CHICAGO--Fitch Ratings has affirmed at 'BB' the ratings for Kleen Energy Systems, LLC's (Kleen) $435 million ($176.3 million outstanding) term loan A due 2018 and $295 million ($259.9 million outstanding) term loan B due 2024. The Rating Outlook is Negative.
The Negative Outlook is based on the continued volatility in Kleen's cost structure, particularly with respect to rapidly escalating Regional Greenhouse Gas Initiative (RGGI) costs. Fitch recognizes that operational performance has stabilized, and the project's liquidity position has improved with the prospective repayment of deferred target amortization. Nonetheless, Kleen's projected 2015 debt service coverage ratio (DSCR) of 1.28x remains slightly below Fitch rating case levels. Resolution of the Negative Outlook is contingent upon Kleen's actual financial performance relative to Fitch's rating case projections.
KEY RATING DRIVERS
Revenue Risk: Midrange
Fixed price agreements - Kleen's revenues are currently derived from fixed-price tolling and capacity agreements with investment-grade counterparties, partially mitigating price risks through 2017. The project remains subject to replacement power costs in the event of a forced outage under the tolling agreement. Kleen is vulnerable to margin risks during the post-2017 merchant period but is not entirely dependent on market-based revenues, as capacity payments alone should be sufficient to meet debt service requirements. A scheduled step-down in debt service should moderate Kleen's energy price exposure after the tolling agreement expires.
Operation Risk: Weaker
Volatile operational history - Kleen has not yet established a stable cost profile or demonstrated a pattern of consistent operating performance. Actual costs have exceeded original projections by a wide margin, heightening the potential impact of operational underperformance. It is uncertain whether Kleen can reliably meet target availability requirements over the long-term to avoid contractual penalties and maximize revenues, based on Kleen's history of forced outages. Favorably, Kleen benefits from commercially proven technology operated and maintained by experienced O&M providers.
Supply Risk: Midrange
Low supply risk - Volumetric risks are minimal, as the project is situated in a highly liquid and competitive natural gas market. The tolling counterparty bears natural gas supply risks in the medium term.
Debt Structure: Midrange
Mitigated refinancing risk - Fitch believes Kleen will likely fully prepay the term loan A balloon payment prior to maturity, absent persistent operational challenges. The supplemental amortization mechanism relies upon contracted revenues during the tolling period, and catch-up provisions provide some protection against temporary interruptions in cash flow. Kleen's debt structure otherwise incorporates standard terms and conditions with adequate liquidity provisions.
Weakened financial profile - Fitch-projected DSCRs range between 1.25x and 1.35x during the tolling period under a Fitch rating case that considers a combination of low availability, technical underperformance, and further increases to a deteriorating cost profile. The rating is not constrained by financial performance during the merchant period, primarily due to declining debt service relative to higher projected revenues.
Peer comparison - Kleen's credit quality is consistent with other thermal projects in the 'BB' rating category. Lea Power Partners, LLC (rated 'BB+' with a Stable Outlook) has stabilized its operating costs, and cash flows are sufficient to support a higher average rating case DSCR of 1.37x. Conversely, CE Generation LLC (rated 'BB-' with a Stable Outlook) is exposed to a greater degree of price risk with rating case DSCRs that fall below breakeven, such that the project is reliant upon sponsor support.
Comparable projects often demonstrate an uncertain cost profile, heightened operating risks, and/or elements of merchant exposure. Investment-grade projects with fully contracted output exhibit considerably stronger financial profiles with rating case DSCRs that consistently exceed 1.4x.
Negative - Ongoing Cost Volatility: Demonstration of a stable cost profile would be consistent with the rating, while further increases in costs would heighten the project's vulnerability to operating event risks.
Negative - Performance Shortfalls: Persistently low availability, repeated forced outages, or an accelerated degradation in heat rates could reduce revenue and subject the project to contractual penalties.
Negative - Inability to Refinance: In the event that an outstanding balance remains on the term loan A at maturity, market conditions and/or project-specific factors could prevent Kleen from refinancing.
