Due to factors like power market problems and high debt load, La Paloma Generating Co. LLC, the operator of a gas-fired power plant In California, filed Dec. 6 for Chapter 11 protection at the U.S. Bankruptcy Court for the District of Delaware.
Niranjan Ravindran, a Senior Vice President at EIG Global Partners LLC, provided initial testimony to the court about the cirumstances surrounding the bankruptcy. He testified in support of several first-day motions that will allow, among other things, the companies to pay critical vendors so it can keep up plant operations during the course of this bankruptcy case.
The companies seeking Chapter 11 were La Paloma Generating Co. LLC, La Paloma Acquisition Co. LLC (LPAC) and CEP La Paloma Operating Co. LLC.
EIG is a member of Blocker (La Paloma) LLC, which is the parent and sole member of CEP La Paloma Operating Co. LLC (CEP). CEP is the manager of La Paloma Generating Co. LLC. As the bankrupt companies don’t have any of their own employees, CEP has entered into support agreements with RC La Paloma Management LLC (RCLP) and NAES Corp. whereby RCLP and NAES provide operating, maintenance, and asset management services to La Paloma.
La Paloma owns a natural gas-fired, combined-cycle facility consisting of four identical power blocks, located on an approximately 400-acre site in McKittrick, California. The facility has a nameplate generating capacity of 1,022 MW. The facility is located approximately 110 miles northwest of Los Angeles and 40 miles west of Bakersfield, which is at a point on the electric transmission grid where it can provide energy for use in both northern and southern California.
Ravindran noted: “The Facility also has a unique and highly advantageous feature in that it can be modified during a short outage to improve its ability to turn down and reduce its output during periods of low demand (though this requires capital expenditures by La Paloma). This unusual feature of the Facility can help to support reliable electric grid operations by offering an efficient and flexible way to provide electric generation that can compensate for fluctuations in electric output from renewable energy projects (such as wind and solar power projects that are affected by in the amount of sunlight and wind).”
The facility receives its natural gas fuel directly from the Kern River Gas Transmission System and the Mojave pipeline. It is directly interconnected to the electric transmission grid at the Midway Substation, which is owned by Pacific Gas & Electric (PG&E) and is operationally controlled by the California Independent System Operator.
The electric energy and certain related services from the facility are sold into a centralized electric market operated by CAISO and purchased by utilities such as PG&E, Southern California Edison (SCE), Sacramento Municipal Utility District (SMUD) and San Diego Gas and Electric (SDG&E). It operates as a merchant facility, which means that, with minor exceptions, it does not have a contract for sale of its output at a fixed price but rather is subject to prices in the CAISO day-ahead market that vary from hour-to-hour based on the amount of demand and the amount of supply being offered by competing sellers. As of the Dec. 7 bankruptcy petition date, 97.6% of La Paloma’s revenue is generated from the sale of energy into the CAISO market.
La Paloma also sells a product called resource adequacy capacity (RA), which helps utilities to ensure that they have access to adequate electric generating capacity available to serve the needs of their customers and to maintain the reliability of the electric grid. La Paloma sells RA to numerous customers, either through bilateral trades arranged by EDF Trading North America LLC, or through auctions held by various utilities such as SCE, PG&E, SMUD, and SDG&E. As of the petition date, 2.4% of La Paloma’s revenue is generated from the sale of RA.
In addition, La Paloma sells another product, known as ancillary capacity (AC), in the CAISO market. AC helps certain zones of California’s electric grid to regulate the amount of electric generation on the grid in response to sudden changes in the amount of generation available from other sources. As of the petition date, 0.01% of La Paloma’s revenue is generated from the sale of AC.
La Paloma was formed in 1993. The facility was completed in March 2003. The current ownership structure came about in April 2010 when a group of lenders foreclosed on the prior owner’s majority interest in the facility. Shortly thereafter, Rockland Capital LLC acquired an interest in the facility and RCLP became the project asset manager.
Various factors drove the need for Chapter 11
Ravindran explained about the need for Chapter 11 protection: “The Debtors’ bankruptcy filings are the result of a confluence of adverse market developments, a challenged regulatory environment, mounting compliance obligations under California’s “cap and trade” scheme, and substantial debt service requirements. Slower than expected growth in demand for electric energy, changes in commodity markets, and the build out of renewable generation resources in the California market have compressed the Facility’s generation output and reduced the margin between the market price for electric energy and the market price for natural gas fuel consumed in generating such energy (this margin often is referred to as a “spark spread”).
