison Mission ? project finance still works.
Ogunlesi says there is still keen competition among lenders for one-off project financing. ?One-offs are usually easier to finance because of the long-term power contracts.? The greatest risk associated with merchant plants is the cost of fuel. With merchant plants you have to guess the future price of energy.
The length of fuel contracts and the potential for mismatching inputs under the contract against future market prices is a key point.
Fuel costs can be hedged. But benefits are limited by debt maturities and the short time horizons of the power and fuel forward markets. Another strategy is subordination of fuel costs to debt service. Fitch notes in a recent report on merchant power projects that Calpine and EMI's Dighton facility have a 20-year gas sale and purchase agreement with a subsidiary of MCNIC. The agreement provides for 365 days of gas supply and transportation with the purchase of gas tied to a market index plus a premium. Importantly, payments to MCNIC are subordinated to non-fuel operating expenses, reserves and senior debt service payments. Bondholders are advantaged by their senior position to roughly 60% of the cash costs to generate a MWh of power.
The far greater proportion of activity in the US is financing the spin-off of existing assets caused by deregulation, according to Jonathan Berman, director of the power and utilities group at Barclays Bank. ?Generally, when a portfolio of properties is sold off, financing takes the form of a halfway house between corporate debt and traditional project finance.? Berman says the hybrid financing emanates largely because of the absence of long-term power agreements that have traditionally been an integral element of project finance. ?On the other hand, these deals are not pure corporate deals either because the traditional utility risk was a regulated entity.? Utility regulation had been an important part of the ratings process. Now banks are finding it more difficult to assess risk, he said. ?There are a large volume of portfolio deals being done, but banks are still trying to figure out if they have the right structure in using a mix of corporate and project finance,? Berman said.
?Most US deals are merchant plant risk where project finance doesn't work. We have got away from rigid emphasis on project finance. Cutting-edge banks are not providing incentives to people just for using project finance. In fact, deals are more likely to include two tranches, a 364-day revolving credit facility plus a three or four loan. We also realise that the industry is moving to financing structures that are changing every day.?
Even Edison Mission Energy, which has been a big user of project finance, has struck out in other directions, in spite of having closed over 40 project financings totalling approximately $15 billion. Eleven of these financings were arranged in currencies other than US dollars. Of the 40 largest banks in the world, as measured by total capital, company officials maintain that 28 have made loans to Edison Mission Energy or its projects. Projects also have received support from export credit agencies, such as the Ex-Im Bank of Japan and the US Ex-Im Bank, and government-sponsored agencies, such as the US Overseas Private Investment Corporation.
The bulk of EME's investments in 1999 represented the acquisition of merchant plant facilities, a relatively new emphasis for the company. In the past, facilities developed or acquired by EME typically featured power purchase agreements that provide long-term certainty of electricity sales and cash flows. Two large recent acquisitions in the US have added to EME's merchant plant portfolio. The first is the twelve power stations in Illinois purchased at the end of last year from Commonwealth Edison Co. Rather than acquiring just one or two individual plants, Edison bought that company's entire non-nuclear generation portfolio.
Owning and operating an entire generating system in a single market as the company did at Southern California Edison allows Edison Mission to fill the full range of power generation needs ? base load, mid-merit, peaking, auxiliary and emergency support. For the first several years, these plants sell largely under contract back to the utility. Thereafter, the company will be free to sell the power wherever it brings the greatest value.
EME's ownership interest in generating capacity more than tripled in 1999. The company's net interest in plants that either are operating or are under construction increased to 22,770MW at yearend 1999 from 6,485MW at the end of the previous year. Included in the acquisitions was the $4.9 billion acquisition of a package of coal, gas and oil-fired electricity generating facilities with a total capacity of 9,510MW from Commonwealth Edison Co. That transaction closed in December and was not project financed. Last year's transactions ? amounting to roughly $10 billion ? were funded through roughly equal amounts of project finance and equity contributions by EME. The equity contributions were financed off-balance sheet and with a capital infusion from parent Edison International.
A New York-based banker laments, ?It's going to be a lot tougher for start-ups and independents today than it was 10 years ago because of deregulation. Adding to the problems of potential start-ups is that rates charged to customers are being shaved to the bone as new entrants and established energy seeking to buy greater market share cut prices to retail customers. I can't even guess what the US market will look like three or four years from now ? except that there will be a number of casualties along the way.?
