The Credit Rating Information Services of India Ltd (Crisil) has developed arating methodology for such projects to help developers of power projectsand investors in project financing. A higher rating would lead to anenhanced ability to raise resources and generate greater efficiency inpricing debt.

The focus on IPP ratings is on nine factors. These factors cannot be lookedat in isolation and their inter-relationship will be a source of creditstrength or risk. These factors are:

POWER PURCHASE AGREEMENTS

The focus of Crisil's analysis is on the various conditions placed on therevenue stream. The tariff, its structure, the terms and theirinter-relationships in the PPA are analysed to determine their impact oncash flow. The tariff structure is usually based on the guidelines issued bythe ministry of power for private sector negotiated and competitively bidprojects. The tariff in most projects has two parts -- the fixed charge and thevariable charge.

a) Annual Fixed Charges: The annual fixed charges or capacitypayments usually cover the standing charges of the project and includeinterest and depreciation charges, fixed operation and maintenance charges,a return on equity and taxes on income. These charges are linked to aminimum level of performance. The focus of the rating agency's analysis hereis to determine the degree of adequacy of capacity payments to cover theprojects' standing costs as long as the minimum performance characteristicsare met. The reasonableness of the minimum level of performance is alsoassessed.

b) Energy Payment: Crisil examines the structure of the variableenergy payment to see if the project's fuel cost and other variable costsincluding variable operating and maintenance expenses are covered. Thelinkage of the variable charge to the project's actual fuel costs and thetimelines of the adjustment of variable charge to variations in fuel pricesand calorific value are studied.

c) Electricity Demand Risk: Most of the regions in the country haveenergy as well as a peak power shortage. Crisil, however, believes that inthe absence of a clearly defined principle of despatch, the backing down ofIPP stations during off-peak hours in certain regions, cannot be ruled out.Even if merit order despatch is applied, the fuel choice of the IPP maydictate that it is the first to be backed down. Rating agencies analyse thedemand supply gap for the utility to which the private sector power produceris under contract to supply electricity and in the context of the region inwhich the power station is situated.

d) Changes In Law: Crisil expects the power purchase agreement toprotect the power producer from any costs arising from change inregulations, especially environmental and tariff related regulations. Thisprotection is expected to be both for capital and operating expenses.

FINANCIAL STRUCTURE AND COVENANTS

Some parameters considered by rating agencies to assess the credit strengthfor a project are:

a) Capitalisation And Financial Flexibility: Rating agencies assesswhether the project is adequately capitalised. The government guidelinesprevent a debt-equity ratio of more than 4:1. Restrictions placed byfinancial institutions may further limit the extent of gearing for aproject. Crisil is of the belief that FIs would influence the capitalstructure of most projects. The actual level of equity needed would varyfrom project to project and depend on the extent of construction andoperating risks associated with the project. However, there are nobenchmarks for the capitalisation ratio to qualify the project for a certainrating grade as the rating would depend on other factors as well.

POWER COSTS

The attractiveness of the power project to the buyer of the electricitygenerated, is a key determinant of credit quality. It is felt that in theIndian scenario, the legal structuring of a project may not as effectivelyinsulate a project from regulatory risks, as an efficient, reliable and lowcost power plant.

SEB's/PURCHASER's CREDIT STRENGTH

The weak financial position of state electricity boards (SEBs) need notalways limit the credit rating of an IPP as Crisil may assign a projectrating higher than that of the purchaser in the presence of certain creditenhancements. With sufficient credit enhancements like escrow accounts,sovereign and state government guarantees or counter guarantees, a projectmay warrant a rating higher than the purchasing utility's rating.

The rating agency would evaluate the payment structure to assess how itassists in the timeliness of the payment of dues to the project guarantees'especially from state governments not backed by an operable paymentstructure, may practically be enforced only in the case of terminationpayment. The access of the project to a diversity of a buyers would mitigatethe risk associated with the poor credit quality associated with a SEB. Incase an IPP is selling electricity to several buyers, the rating agency mayassign it a rating higher than the highest rating of its buyers, if itbelieves that the risk has been adequately diversified.

