OREANDA-NEWS. Fitch Ratings has affirmed the rating of Midland Cogeneration Venture LP's (MCV) combined $741.25 million ($616.7 million outstanding) senior secured notes due 2025 at 'BBB-'. The Rating Outlook is Stable.

KEY RATING DRIVERS

The affirmation reflects MCV's stable financial profile, which is driven primarily by steady revenues under its power purchase agreement (PPA). Debt service coverage ratio (DSCR) forecasts provide adequate cushion for the project to absorb temporary operational stresses or extreme market pricing conditions with average Fitch rating case coverage above 1.40x. The forecasted Fixed Energy Rate (FER) along with continued stable operating performance are expected to produce a financial profile consistent with an investment grade rating.

Substantially Contracted Cash Flows [Revenue Risk: Midrange]:

On average over 90% of MCV's fixed and variable revenues are derived from contracted power and steam sales to investment grade offtakers. The Consumers Energy Co. (Consumers; 'A-'/Stable Outlook) PPA passes along most of the fuel, operations and maintenance (O&M) and emission costs through capacity and energy payments. The project also receives FER payments based on the avoided cost of coal generation at Consumers' coal plants. Project revenues are partially exposed to volume and price risk through the PPA fixed energy rate, local gas and power pricing, and dispatch.

Proven Operating History [Operation Risk Midrange]:

The facility has historical PPA availability exceeding 98% since its completion in 1990, supported by excess capacity and redundant equipment. The O&M profile, along with the long-term service agreement (LTSA) with a subsidiary of General Electric ('AA-'/Stable Outlook) is expected to support PPA requirements through 2025.

Limited Fuel Risk [Supply Risk: Midrange]:

The abundance of fuel management suppliers mitigates the risk of MCV's shorter-term contract with Shell Energy. Additionally, fuel costs are a pass-through under the off-take agreements or the majority hedged with forward contracts, mitigating the price risk associated with contract extension or replacement.

Fully Amortizing Debt Structure [Debt Structure: Midrange]:

MCV's debt is fixed and fully amortizes over the debt term. The structure contains typical project finance features, such as a six-month debt service reserve and 12 months forward - and backward-looking distribution test of 1.20x DSCR.

Stable Financial Profile:

Debt service coverage in 2017 is currently expected to be below typical coverage for investment grade thermal projects, but is supported by a rating case average DSCR of 1.44x for the remaining debt term. Lower coverages are the result of lower FER increases than previously forecasted. The financial profile strengthens in the outer years, as FERs adjust upwards with DSCRs in line with the investment grade rating.

Peer Comparison:

MCV's high proportion of contracted cash flow and midrange debt structure and profile are consistent with other single-site investment grade cogeneration peers. MCV is more exposed to volume and fuel price risks compared to Orange Cogen ('BBB+'/Stable Outlook). Lower-rated cogeneration peers with similar exposure to partial price and volume risks have lower projected margins, lower coverages, and/or experienced volatility in operations.

RATING SENSITIVITIES

Negative: Material deterioration in operating performance and/or significant rise in operating costs, in particular to the rates under the gas exchange agreement, that causes DSCRs to fall below rating case projections.

Positive: Higher than expected FER adjustments generating forecasted DSCRs above Fitch's base case projections.

TRANSACTION SUMMARY

MCV was formed in 1987 as a limited partnership to convert a portion of an uncompleted nuclear power plant owned by Consumers into a 1,633-MW natural gas-fired, combined cycle, cogeneration facility. MCV issued series A notes in 2011 and series B notes in 2013. The series are pari passu, are secured by a typical pledge of project assets and contracts, and fully amortize in March 2025 via semi-annual payments of principal and interest.

SUMMARY OF CREDIT

Changes in the FER are largely beyond MCV's control, representing a potentially substantial price risk under the PPA. Previous adjustments to the FER in April 2015 and 2016 were lower than projected due to lower O&M costs at the coal units that closed in April 2016. Beginning in 2017, the FER index is expected to increase by approximately 22% as a result of the closure of seven coal units and completed installation of pollution control equipment at the remaining five units. After that, the FER index is expected to increase by an average of 7% to 8% for the remaining life of the debt. The lower coal output combined with increased O&M costs is expected to substantially benefit the FER index.

Through the end of 2015 and first quarter of 2016, operations were in line with MCV's forecasts and improved from the same period last year. MCV continues to maintain high availability exceeding 98%, in line with historical averages. The low gas prices and supportive off-peak power prices have allowed the project to operate more often in combined cycle mode, limiting the use of their auxiliary boilers, and resulting in favorable volume and efficiency variance compared to the same period last year. The redundancy of the components allows the project to maintain high PPA availability in addition to operating at optimized configurations based on market pricing for gas and energy.

MCV is forecasting a DSCR of 1.39x for 2016, as it is experiencing more favorable merchant dispatch due to low gas prices and better positioning in the dispatch curve resulting from the closure of Consumers coal plants. In addition, excess capacity of 302 MW was sold to creditworthy offtakers, providing approximately $13 million in revenues. MCV's 2017 excess capacity has not yet been sold as the Midcontinent Independent System Operator (MISO) is in process of reviewing its resource adequacy requirements to potentially allow a three-year forward auction versus the current one-year auctions. This is an expected benefit if passed as it will provide MCV with the ability to contract capacity revenues three years into the future.

Fitch's rating case considers debt service coverage under stressed market conditions aimed to capture the potential downside of MCV's volume and price risk. FER projections are based on a detailed analysis of expected coal generation and O&M costs of the remaining units. These projections are incorporated under Fitch's various gas/power pricing scenarios to assess the potential variability of this index under shifting market conditions. Debt service coverage in 2017 will be 1.23x in the Fitch rating case, which also excludes all merchant revenues. The lower coverage is primarily due to slower than forecast FER increases, although this is expected to improve once impact of the coal plant closures are recognized.

Individual stresses were conducted for the 2017 cash flow under rating case scenarios where the FER needs to decline by more than 28% to reach breakeven coverage. In addition, heat rate increases by 10% or O&M increases by 65% will also trigger breakeven coverages. Based on the individual breakeven stresses, the project maintains adequate cushion as demonstrated by the continued stable operations, costs, and ability to maintain high availability. The numerous redundancies built into the plant provide adequate cushion for risk of prolonged downtimes.

Over the full remaining debt term, rating case DSCRs average 1.44x, with a minimum of 1.23x. The profile strengthens in the outer years and DSCRs are in line with an investment grade rating.

Consumers has filed an application with the Michigan Public Service Commission (MPSC) requesting to increase the rate under the gas exchange agreement. The request is currently under review with results expected around mid-2017. An adverse outcome would result in a potential $15 million increase in annual operating costs reducing average rating case coverages by 15 bps.

SECURITY

Collateral includes a first-lien security interest for the benefit of all senior secured noteholders, 100% of the assets of the issuer (MCV); 100% of the sponsors' equity interests in the issuer; all material project documents and agreements; the funds of collateral accounts and all permitted investments; all insurance and reinsurance and condemnation awards; and all revenues. Shell Energy also holds a $100 million pari passu lien for the above assets and interests as collateral under the obligation of the secured commodity agreement.