No one has summoned clergy to lead a requiem mass for project finance. But even die-hard project finance fans recognise that the structure harbours some vestiges of a bygone era. Bankers tied to project finance rather than financing projects may find themselves employed in the fast foods industry.
Financing schemes have evolved and become more sophisticated. Transition contracts have benefited the financing of plants sold by utilities in the US. These transition contracts ? usually two to five years long ? provide predictable cash flow for a period, and some comfort for lenders. Over the last few years, electricity markets have changed dramatically. Power plants in developed countries are now sold or built almost exclusively without the security of long term power purchase agreements. Instead, merchant plants sell directly into wholesale power markets. The power sector also has been marked by a declining number of one-off acquisitions in favour of portfolio acquisitions. The move toward portfolio acquisition represents a huge change for project finance banks and the bankers making the deals.
?The mindset seems to be that you can't live by one unit alone. The days of individual players are pretty well gone,? according to Fitch Managing Director Alan Spen. Portfolio acquisition allows for multiple revenue streams, reduced legal and ratings fees, and the ability for an acquirer to add or sell assets to correspond with corporate strategy. ?While we may end up with 10 big companies because of rampant consolidation, ratings agencies still look at how good individual projects or properties are,? adds Spen, Gencos benefit from cash flow diversification, and if assets are geographically diverse, the downside effect of overbuilding in a single region is minimised.
Calpine is at the forefront of changes in the way deals are structured and financed. The California-based company recently announced plans to acquire Northbrook, Illinois-based SkyGen Energy from Michael Polsky and from Wisvest Corporation, a Wisconsin Energy Corp affiliate, for $450 million, plus the assumption of $122 million of SkyGen Energy debt obligations. To fund the SkyGen Energy and other recently announced acquisitions, Calpine has obtained a $1 billion six-month credit facility with Bank of Nova Scotia, Credit Suisse First Boston (CSFB) and CIBC World Markets. The company expects to refinance this facility in the capital markets.
To pay down the bridge facility, Calpine will issue a mix of common equity, convertible preferred and debt securities from a soon to be filed $2 billion shelf registration that will effectively pre-fund Calpine's future equity commitment for announced plants under development. For its requirements over the next four years, Calpine is finalising a construction revolver in the $2 billion to $2.5 billion range. Calpine is expected to refinance this facility after the plants move from development to commercial operation.
As part of the SkyGen acquisition, Michael Polsky, who founded the company in 1991, will receive approximately 1.1 million shares of Calpine common stock. In addition, Calpine will make contingent payments for completion of certain project development milestones. Goldman Sachs acted as financial advisor to SkyGen Energy, with Credit Suisse First Boston serving as Calpine's advisor. SkyGen will continue to develop its portfolio of development projects as a wholly owned subsidiary of Calpine.
At the same time, Calpine announced that it had secured rights to develop, build, own and operate a 600MW natural gas-fired electricity generating facility near the town of Thermal in Riverside County, California through a development agreement with Adair International Oil and Gas. The $275 million Teayawa Energy Center will be sited on the Torres Martinez Desert Cahuilla Indians' land through a long-term lease agreement between Calpine and the Torres Martinez. Construction of the project may begin as soon as mid-2001, with commercial operation beginning in late 2003. The venture will not be project financed. Output from the project will be sold into California's competitive electric power market.
As the power project is located on Native American land, the lead permitting agency under the National Environmental Policy Act is the federal Bureau of Indian Affairs (BIA). Additionally, BIA approval is necessary to ensure that the Teayawa Energy Center appropriately meets the cultural, environmental and economic considerations of the Torres Martinez.
Calpine will manage all aspects of project development for the Teayawa Energy Center, including engineering and design, construction, fuel supply, and power marketing. The project will interconnect with an existing transmission line adjacent to the property.
Bob Kelly, senior vice-president for finance at Calpine, says, ?Calpine's new plants generally are not project financed unless it's a partnership agreement and part of negotiations for varying reasons. And it's very rare for us to make a one-off acquisition unless there is a partner involved.? Kelly notes that changes in the power market ? such as short-term power contracts ? are not compatible with traditional project finance.
?We just acquired SkyGen Energy. They are a very good project developer. But they were creating a structure to satisfy project finance bankers. As a result, they were giving too much to the customer to appease the lender. The problem with project finance bankers is that they have not evolved from the long-term power contract concept to understanding the pricing of power over time.? Kelly asserted that most bankers have adapted to changes in other industries ? such as pulp and paper as well as chemicals and aircraft ? but not power. ?We were the first company to finance an acquisition using a revolving credit facility. We find that moving away from project finance gives us flexibility.?
