Fitch Rates American Municipal Power, Inc., OH's Combined Hydro Project 'A-'; Outlook Stable
--$237 million combined hydroelectric projects revenue bonds, series 2016A (Green Bonds).
The bonds are expected to sell via negotiation during the week of September 12th. Proceeds will be used to fund capital expenses, repay draws on a line of credit used to provide interim financing, refund a portion of the outstanding series 2009 bonds for interest cost savings, fund a deposit to the debt service reserve and pay issuance costs.
In addition, Fitch has downgraded the rating on the following outstanding combined hydroelectric project revenue bonds to 'A-' from 'A':
--$497 million series 2009B (federally taxable);
--$122.4 million series 2009C (tax-exempt);
--$152.9 million series 2010A (federally taxable);
--$1.1 billion series 2010B (federally taxable BABs);
--$116 million series 2010C (federally taxable CREBs).
The Rating Outlook is Stable.
The bonds are secured by the trust estate, which will include all gross receipts (primarily payments made by the participants under power sales contracts), as well as other rights under the power sales contracts and transactional documents. The pledge of gross receipts will be subject to the prior payment of operating and fuel expenses.
KEY RATING DRIVERS
WEAKENED PARTICIPANT CREDIT QUALITY: The rating downgrade to 'A-' on AMP's Combined Hydroelectric Project (CHP) reflects the weakened credit characteristics of several of the largest participants, including Cleveland Public Power (not rated by Fitch) and Paducah Power System ('BBB'/Stable Outlook), which combine for 20.46% of total project allocation. The weaker credit quality is exacerbated by CHP's large debt load and high anticipated cost of power, which is not yet fully reflected in participant rates as debt service for the Smithland project is not yet being collected as it is for the other five CHP units that are already in service.
CONTINUED RESOURCE DIVERSIFICATION: CHP, which consists of three run-of-the-river hydroelectric generating facilities located on the Ohio River, furthers AMP's strategy of resource diversification. While the projects are expected to provide power that is well above current market prices (approximately $138/MWh), CHP adds an environmentally-friendly resource to a region dominated by fossil-fuel fired generation. CHP power comprises a manageable portion of each member's overall power portfolio.
STRONG TAKE-OR-PAY CONTRACTS: The rating is supported by the take-or-pay power sales contracts, which obligate the 79 participating municipally-owned electric systems to pay for their respective shares of all project costs, including debt service on the bonds, whether or not the project is completed, operating or operable.
PROJECTS SUBSTANTIALLY COMPLETE: After significant delays related to permitting, two of the three facilities were put into commercial operation in 2016. The delays caused only a minimal rise in total construction costs as a result of aggressive initial bidding on some of the original contracts. AMP expects to complete the remaining project by early 2017.
STANDARD CONTRACT STEP-UP PROVISION: The power sales contracts include standard step-up provisions that require each participant to purchase up to 125% of its original allocation of the project output in the event that another participant defaults. This step-up is sufficient to absorb a default by any individual participant.
CHANGE IN PARTICIPANT CREDIT METRICS: Improved financial and operating metrics of American Municipal Power, Inc.'s Combined Hydro Project Participants, particularly the largest six, could lead to positive rating consideration.
AMP is a nonprofit wholesale power supplier and services provider organized in 1971 for the benefit of its members. AMP reported 133 members as of Aug. 1, 2016, located throughout nine states: Delaware, Kentucky, Michigan, Ohio, Pennsylvania, Indiana, Maryland, Virginia and West Virginia. AMP's members supply a total of approximately 16.5 million MWhs of electricity to approximately 645,000 retail electric customers, for a total of approximately $1.2 billion in gross sales.
AMP and its members have continued to shift from market purchases to owners of generating assets. AMP's project activities include the recent completion of hydroelectric projects totaling 237 MW, including CHP's Cannelton and Willow Island units, and the recently completed 105-MW Meldahl hydroelectric facility, an ownership interest in the Prairie State Energy Campus and the 2011 acquisition of the Fremont Energy Center. The projects represent the cornerstone of AMP's strategy to own an increasing portion of member power supply resources. AMP anticipates power purchases will compose 39% of its resource mix by 2017, down from roughly 75% just 10 years prior.
TAKE-OR-PAY POWER SALES CONTRACTS
Each participant's obligation under the power sales contracts (PSCs) is made on a take-or-pay basis. The strength of a take-or-pay agreement lies in the participant's requirement to make payment regardless of the unit operation and as long as the bonds remain outstanding. Contract payments are considered an operating expense for all but two of the participants, where payments may be subordinated to their own utility system debt.
Additionally, the PSCs feature a step-up provision that would require non-defaulting participants to purchase a pro-rata share of any defaulting participants' allocation up to 125% of their original allocation. This provision serves to mitigate participant default risk, particularly of the weakest and smallest participants. The required step-up is sufficient to cover a default of the largest entitlement of 16.8%, held by Cleveland Public Power, (CPP).
DOWNGRADE REFLECTS WEAKER PROJECT PARTICIPANT CREDIT QUALITY
The project rating will continue to reflect the creditworthiness of the underlying participants. The participants collectively serve a wide variety of cities and towns dispersed over a broad geographic area. Financial and debt metrics for the six largest participants (equivalent to 47.3% of CHP participation) have displayed satisfactory credit characteristics that are increasingly more supportive of the lower but Stable 'A-' project rating on the bonds.
Energy sales among the largest six participants exhibit higher than average exposure to industrial customers and energy sales concentration. None are publicly rated by Fitch, with the exception of Paducah. Although credit metrics for two of the largest participants, CPP and Paducah, have stabilized in recent years, Fitch remains concerned about sustainability, particularly given higher costs and prevailing competitive and rate pressures. CPP and Paducah combine for 20.46% of CHP's project output.
STAND-ALONE PROJECTS, FINAL COMPLETION ANTICIPATED IN 2017
The CHP consists of three separate run-of-the-river hydroelectric generating facilities on the Ohio River. Each individual project utilizes substantially similar design elements and entails the diversion of water from an existing Army Corps of Engineer dam through bulb turbines to generate electricity.
In total, CHP will have an aggregate generating capacity of approximately 208 MW. After construction delays shifted the timeline for availability, two of the three projects (Cannelton and Willow Island, comprising 132 MW) were placed into commercial operation earlier in 2016. Major construction for the third project (Smithland) has been substantially completed. AMP anticipates Smithland will begin commercial operations in early 2017.
ELEVATED COST OF POWER
The total cost of project construction is approximately $2.2 billion including the current issuance, which at $10,600/kW is very high compared to alternative resources. Similarly, CHP's gross cost of power to the participants is above current market, averaging roughly $148/MWh over the next five years based on current estimates. In contrast, gross power costs for AMP's Meldahl and Greenup are roughly 60% and 50% of CHP's current estimates, respectively.
Power costs will be influenced somewhat by revenues obtained from offering some CHP capacity into the PJM reliability pricing model and the sale of renewable energy certificates, but net power costs are still projected to be above market at $138/MWh over the next five years. Favorably, CHP will offer its participants fuel diversity, particularly given their reliance on fossil fuel generation, and will represent a manageable amount of peak participant demand, further offsetting the very high unit costs.