EnergySource, a consortium of Catalyst Renewables, Hannon Armstrong and GeoGlobal Energy, closed the debt financing for the $401.3 million Hudson Ranch I geo­thermal power project on 13 May 2010. The project is progressing well and on budget with drilling underway on the third production well.

As the first utility-scale US geothermal construction financing since the 1980s to close with commercial bank lenders, the deal had to overcome a number of chal­lenges. “The first hurdle was the timing,” says Brian Harenza, senior vice-president for project fin­ance at Hannon Armstrong. “We approached the market in the sum­mer of 2009, when markets were still vola­tile. Secondly, commercial banks were focused on existing custom­ers, and seem­ed to place an emphasis on cer­tain sectors such as wind. And EnergySource was a new customer.”

Given the need for expensive production well drilling, geothermal plants have high upfront costs. Poten­tial banks were therefore comforted with the fact that two of the three production wells were drilled before bank financing, though less enamoured by the lack of an EPC con­tract. “We obtained permits for the pro­ject in 2007 and at that time the EPC market was blowing out,” adds Harenza. “It was hard to get anyone to answer the phone, or when we did get a response it was with ridiculous pricing for the wrap.”

The sponsors decided to use an owner-construct model, provid­ing lender comfort with the contractual pass-through of risks to the subcontractors and equipment suppliers, such as a Fuji performance guarantee for its turbines, letters of credit and contingencies.

The total project cost plus contingency is $401.3 million. The debt is a $300.2 million mini-perm and is priced at roughly 325bp over Libor. The debt facilities comprise a $204.9 million tranche A construction/term loan (2-year construction + 5-year term) and a $95.3 million tranche B ITC cash grant bridge loan (2-year construction + 120 days).

Tranche A has been sized to ensure healthy debt service coverage ratios of at least 1.45x minimum and 1.50x average over an 18-year hypothetical amortisation, assuming the use of $50 million of contingency. Tranche B has been sized to cover 100% of the expected amount of the ITC cash grant assuming no use of contingency. Overall leverage is capped at 75% of total costs, as defined in the closing budget. Once the project is successfully completed unused contingencies will be repaid. The excess cash will split via the debt/equity ratio of 75:25.

Its lead arrangers are ING Capital, Societe Generale and WestLB, while Union Bank, MetLife, CIBC, Siemens Financial and Investec participated. It refinances a $15 million resource verification loan from Glitnir Bank (now Islandsbanki) to the project. The equity is $101.1 million, of which $90 million comes from a preferred equity investment from GeoGlobal, which joined the original two developers as a sponsor at a later stage.

Hudson Ranch is located near El Centro, in Imperial Valley, California, to the south of the Salton Sea, a prolific geothermal resource area with at least 1,200MW of generation capacity. The region is home to existing geothermal producers, including several operated by CalEnergy, Ormat and Calpine. But Ormat, the developer of the most recent new capacity plants, uses its own binary-cycle technology, and Hudson Ranch will be the first in 20 years to use flash technology.

The two developers are not project finance novices, though neither has utility-scale geothermal experience. Catalyst, former­ly NGP Power, and in existence since 2001, is owned by the Natural Gas Partners VI fund, and has previously developed a biomass plant in New York. Hannon Armstrong develops energy and energy efficiency projects for local and federal government entities, often by assembling tax-advantaged financings.

The project is underpinned by a 30-year power purchase agreement with Arizona’s Salt River Project. The SRP, in existence for over 100 years, was formed as an irrigation district, but now provides power to three large urban areas, Phoenix, Mesa and Scottsdale, and is rated Aa1/AA (Moody’s/S&P).

The $15 million Glitnir loan, which closed in 2008, funded drilling at the resource, which typically costs $6 million to $10 million per hole. Through a combination of skill and luck, the first resource verification wells drilled in 2008 produced a strong, solid resource, even though the developers had expected that four would be necessary. The two holes were enough to support the bank debt component of the financing, and the risk attached to drilling a third is essentially borne by equity. The existing two holes, according to the banks’ downside case, should produce 30MW, enough for the lenders to get paid back from a lengthened amortisation schedule.

The mini-perm structure suits the project. Harenza, who used to work at Calpine, says the US power lending market can be broadly split into two: those who are comfortable with construction risks and those that like operational risk and provide term debt. “It is our intention to go for a long-term capital markets take out post-construction,” Harenza adds. “Even in today’s bank market you could get 15, maybe 17, years, but this is not efficient with a 30-year PPA. We were happy to split the financing in two.”

The Hudson Ranch I transaction was around 1.75x oversubscribed and generated strong interest amongst lenders despite the volatile market conditions. Given that the project will almost certainly be refinanced in the capital markets, there is a ready club of banks with spare capacity to finance Hudson Ranch II, so that will also almost certainly be a mini-perm too.

Hudson Ranch I, LLC
Status: Closed 13 May 2010
Size: $401.3 million
Location: El Centro, Imperial County, California
Description: 49.9MW high-temperature flash geothermal plant
Sponsor: EnergySource (Catalyst Renewables, Hannon Armstrong and GeoGlobal Energy)
Debt: $300.2 million
Tenor: 5 years after completion
Lead arrangers: ING Capital, SG, WestLB
Participants: Union Bank, Investec, MetLife, CIBC and Siemens Financial Services Resource consultant: GeothermEx
Independent engineer: RW Beck
Insurance consultant: Moore-McNeil
Market consultant: MRW & Associates
Environmental consultant: Environmental Management Associates
Cost segregation consultant: Ernst & Young
Borrower legal counsel: Orrick
Lender legal counsel: Latham & Watkins
Contractors: Hudson Ranch Power I LLC (owner, constructor and equipment procurer), PMCca (construction contractor), AMEC E&C Services (project engineer), and URS Washington Group (construction monitor)