HomeMy WebLinkAboutUnalaska Geothermal Project Review of OESI DEV 1993FINAL DRAFT REPORT
UNALASKA GEOTHERMAL PROJECT
REVIEW OF OESI DEVELOPMENT
PROPOSAL
OCTOBER 1993
Unalaska Geothermal Project
Review of OESI Proposal
Table of Contents
I
Il
Il
IV
Introduction and Purpose of Report.....................
OESI Proposal
Gerneral 0.0.0...ccceseeeeessseesecsseeeeseseees
Project DeSCTiption ..........cesecceeseeeeeees
Project Schedule/Cost............sceesseeceesessneeeseeeee
Operating COSts .........ccesseceessseescessesesesnssreeeeres
Project Energy Sales ........cceessesseeeees
Projected Operating Results .............sccessseceeees
Review of OESI Model
Gerneral o....cc cccccceccceeesseeseeeseeeeeeee
Turnkey Approach .........ee ccsssreeesenees
NYo)11011)(ee
Construction Costs/Operating Costs....
Interest Rate 0.0...ccceseceesseseeseeseeeseseeerssseeseesees
Project Energy Sales 20.0.0...scceccessseesesseeeesees
Future Load Growth ...........ccsccseseseeees
City Distribution Costs..........ceeeeseeeeeee
Debt Service Reserve Fund..............06
Rate Stabilization Fund ................eee
Base Case ........ssccessssccsseseeseeesseeeseeeees
Sensitivity Runs
Escalation of City Costs ............006.
Cost Of POWET.........cccessceessreeeseees
Project Energy Sales ..............ss0e-
Interest Rate 2.0.0...eessceeseeseeeees
toesecconessene
oo enreececveccs
woecccenconsoce
Pew eeerenescces
see eroeroerccns
Pee ecccccvccccs
Coe reeeonveerce
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Pow svcveccevees
Deere enccecevce
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eee eenevceecoce
Porree rer eer erry
Po ceceesccccoes
Pere eee Serre
Financing Structure and Impact on Authority
Credit
General ............ccccccesccescccssccevesceccensrenes
Risks
Geothermal!Resource Risk............
Technology and Construction Risk
Co cecrcaceccecs
Preece reer rer eeny
Coe eeesoscccsce
Need for Credit Enhancement ...........ccssscsssseeees 19
Effect of Bonds on State oo...eeeseeessereeeones 19
Effect of Bonds on Future Authority
Financing .........sssseesseecessescesesesssescsssesesseesones 20
Vv Legal Issues
Gereral ........cececcceesseeceescesecescsseeesecseeessoossseeeeons 21
Sole-Source Turnkey Contract........ccsssessssssesees 21
Issuer Of BondsS............csscccccsssscessssresesssseacesevees 22
Moral Obligation...............:ccccccsssssscereeceeteseseeseees 22
Industrial Development Bond Allocation............22
Legislative Approval .............sssccssssssccsssssreeessees 23
VI Regulatory/Environmental
Required Project Permits...............cssecsssssressessees 24
Air Quality Benefits 00...eee eee sssceeseeenenseeees 26
Vil Agreements
General .0.0.......ces cccsseecescesreeeecsceseesessessessssseeeooees 29
Turnkey Contract...cceeccccscssseescessssersesseessoees 29
Power Sales Agreement .............cccssescsessreeeseeeee 30
Vill SUMIMALY...........:::.ccccceesesssececcccessseeceeccessesseneceeeeeeees 32
Appendix A -Permits
Appendix B -Diesel Emission Reductions
I.INTRODUCTION AND PURPOSE OF REPORT
The technical,economical and financial feasibilities of the Unalaska Geothermal Project
(the "Project")have been investigated over the past several years by both the Alaska
Energy Authority ("AEA")and the Alaska Industrial Development and Export Authority
(the "Authority").These early studies have shown that while there are certain risks
associated with the Project,development of this geothermal resource could under certain
conditions provide net economic and other benefits over present diesel generation.
As the studies progressed,it became clear that the amount of energy sold from the Project
and the security provided by the purchasers would both play important roles in the success
of the Project.In order for sufficient energy sales to occur,the local electric utility
(owned and operated by the City of Unalaska)and the fish processors that currently
produce their own power would all have to participate in the Project.Furthermore,the
purchasers must make some sort of commitment to purchase Project power in order for
bonds to be sold or for the State to not absorb all of the risk.