Adebayo Ogunlesi, head of global energy and the project finance group at CSFB, notes: ?When you try to operate your business on a system-wide basis like Calpine, traditional project finance ? designed for a single plant with a long-term power contract ? is dead.? He adds that for a company with a lot of debt which finances single projects ? such as Edison Mission ? project finance still works.
Ogunlesi says there is still keen competition among lenders for one-off project financing. ?One-offs are usually easier to finance because of the long-term power contracts.? The greatest risk associated with merchant plants is the cost of fuel. With merchant plants you have to guess the future price of energy.
The length of fuel contracts and the potential for mismatching inputs under the contract against future market prices is a key point.
Fuel costs can be hedged. But benefits are limited by debt maturities and the short time horizons of the power and fuel forward markets. Another strategy is subordination of fuel costs to debt service. Fitch notes in a recent report on merchant power projects that Calpine and EMI's Dighton facility have a 20-year gas sale and purchase agreement with a subsidiary of MCNIC. The agreement provides for 365 days of gas supply and transportation with the purchase of gas tied to a market index plus a premium. Importantly, payments to MCNIC are subordinated to non-fuel operating expenses, reserves and senior debt service payments. Bondholders are advantaged by their senior position to roughly 60% of the cash costs to generate a MWh of power.
The far greater proportion of activity in the US is financing the spin-off of existing assets caused by deregulation, according to Jonathan Berman, director of the power and utilities group at Barclays Bank. ?Generally, when a portfolio of properties is sold off, financing takes the form of a halfway house between corporate debt and traditional project finance.? Berman says the hybrid financing emanates largely because of the absence of long-term power agreements that have traditionally been an integral element of project finance. ?On the other hand, these deals are not pure corporate deals either because the traditional utility risk was a regulated entity.? Utility regulation had been an important part of the ratings process. Now banks are finding it more difficult to assess risk, he said. ?There are a large volume of portfolio deals being done, but banks are still trying to figure out if they have the right structure in using a mix of corporate and project finance,? Berman said.
?Most US deals are merchant plant risk where project finance doesn't work. We have got away from rigid emphasis on project finance. Cutting-edge banks are not providing incentives to people just for using project finance. In fact, deals are more likely to include two tranches, a 364-day revolving credit facility plus a three or four loan. We also realise that the industry is moving to financing structures that are changing every day.?
Even Edison Mission Energy, which has been a big user of project finance, has struck out in other directions, in spite of having closed over 40 project financings totalling approximately $15 billion. Eleven of these financings were arranged in currencies other than US dollars. Of the 40 largest banks in the world, as measured by total capital, company officials maintain that 28 have made loans to Edison Mission Energy or its projects. Projects also have received support from export credit agencies, such as the Ex-Im Bank of Japan and the US Ex-Im Bank, and government-sponsored agencies, such as the US Overseas Private Investment Corporation.
The bulk of EME's investments in 1999 represented the acquisition of merchant plant facilities, a relatively new emphasis for the company. In the past, facilities developed or acquired by EME typically featured power purchase agreements that provide long-term certainty of electricity sales and cash flows. Two large recent acquisitions in the US have added to EME's merchant plant portfolio. The first is the twelve power stations in Illinois purchased at the end of last year from Commonwealth Edison Co. Rather than acquiring just one or two individual plants, Edison bought that company's entire non-nuclear generation portfolio.
Owning and operating an entire generating system in a single market as the company did at Southern California Edison allows Edison Mission to fill the full range of power generation needs ? base load, mid-merit, peaking, auxiliary and emergency support. For the first several years, these plants sell largely under contract back to the utility. Thereafter, the company will be free to sell the power wherever it brings the greatest value.
EME's ownership interest in generating capacity more than tripled in 1999. The company's net interest in plants that either are operating or are under construction increased to 22,770MW at yearend 1999 from 6,485MW at the end of the previous year. Included in the acquisitions was the $4.9 billion acquisition of a package of coal, gas and oil-fired electricity generating facilities with a total capacity of 9,510MW from Commonwealth Edison Co. That transaction closed in December and was not project financed. Last year's transactions ? amounting to roughly $10 billion ? were funded through roughly equal amounts of project finance and equity contributions by EME. The equity contributions were financed off-balance sheet and with a capital infusion from parent Edison International.
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