Project Finance

Allegheny closes pollution control issue

12 April 2007

Allegheny Energy has closed a $459 million pollution control bond issue to pay for the installation of scrubbing equipment at a West Virginia coal-fired plant. The bonds, underwritten by Loop Capital and First Albany Capital, and co-managed by Bear Stearns and Scotia, closed on 3 April. The taxable bonds featured maturities of 4, 10, 16 and 20 years, and had coupons of 4.98%, 5.23% (or 56bp over the Treasury of the same maturity), 5.46% and 5.52%, respectively.

The deal is notable as the first pollution control financing specifically backed by a surcharge on the bills of electricity customers. The regulatory support for such surcharges from the West Virginia Public Service Commission (WVPSC), which mandates the surcharge and apportions the burden of repaying the surcharge on a joint and several basis between ratepayers, allowed the bonds to gain an AAA/Aaa rating.

The bonds resemble the stranded cost securitizations that have taken place in deregulated power markets over the last ten years. Such debt has enjoyed exceptionally good performance histories, and allows borrowers to access debt at a low cost of capital and keep it off-credit, as far as the agencies rating Allegheny's debt are concerned.

The debt is split between the $350 million for Monongahela Power, and $116 million for Potomac Edison, both of which are subsidiaries of Allegheny Energy located in the state. The bonds are described as senior secured sinking fund environmental control bonds. Using a true-up mechanism, the state will raise the surcharge by an amount necessary for the issuer to stay current.

The scrubbing equipment is being installed at the Fort Martin power plant, which runs on the local, highly sulphurous coal, and will allow it to keep operating, at 95% lower emission levels, and keep local miners in work. The WVPSC approved the bonds on 19 January.

Project risk is allocated in several different ways. Construction risk is managed partly by means of a contract with Washington Group, but also by an escrow mechanism that only releases funds as and when they are required for installation. In the event that the equipment does not perform properly, or the plant is not operated properly, this would be reflected in the regulatory treatment that Allegheny receives from the PSC, but would not alter the surcharge mechanism in any way.

The financing could be a useful way of financing the $50 billion in pollution control upgrades that the US Department of Energy estimates will be necessary in the near future. The structure works best with utilities operating in tightly-regulated markets, and achieves the greatest pricing benefits for utilities with poor ratings and thus high corporate debt costs (Allegheny, for instance, is sub-investment grade). Saber Partners advised the WVPSC on the issue.