Merchant plant tolling contracts divide risk

As gas prices rise and electricity prices spike, more companies are turning to tolling agreements to fund and divide risk of building new merchant power plants, dealmakers say. Speaking Wednesday at Power-Gen International, Roger D. Feldman, partner and cochair of the project finance and development group for Bingham Dana LLP, said the basic model appears to be the energy companies which can handle both the fuel and the electricity risk are �getting the upper hand in these kinds of projects.�


Kate Thomas
OGJ Online

ORLANDO-As gas prices rise and electricity prices spike, more companies are turning to tolling agreements to fund and divide the risk of building new merchant power plants, dealmakers say.

Speaking Wednesday at Power-Gen International, Roger D. Feldman, partner and cochair of the project finance and development group for Bingham Dana LLP, said the basic model appears to be the energy companies which can handle both the fuel and the electricity risk are "getting the upper hand in these kinds of projects."

Under a tolling agreement, the tolling party supplies the fuel to a power plant operator and receives the electricity as the product, which it then markets. Feldman said these arrangements have begun a key cog in risk allocation in the industry and are based on different economics from the original independent power producer projects.

"A lot of merchant plants were based on gas prices of 9 months ago," Feldman said. Since then, natural gas prices have doubled. "Only the largest players can handle that risk," he added.

Project sponsors reduce their risk but they also trade off the ability to make money on the spark spread. They become responsible for development and subsequent performance of the plant processing the fuel, including its heat rate and availability, in exchange for capacity payments whether or not the plant operates.

These payments are critical to financing the project, Feldman said.

They also receive operating and maintenance payments and a start payment for ramping up the turbine. Project sponsors are also subject to various penalties for not meeting expectations of the tolling party, including not constructing the facility on time. This has become a hot topic during negotiations. Original equipment manufacturers are having trouble meeting delivery deadlines. There are also problems with malfunctioning or poorly assembled components, said Feldman. Many project sponsors are trying to shift some of the plant delivery risks to the contractor.

For the tolling party, the agreement serves as a physical asset hedge to cover electricity trading positions. At the same time, merchant plants can be used to extract the "volatility value", or upside, potentially present in volatile gas and power markets, said Feldman.

In the restructuring of power purchase agreements and the calculation of equity returns, he explained, volatility value represents an effective buffer to cash reserves needed to cover debt service.

Regulatory risks remain, he said, notably in California where price caps have been instituted that affect merchant plants.

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