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-- Yellowstone Energy L.P. is issuing $123 million senior secured notes supporting its 54-megawatt petroleum-coke-fueled circulating fluidized bed power plant located in Billings, Mont.
-- Bond proceeds from this issuance, along with approximately $20 million of cash, will be used to refinance existing senior debt, fund a number of reserve accounts, settle a number of claims on defaulted subordinate and deferred creditor debt, and pay for replacement of the plant's underperforming air-cooled condenser.
-- We are assigning our preliminary 'BBB-' rating to the notes, with a stable outlook.
On Nov. 15, 2012, Standard & Poor's Ratings Services assigned its 'BBB-' preliminary rating to Yellowstone Energy L.P.'s (YELP) $123 million senior secured notes due 2027. The outlook is stable. The bonds are backed by revenue from YELP's circulating fluidized bed (CFB) power generation facility, which has been in operation since 1995. Assignment of a final rating is conditional on our receipt and review of executed documentation. The final rating could differ if any terms change materially.
The rating on YELP's $123 million senior secured bonds is 'BBB-'. The outlook is stable.
The YELP project is a CFB power plant located in Billings, Mont., on a 10-acre site adjacent to an ExxonMobile (Exxon) refinery. Its fuel source is pet coke that is produced as output waste from three local oil refineries. It burns the pet coke together with crushed limestone, which helps to capture sulfur emissions. The plant produces electricity, steam, and ash. The project has one general partner, Billings Generation Inc. (BGI), and one limited partner, Exxon Billings Cogeneration Inc. (EBCI). EBCI is ultimately owned by ExxonMobil.
The project is set up as a special purpose entity (SPE) and is not linked to the credit strength of any parent. Rosebud Operating Services Inc. has operated the plant through the plant's entire life. The project has been operating since 1995, and the proceeds of this debt issuance will refinance existing senior debt, settle a number of subordinate debt claims that are in default, and fund construction of a new air-cooled condenser.
The plant has a nominal generation capacity of 54 megawatts (MW) and sells all electricity generated under a take-and-pay power purchase agreement (PPA) with NorthWestern Corp. (BBB/Stable/A-2). The PPA has three energy blocks, with 85% of 54 MW sold at a rate of $83 per MW-hour (MWh) in 2012. This rate will be adjusted annually by an average of 4.6%. The next 8% is sold at a fixed price of $38 per MWh, and the remainder sold at Mid-C market prices. The price of energy includes a fixed-price capacity payment that was $6.65 per kilowatt per month in 2012 and that increases by an annual average of 3.5%.
We consider fuel supply and operational reliability the key risks to timely debt service.
We see two possible weaknesses in fuel supply for the plant: first, whether the refineries will continue to produce sufficient fuel for the project, and second, whether the non-Exxon refineries will choose to sell to YELP. Although Exxon is obligated to supply pet coke to YELP through 2028 so long as it is operating, the other two refineries could raise their pet coke input prices for YELP at the end of their short- to medium-term contracts or market their supply elsewhere.
With three highly creditworthy refineries in the Billings area, the total local pet coke supply exceeds the plant's maximum need by about 3x. The contract with Exxon is a particular strength, in that Exxon supplies approximately half of the fuel needs for no cost so long as the Exxon refinery continues to operate at historical volumes. The additional strength of this contract is that Exxon is obliged to supply all its pet coke to YELP. The Exxon refinery has operated since 1949.
YELP has obtained fuel from Phillips66 and CHS Inc. at prices of negative $8 to $18 during the past 10 years. YELP is exposed to fuel price and volume risk over multiple contract renegotiations during the debt's 14-year term. The price of pet coke in parts of Asia has been high and somewhat volatile, and allows for a possible alternative market for pet coke from Billings, despite the substantial cost of transport to destinations in Japan, China, India, or Southeast Asia. CHS has been disposing of at least a portion of its pet coke to those destinations. We see the project able to break even with local pet coke prices of $70 to $90, depending on the volume of fuel coming from Exxon.
A related risk is the possibility of refinery closures. The three refineries are in a strong economic position, with plentiful crude oil supply from Canada and Wyoming, limited competition in the Rocky mountain region, and some geographic isolation as a result of limited pipeline capacity and sheer distance from larger refineries on the East and West coasts and the Gulf Coast of the U.S. We anticipate that this strong position will continue for at least the next five years, but the situation may weaken during the term of YELP's debt. However, our analysis assumes that YELP, at the current rating, will find at least one of the refineries in service through the 14-year debt term, and our downside case contemplates that YELP will meet shortfalls in pet coke fuel with coal, although doing so would expose the project to coal price risk.
Specifically, our downside fuel stress scenario has Exxon continuing to produce historical volumes of pet coke while YELP is forced to burn coal for the other 50% of its fuel needs because of either refinery closure or a large increase in market prices for pet coke. In this stress scenario, we also assumed diesel fuel prices increase substantially along with coal prices. The presence of four other large coal mines within the same distance from Billings as the backup coal supplier means the project is not tied to the backup coal supplier's speculative-grade credit strength. We project that the project would be able to fully service debt under this scenario.
The other main risk to the project is operational reliability. The plant commenced operations with a number of unresolved construction issues. Management and the independent engineer (IE) attribute most of these problems to an engineering, procurement, and construction (EPC) contractor that filed for bankruptcy during construction and left some work items incomplete. Although a lot of capital investment and remedial work has been completed in recent years and the plant is now operating much more efficiently, two unplanned outages in 2008 and 2010 led to reduced capacity factor in those years. Other than these two outages, the plant has been running at 90% to 95% capacity for the past eight years. However, liquidity has been sized to mitigate the risk of additional outages and consists of a debt service reserve, operations and maintenance (O&M) reserve, and sufficient major maintenance reserves to cover likely levels of unscheduled outages. Only one major capital project remains -- the replacement of the air-cooled condenser -- and with this investment the project should be positioned to sustain its projected operating performance.