Positive - Robust Post-Tolling Profile: Kleen's financial profile could improve if the facility maintains long-term operational stability and demonstrates the ability to consistently earn merchant revenues once the tolling period expires.
Kleen has achieved substantial progress with respect to liquidity and operational stability but the uncertainty inherent to Kleen's cost profile persists. Kleen projects a YE 2015 DSCR of 1.28x, a significant improvement over the 1.01x recorded for YE 2014 but slightly below Fitch's rating case estimate of 1.3x. The project has generated sufficient cash flow to repay all but $2.8 million of deferred target amortization, and the project anticipates that it will settle the outstanding deferrals at the next quarterly payment date in December. Increased revenues are the primary driver of improved financial performance for 2015, though operating cost issues continue to adversely impact cash flow. Kleen had originally planned to fully repay deferred target amortization by Q2 2015 and budgeted a 1.36x DSCR for YE 2015.
Kleen's operational performance has stabilized with rolling 12 month availability of 97.5%. Availability reductions include minor cold weather-related outages in Q1 2015 and additional downtime for unscheduled preventative maintenance in September that addressed a leak in the steam injection system. Hot gas path and combustion turbine inspections, which are not included in the availability calculation under the tolling agreement, were performed in March without complications. The project confirmed that there is no major maintenance planned for 2016 that could affect tolling availability. The capacity factor has recovered to nearly 80% for YTD Oct 2015 and heat rates remain well below contractual requirements.
The recovery in operational performance thus far in 2015 has translated into considerably higher revenues under the tolling agreement compared to 2014, when severe outages drastically reduced availability. Increased dispatch has allowed for higher variable O&M reimbursements, for which Kleen earns a positive margin. Capacity payments have otherwise remained steady despite the 2014 outage, as the capacity agreement includes relatively liberal availability requirements. Fitch expects Kleen's revenue profile to return to pre-2014 levels going forward, absent further operational interruptions.
Operating costs for the YTD Q3 2015 are slightly below expectations with the exception of RGGI costs incurred earlier in the year. RGGI costs have skyrocketed to nearly $6.70/ton and continue to reach all-time highs. RGGI costs drove the Q1 2015 DSCR to 1.0x in combination with a higher Connecticut Gross Receipts Tax (CGRT). Kleen's 2016 budget, which assumes no further technical performance shortfalls but takes higher RGGI and CGRT costs into account, projects a 1.33x DSCR that falls slightly below Fitch's base case of 1.34x. Fitch believes that the increased RGGI costs likely represent a permanent change to Kleen's cost profile.
Fitch expects 2015 should represent a normalized year of operations and will revise its financial projections once full year 2015 financial results are available. Fitch had originally intended to base revised projections on 2014 performance. However, Fitch believes that the data forms an unsuitable basis for expectations due to the extraordinarily low operating performance and related expenses. Kleen's cost profile has otherwise compared favorably to Fitch's rating case over the past two years, notwithstanding the inherent volatility.
Kleen is a special-purpose company created to own and operate the project, which consists of a 620-megawatt combined-cycle electric generating facility located near Middletown, CT. Kleen sells capacity under a 15-year agreement with Connecticut Light & Power (Fitch IDR 'BBB+' with a Positive Outlook). Exelon Generation Company (ExGen, IDR 'BBB' with a Stable Outlook) purchases the facility's energy output under a seven-year tolling agreement. Exelon Corp. (IDR 'BBB+' with a Negative Watch), ExGen's parent, has partially guaranteed ExGen's contractual obligations.
The collateral includes a first-priority security interest in the ownership interests in Kleen, all real and personal property, including Kleen's rights under the project documents, the project accounts, and all revenues.
Additional information is available on www.fitchratings.com
Rating Criteria for Infrastructure and Project Finance (pub. 28 Sep 2015)
Rating Criteria for Thermal Power Projects (pub. 23 Jun 2015)
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