Higher-than-expected clearing prices in the latest PJM Interconnection capacity auction could mean that several gas-fired projects that have been in the works for months could finally circle financing, deal watchers tell PFR.

Capacity cleared in much of the regional transmission operator's territory at $140/MW-day, versus $76.53/MW-day in most of the same zones last year.

Senior project finance bankers had mostly expected the outcome of the auction to be flat to last year or lower, according to a survey conducted by PFR last month ( PFR, 4/26). 

"Everybody is surprised," says an executive at a strategic investor. "Almost everybody thought it would be a lot lower. Maybe a little bit of an increase from last year but not much."

Several reasons were given for the higher print, including bidders seeking to offset low power prices with higher capacity revenues; an increase in the net cost of entry for new generation resources because energy revenues have decreased, resulting in upward shift of the capacity demand curve; and a decrease in the total capacity that cleared—which was not unexpected given a fairly high reserve margin and low prices.

These were all somewhat offset by a forecast decrease in future electricity demand.

PJM also attributed the higher prices to transmission limits in some regions.

Many market watchers were curious about the potential effect of FirstEnergy nuclear retirements in Ohio. Some 19.9 GW of nuclear generation cleared the auction, about 7.4 GW less than last year—a smaller reduction than was expected by analysts.

"The outcome signals rational bidding from key players" such as FirstEnergy and Exelon, wrote analysts at Cantor Fitzgerald in a report, noting that about 5.5 GW less generation capacity had cleared the auction overall compared with last year.

TIME TO HIT THE GAS

Bankers now expect the recent lull in quasi-merchant financing, which has become something of an annual ritual in the run up to the capacity auctions, to end as developers push to round up their final equity checks.

"Did you see the capacity prices?" exclaimed one project finance banker. "I’d look to sell and take advantage of it today."

Others are more cautious, saying that banks need more time to ponder whether the higher capacity prices are here to stay. "One good auction jump doesn’t make a trend," another senior banker said.

The location of a project and nature of the sponsor behind it will be determining factors in how quickly it is able to come to the debt market.

"Many projects in the pipeline will move from amber to green light, depending on where they’re located, especially if they they are backed by a private equity sponsor," says Louise Pesce, m.d., project finance, at MUFG, in Los Angeles.

"If there is one large P.E. sponsor who can hold 50% to 70% of the project, it’s much easier to circle equity," she adds. "If they're relying on a group of three or four investors, one could hold the whole project up."

An additional gigawatt of gas-fired generation cleared the auction compared with last year, including one new combined-cycle plant.

Ares-EIF’s 664.7 MW Hill Top Energy Center in Greene County, Pa., was the only greenfield CCGT project to clear the auction, PFR understands. Officials at the private equity sponsor in New York did not immediately respond to inquiries.

SIZING THE DEBT

While higher capacity prices might be expected to result in higher leverage ratios for project finance deals, this may not be the case across the board.

"A project's leverage ratios may not necessarily shift because of higher capacity prices," says Pesce. "Prices for hedging tools like heat-rate call options and revenue puts have not moved upward as energy prices are still depressed—which is why capacity prices were bid up in the first place!"

What is more likely is a wave of refinancings along the lines of what BNP Paribas arranged for Ares-EIF’s 700 MW St. Joseph CCGT in Indiana earlier this year ( PFR, 3/16).

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