DBRS Morningstar Confirms Spy Hill Power L.P. at “A,” Changes Trend to Negative

DBRS Limited (DBRS Morningstar) changed the trend on the Issuer Rating and the Series A Senior Secured Amortizing Bonds (the Bonds) issued by Spy Hill Power L.P. (Spy Hill or the Issuer) to Negative from Stable. DBRS Morningstar also confirmed the Issuer Rating and the rating of the Bonds at “A.” The Issuer is a special-purpose entity that owns a simple-cycle natural gas-fired 86-megawatt power generation facility (the Project). The Issuer benefits from a 25-year peaking power purchase agreement (PPA) with Saskatchewan Power Corporation (SaskPower; rating of AA placed Under Review with Negative Implications by DBRS Morningstar in March 2020) to provide electrical power to the Province of Saskatchewan’s transmission system. At this time, DBRS Morningstar does not consider the current rating status of SaskPower as constraining the ratings of the Issuer and the Bonds. The Bonds are secured by the Project’s assets and are fully amortizing with maturity on March 31, 2036, six months prior to the PPA’s expiry. The trend change reflects the Project's operational and financial underperformance over the last three years, continued projections of lower-than-expected performance in the near term, and potential for increased future maintenance costs from equipment wear and tear as the Project continues to operate at much higher levels than the original projections when the Bonds were issued.

The PPA insulates the Issuer from electricity price and demand fluctuations as well as fuel price and supply risks as 100% of fuel supply costs are passed through to SaskPower. The remaining primary risk for the Issuer is performance risk. The Project must (1) meet an availability factor of at least 97%, (2) provide energy at the level requested by SaskPower, and (3) be able to start up within 15 minutes of a dispatch request or else pay liquidated damages, which are capped at $4 million per year, indexed. The Project must also meet specific heat rate requirements or pay a higher operating cost.

In 2019, the financial performance was lower compared with projections because of higher operations and maintenance (O&M) costs of approximately $1.2 million and availability revenue loss of approximately $500,000, incurred as a result of low pressure turbine (LPT) failure in one of the turbines (Unit#2). Consequently, the debt service coverage ratio (DSCR) for 2019 dropped to 1.53 times (x) compared with projections of 1.67x. The LPT failure occurred in June 2019 and required removal of the unit, which was brought back into service in July. DBRS Morningstar has been informed that the same issue occurred in the other turbine (Unit #1) in May 2020. The Issuer considers the LPT failures as one-time issues with no long term implications. In addition, the Issuer contends that part of the higher O&M costs resulting from the LPT failures could be recovered through insurance proceeds; however, the amount remains to be determined, pursuant to ongoing discussion with the insurance provider. The Project has been dispatched by SaskPower at a much higher level with average cumulative fired hours (FH) approximately 160% more than originally expected on average between 2013 and 2019, and this trend is expected to continue in the future, causing several key maintenance activities to be accelerated. As a result, the Issuer is changing the major maintenance reserve account funding (MMRA) from $185/gas turbine (GT)/ FH to $291/GT/FH. DBRS Morningstar notes that the Project expects to recover the cost of these maintenance activities through the Variable Tariff Structure under the PPA. Accordingly, DBRS Morningstar has updated its projections from 2020 onwards, based on information provided by the Issuer.

This is the third straight year in which operational issues at the Project have caused the financial performance to be lower than the initial DSCR projections of around 1.70x (DSCR in 2017 and 2018 was 1.61x and 1.63x, respectively). The average DSCR in the six-year period between 2014 and 2019 was 1.64x. In 2020 and 2021, DSCRs are projected to remain low, at around 1.47x and 1.56x, respectively, because of additional MMRA funding and higher O&M expenses (in addition to the LPT issue on Unit #1 in 2020, there will be extra expenses related to Gas Turbine Hot Section maintenance now projected in 2022). In addition, as the Project continues to be dispatched at much higher levels than original projections, there is the increased risk of equipment wear and tear, which could result in higher future O&M expenses. As such, DBRS Morningstar is changing the trend to Negative from Stable. Beyond 2021, the DSCR is expected to bounce back to the 1.65x to 1.70x range; however, DBRS Morningstar may update its future projections based on actual Project performance in 2020 and/or 2021. DBRS Morningstar will continue to closely monitor the Project and, as the Project accumulates actual operating/financial history, may take further rating action if it considers that the overall Project performance has been volatile and/or materially below initial projections. The Negative trend can be reversed if the Project performance is closer to initial projections and forced outages are minimized.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodology is Rating Project Finance (August 21, 2019) which can be found on dbrsmorningstar.com under Methodologies & Criteria.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrsmorningstar.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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