- The hedging arrangement with investment-grade-rated TXU reduced merchant risk sub-
stantially by supporting most of debt service until 2007. - Drax’s high efficiency rate of 38 per cent and its low marginal costs gave it a competi-
tive position in the UK electricity market. - AES had experience of operating older, coal-fired plants and of operating in the UK mer-
chant power market. - The company had retained highly qualified personnel, minimising its O&M risk.
- The plant’s assets had been well-maintained, and significant capital expenditure and
operating expenses were budgeted to improve operations on an ongoing basis. - Fuel procurement and fuel price risk were expected to be minimal.
- Environmental risk was minimised by the flue-gas desulphurisation system.
- The financing benefited from adequate projected debt-service-coverage ratios in the bank
base case, which also held up under stress scenarios such as continued decreasing elec-
tricity prices, new capacity entering the generation market at a low cost and lower load
factors.
The stable outlook in the rating from Standard & Poor’s reflected the support for debt service
in the first seven years provided by the hedging contract, under which Drax would have rel-
atively low exposure to fluctuating electricity prices and a reasonably predictable level of
cash flow. Nonetheless, the agency explained that regulatory and price uncertainty limited an
upgrade of the ratings. Finally, the agency pointed to the cash flow sweep mechanism that
supported the payment of senior debt.
Subsequent developments
Since the project financing in 1999 AES and its Drax power plant investment have been
affected primarily by two important developments with far-reaching ripple effects. First, the
combination of NETA and an oversupply of generating capacity reduced wholesale electric-
ity prices in the United Kingdom by far more than expected, and consequently reduced the
earnings and value of power plants such as Drax. Second, the Enron bankruptcy caused
investors and lenders to take a more conservative stance towards companies throughout the
power industry, requiring companies such as AES to deleverage and sell off assets.
When the NETA system was implemented, in March 2001, Drax’s hedging contract with
TXU Europe had to be renegotiated because the Pool price that had been used as an index
price no longer existed. The two parties had difficulty agreeing on a new index price.
Consequently the hedging contract was changed to a physical delivery contract. The parties
also agreed that Drax would pay 75 per cent and TXU Europe 25 per cent of transmission
charges; and the call notice for TXU Europe to dispatch power from the Drax plant was
changed from one day ahead to periods ranging from four hours to six months. Drax’s rev-
enues would come from the new physical delivery contract with TXU Europe, the sale of
excess power through the balancing mechanism run by the system operator and the sale of
ancillary services.
In April 2001 Moody’s reaffirmed its ‘Baa3’ rating of the senior secured bonds and its
‘Ba2’ rating of the subordinated notes. It said the impact of NETA on Drax was negligible,
because the bulk of its contract revenues remained the same, but that Drax would face high-
er financial risk whenever the plant was not available to meet all its contractual obligations.
DRAX, UNITED KINGDOM