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<title>Powering the Yankee Merchant Clipper</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>October 1998</u><br>
<font FACE="Palatino" SIZE="5"></font></b></p>
<b><font FACE="Palatino" SIZE="5"><p></font><font face="Arial" size="6">POWERING THE
YANKEE MERCHANT CLIPPER</font></b></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:
10/98</em>)</font></p>
<p> <font FACE="Palatino" SIZE="2"></p>
<p ALIGN="JUSTIFY"></font><font face="Arial">Yankee Clippers were the swift merchant
vessels out of New England that opened up world trade. Were briefly, until steam powered
vessels rapidly rendered them obsolete.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Are the high efficiency merchant plants
proliferating on New England’s rocky shores an antecedent of the future —
responding opportunistically to the attractions of high prices in certain markets
(transmission constrained or otherwise); falling reserve margins (as nuclear plants tank
and old plants prove inefficient and uncompetitive); by repowering (exploiting existing
transmission rich sites) and by rising industrial and public/private interest in lower
priced outsourcing and cost effective dispersed generation. Or are they, as Power
Engineering recently suggested, doomed to Yankee Clipper-like extinction: "The
merchant phenomenon will probably die out in the United States (perhaps as early as 2003,
when proposed national legislation dictates full Customer choice") ... - as all power
plants will ultimately represent "merchant capacity". Leaving aside the lawyers
tendency to quibble with simple logic, i.e. if all plants become merchant, how can
merchant plants be said to be dying out (and also to split definitional hairs, i.e.
"It depends on what you mean by" "merchant power plant", cf W.J.
Clinton 9/98), I believe the pragmatic answer is "No, merchant plants will not die
out."</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Not just because the markets are there, but because
of the creativity and flexibility of the financial community. One clue: Standard &
Poors has placed its current analysis of "merchant power plants" in immediate
conjunction with its description of "Collateralized Loan Obligations" (CLOs) and
"Collateralized Bond Obligations" (CBOs).- a tool it sees for future merchant
plant development. Standard & Poors now refers to this means of financing as the
"third way". </font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Under the CLO or CBO structure, capital market bonds
are paid from the cash flow generated from a pool of loans made, for example, to
individual merchant plant projects. The diversification of cash flow securing the CLO
bonds improves their credit strength above the level for individual projects, and may be
further enhanced by overcollateralization, i.e. more loan repayments than necessary
pledged to secure the bonds. It is not alchemy: sound CLOs still depend on underlying
sound transactions. But it is a new way to obtain debt and equity capital, which may be
particularly appropriate for merchant plant projects. They are, after all, themselves,
from a financial standpoint, nothing more than cash flow plays dependant on power markets,
and the ability of power marketers to smooth markets, by using derivative structures.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">The possibilities of CLO use are increased by the
fact that while the world of deregulated power and power marketing has been changing, so
too have the potential types and sources of risk management and credit enhancement for
merchant deals. Increasingly larger, integrated capital pools for risk assumption are
seeking ways not merely to provide a credit grade uptick, but to assume at least some
portion of those specifically identified risks necessary to achieve financeablility. (In
turn, these capital pools themselves back fall behind those risks throughout a mixture of
commodity trading, risk spreading through reinsurance and development of appropriately
priced financial products.)</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Future prospects for merchant plants may well be
through CLOs or CBOs, sponsored by large energy firms which are establishing the multiple
building blocks of their globe encircling fuel-energy facility endeavors. There will be
strategic partnering by these energy companies, with those utilities still possessing
transmission capabilities. There may even be some privately sponsored - politically
correct "green" merchant power "apples" serving specialized customer
classes, bobbing in a surge of "microsoft" electrons produced for the mass
retail markets by the mega-energy firms.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Correlatively, project finance will be restored to
simply an alternative technique for getting the energy station funding job done - drawn
from antediluvian ’80s , but adapted to new realities through securitization
techniques.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">While some bankers wring their hands about
"immature" debt markets for merchant plants, next generation financial and
internal corporate CFOs are already conceptualizing power revenues as merely another type
of cash flow, which - once the risk management markets have gotten statistically
comfortable with its aggregate forward price curve profile - may be credit enhanceable to
a level where such securitization is possible. Securitization obviously has been done with
mortgages and recently even utility receivables; it may be done with merchant plant
revenues in the future.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">This perception of the future role of merchant plant
development, perhaps nascent in the US situation where multiple facilities simultaneously
developed in a single region like New England, could well take hold first in non-US
settings, such as Latin America, where corporate strategies of fuel-power multiple
facility development of large scale facilities throughout allocated franchise territories
are being implemented. Whether credit enhancers will be step up to corporate risks in such
settings and do CLOs as a means of responding to the turbulent times overseas remains to
be seen. The likelihood seems good that they will be done in the United States.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Certainly the direction portfolio financing - with
or without credit enhancement - is the one in which many bankers assume merchant plant
finance will evolve. Current merchant structures are perceived as simply a product of
where expertise resides right now: a the stopgap while different regulatory requirements,
auction processes and stranded costs recovery are sorted out.</font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Historically, project financed projects generally
have been dismissed as not subject to mortgage-like portfolio finance because of their
absence of heterogeneity, particularly where multiple sponsors, multiple power off takers
and multiple credits have been involved. The perceived potential benefit of risk dilution
via the law of numbers has in effect been trumped, thus far, by Murphy’s law, applied
to each IPP investment. On the other hand in the merchant plant arena, there is an
emerging field of transactions where the structural issues key to financing are coming
into clear focus. The rating agencies have articulated those standards, and new techniques
for conforming these risks are emerging daily. With this in mind, the possibility of
credit enhanced merchant plant portfolios looks increasingly bright. </font></p>
<p ALIGN="JUSTIFY"><font face="Arial">Far from premature obsolescence, the prospect of the
Yankee Merchant Clipper is to use structured finance to catch the winds of the capital
markets and deliver the goods in many parts of the world.</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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