Moody’s: Carbon Concerns Denting Merchant Coal Refinancing Prospects

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Environmental, social, and governance (ESG) risks are diminishing the number of potential investors in U.S. merchant coal projects, and that is putting more pressure on already squeezed coal plant economics, Moody's Investors Service said in a new sector report.

The U.S. merchant coal plants, which are already grappling with persistently low power prices that are challenging coal plant economics and high leverage relative to sustained cash flow, are among the "most exposed to environmental-related risks across the power generation projects sector," the credit ratings agency said in its Oct. 2 report. Higher variable costs-pegged to direct costs for carbon emissions credits and operating or capital expenses for environmental compliance for things like air pollution, groundwater contamination and ash disposal-can drive lower utilization, reducing capacity factors as plants move up the dispatch curve.

"These concerns have heightened refinancing risk for single-asset coal-fired projects as their debt matures," Moody's said.

In August, Chief Power Finance's sponsor pulled a term loan refinancing transaction "because of market conditions and a narrower investor base," the agency noted. At least two other coal projects that the agency rates-Sandy Creek Energy Associates, LP (B3 stable) and Longview Intermediate Holdings C, LLC- have maturities in the next two years and "are likely to face challenges when they seek to refinance," it said.

Market Fundamentals Key to Refinancing

At least in the near-term, market fundamentals of the regional power markets will be a key factor in whether merchant coal projects can refinance debt, it noted. "Future natural gas prices, new entrants, potential retirements, cost of renewables, regulatory concerns, and emerging technologies like battery storage will all affect power prices."

Chief and Longview are located in PJM Interconnection, a region characterized by low demand growth and a glut of natural gas combined-cycle generation. Those factors have "exacerbated oversupply, causing sustained downward pressure on power prices," it said.

Prospects for merchant coal generators in the Electric Reliability Council of Texas (ERCOT), however, appear more promising. However, though it has two long-term power purchase agreements, prices in ERCOT where the six-year-old Sandy Creek plant is located "have been anemic during most of Sandy Creek's financing term resulting in higher than expected leverage (although partially mitigated by Sandy Creek's contracted cash flow)," it noted. "Sandy Creek benefits from long-term contracts for a significant portion of its cash flows and is therefore more of a hybrid rather than a pure merchant generator, which helps to mitigate the relatively higher leverage," it said.

Moody's also noted that some of the merchant coal projects it rates "own some of the most efficient, environmentally compliant and well-maintained merchant coal plants in the U.S." But, it added, "these factors have not produced enough cash flow generation to fully offset the carbon transition risk."

Unregulated Utilities, Power Companies 'Moderately Risky'

The ratings agency said it generally views unregulated utilities and power companies where fossil fuels represent a significant portion of the generation mix as moderately risky. The unregulated power sector is scored "elevated risk-immediate," owing mainly to policy and public pressure in developed economies to cut emissions from the power sector. "Unlike the regulated utilities sector, unregulated utilities and merchant power projects do not receive the benefit of cost recovery from rate payers," it noted.

Significantly, it suggests that states could "stave off near-term carbon transition risk for coal plants" by enacting support measures for existing thermal generation. Efforts like Ohio's HB 6, for example, will keep the W.H. Sammis plant open beyond its retirement date of 2022.

However, more often, state or local measures tend to back carbon-free sources. Subsidies for nuclear have so far passed in four states-Ohio, Illinois, New York, and New Jersey-and at least two other states-Pennsylvania and Maryland are considering them. Twenty-nine states have also enacted renewable portfolio standards.

Meanwhile, investors concerns about ESG and carbon transition risk must be recognized, it said. "Rising investor concerns over ESG and carbon transition risk are evidenced by the inability of Chief to complete an attempted refinancing," it said. "We understand that, in order to try to attract potential investors, the terms and conditions were materially more lender friendly, including having a shortened tenor and offering higher interest rates compared with its previous financing and more recent natural-gas fired term loans. Even with a higher yield and other enhancements to the collateral package, the sponsor pulled the syndication because of market conditions, which also included compressed PJM energy prices and margins for the first part of 2019 because of low natural gas prices, new plant additions and tepid electric demand."

Moody's predicted investor concerns about the carbon transition would increase. "[More] lenders, including collateralized loan obligations (CLOs), are incorporating formal carbon financing restrictions," it noted. "We expect ESG criteria to further evolve and become more stringent, inhibiting the ability of non-ESG friendly companies and sectors to access capital markets. In addition, the growing importance of ESG considerations will push for both the ESG friendly transformation of companies as well as the establishment of ESG friendly companies and sectors, for example, renewables."

-Sonal Patelis a POWER senior associate editor (@sonalcpatel, @POWERmagazine).

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