“To mitigate these pressures, La Paloma has attempted to secure additional contracts for the sale of RA, but has not been able to meet this goal. These issues have been exacerbated by an inhospitable regulatory environment. Further, CAISO has failed to provide a market mechanism to compensate the Facility and other similar facilities for the reliability service that they provide. Indeed, CAISO has denied or withdrawn outage requests from the Facility to place some of its units in “outage” mode so that they would not be required to operate.
“As a result of the foregoing factors, the margins La Paloma earns from energy sales have been compressed, and their cash flows are insufficient to address their environmental requirements, together with debt service payments of over $30 million per year.
“La Paloma has experienced a substantial decline in its generation output and margins from merchant sales of output from the Facility, despite efforts to sell all of the energy and other services available from the Facility. EDF, on behalf of La Paloma, generally offers for sale into the CAISO market energy from all four of the Facility’s units. When the price of such offer is at or below the clearing price in the wholesale market, then CAISO provides an award and subsequently “dispatches” the unit to generate and sell energy. The Facility is regularly dispatched by CAISO for power, but capacity factors (i.e., the amount of energy actually generated compared to the maximum capacity to generate) across the full year cycle and spark spreads have compressed. La Paloma has sought to enter into bilateral contracts with third parties to sell energy and capacity (i.e., RA) at fixed prices but has been unable to find additional purchasers willing to enter into such contracts. In addition, despite efforts to augment revenues with sales of RA, La Paloma has only been able to find purchasers for 17.6% of the Facility’s capacity for 2016 (as reported by RCLP).”
Ravindran cited a CAISO report from 2015 that stated that a combined cycle, natural gas-fired facility (such as La Paloma) requires compensation of $162.20 per year for each kilowatt of capacity to cover its fixed costs, however, the report stated that net revenues in 2015 to cover fixed costs of such units were only $39.62/kW-year in the northern California market zone and $45.77/kW-year in the southern California market zone. There is hope that market reforms in the future will address this situation, but it is not clear how long this may take, Ravindran added.
As a result of the inability of the CAISO market to provide sufficient compensation to La Paloma for the past several years, La Paloma requested CAISO approval in May 2016 to designate units 1, 3, and 4 of its facility as being in “outage” mode from July 1, 2016, to Nov. 30, 2016, to alleviate the financial losses they were experiencing. These proposed outages would protect La Paloma from being required to operate those units and provide associated energy for sale in the CAISO market. La Paloma argued that the outages were necessary because no RA had been procured from the units and operation was expected to be uneconomic. These requests were denied by CAISO because the CAISO tariff did not have a provision for declaring outages for economic reasons. In addition, in June 2016, CAISO canceled a previously approved maintenance outage for unit 2 due to the need for the facility to be available to generate during an impending heat wave.
La Paloma has sought other forms of compensation, including proposing to enter into a Reliability Must Run (RMR) contract with CAISO or being designated a “CPM” (Capacity Procurement Mechanism) resource under the CAISO tariff. RMR and CPM contracts provide compensation to generating units that are needed to maintain the reliability of the electric grid but are not receiving sufficient compensation from the market to support continued operation. However, even though CAISO previously had found unit 2 of the La Paloma facility was needed during the 2016 summer heat wave, CAISO declined to execute an RMR or CPM contract with La Paloma.
On June 17, 2016, La Paloma filed a complaint against CAISO with the Federal Energy Regulatory Commission, requesting that FERC issue an order requiring CAISO to grant La Paloma an RMR designation effective as of July 1, 2016, for units 1, 3, and 4, or otherwise provide a mechanism for cost recovery to allow La Paloma to continue operation of those units. On Oct. 3, 2016, FERC denied the complaint, finding that CAISO reasonably denied La Paloma’s economic outage requests for units 1, 3, and 4.
Ravindran added: “The Debtors’ current balance sheet is unsustainable. As of the Petition Date, the La Paloma and LPAC carried funded-debt obligations of approximately $524 million. The Facility’s cash flows are insufficient to support the Debtors’ annual interest expense of approximately $34.6 million, and annual debt amortization requirements of approximately $3 million. Absent a restructuring of their indebtedness, the Debtors would be unable to service their debt and fund necessary operating expenses, including projected carbon credit requirements. Moreover, due to this significant indebtedness, the Debtors would lack sufficient cash flow to continue to maintain the Facility and reinvest capital to ensure continued reliable performance in accordance with prudent operating practice. The Debtors have therefore concluded, in their business judgment, that filing these cases is in the best interests of their stakeholders.”