July 16, 2012 / 10:49 PM / 5 years ago

TEXT-S&P Rates CE Oaxaca Cuatro's $167.5 Million Notes 'BBB-'

(The following was released by the rating agency)

Overview

-- Mexico-based wind power project Oaxaca IV is planning to issue $167.5 million senior secured notes due December 2031.

-- The notes will be backed by the issuer's right to receive payment under the 20-year power purchase agreement with Comision Federal de Electricidad.

-- We are assigning our preliminary 'BBB-' rating to the issue.

-- The stable outlook reflects the project's long-term power purchase agreements with Comision Federal de Electricidad and reasonable expectations for wind resource and turbine performance.

Rating Action

On July 16, 2012, Standard & Poor's Ratings Services assigned its preliminary 'BBB-' rating to CE Oaxaca Cuatro, S. de R.L. de C.V.'s (Oaxaca IV) proposed $167.5 million senior secured notes due Dec. 31, 2031. The outlook is stable.

The preliminary rating assumes that all project documents are finalized on comparable terms as presented to Standard & Poor's. The final rating will depend on a review of all finalized project documents.

Rationale

Oaxaca IV will repay debt with cash flow from its 102 megawatt (MW) wind farm project that earns revenues from energy it sells under long-term power-purchase agreements (PPA) with Comision Federal de Electricidad (CFE; foreign currency: BBB/Stable/--; local currency: A-/Stable/--). Acciona S.A., a wind turbine supplier, indirectly owns Oaxaca IV.

The 'BBB-' ratings reflects the following strengths:

-- Twenty-year PPA with strong off-taker, CFE, which eliminates price risk, but not volume risk.

-- Different favorable technical opinions, the track record of wind availability and the on-site information for five years support the excellent conditions of wind resource in the state of Oaxaca.

-- Operations and maintenance (O&M) contract is for the next 20 years, which matches the PPA's term and the tenor of the notes. Moreover, we believe O&M budget to be conservative, mitigating possible variations on actual O&M.

-- Proven technology as Acciona has used these turbines since 2004 with an average availability on its wind projects of 98%.

-- Adequate debt service coverage (DSCR) under our base-case scenario which considers a one-year P90 with the 96% availability. Under this scenario, the minimum DSCR is 1.40x and the average DSCR is 1.41x.

These strengths are somewhat offset by the following weaknesses:

-- The cash flow depends directly on energy production that relies on the wind resource that is seasonal and beyond management's control.

-- Reliance on one type of wind turbine technology. While the AW 70 1.5 MW wind turbines are commercially proven, any future serial defect or maintenance/spare parts issues after the warranties expire could result in lower revenues and increased costs. The certified design life of this turbine is 20 years, which matches the debt tenor.

-- O&M costs for the wind energy industry have proven to be higher than initially projected.

Oaxaca IV is a 102 MW wind farm located in the Isthmus region of Tehuantepec in the state of Oaxaca, 17 kilometers away from the Pacific Coast. The wind farm is comprised of 68 wind turbines laid out in three sections. The project reached commercial operation in March 5, 2012.

The generated revenues are fully contracted under the 20-year, dollar-denominated, fixed price PPA with CFE. The PPA is a take-or-pay contract for 100% of the wind farm's net energy production. The price for Oaxaca IV is $63 per megawatt hour. The formula to adjust payments considers O&M costs which are adjusted according to the U.S. producer price index and non-O&M related costs. If the produced energy is lower than expected, there are no penalties. Under the PPA, CFE allows Oaxaca IV to connect to the preferred interconnection point in the Ixtepec substation which the utility owns. The Ixtepec substation transmits power from several wind farms in the region. The wheeling/delivery risk is borne by CFE as the national grid operator. We believe the PPA with CFE provides Oaxaca IV with a strong contractual foundation and mitigates market risk. However, volume risk remains, as it depends on on-site wind availability.

The rating also considers the several studies that indicate the favorable wind conditions in the region. The wind availability study for Oaxaca IV was prepared by the independent engineer consultant, Alatec, which has worked on more than 150 wind projects totaling 8,100 MW. Alatec based its assessment on onsite data from three stations at Oaxaca IV with near-hub height wind data. In addition, there are long-term reference stations near the wind farm. The study collected more than five years of on-site data, almost 10 years of long-term reference data on or nearby the project, which gives more certainty about the availability of the wind resource at the site. During this period, the wind has been consistently strong with an average speed of 10-12 meters per second, and unidirectional, which resulted in low wind production variation. However, given the fact that the wind resource is seasonal in nature and beyond management's control, we believe that cash flow dependency on wind availability remains the most significant risk.

We expect O&M costs to be in line with budget, given that Acciona Energia Mexico (AEM) will operate and maintain the wind farm through a 20-year O&M contract. AEM will operate and maintain the wind farm. Oaxaca IV is using a proven turbine technology: a 68 Acciona Windpower AW 70 1.5 MW wind turbine. There are more than 2,500 turbines installed worldwide, with a global average fleet availability of 98%. Acciona's wind turbines have been operating for more than 15 years. Moreover, Acciona's turbines have experienced no serious defects with global failures of less than 1% on their major components. In the opinion of Alatec, Acciona has ample experience as a wind turbine supplier and does not anticipate any relevant problems in their operation. However, we believe that there is dependency risk due to only one type of wind technology.

The $167.5 million notes will be fully amortizing. The capital structure is somewhat backloaded, as around 46% of the debt is due in the last quarter of the notes' term. However, given that the debt amortization matches the revenue generation under the PPA, we consider this structure as adequate. The debt matures only a couple of months before the PPAs expiration date. Under our base-case scenario, which incorporate a one-year P90 96% availability scenario, the expected minimum DSCR is 1.40x and the average DSCR is 1.41x. We don't believe there is a refinancing risk on this structure as the PPA provides for stability in cash flow generation. However, if O&M is significantly higher than our expectations or if wind is significantly below than our expectations, there could be a refinancing risk.

Liquidity

Oaxaca IV's liquidity is sufficient as there is a six-month debt service and O&M reserves that are initially funded. However, since the O&M in the first couple of years is low given that most of these costs are still covered by the EPC contractor, the reserve is low. In 2014, the O&M reserve is replenished with cash available after debt service to cover the following six months of O&M. If for some reason, the reserves are used, they will be replenished after debt service payment. We believe that this partially mitigates the risk of low wind or higher-than-expected O&M costs during a certain point in time. Moreover, cash distributions are restricted to certain covenants, such as a 12-month backward and forward looking DSCR of more than 1.2x. If during three consecutive years, cash is trapped because it does not meet the test, it will be used to make a prepayment of the notes. We believe that this mitigates the risk of cash outflows during periods of stress. Outlook The stable outlook reflects our expectations that Oaxaca IV will generate stable revenues due to its PPA with CFE, which mitigates price volatility, strong wind availability in the state of Oaxaca, and the proven technology. Also we expect O&M costs to be in line with the expectations, as Acciona has experience in managing similar projects around the globe. A downgrade could occur if wind availability is below the IE assumptions, or if O&M costs are higher than in the projected scenario resulting in a decline of the DSCR below the expected minimum 1.4x. A downgrade of CFE could result in a credit deterioration of the project. We believe an upgrade is not likely at this point.

Related Criteria And Research

-- Project Finance Construction And Operations Counterparty Methodology, Dec. 20, 2011

-- Updated Project Finance Summary Debt Rating Criteria, Sept. 18, 2007

Ratings List

New Rating

CE Oaxaca Cuatro, S. de R.L. de C.V.

Senior Secured BBB-(prelim)/Stable

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