DBRS Confirms Cory Cogeneration Funding Corp. at A (low) and Changes Trend to Negative

DBRS has confirmed the rating on the senior secured Project Bonds (the Bonds) of Cory Cogeneration Funding Corporation (the Issuer) at A (low) but has changed the trend to Negative. The Issuer is a single-purpose financing entity for the Cory Cogeneration Station (the Project), a 228 to 260 megawatt (MW) natural gas-fired cogeneration facility. The Bonds are secured by the Project. The rating continues to benefit from a 25-year power purchase agreement (PPA) with Saskatchewan Power Corporation (SaskPower; rated AA with a Stable trend), which is beyond the Bond maturity. The rating action reflects lower-than-expected operating and financial performances over the five-year period ended September 30, 2013, which may not recover sufficiently on a long-term basis through 2017. The weaker performance is mainly due to higher operating and maintenance (O&M) costs. Expected expiry of an existing service contract in 2017 also brings uncertainty regarding contract renewal, costs and other terms under the new contract. A lack of action plans in the next 12 months to adequately provide for the expected high costs in 2016 and 2017 could have negative rating implications.

SaskPower makes two main types of payments under the PPA related to plant availability and running hours. Availability payments comprise over 80% of the PPA revenues. SaskPower also provides and pays for fuel when it requests energy production and delivery from the Project. Plant outages or breakdowns result in reductions in PPA payments. The PPA tariffs have components relating to O&M expenses, including turbine maintenance expenses under a long-term service contract (LTSC) with General Electric Canada, Inc. (GE Canada). The payments under the LTSC vary according to the cumulative running hours of each turbine, with predetermined spikes for scheduled major overhauls and inspections. The non-LTSC O&M costs also tend to rise during turbine overhauls. The PPA run-hour revenues, however, have a smoother trend over time with adjustments for inflation and foreign exchange that do not accommodate the cyclical nature of the LTSC costs. On the Project level, neither the accounting practice of making a provision (under Canadian Generally Accepted Accounting Principles) nor deferring revenue recognition (under International Financial Reporting Standards (IFRS)) mitigates the cash flow volatility because they do not result in a funded cash reserve that is available to cover the peak expenses relating to the LTSC. As a result, the cash flow and DSCRs have shown intra-year volatility, which could potentially require usage of the working capital credit facility and/or the debt service reserve (DSR) from time to time. Although the proactive cash management practices, commitment and experience of the high-rated owners, SaskPower and ATCO Ltd. (rated A (low) with a Stable trend), could provide some underlying support, they cannot replace legal protection for the Project on a stand-alone basis as required by the discipline of a non-recourse or limited-recourse financing structure. DBRS notes that the primary cause of cash flow volatility is somewhat predictable as the gas turbine service costs have a contracted profile under the LTSC and the non-LTSC O&M costs are affected by the overhaul schedule as well. Plant dispatch and usage level by SaskPower could affect the timing of the major maintenance schedule. The Project attempts to manage the pressure of the O&M costs by spacing the running and hence maintenance cycles of the two gas turbines so that the cost spikes on each turbine do not coincide.

The DSCR for the 12 months ended September 30, 2013, as disclosed in the quarterly compliance certificate, was 1.18 times (x). This, together with 1.18x DSCR in 2010, resulted in a rolling five-year DSCR of 1.31x after adjustments. Although performance is expected to improve in 2014 and 2015, the next major maintenance cycle in 2016 and 2017 will likely cause a drop in the DSCR to below 1.20x for two consecutive years. The current management expectation is that the LTSC will expire in 2017, although plant usage in the next few years could move the expected end date. The O&M costs after 2017 will remain uncertain until there is a new service contract. It is noted that the availability of multiple service providers could likely result in more favourable terms and costs under a new contract, although the renewal risk will not be fully resolved in the next couple of years.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Project Finance, which can be found on our website under Methodologies.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.