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Finance trend provides flexibility -- Synthetic purchase agreements

Irish Airtricity's recent financing package for a wind project in Texas offers a glimpse into an uncommon but increasingly popular approach in the US market. The company's 126.5 MW Champion Wind Farm, expected online next year, is made possible without a traditional utility power purchase agreement (PPA). Instead it secured a five year hedge deal with Coral Energy Holding, a subsidiary of Royal Dutch Shell, for the $231 million project. Power will be sold into the competitive Texas market, providing Airtricity with a chance for higher returns, but with financial security built-in.

A hedge of that type, these days being referred to as a "synthetic" power purchase agreement in the industry, is one of the major new trends in the American market place, says Edward Zaelke of legal advisor Chadbourne & Parke LLP. "These are a big change in the industry and show that the US market is flexible in terms of entrance."

The mechanism finds a middle ground between a developer securing a PPA that provides a long term fixed price versus selling power into wholesale markets in a merchant deal, accepting that the price will fluctuate. PPAs are used for wind projects because the certainty of income makes financing easier, but they offer little chance for higher returns as market prices rise. Merchant deals can provide a much greater return if prices rise, but they carry greater risk if prices drop, making them costly to finance.

"I don't know of anybody that's really been able to secure any significant level of financing for a true merchant wind deal," says Airtricity's Darrell Hayslip. The hedge provides insurance against declines in electricity prices, which facilitates bank financing of the project, while also allowing Airtricity to earn more if electricity prices increase.

Zaelke gives an example: if a given wind project proposed for a wholesale market, such as the 14 state PJM market or that of the Texas Electric Reliability Council of Texas (ERCOT), is expected to earn anywhere between $0.05-0.10/kWh as prices fluctuate, a financing partner will provide a contractual hedge that guarantees the wind plant owner a price of, say, $0.075/kWh for a specified period of time. The hedge provider takes the risk of power prices dropping low but in return takes a cut, such as an equity stake in the wind plant.

"When you do a PPA, you're really forced to sign the contract at a point in time that supports your construction and financing schedule," says Hayslip. "The excellent thing about a hedge is that it allows us to execute future transactions at a time that would be most beneficial to the project." For now, GE Financial Services is providing an unknown level of structured equity in the project alongside Airtricity.

More players

The synthetic PPA also gives Airtricity the ability to seek multiple buyers for sale of electricity into the Texas ERCOT grid. Cumulative power from the Champion project's Siemens 2.3 MW turbines can be broken up into much smaller blocks, allowing more players to enter the game. "It gives us a great deal of flexibility and the ability to go to more customers," Hayslip says. "We can expand our customer reach and expand the number of potential buyers that are out there for us since they don't have to take the full position for five years or longer."

Hayslip, formerly of energy giant Calpine, eventually expects to see more developers structuring hedge deals as the path becomes clearer. "I think one of the reasons a lot of the other companies don't do it is that they're running a development shop," he says. "And in order to enter into and manage some of these newer things in the marketplace you need a special skill set."

Zaelke sees the trend opening up the US market to more outside investment, particularly for foreign companies wary of negotiating the bilateral US markets that exist in half of the country. But the other half of the country is governed by competitive electricity markets where synthetic PPAs can offer wider financial flexibility and a higher rate of return.

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