After hedge providers got burned earlier this year on deals for new-build gas-fired projects in PJM Interconnection, they are quoting revenue puts at pricing that no longer makes as much sense for CCGT developers, forcing them toward alternatives.

In recent years, the revenue put has been the hedge of choice for developers of so-called “quasi-merchant” gas-fired projects, to mitigate the volatility of spot market prices and ensure their projects are palatable to equity investors and lenders in the bank and institutional debt market.

But the market for these contracts has softened considerably this year under pressure from sustained low gas prices, CCGT build-out in PJM and expectations that wind and solar development is set to grow.

“There’s so much volume that’s either in the market or coming to the market, between wind and gas-fired projects, that the forecast price for energy in PJM has softened a lot,” says a project finance attorney. “Everyone has been very bullish on power in PJM, but things are starting to turn a bit and a very big project really had trouble recently trying to find somebody to sell them a revenue put.”

The cracks started to show in April, when Indeck Energy brought its 1,085 MW Niles Energy Center to financial close. As with many CCGTs financed in recent years, the debt and equity were supported by a five-year revenue put (PFR, 4/25).

“The understanding among market participants is that some of the people bidding on that structure were trying to lay off the risk, in advance and subsequently,” says a senior commodities banker in Houston. “When they won the position, they tried to hedge very quickly.”

This was the moment when “the game changed,” says the banker. “Right around pre-closing and post-closing, the market moved dramatically,” resulting in mark-to-market losses for traders with revenue puts on their books that they had not been able to fully hedge.

Just two months later, J-Power USA closed the financing of Jackson Generation in Illinois, an even bigger project than Niles at 1.2 GW. This time the five-year revenue put came from J. Aron, the commodities trading arm of Goldman Sachs (PFR, 6/26).

“Immediately after the deal closed, the market moved quite a bit,” says the commodities banker. “Pain across the board for all market participants.”

liquidity pfr full size
"Where did the liquidity go?"
In the aftermath of that deal, some participants withdrew from the revenue put market and those that remained became much more cautious about the prices they would quote.

“Both of those experiences over a six week period was really, really painful,” says the commodities banker. “The natural reaction was that any subsequent quotes the market would be providing would be much wider, from the project’s perspective.”

It was during this period that Caithness Energy was in talks with Morgan Stanley to provide a five-year revenue put for its 1,836 MW Guernsey Power Station in Ohio, the largest CCGT to be financed in the U.S. so far this year. But after the experiences of Niles and Jackson Generation, the terms on offer were suddenly not as favorable as they had been.

There was another hedging option available, however, in the form of the gas netback, a product typically offered by gas producers and suppliers.

Caithness had pioneered the use of the gas netback in 2015 with its 1,050 MW Freedom project in Pennsylvania (PFR, 11/10/15), and it has since been employed by Invenergy and Ares Management (PFR, 1/6/17, 3/19/19).

Gas producers are eager to provide gas netbacks to power plants in the Northeast—near the shale gas plays—rather than shipping natural gas via pipelines for sale in other markets.

“From the gas producer’s perspective, you’re selling your gas at a different location than you otherwise would and hopefully getting a better price for it,” says Noam Berk, managing director at Dean Street Capital Advisors, which advises on commodity hedges.

In the case of Guernsey, Caithness ended up inking a 10-year gas netback with Equinor for about two-thirds of the project’s capacity alongside a five-year revenue put with Morgan Stanley for a smaller portion. The capital raise and financing closed successfully in August (PFR, 8/29).

Equinor, the Norwegian state energy company formerly known as Statoil, has double-A credit ratings from Moody’s Investors Service and S&P Global Ratings, making its gas netback highly bankable. Other oil and gas companies that would like to offer gas netbacks are unrated or sub-investment grade, which limits their usefulness and makes dealmaking more complicated.

Since August, some market participants say the revenue put market has recovered, though not at the same pricing that was available at the beginning of the year. “I’ll believe that when I see it,” says a senior power and gas originator in New York.

In the meantime, observers note that traditional gas-fired project developers such as Advanced Power seem to be taking the hint and diversifying into wind and solar development (PFR, 10/3).

“That’s absolutely necessary if you want to have a long-term focus on the business,” says Dean Street's Berk. “I do think there is limited additional appetite and need for CCGTs in most of these areas.”

“It’s absolutely the right answer,” the commodities banker agrees. “Nobody should just be a pure gas developer at this point in the cycle. Especially in this environment, where it’s so much easier to raise capital on the renewables side.”

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