Catalyst Renewables, Hannon Armstrong and GeoGlobal Energy have closed the debt financing for the $400 million Hudson Ranch I geothermal power project. The deal is the first US geothermal financing since the 1980s to close with commercial bank lenders. For sponsors with the time and energy to prove a resource properly, the wait until the next deal should not be as long.

The debt is a $300 million mini-perm with a tenor of five years after construction and is priced at roughly 325bp over Libor. Its lead arrangers are ING Capital, Societe Generale and WestLB, while Union Bank, MetLife, CIBC, Siemens Financial and Investec participated. It refinances a $15 million resource verification loan from Glitnir Bank (now Islandsbanki) to the project. Of the rest of the project’s cost, which is understood to include an almost $100 million contingency, $90 million comes from a preferred equity investment from GeoGlobal, while the rest is cash that the other two developers have contributed to the project as equity.

Banks have struggled to cope with the risks associated with proving and maintaining geothermal resources, even though geothermal plants are baseload generators with zero fuel costs.

Hudson Ranch is located near El Centro, in Imperial Valley, California, to the south of the Salton Sea. The region is home to existing geothermal producers, including several operated by CalEnergy, Ormat and Calpine. But Ormat, the developer of the most recent new capacity plants, uses its own binary-cycle technology, and Hudson Ranch will be the first in 20 years to use flash technology.

GeoGlobal’s arrival as a sponsor is recent, and involves both the preferred equity contribution to the project, and taking a 20% stake in the utility-scale geothermal and solar joint venture Hannon Armstrong and Catalyst have formed, which is now called EnergySource. The deal allows the two original developers to get back some of the equity that they have spent on perfecting the resource, and retain GGE as a long-term investor.

The two developers are not project finance novices, though neither has utility-scale geothermal experience. Catalyst, formerly NGP Power, and in existence since 2001, is owned by the Natural Gas Partners VI fund, and has previously developed a biomass plant in New York. Hannon Armstrong develops energy and energy efficiency projects for local and federal government entities, often by assembling tax-advantaged financings.

The centrepiece of the project, and one big reason for its ability to clear the bank market, is its 30-year power purchase agreement with Arizona’s Salt River Project. The SRP, in existence for over 100 years, was formed as an irrigation district, but now provides power to three large urban areas, Phoenix, Mesa and Scottsdale, and is rated Aa1/AA (Moody’s/S&P).

The plant uses Fuji-supplied turbines, and construction is scheduled to take 21 months to complete. The joint venture, then known as CHAR LLC, decided in 2007 against using a fixed-price turnkey engineering, procurement and construction contract to build the plant, since at that time the additional cost would have been prohibitive.

The $15 million Glitnir loan, which closed in 2008, funded drilling at the resource, which typically costs $6 million to $10 million per hole. Through a combination of skill and luck, the first resource verification wells that CHAR drilled in 2008 produced a strong, solid resource, even though the developers had expected that four would be necessary. The two holes were, on their own, enough to support the bank debt component of the financing, and the risk attached to drilling a third is essentially borne by equity. The existing two holes, according to the banks’ downside case, should produce 30MW, enough for the lenders to get paid back from a lengthened amortization schedule

The sponsor is set to take the ITC cash grant, the proceeds of which, equivalent to a third of the plant’s cost, will be used to pay down senior lenders. The $400 million cost of the plant includes the $100 million contingency, with customary provisions for the unused contingency to be shared between equity and lenders, and the decrease in leverage at completion will be substantial.

In September 2009, the two went out to banks looking for lead arrangers. According to Brian Harenza, senior vice-president for project finance at Hannon Armstrong, “we thought it would be a difficult project to finance, given that we weren’t using an EPC contract, and only three of our lenders had any geothermal experience, and that was from the 1980s.” Harenza joined the sponsor from PG&E, and before that had worked at Calpine since it acquired SkyGen, and he went out to banks that he had worked with extensively at Calpine. “We got a very strong response from lenders, with more commitments than we needed, and were able to skip needing a retail syndication.” This allowed the project to survive the departure of Helaba, one of the original mandated leads, from the arranging group. The five participants joined between March and April 2010.

The mini-perm structure works well with the project, since its 30-year PPA makes a take-out with a long-term institutional lender a strong possibility. While the sponsors considered a loan guarantee from the Department of Energy, and went so far as to submit an application in early 2009, they decided to shelve the idea, says Harenza, when they got good interest from the project finance market. Asked whether the 18-year tenors now on offer in the US bank market look appealing, Harenza says “they might do, for an asset with a shorter PPPA.”

The preferred equity investment from GeoGlobal gives an indication of how things are looking up for geothermal developers. Until recently, this sort of funding was the only form of funding available to developers, but it now sits snugly in the capital structure between debt and equity. GeoGlobal receives most of its funding from Mighty River Power, a New Zealand State-owned generator with some existing Fuji-equipped geothermal assets.

Hudson Ranch I, LLC
Status: Closed 17 May 2010
Size: $400 million
Location: El Centro, Imperial County, California
Description: 49.9MW high-temperature flash geothermal plant
Sponsors: Catalyst Renewables, Hannon Armstrong and GeoGlobal Energy
Debt: $300 million
Tenor: 5 years after completion
Margin: 325bp
Lead arrangers: ING Capital, SG, WestLB
Participants: Union Bank, MetLife, CIBC, Siemens Financial Services and Investec
Resource consultant: GeothermEx
Independent engineer: RW Beck
Borrower legal counsel: Orrick
Lender legal counsel: Latham & Watkins