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.
Financial Metrics
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.
RATING SENSITIVITIES
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.
CREDIT UPDATE
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.
SECURITY
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
Applicable Criteria
Rating Criteria for Infrastructure and Project Finance (pub. 28 Sep 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=870967
Rating Criteria for Thermal Power Projects (pub. 23 Jun 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=867314
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=994432
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=994432
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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