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Fitch Affirms OrCal Geothermal LLC's $165MM Sr. Notes at 'BB'; Outlook Remains Negative

Fitch Ratings has affirmed OrCal Geothermal LLC's (OrCal) $165 million senior notes ($43.3 million outstanding) due in 2020 at 'BB'. The Rating Outlook remains Negative.

KEY RATING DRIVERS

The 'BB' rating reflects Fitch's expectation of stable operations of OrCal's geothermal projects under long-term revenue contracts with some exposure to index-based price risk. The rating considers that stable resource production remains dependent on sponsor-funded discretionary capital expenditures.

The Outlook remains Negative due to ongoing uncertainty that the full benefit of recent efforts to improve plant capacity and overall efficiency will come to fruition. Operational performance below expectations could suggest financial performance over the remaining debt term is more consistent with a lower rating.

Production Below Expectations - Supply Risk: Weaker

The absence of substitute fuel supply leaves OrCal exposed to the risk of declining geothermal resource production. Production is dependent on an active, sponsor-supported capital plan that is funded at the sponsor's discretion. Although the sponsor demonstrates a strong track record of funding capital expenditures, annual production has generally trended down over the last five years.

Diminished Price Risk - Revenue Risk: Midrange

At the beginning of 2016, 50% of OrCal's total capacity transitioned to a power purchase agreement (PPA) with the Southern California Public Power Authority (SCPPA). As a result, the proportion of capacity tied to volatile energy pricing under the Short Run Avoided Cost (SRAC) methodology has been reduced to one-third. OrCal's entire capacity is contracted with PPA expirations ranging from three to 11 years beyond debt maturity.

Stable Operating Cost Profile - Operation Risk: Midrange

OrCal has maintained a stable cost profile over the past few years, excluding sponsor-funded capital expenditures. The operator is a subsidiary of the project sponsor and has significant experience operating geothermal assets.

Fully-amortizing Debt Structure - Debt Structure: Midrange

OrCal's fully amortizing debt faces no refinancing risk and contains features typical of project finance structures, such as a six-month debt service reserve.

Vulnerable Financial Coverage

Underperformance of the geothermal resource or continued weakness in SRAC pricing could impair OrCal's ability to service debt payments over the remaining five-year debt term. Under Fitch's rating case, which assumes 2.5% annual declines in resource production and SRAC energy pricing averaging approximately $30/MWh, DSCRs average 1.14x with particularly weak coverage in the final two years of repayment. OrCal may rely on its parent company to absorb a portion of operating costs or draw on its debt service reserve in the event that operational cash flow is not sufficient to meet debt payments.

Peer Comparison

The geothermal assets within Coso Geothermal Holdings, LLC ('C') have suffered substantially greater resource depletion than Orcal's plants. CE Generation, LLC's (CE Gen, 'BB-'/Outlook Stable) portfolio has a proportionally larger exposure to variable SRAC price risk than Orcal, and its debt is structurally subordinate to project-level indebtedness. Like OrCal, CE Gen relies on non-obligatory financial support from its parent company.

RATING SENSITIVITIES

Negative - Production declines or low SRAC pricing in 2016 resulting in a Fitch-calculated DSCR below the 2016 rating case of 1.30x would trigger a downgrade.

Negative - A significant increase in operating costs or cessation of sponsor support for operating expenses or capital expenditures could lead to a downgrade.

Positive - Stable or improved production in 2016 and a Fitch-calculated DSCR above the 2016 rating case of 1.30x could trigger a return to a Stable Outlook.

SUMMARY OF CREDIT

After significant downtime to implement capex investments in 2014, annual production in 2015 returned to the level seen in 2013. This suggests some success in stemming production declines. Nevertheless, the substantial capex investment to improve overall system efficiency at the Heber 1 complex fell short of expectations. Plant output averaged 36MW in 2014 and 2015, below the sponsor expectation of 44MW, due to lower-than-expected efficiency from the refurbished steam turbine.

The ongoing environment of low natural gas pricing dragged the average Southern California Edison (SCE, 'A-'/Outlook Stable) SRAC price down from $48/MWh in 2014 to just over $31/MWh in 2015, a 35% decline. As a result, total revenue fell by 13% from year-ago levels, despite OrCal's rebound in production. Operating expenses declined modestly in the past year, as variable O&M normalized from higher levels associated with the Heber 1 enhancements. Overall, Fitch calculates that operational cash flow in 2015 reached approximately $12.5 million, generating a Fitch calculated DSCR of 0.84x.

As it has done in the past OrCal's parent company, Ormat Nevada (Ormat), stepped in to bolster operational cash flow. The plant operator is a subsidiary of Ormat and, at Ormat's discretion, a portion of 2015 operating expenses (estimated at $8 million) owed by OrCal to the operator were not collected. This resulted in a higher level of cash flow available to service the debt, and a sponsor-calculated DSCR of 1.37x. The rating incorporates the expectation that parent Ormat would continue its practice of relieving OrCal of some level of operating expenses in order to ensure that there is sufficient cash available to meet debt payments. However, Fitch's DSCR calculation does not include the benefit of sponsor support, and accounts for all expenses as presented in OrCal's income statements..

Looking forward, the impact of continued low natural gas pricing will moderate. The Heber 1 complex has satisfied its performance testing requirement under the SCPPA contract, facilitating the commencement of the PPA beginning in January 2016. The SCPPA contract utilizes a fixed, escalating energy price that begins at a significantly higher rate than current SRAC pricing. This leaves one-third of OrCal's overall capacity exposed to SRAC pricing under the PPA with SCE at the Heber 2 complex.

Under the base case, Fitch assumes that resource production declines at the five-year historical rate of 1.9% per year while expenses grow by an assumed inflationary rate of 2.5% per year. SRAC pricing, based on Fitch's long-term assumption for gas prices, averages $36.80/MWh through 2020. The resulting financial profile demonstrates declining coverage over the remaining debt term with an average DSCR of 1.34x and a minimum of 1.19x in the final year of repayment (2020).

Under the rating case, Fitch assumes modestly steeper production declines of 2.5% per year. The rating case does not assume any additional stress on expenses beyond the 2.5% growth assumption in the base case, in recognition of OrCal's proven ability to manage costs historically. SRAC prices are based on Fitch's low natural gas price deck, yielding an average price of $30.50/MWh through 2020. The resulting profile suggests a declining DSCR profile, due to the compounding effect of increasing costs and declining production. The DSCR averages 1.14x through 2020 with coverage hovering around breakeven in 2019 and 2020.

OrCal is a special-purpose company that was created to acquire the Heber 1 and Heber 2 geothermal power facilities (the Heber power plants) located in Imperial County, CA. OrCal also owns the Gould 1 and Gould 2 plants, and the Heber South power plant, which became operational in 2008. OrCal is jointly owned by a tax-equity investor and Ormat Nevada Inc. Ormat Nevada is a subsidiary of Ormat Technologies, Inc., a vertically integrated owner and developer of geothermal and other recovered energy projects.

Additional information is available on www.fitchratings.com

Applicable Criteria

Rating Criteria for Infrastructure and Project Finance (pub. 28 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=870967

Rating Criteria for Thermal Power Projects (pub. 23 Jun 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=867314

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=998556

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=998556

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings
Primary Analyst
Andrew Joynt, +1-415-732-5622
Director
Fitch Ratings, Inc.
650 California St.
San Francisco, CA 94108
or
Secondary Analyst
Christopher Joassin, +1-312-368-3166
Director
or
Committee Chairperson
Gregory Remec, +1-312-606-2339
Senior Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com


Source: Business Wire (January 28, 2016 - 2:45 PM EST)

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