With the ground rules finally in place for the monetization of tax credits for carbon capture and sequestration (CCS), Enchant Energy has begun to test whether investors are ready to take the plunge, as it seeks equity partners for a $1.3 billion project located at the 847 MW San Juan coal-fired generation station in New Mexico.
Enchant retained Bank of America as financial adviser for the equity raise on June 11. BofA managing director and co-head of global natural resources Ray Wood is leading the effort.
Wood is a trusted adviser to Enchant’s chief operating officer Peter Mandelstam, having been part of the Credit Suisse team that sold Mandelstam’s offshore wind development outfit Bluewater Wind to NRG Energy in 2009.
Mandelstam joined Enchant in October 2019 after a 30-year career in renewables and relocated from New York to New Mexico in December to be nearer to the project.
Enchant is already in talks with several infrastructure funds as it seeks to secure permits, offtake contracts and – eventually – tax equity and construction debt. The sponsor is exploring the prospects for both public and private debt, given the novelty of the project.
Road to restart
New York-based Acme Equities – the hedge fund sponsor behind Enchant – agreed to buy the 46-year old San Juan coal plant from a group of investors, the largest of which is PNM Resources, last year (PFR, 3/14/19).
The current ownership structure is:
Unit 1 (340 MW)
· PNM – 50%
· Tucson Electric – 50%
Unit 4 (507 MW)
· PNM – 77.3%
· City of Farmington – 8.5%
· Los Alamos County – 7.2%
· Utah Associated Municipal Power Systems – 7%
Following the handover, Enchant and the City of Farmington will hold stakes of 95% and 5% respectively.
As part of a deal with regulators to allow PNM to divest its stake, the utility company will securitize the $361 million retirement costs in the bond market to spread them over 20 years, while replacing the coal-fired generation in its portfolio with solar and storage (PFR, 8/12).
Enchant plans to reopen the plant with carbon capture technology in 2023. The business will be structured as a carbon capture “island” – owned by Enchant and potential tax equity investors – which will serve as the anchor customer of the legacy coal plant.
“There’s a lot of local support to have people employed at the coal plant,” says a person familiar with the plans. “With the carbon capture technology, it ends up having a lower carbon footprint than even natural gas.”
Enchant hired Cindy Crane, the former CEO of Rocky Mountain Power, to be its chief executive in July 2020. A large part of her job will be to secure revenue contracts.
The company is aiming to earn roughly 40% of its revenues from the sale of electricity, 40% from the 45Q tax credits and 20% from the sale of CO2 to oil and gas producers, and is looking beyond New Mexico for customers.
“We believe we’ll meet California’s standards and are seeking transmission into California,” says Mandelstam. “There is a rather significant capacity market there and so we plan to offer an energy package and a capacity package.”
Securing strong offtake contracts for the CO2 is critical. Earlier this year, NRG mothballed its own CCS facility, Petra Nova, when demand for CO2 dropped because of a slowdown in oil production (PFR, 11/8/19).
Enchant plans to capture 6 million to 7 million metric tons of CO2 a year, of which 2 million will be stored at a site 20 miles from the coal plant, with the remainder sent to the Permian Basin for use in enhanced oil recovery.
This assumption is among several that have been questioned by The Institute for Energy Economics and Financial Analysis. In a February 2020 report, the think tank deemed several projections “unrealistic”, including: · the coal plant operating at an 85% capacity factor, · the CCS system capturing 90% of the CO2.
Enchant and Mandelstam have provided a point-by-point rebuttal of the report. “Given Sargent & Lundy’s knowledge of San Juan Generating Station, there’s no reason why it can’t achieve 85% capacity,” said Sean McHone, senior vice president at Sargent & Lundy, Enchant’s engineering consultant.
“Unusually for a coal plant, we won’t follow the load on merit order dispatch,” Mandelstam tells PFR. “We’ll run it because our anchor customer is the carbon capture island, which produces the tax credits.”
Enchant is trying to assuage industry skepticism – especially after the Petra Nova mothballing – through measures including a full-wrap engineering procurement and construction contract from Kiewit Power Constructors.
Mitsubishi Heavy Industries America is providing the CCS equipment – the same contractor used for Petra Nova.
Legal and technical advisers include:
· Sidley Austin – legal
· Tenaska Power Services
· Navigant Consulting
· EJM Associates
Officials at private equity firms and infrastructure fund managers are interested but wary when asked about carbon capture – their funds would be at play long before tax equity – notwithstanding the recent guidance from the Internal Revenue Service (PFR, 2/20).
An investment banker said investments would be made on a project-by-project basis, and would be “geographically constrained” to oil-drilling hotspots.
“I think there is a big opportunity here, although ‘cleaner coal’ has been in the mix for a while and no one has really made it successful as yet,” says the head of a European infrastructure fund. “Tax equity sees the 45Q as their saving grace once (if) the PTC/ITC fades, so I know a lot of the tax equity guys are getting up the curve in order to start making investments in 22/23.”
Tax equity investors, meanwhile, have so far been reluctant to discuss coal-related investments to capture the 45Q credits (PFR, 7/3/19, 7/2).
“It’s a harder sell when the source of CO2 is coal, compared to say ammonia or natural gas, since many banks have policies that require them not to invest in coal,” said Martha Kammoun, a partner at Bracewell.
Mandelstam notes the need for appropriate reps and warranties and/or insurance to make tax equity investors whole if there is a leak at the storage site and the government claws back the credits from investors. The recapture period can be up to 17 years.
But even with the most sophisticated risk mitigation techniques in place, being among the first investors in a new technology is a bold move.
“The first few deals are always very difficult,” says a private equity investor, recalling the early days of solar finance. “Sometimes in life, it’s better to go second.”