Under the management base case scenario, debt service coverage (DSC) is projected to be 1.5x in 2013 (a year in which an extended outage is planned to replace the air-cooled condenser). For the remainder of the debt term, the average is 2.04x, with a minimum of 1.73x. We looked at the project's operations under a number of scenarios: a 10% decrease in generation, a 20% increase in fuel and limestone costs, replacement of half or all the pet coke with coal, a 50% increase in O&M and major maintenance costs, an increase in unplanned outages, and a decline or termination of ash sales and other non-electrical-generation revenue.
The two major potential stresses for the project are large increases in fuel costs and reductions in operational performance, and our downside case simulates the combined impact of both. In this scenario, O&M costs are 50% above pro forma, generation is down 10%, fuel costs are up 20%, and ash sales are down 20%. DSC is 1.25x in 2013 and averages 1.79x in subsequent years, with a minimum of 1.59x.
The rating reflects our view of the following credit strengths:
-- The project has a strongly rated offtaker for electricity (NorthWestern Energy), with no minimum generation or availability thresholds and fixed prices.
-- There are three sources of pet coke in Billings, and no other local consumers of this product. Exxon, the main coke supplier, supplies coke at no cost.
-- The other two refineries have limited ability to store pet coke onsite.
-- The project has a backup coal supply contract and the plant can operate on a mix of pet coke and coal if insufficient pet coke is available.
-- Exxon relies on YELP to meet current emission constraints for sulfur at the refinery and thus has strong incentives to perform under its contract.
-- Exxon relies on YELP for a significant portion of its steam needs and the steam supply agreement does not have minimum volume levels.
-- YELP offers the supplying refineries a local source of coke disposal compared with other alternatives that require long-distance transportation of pet coke.
-- Construction risk is minimal, with one major construction item in 2013 and then ongoing maintenance.
-- The project has a fully amortizing debt profile and robust forecast minimum and average DSC. The debt is scheduled to be fully repaid two years prior to the end of the PPA.
-- The project has a 12-month forward- and backward-looking distribution test of 1.25x.
-- The project has adequate liquidity, including a nine-month debt service reserve, a 180-day O&M reserve, and a major maintenance reserve. All three reserves are funded at financial close, and the major maintenance reserve is maintained at the higher of funding for the next year or a three-year look-forward (40% in each year) basis.
We weigh these strengths against the following credit weaknesses:
-- The plant has faced high-cost maintenance items multiple times in the past, although the IE believes that these issues were mostly a result of poor initial construction from an EPC contractor that went bankrupt. The IE anticipates that plant efficiency will improve to 91% or more in 2013 and beyond, relative to 88.5% during the past 10 years.
-- The plant relies on the adjacent Exxon for half of its fuel. If Exxon closed its refinery, the project would face increased fuel costs because it would have to purchase 100% from other sources.
-- Remaining fuel is purchased through short- and medium-term contracts, exposing the project to price risk during subsequent fuel contract negotiations.
-- Although coal is available as an alternative fuel (and contracts are in place that ensure adequate supply), the plant would be more expensive to operate on coal.
-- The PPA is mainly take-and-pay, with a relatively small capacity payment, requiring high levels of actual generation to earn maximum revenue.
-- The debt is a refinancing of existing debt; the project is in default for its subordinate debt and settlement is still being negotiated with at least one creditor. An escrow account has been established in an amount sufficient, in our view, to meet the obligation. And the escrow amount of $7.5 million is approximately 10% above the disputed claim amount.
-- Pro forma projections assume higher-than-historical capacity, lower fuel use, and lower limestone use than long-term historical usage, although this anticipation is based on recent capital improvements and resultant operational efficiencies.
The project has a number of cash-funded reserves that provide short-term liquidity to enable the project to fund somewhat cyclic operational and capital expenditures. The note reserve contains nine months of debt service, the O&M reserve is funded with 180 days of expenses, and the major maintenance fund is funded with the higher of next year's spending or 40% of each of the next three years funding.
As well, the project has a 1.25x 12-month forward- and backward-looking distribution test.
The stable outlook reflects our view of the project's strong PPA and highly rated offtaker that takes most energy at high fixed prices and runs beyond the term of the debt. It also reflects the three local pet coke fuel sources, which together generate more than 3x YELPs' fuel needs each year. YELP is the only local consumer of pet coke. The project is exposed to potential increases in operating or fuel costs and the risk of shutdown of one or more of the refineries. However, the YELP plant has a 17-year operating history and a 10-year history of pet coke purchases from Phillips66 and CHS, and the three refineries are economically strong.
We believe the project has little potential for an upgrade because of single-asset risk and fuel price exposure.
A downgrade of the project may occur if operating costs escalate or plant performance falls below the level of the past two years. The rating may also come under pressure if the plant faces significant unplanned outages, or if local pet coke volumes shrink or prices escalate substantially. A downgrade would be likely if project DSC fell to less than 1.5x through the debt term.
Related Criteria And Research
-- Updated Project Finance Summary Debt Rating Criteria, Sept. 18, 2007
-- Project Finance Construction and Operations Counterparty Methodology, Dec. 20, 2011
-- Criteria for Special-Purpose Entities in Project Finance Transactions, Nov. 20, 2000 Ratings List New Rating Yellowstone Energy L.P. $123 mil sr sec nts ser 2012 BBB-(Prelim)/Stable