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<title>The New Merchant Mantra</title>
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<p align="left"><font face="Arial"><strong><small>About The Author:<br>
<br>
</small></strong><span lang="X-NONE" style="color: black"><font size="2">
ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon
Markets Group has practiced law related to the finance of environmental and
energy projects and companies for 40 years. In particular, he has analyzed
and executed a wide variety and substantial value of project financings. He
chairs the American Bar Association’s Committee on Carbon Trading and
Finance, serves on the Board of the American Council for Renewable Energy,
and has been a senior official in the Federal Energy Administration. He is
a graduate of Brown University, Yale Law School and Harvard Business School.</font></span></font></p>
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<td width="75%" valign="top"><img src="../images/feldman.gif" alt="Washington Viewpoint by Roger Feldman" border="0" WIDTH="375" HEIGHT="75"><p><b><u>November 1997</u><br>
</b><br>
<font size="6"><strong>THE NEW MERCHANT MANTRA</strong></font></p>
<p><strong>by Roger Feldman -- Bingham, Dana and Gould, P.C.<br>
</strong><font face="Arial" size="2">(<em>originally published by PMA OnLine Magazine:
04/98</em>)</font></p>
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<p><font face="Arial">Power privateers have looked to the new competitive markets as ones
in which they could achieve greater refinanced value on their existing IPPs
("refi") and/or could try and enhance existing assets to a competitive state
("repow") and then refinance them. As the capital markets have begun to
scrutinize these possibilities, at this early stage of deregulation, they have made
timorous sounds of willingness to come forward with proper innovative adaptations, to be
sure. To jump-start the process, power privateers have begun to employ some creative
capital market techniques themselves. To do so, they have had to address the standards for
private power credit earlier established by the rating agencies, and to familiarize
themselves with emerging insurance risk management devices.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">"Refinancing" - in the sense of improving
capital structure - has been a traditional approach to seeking benefits from changes in
market rates. Power market refinancing today has taken on a new meaning, as shifts in the
underlying regulatory structure of the capital markets modifies the underlying cash flow
prospects of what is being refinanced. Nowhere is this becoming more apparent than in
efforts to utilize refinancing as a means of resuscitating existing assets which are
becoming available as a result of restructuring. These include those assets made the
subject of utility asset sales (potentially including nuclear plants). Candidates include
also refugees from the last wave of deregulation: "stranded" IPPs and EWGs now
facing a truly merchant market, and underutilized, or incompleted projects with potential
future competitive value. Refinancing thus may be linked to repowering, in terms of need
for market as well as capital improvement support.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Unfortunately, these refinancing efforts enter the
world seeking to address the world of merchant powerplant financing, at a time when
lenders and capital markets still are seeking to develop new benchmarks for evaluation:
they have not yet departed from the clearcut rating standards forged laboriously several
years ago so that Rule 144A financings could be >done for IPPs. Recently rating
agencies have begun to focus on what the credit really is for a refinancing of a repowered
facility. In their view, to date, electricity commodity trading markets have not had the
depth to provide a basis for offsetting capital market risks. Protection for cash flow
risks arising from "counterparties" entering over-the-counter trading
arrangements are recognized to provide conceptually for such support, but to suffer
currently from certain perceived deficiencies: uncertainty of parent support for
non-recourse trading company subsidiary counterparty obligations; significant credit risk
exposure as to counterparty financial strength (a concern common in commodities, but as
yet not a major subject of focus in the power industry); and discomfort with the
possibility that if the power marketer or other counterparty does not net its trades and
enters Chapter 11, individual contracts (like those of the power privateer) may not be
affirmed in bankruptcy. </font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Given these rating agency concerns, the obvious
solutions for refi-repow privateers are the same (and as costly) as for new MPPs - more
equity; less leverage; more efforts at partial offtake contracting; greater short term
price hedging; more pressure on equipment suppliers not just to provide subordinated debt,
but also equity (including possible monetization of future power sales as consideration
for their upfront investment). </font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Another alternative is to enlist the creativity of
investment bankers dealing with capital markets. This may well trigger efforts: pool
multiple project risks; credit enhance the resulting pool; and issue derivative
securities. Of course, a "chicken & egg" problem is presented by this
possible solution: it is easier to pool cash flow from multiple projects when there is
more MPP product on the market. </font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Given the shortcomings of those approaches, creative
sponsors and bankers have been led to an effort to put new risk mitigation tools to work
by themselves, with a view to improving projected cash flow either on individual projects
or on specially constructed "synthetic" portfolios created with credit
enhancement. The most clearcut of these techniques are securitization of project balance
sheet item (not to be confused with utilities' efforts to securitize the "regulatory
assets" expected to be derived from stranded costs) and the application of
specifically targeted integrated risk insurance to portfolios of MPP risks. In effect, the
use of sophisticated risk management and capital markets techniques by privateers may have
to precede the willingness of capital markets to broadly supplant "one off"
financings (frequently based on "toll financing" with fuel costs locked in and
power prices are believed to be predictable, or net backed fuel supply arrangements). </font></p>
<p><font face="Arial">In sum, the power privateer cannot focus only on the improved heat
rate of the repowered facility to assure the success of its new refinancing. Attention to
sculpting cash flows for capital market acceptance is essential. Implementation of a
refi/repow strategy may require reinsure coverage ("recov") as well. A new
mantra for our merchant times: repow, >refi, recov.</font></p>
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<p class="MsoBodyText" align="left" style="margin-bottom:0in;margin-bottom:.0001pt;
text-align:left"><font face="Arial" size="2">
<span lang="X-NONE" style="color: black">ROGER FELDMAN, Co-Chair of Andrews
Kurth LLP Climate Change and Carbon Markets Group has practiced law related
to the finance of environmental and energy projects and companies for 40
years. In particular, he has analyzed and executed a wide variety and
substantial value of project financings. He chairs the American Bar
Association’s Committee on Carbon Trading and Finance, serves on the Board
of the American Council for Renewable Energy, and has been a senior official
in the Federal Energy Administration. He is a graduate of Brown University,
Yale Law School and Harvard Business School.</span></font></p>
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