Due to factors like the loss of a major power offtake contract and uncertain environmental spending, Fitch Ratings said May 10 that has downgraded PPL Montana LLC‘s (PPLM) pass-through trust certificates due 2020 to ‘BBB-‘ from ‘BBB’.
The Rating Outlook is revised to Stable from Negative, Fitch advised. “The downgrade reflects Fitch’s expectation of lower power pricing and a potentially weaker hedging position, which could reduce PPL Montana’s flexibility to manage costs as exposure to low merchant market prices increases,” it added. PPLM is a unit of PPL Corp. (NYSE: PPL).
PPLM manages a diverse portfolio of low-cost coal, including the minemouth Colstrip plant, and hydro generation assets and sells energy at market-based prices. The hydro assets benefit from favorable dispatch. The project partially mitigates merchant risk by selling power through medium-term power purchase agreements (PPAs) and short-term hedges. The project benefits from a history of solid operating performance, Fitch said.
Exposure to potential increases in coal prices is mitigated by having most of the coal supply coming from Westmoreland Coal’s (NASDAQ: WLB) adjacent Rosebud coal mine. Financial pressure from PPLM’s $263m five-year (2012-2016) capital plan is moderated by the pending completion of the Rainbow Dam expansion and the flexibility to delay other capital expenditures.
Projected financial metrics remain strong, but below the historical levels. Hydrology variability, affecting hydropower performance, is mitigated by management’s use of 10 years actual historical water flows, which include drought-like conditions, to project energy production. Persistence of low hydrology, however, could materially erode future cash flow, Fitch pointed out.
PPLM has adequate liquidity to meet debt obligations. The rating downgrade primarily reflects the project’s increased exposure to merchant power prices. After wholesale power offtaker Southern Montana Electric Cooperative (SME) filed for Chapter 11 bankruptcy protection in October 2011, the trustee terminated the PPA between SME and PPL Montana. Loss of the SME contract, which would have accounted for 20% of PPLM’s output between 2014 and 2019, exacerbates the project’s exposure to merchant power market prices, Fitch said. Further, the amount of power provided to NorthWestern Corp. (NYSE: NWE) drops significantly in 2014, adding to the project’s merchant market price exposure. PPL Montana continues to seek opportunities for medium and long-term power agreements, it said.
Coal units suffer erosion in capacity factors
The hydro and coal units continue to demonstrate solid availability consistent with historical performance. The hydro units achieved overall availability of 93%, while the five coal units achieved availability ranging from 83% to 86%, Fitch wrote. The decline in power prices, however, has resulted in reduced dispatch for the coal units as reflected in lower capacity factors of 62% to 72%, which are 9%-16% lower than historical averages. Persistent reductions in generation output in the low power price environment could adversely affect future cash flow, Fitch said.
PPLM reports that up-to-date environmental controls are installed on its coal units. Capital expenditures of $263m through 2016, however, could increase if the U.S. Environmental Protection Agency imposes additional requirements to reduce emissions of SO2 and NOx on the coal units. A decision could come as early as this summer, while potential compliance requirements could be phased in over a multi-year period, Fitch said. Upgrades to the Rainbow Dam facility are on schedule to be completed by mid-2012, resulting in increased energy production for the project.
Fitch projects operating margins declining beginning in 2016 with increased exposure to low merchant power prices. The project’s financial performance is most vulnerable to decline in 2013-2015 as the project implements its capital investment plan and as annual rent service peaks to $40m-$45m. A material decline in annual rent service beginning in 2016 to $15m decreasing to $3m from 2017 through 2019 provides financial relief.
PPLM owns, operates and leases a portfolio of 13 hydro and coal-fired facilities with a total capacity of 1,239 MW. The PPLM portfolio includes 11 hydro projects, a storage reservoir, the coal-fired Corette facility and the owner-lessors’ share of Colstrip. The pass-through certificates were issued by a pass-through trust to fund the owner-lessor’s acquisition of the leased Colstrip assets, which represent 25% of Colstrip’s 1,278-MW capacity and 41% of PPLM’s total portfolio capacity.
PPL offers details on loss of power contract
PPL Corp. refers to Southern Montana Electric Generation & Transmission Cooperative Inc. (SMGT), another variation of the SME name used by Fitch, in its May 7 Form 10-Q filing. “In October 2011, SMGT, a Montana cooperative and purchaser of electricity under a long-term supply contract with PPL EnergyPlus expiring in June 2019 (SMGT Contract), filed for protection under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Montana,” said the Form 10-Q. “At the time of the bankruptcy filing, SMGT was PPL EnergyPlus’ largest unsecured credit exposure.”
The Form 10-Q added: “The SMGT Contract provided for fixed volume purchases on a monthly basis at established prices. Pursuant to a court order and subsequent stipulations entered into between the SMGT bankruptcy trustee and PPL EnergyPlus, since the date of its Chapter 11 filing through January 2012, SMGT continued to purchase electricity from PPL EnergyPlus at the price specified in the SMGT Contract, and made timely payments for such purchases, but at lower volumes than as prescribed in the SMGT Contract. In January 2012, the trustee notified PPL EnergyPlus that SMGT would not purchase electricity under the SMGT Contract for the month of February. In March 2012, the U.S. Bankruptcy Court for the District of Montana issued an order approving the request of the SMGT trustee and PPL EnergyPlus to terminate the SMGT Contract. As a result, the SMGT Contract was terminated effective April 1, 2012, allowing PPL EnergyPlus to resell the electricity previously contracted to SMGT under the SMGT Contract to other customers. … At this time, PPL Energy Supply cannot predict the prices and other terms on which it will be able to market to third parties the power that SMGT will not purchase from PPL EnergyPlus due to the termination of the SMGT Contract.”
PPL Montana’s additional compliance cost for EPA’s Mercury and Air Toxics Standards at Colstrip is not expected to be material. For the Corette plant, “additional controls are being evaluated, the cost of which could be significant,” the company said.