The growing peak and total energy requirements of the City and the processors have
caused them to operate their diesel generators in amounts that approach or,in some cases,
exceed that allowed under their existing air quality operating permits.This,in turn,has
given rise to renewed interest in the Project.Consequently in June 1993,a meeting was
held in Juneau with the processors and the City of Unalaska to determine their interest in
the Project and what type of commitments they might make.
At the meeting,it was determined that:
1.A take-or-pay contract was not acceptable to the processors,although some
form of requirements contract was a possibility;and
2.The proposed delivered cost of 12.0 cents/kilowatt-hour (in 1992 dollars)might
be acceptable to some,but the price would have to be revisited before they
would be willing to make a commitment.
After the meeting,the proposed Project developer,OESI Power Corporation ("OESI"),
offered to submit a proposal for the development of the Project.The proposal was to be
based on a turnkey development where the State does not take ownership of the Project
Unalaska Geothermal Project FINAL DRAFT Page 1
until it is operational.The price of the delivered power was to be 12.0 cents per kilowatt-
hour in 1992 price levels including 1.5 cents per kilowatt-hour for distribution and other
costs estimated by the City of Unalaska.
OESI submitted its proposed development plan to the Authority on August 18,1993,and
the Authority retained the services of a multi-firm team to review the merits of the
proposal,its impacts on existing and future Authority financings,the risks associated with
the contemplated finance plan,legal issues that must be resolved,and other factors.
Members of this team and their respective tasks include:
R.W.Beck and Associates -Finance,Project Usability,Air Quality
Public Financial Management -Finance
Birch,Horton,Bittner and Cherot -Legal
Douglas Kemp Mertz -Permitting,Air Quality
This report summarizes the findings of the team's review.
Unalaska Geothermal Project FINAL DRAFT Page 2
II.OESI PROPOSAL
GENERAL
The Development Plan submitted by OESI to the Authority does not constitute an offer by
OESI but was intended to form the basis on which the parties could negotiate agreements
necessary to develop the Project.It contains,in general terms,a Project description,
estimates of construction,operating,and financing costs,a proposed construction
schedule,and a pro forma of power costs.
The financing concept included in the plan assumes long-term debt to be issued by the
Authority prior to Project completion.Two bond issues are assumed:the first to fund the
development of the steam field and the second to fund the power plant,transmission line
and other related costs.OESI believes that this reduces the risk to the Authority,because
only a portion of the long-term debt is issued prior to proving up the geothermal field.
Since past meetings with the City and the processors have included projections of power
costs based on 12.0 cents/kilowatt-hour,OESI's pro forma and financing plan are similarly
based.Power from the Project would be delivered to the Project participants at 12.0
cents/kilowatt-hour in 1992 dollars.This includes 1.5 cents/kilowatt-hour for the City's
distribution costs.Delivered power costs would not be shielded from inflation but would
rather increase on an annual basis such that they remain constant in real terms.
PROJECT DESCRIPTION
OESI proposes to construct a geothermal power project near the Makushin Volcano,
approximately 12 miles west of the City of Unalaska.Steam to drive the turbines is to be
derived from geothermal fluid located in an underground reservoir located near the
Project.The fluid will be drawn from the reservoir via wells,piped through a heat
exchanger,and then returned into the reservoir through a re-injection well.The Project
facilities and wells will be located to allow the fluid to be drawn froma fracture zone
located approximately 1,950 feet below the surface and connected to the underground
geothermal reservoir.Although well-field development within the fracture zone allows
greater access for drilling than the reservoir does,it also adds greater risk in completing
production wells.
Unalaska Geothermal Project FINAL DRAFT Page 3
The Project will be constructed in modular fashion such that four interconnected
generating units will be used.Peak capability of the Project will vary depending on the
ambient temperature.OESI expects that the Project will be able to deliver an average of
11.5 megawatts on an annual basis after accounting for seasonal variations and
transmission losses to the point of interconnection with the City of Unalaska's distribution
system.
