OGJ Online

ORLANDO, Fla., Nov. 15, 2000—As gas prices rise and electricity prices spike, more companies are turning to tolling agreements to fund and divide the associated risk of building new merchant power plants, dealmakers say.

Speaking Wednesday at Power-Gen International 2000, Roger D. Feldman, partner and co-chair of the project finance and development group for Bingham Dana LLP, said the basic model appears to be the energy companies which can handle both the fuel and the electricity risk are “getting the upper hand in these kinds of projects.”

Under a tolling agreement, the tolling party supplies the fuel to a power plant operator and receives the electricity as the product, which it then markets. Feldman said these arrangements have begun a key cog in risk allocation in the industry and are based on different economics from the original independent power producer projects.

“A lot of merchant plants were based on gas prices of 9 months ago,” Feldman said. Since then, natural gas prices have doubled. “Only the largest players can handle that risk,” he added.

Project sponsors reduce their risk but they also trade off the ability to make money on the spark spread. They become responsible for development and subsequent performance of the plant processing the fuel, including its heat rate and availability, in exchange for capacity payments whether or not the plant operates.

These payments are critical to financing the project, Feldman said.

They also receive operating and maintenance payments and a start payment for ramping up the turbine. Project sponsors are also subject to various penalties for not meeting expectations of the tolling party, including not constructing the facility on time. This has become a hot topic during negotiations because of the troubles original equipment manufacturers are having meeting delivery deadlines, in addition to problems with malfunctioning or poorly assembled components, said Feldman. Many project sponsors are trying to shift some of the plant delivery risks to the contractor.

For the tolling party, the agreement serves as a physical asset hedge to cover electricity trading positions. At the same time, merchant plants can be used to extract the “volatility value” or upside potentially present from participating in volatile gas and power markets, said Feldman.

In the restructuring of power purchase agreements and the calculation of equity returns, he explained, volatility value represents an effective buffer to cash reserves needed to cover debt service.

Regulatory risks remain, he said, notably in California where price caps have been instituted that effect merchant plants.

Click here to enlarge image

Power-Gen International 2000 is an international PennWell conference that focuses on power generation issues. More than 1,100 exhibitors and 15,536 attendees had gathered in Orlando’s convention center by Wednesday, and show officials expect to see as many as 17,000 before the event ends on Thursday. Check the Power Engineering web site for daily updates by Power-Gen correspondents.