Capacity performance penalties imposed by the PJM Interconnection LLC on certain power generators present a substantial credit risk for affected projects, Moody's analysts said.
The 13-state grid operator in early April issued the first installment of invoices for $1.8 billion in penalties assessed on generators that failed to perform as expected during a December 2022 winter storm. In January, PJM said it expected to assess between $1 billion and $2 billion in capacity performance penalties based on an "unacceptably high" level of resources unavailable amid extremely cold weather.
"The penalties are substantial — greater than $100 million in some cases — and represent a material downside event risk for the credit quality of affected power projects," Moody's analysts wrote in an April 26 report.
The rating agency added that large capacity performance penalties "increase liquidity strain and can result in rating pressure for smaller issuers."
Generation outages reached about 34,500 MW during the evening of Dec. 23, 2022, the grid operator said in a January committee meeting. Outages reached nearly 46,000 MW, or 23.2% of PJM's total capacity, on the morning of Dec. 24, 2022. Most of the capacity that was not available, about 32,500 MW, was fueled by natural gas, with about 7,600 MW of coal generation also unavailable.
PJM implemented its capacity performance program in June 2016 requiring generators to deliver electricity whenever the grid operator determines the need to meet power system emergencies. Generators that exceed performance commitments are entitled to funds collected from generators that underperform.
"Power generation projects, particularly single-asset financings and portfolios concentrated in PJM, bear the most credit exposure to capacity performance penalties," Moody's analysts wrote. "Single-asset projects could receive bonus payments if they outperform, but the concentration of this risk and the potential for nonperformance penalties creates greater potential for a large loss that would be further exacerbated by losses under any energy hedges."
Independent power producers such as Constellation Energy Corp., Vistra Corp. and Calpine Corp. have "less credit exposure" to capacity performance penalties because of the size and operational diversity of their generation fleets, the rating agency said. "Moreover, bonus revenue received from other outperforming plants within these companies' fleets offsets penalties incurred, reducing cash flow at risk," analysts wrote.
Of the smaller generators, Moody's highlighted credit risks from performance penalties for Boston-based Parkway Generation LLC; Princeton, NJ-based Nautilus Power LLC; and Lincoln Power LLC, which owns two gas-fired plants in Illinois and filed for bankruptcy at the end of March after incurring $39 million in capacity performance penalties. Both Nautilus Power and Lincoln Power are owned by The Carlyle Group Inc.
The rating agency, however, noted that the capacity performance penalties are "designed to be substantial."
"PJM imposes penalties without exception for fuel constraints or preexisting force majeure," analysts wrote. "Depending on the magnitude of the event, penalties for some nonperforming plants can exceed capacity performance revenue for the current planning year.
"Winter Storm Elliott is the first major capacity performance event, with total penalties approaching $2 billion, which is in line with the worst-case scenario we had envisioned when the penalty plan was developed."
The performance penalties were implemented after the January 2014 polar vortex, where forced outages in PJM approached 40,000 MW, or at least 20% of its total generating capacity.
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