Fitch Ratings has affirmed the ratings on Mission Economic Development Corporation's (Dallas Clean Energy McCommas Bluff LLC, or DCEMB) $40.2 million aggregate series 2011 revenue bonds due 2024. The Rating Outlook has been revised to Negative from Stable.
The Negative Outlook is based on uncertainty regarding the project's ability to produce at output levels consistent with Fitch's base case. Over the short term, Fitch will monitor progress towards reaching an agreement with the City of Dallas to reinstate and consistently operate the enhanced leachate recirculation system installed at the landfill which could help to bolster resource availability despite the extended ramp up period and reduced rainfall. The Negative Outlook is also tied to the project's ability to reduce operating costs to original projections following cost overruns associated with reaching completion and operating milestones.
KEY RATING DRIVERS
Long-term Revenue Agreement in Place - Revenue Risk: Midrange
The project benefits from a long-term, fixed-price gas sale agreement (GSA) with Shell Energy North America that provides revenue stability through the life of the contract. In addition to these contracted revenues, the project is expected to earn incremental revenues under base case conditions by selling excess gas production at market prices. Under Fitch's rating case, the project is not reliant on any merchant sales.
Material Resource Risk - Supply Risk: Weaker
The project is highly dependent on the accuracy of the landfill gas recovery forecast. The landfill gas recovery estimates have been revised several times since the original projections due to drought, landfilling timing lags and fluctuating refuse placement within the project site with a positive adjustment in 2013 due to the high organic content of actual refuse received. These revisions highlight the project's exposure to resource risk. Resource risk is partially mitigated by the active nature of the landfill gas site, which is expected to remain active through at least 2040.
Unproven Operating Cost Profile - Operating Risk: Midrange
The project has yet to establish a history of stable operating costs. Since inception, operating costs have increased compared to original projections due to ongoing maintenance and completion repair efforts. The sponsor expects a normalization of costs going forward, however Fitch has increased operating costs by 10% under base case projections.
Strong Debt Structure - Debt Structure: Stronger
The project benefits from a 12-month debt service reserve based on maximum annual debt service, a $1.3 million operating reserve and typical cash lock up provisions. The debt structure is considered stronger due to the increased liquidity compared to the typical six-month debt service reserve.
Uncertain Financial Profile
Recent financial performance has indicated a deviation from original rating case expectations due to resource availability and an extended ramp up period. The sponsor budget for 2015 shows coverage of 1.86x, however, longer-term performance remains uncertain. Fitch's rating case incorporates a 5% reduction to availability, a 2% increase to treating loss, 15% reduced resource ramp up and a 15% increase to O&M expenses which result in average DSCRs of 1.79x with a minimum of 1.70x. The increased coverage compared to the typical 1.40x threshold for other typical investment grade thermal projects helps to mitigate resource risk over the long term.
RATING SENSITIVITIES
Negative - Resource Reductions: Failure to meet target ramp up production levels over the next year or the inability to reach an agreement with the City of Dallas on the leachate recirculation program could result in a negative rating action;
Negative - Increased Downtime: Decreases to availability below Fitch's stressed level of 90% could result in a downgrade;
Negative - Cost Profile: Failure to demonstrate a stable cost profile and margins consistent with rating case expectations could reduce credit quality.
UPDATE
During 2014, the project exhibited an extended ramp up period, resulting in cash flows below Fitch rating case projections. Recent landfill gas resource recovery has fallen short of expectations, largely due to the discontinued leachate recirculation program with the City of Dallas which has reduced the amount of recoverable LFG at the site.
The project has also faced increased maintenance expenses due to repairs and equipment modifications and replacement at train 2. During 2014, the project required substantial redesign and vessel repairs associated with the hydrogen sulfide removal system as well as a thermal oxidizer replacement, resulting in more than twice the anticipated repairs and maintenance cost for the year. The project was taken offline for 15 days during May 2014 due to these repairs; however, annual project availability remained strong at 97.2%. Plant capacity fell short of prior years at 70.8%, largely due to decreased production as a result of the reduced supply.
In addition to the increased repairs expenses during 2014, the project faced increased costs associated with a natural gas buyback program. The increased costs were due to higher than anticipated retail gas prices (exceeding $8.00/MMbtu) and increased purchased volumes for flaring. Actual natural gas purchase volumes have decreased from 22,000 MMBtu per month on average to 7,323 MMbtu purchased in September as a result of the newly installed thermal oxidizer. While reduced flaring should mitigate the impact of increased purchase volumes going forward, the project remains exposed on natural gas pricing. Positively, the new hydrogen sulfide removal system is expected to improve annual sulfur removal expenses which account for 6% of total costs.
As a result of the reduced resource availability and increased expenses, actual DSCRs for 2013 and 2014 have fallen short of expectations at 1.28x and 1.20x, respectively. Actual 2014 coverage would be 1.04x absent a forgiven management expense from the previous sponsor, Clean Energy.
Sponsor budget estimates indicate expectations of project ramp up from the near 5,100 MMbtu per day level experienced in 2014 to 5,800 MMbtu per day by December 2015. The 2015 budget also incorporates the cost savings anticipated from the sulfur removal program. Budget 2015 DSCR is 1.86x per sponsor expectations compared to 2.40x as of last review. This level of performance would be consistent with the rating category. A revision of the Outlook back to Stable is contingent upon achieving these budget cash flows as well as the ability to provide evidence of stability for long term financial performance.
The sponsors are currently working with the City of Dallas to reinstate the leachate recirculation program. The City is incentivized due to their ability to collect royalties off of top line revenues at DCEMB. The project's ability to increase production therefore increases revenues generated by the project for the City. Positively, during November 2014, the sponsor reached an agreement with the City to extend the site lease through 2034, eliminating the potential for tail risk at DCEMB since the contract with Shell was subject to an automatic extension upon execution of the lease amendment.
As of a Dec. 29, 2014 acquisition, the project is to owned 51%/49% by Energy Power Partners and Cambrian Energy Development, LLC. By September 2015, the project will revert to a 70/30% ownership split between the two sponsors, respectively. Fitch views this change as a credit neutral given the experience of EPP with substantially similar technology. The project's ongoing legal dispute with the original construction contractor is not expected to have a significant impact on the project's cash flow.
DCEMB is a 15.5 million scfd landfill gas project that converts landfill gas into pipeline quality gas. The landfill is owned and operated by the City of Dallas and covers 2,025 acres in Southeast Dallas. Originally permitted in 1980, the landfill takes in municipal solid waste and construction and demolition waste from Dallas, Fort Worth and the surrounding areas. It is the 11th largest landfill in the U.S. according to Environmental Protection Agency estimates.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Rating Criteria for Infrastructure and Project Finance' (July 11, 2012);
--'Rating Criteria for Thermal Power Projects' (July 30, 2014).
Applicable Criteria and Related Research:
Rating Criteria for Infrastructure and Project Finance
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=682867
Rating Criteria for Thermal Power Projects
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=753208
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=965395
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