PROJECT COMPLETION RISK

This is one of the key risks assessed in the development or constructionstage. The risk elements in project completion are analysed in relation tothe obligations of the IPP under the PPA and other project documentation.

a) Size And Complexity Of Construction: The risk of the project isevaluated as not reaching acceptance as scheduled and budgeted. The trackrecord of completion of similar projects worldwide and in India is looked atto assess the reasonableness of the projected time-frame and of the capacityand other parameters targeted. If the risk has been passed through a tightcontract to a contractor, then the track record of the contractor inrelation to size and technology of the proposed project would be studied.

b) Project Financing Risk: Rating agencies do not expect non-recourseprojects with rated debt to commence construction ahead of financialclosure. It is unlikely that a project with part of the financing not tiedup would be able to achieve an investment grade rating.

c) Site Risk: It is ascertained whether the project site is free fromsignificant political and environmental risks.

d) Construction Schedule And Budget: The break-up of the project costand construction schedule is examined with a focus on the budgetedcontingencies to finance cost overruns and the flexibility available in theconstruction schedule. The rating agency normally seeks the opinion of anindependent engineer for the above factors.

PROJECT OPERATING RISK

The rating agency's assessment of operating risk focuses on the likelihoodthat project operating performance could fall below the expectations assumedin the financial projections. The key areas of assessment are:

a) Availability: The rating agency makes an assessment of the abilityof the operator to deliver the required performance with the particulartechnology employed. The operating track record of the technology-fuelcombination and that of the operator, would be studied to analyse therisk.

b) Thermal Efficiency Of Units: The rating agency ascertains thelikelihood of the plant achieving thermal efficiency required over the lifeof the rated debt. Adverse efficiency conditions can severely disrupt theproject economics of an IPP. Crisil would also determine the periodicoperations and maintenance (O&M) requirements for the plant to maintain thedesired efficiency levels.

FUEL RISK

The following issues are looked at while assessing fuel risk:

a) Fuel Supply Arrangements: The rating agency ascertains whether thefuel linkage with the power stations is dedicated or not. The proximity ofthe fuel source from the plant which influences the availability and thecost of fuel supply is another factor considered. The reliability of thetransportation system carrying fuel to the plant is also assessed. The fueland transportation costs would be analysed to determine the risk that theproject has to bear under varying supply situations.

b) Fuel Cost Risks: In case there is some risk of fuel costescalation affecting margins, the rating agency would carry out asensitivity analysis to assess the impact of fuel cost fluctuation onproject cash flows.

ENFORCEABILITY OF CONTRACTS

The development of generating facilities as non-recourse projects is a newconcept in the country. It requires the establishment of precedents whichallow for the speedy resolution of all disputes. In the absence of suchprecedents, long drawn disputes may strain the project's cash flows andseverely impair its ability to service debt. Crisil believes that the IndianArbitration and Reconciliation Act, 1996 is a significant step forwardtowards resolution of all commercial disputes. However, timely disputeresolution and enforceability of contracts continues to remain a criticalcredit issue.

PROJECTED FINANCIAL PERFORMANCE

The following factors are analysed for this purpose:

a) Robustness Of Cash Flows: The rating agency stresses the keyassumptions underlying the statements forecast. The major revenue andexpenses item as well as their contribution to the cash required forcoverage of changes is analysed. Sensitivity analysis, primarily withrespect to fuel prices and power costs, operating availability and plantload factor, receivable collection efficiency, potential exposure tounhedged interest rate movement, foreign exchange rates and other factorsare carried out to identify the exposure of debt coverage to adversemovements in key assumptions.

b) Cash Flow In Special Circumstances: The degree of protectionavailable to the cash flows to the debt holders under special circumstancesis analysed. These special circumstances could be changes in regulationsresulting in increased operations, maintenance cost, regulations resultingin below par operating performance.