Fitch Ratings - San Francisco - 28 Sep 2021: Fitch Ratings has upgraded Midland Cogeneration Venture LP's (MCV) $560 million secured notes ($221.1 million outstanding) to 'BB+' from 'BB-'. The Rating Outlook is Stable.
The upgrade reflects the financial profile following the redemption of the Series 2013 notes and lower debt service payments through the Series 2011 notes maturity in March 2025. The project's high proportion of contracted revenues under a power purchase agreement (PPA) with Consumers Energy (Consumers; A-/Stable) mitigates price risk. MCV's operational risk is moderate with a stable operating history supported by a strong long-term service agreement (LTSA) coverage and significant equipment redundancy somewhat offset by the project's mild cost variability. MCV's rating case results in an average debt service coverage ratio (DSCR) of 1.33x, while on the lower end of the rating level, is supported by the unique operational flexibility and resiliency not typical of most thermal plants.
KEY RATING DRIVERS
Significant Redundancy and Stable Operations (Operation Risk: Midrange)
MCV self-performs operations, though planned O&M and major maintenance costs are adequately covered under the LTSA with investment grade manufacturer affiliate, GE (BBB/Stable) through final maturity. MCV benefits from a high degree of equipment redundancy and excess capacity, which has allowed for strong historical PPA availability in excess of 99% and stable operations. Accelerated rotor replacements resulted in higher forecasted capital expenditures. Previously, the rotor replacements were planned to begin after debt maturity in 2025. The absence of a dedicated O&M and major maintenance reserve is mitigated by coverage provided under the LTSA, liquidity from the working capital facility and issuer funded General Reserve and flexibility in capital spend.
Some Fuel Supply Risk (Supply Risk: Midrange)
MCV has some supply risk as a result of its short-term fuel contract with Shell Energy. However, the short-term nature of the fuel contract is partially mitigated by an abundant supply of the resource and substitute fuel suppliers, as well as MCV's track record of meeting fuel supply requirements dating back to 1990. Potential price risk stemming from contract replacement or renewal is mostly mitigated by pass-through of fuel costs via MCV's off-take agreements, with any remaining exposure hedged with forward contracts.
Contracted Revenues (Revenue Risk: Midrange)
On average, over 90% of MCV's revenues are contracted between Consumers at roughly 80%, and Corteva at roughly 10%. Revenues are fixed-price with a broad indexation to costs, and risk of performance penalties and PPA termination is limited. Cash flows are moderately sensitive to dispatch levels as the margins generated provide additional cash flow cushion for debt repayment.
Conventional Debt Structure (Debt Structure: Midrange)
MCV's rated debt structure consists of senior, fully amortizing, fixed-rate debt. Bondholders benefit from a backward-looking equity distribution test of 1.20x DSCR as well as leverage limitations, which provide adequate liquidity. MCV also has a six-month debt service reserve funded with a letter of credit.
Fitch's DSCR calculation treats the General Reserve as an operating expense rather than as a cost offsetting line item. Fitch calculated a rating case average DSCR of 1.33x with a minimum of 1.30x. An additional rating case scenario including projected merchant cash flows for generation above 1,240MW results in an average DSCR of 1.38x, a 5-basis point (bp) improvement. The rating case profile is on the lower end for the rating level but is moderated by the demonstrated stable operating history, potential merchant cash flow support, and operational flexibility to delay other discretionary capital projects if needed. MCV's level of flexibility is unique and provides cushion to withstand temporary periods of underperformance.
The rating is comparable to other thermal projects, which may have slightly higher coverages but lack the level of operational flexibility of MCV. Lea Power (BB+/Stable) has an average rating case DSCR of 1.42x and minimum of 1.20x, but historically experienced higher than forecasted operating expenses and lacks equipment redundancy. Higher rated peers such as Orange Cogen (A-/Stable) benefit from a stronger rating case DSCR profile supported by fixed capacity payments alone as sufficient to cover both operating costs and debt service with ample cushion remaining.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
--Costs consistently exceeding Fitch's rating case forecasts;
--Projected Fitch calculated rating case DSCR's persistently falling below rating case forecasts.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
--Pre-funding of forecasted capital expenditures for the remaining debt term exclusive of operating cash flow;
--Projected Fitch-calculated rating case DSCR that is consistently above 1.40x.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
MCV was formed in 1990 as a limited partnership to convert a portion of an uncompleted Consumers nuclear power plant into a 1,633MW natural gas-fired, combined cycle, cogeneration facility. The 2011 debt issuance ($560.0 million, $221.1 million outstanding) refinanced the sponsors' term loans to acquire MCV in 2009, and the additional, pari passu 2013 issuance ($181.3 million) monetizes incremental cash flows resulting from several contract amendments that occurred between 2011 and 2013. In September 2021, the Bank term loan issuance ($330 million, unrated) with a maturity of September 2028 was used to redeem the 2013 debt issuance and monetize the PPA with Consumers Energy that was extended to May 2030.
Overall performance for YTD Q2 2021 is trending close to forecasts with a Fitch calculated DSCR (excluding the general reserve) of 1.20x compared to management's forecast of 1.16x for the review period. Revenues are lower compared to forecasts due to lower plant dispatch which was offset by lower fuel costs and operating expenses. There were no material operational issues noted at the plant during the period.
Fitch's base and rating case assume availability averaging 99%, a SEPA load of 46MW, a 30% reduction to projected ancillary and arbitrage revenues, and exclusion of merchant and black start sales. Fitch's base case assumes inflationary cost growth and a heat rate in line with historical averages. Fitch's base case DSCRs average 1.40x over 2022-2024 with a minimum of 1.36x.
Fitch's rating case assumes a 5% higher cost profile, a 1% increase to the heat rate, and higher fuel prices. In Fitch's rating case, DSCRs average 1.33x over 2022-2024 with a minimum of 1.30x. MCV has a high level of equipment redundancy to withstand temporary operational issues that may arise. Management indicates that two to three gas turbines can be down at a time depending on the season while still continuing to maintain 100% PPA availability.
Merchant capacity and energy cash flows provide on average an additional coverage cushion of slightly more than 5bps. The merchant forecasts are based on Fitch's merchant base and low gas and power price decks. Base case coverages average 1.46x with a minimum of 1.43x when merchant revenues are included. Under rating case, DSCR averages 1.38x with a minimum of 1.37x. Historically MCV has shown the ability to generate merchant cash flow with historical Fitch calculated DSCRs from 2015-2020 averaging 1.37x. The resulting coverages demonstrate the flexibility available to generate additional cash flow cushion to support repayment of the debt.