Integral parts of the Project include:
Power Plant
e Modular binary generating units
e Control and monitoring equipment
e Electrical systems
e Auxiliary systems for maintenance purposes
e Emergency diesel-fueled generator for on-site purposes
e Fire protections system
Pipelines and Transmission Line
e Geothermal fluid gathering and injection systems
e 13.5-mile 34.5 kV transmission line
Road and Pier
e Road from pier to Power Plant
¢Dock located at Nateekin Bay
Well Field Development
e Three production wells
¢Two injection wells
Distribution
e City/Processor interconnection equipment
e Dispatch controls
PROJECT SCHEDULE/COST
OEST's proposed schedule calls for permitting to start immediately (September 1993)and
engineering to start by the beginning of 1994.Construction of the road and dock and
drilling of all five wells would take place in 1994,and construction of the power plant
would occur during 1995.Commercial operation would begin mid-1996.Based on this
schedule,OESI has proposed a development cost of $96.84 million.
H102,7 ir*96"
Unalaska Geothermal Project FINAL DRAFT Page 4
Two additional alternatives to the Project configuration and development have been
identified by OESI to have certain potential.Alternative 1 includes drilling the wells by
utilizing helicopters for mobilization.This alternative adds $2.8 million to the Project
construction costs,but it increases the likelihood of meeting the two-year construction
schedule.Alternative 2 eliminates the pier and part of the roadway and is expected to
decrease the construction cost by $1.15 million.
OPERATING COSTS
An estimate of annual operating costs has been prepared by OESI based on their
expectations of staffing requirements,labor rates,and miscellaneous other expenses.
Total direct operating costs are shown to be $2,400,150 in 1996 dollars.Additional costs
assumed to be paid to the operator on an annual basis include $260,000 for general and
administrative expenses and $240,000 as a fixed fee.The resulting $2,900,150 total
operating and maintenance costs are assumed to increase with inflation.
PROJECT ENERGY SALES
OESI's development plan is based on 82,000 megawatt-hours of annual energy sales from
the Project.OESI believes that recent load growth on the island and the high availability
factor of their other projects warrants a higher Project usage than the 75,000 megawatt-
hours used in previous reports.The significance of this factor will be discussed in the
following chapter.
PROJECTED OPERATING RESULTS
Based on the above and other assumptions,OESI has projected the cost of power from
the Project.Under OESI's model and assumptions,no rate stabilization fund is required.
Project costs are greater than 12.0 cents/kilowatt-hour during the initial two years,but
they have assumed that withdrawals from the debt service reserve fund provided for from
the bonds can be used to offset operating costs during these initial years.
Unalaska Geothermal Project FINAL DRAFT Page 5
il.REVIEW OF OESI MODEL
GENERAL
The OESI proposal was reviewed under the premise that the State's objective is to
develop the Project such that power is delivered at a target price of 12.0 cents/kilowatt-
hour in 1992 dollars.Should actual costs be greater than the 12.0 cents/kilowatt-hour,
withdrawals from a rate stabilization fund (assumed to be initially funded by the State)
would be used to lower costs to the target price.It has been assumed that the State would
desire some sort of return on its investment in the rate stabilization fund.Therefore,
power costs were held constant such that if the cost of power is less than the target price,
payments would be made to the rate stabilization fund.
Two different concepts regarding debt service and the rate stabilization fund can be
pursued.The first is to have the traditional levelized debt service and size the rate
stabilization fund accordingly.The second concept is to minimize rate stabilization by
structuring the debt service to mimic a ramp by using a combination of serial and capital
appreciation bonds (a form of zero-coupon bonds).This second concept has been used in
the analysis in an attempt to minimize the State's investment in the rate stabilization fund.
OESI's development proposal was reviewed for reasonableness of assumptions and
programming errors.The following sections include descriptions of the OESI
assumptions reviewed,a discussion of potential problems with those assumptions,and the
revised assumptions that the review team believes are more appropriate to use.
TURNKEY APPROACH
OESI has assumed the Authority will issue long-term debt during the development of the
Project.This approach is different than the traditional turnkey approach where the owner
does not have financing at risk until the project is completed and meets certain operating
criteria.Therefore,OESI's approach places more risk on the State or the Authority.
Presumably,however,their construction cost figure would increase under the traditional
turnkey approach to compensate for their short-term financing costs and risks they may
assume.Since a revised construction cost cannot be estimated at this time,we have not
modified any assumptions regarding the timing of long-term debt.
Unalaska Geothermal Project FINAL DRAFT Page 6
SCHEDULE
The Project schedule included in OESI's development plan calls for permitting to be
accomplished by March 1994 at which time field development begins.As will be
discussed in Chapter VI -Regulatory/Environmental,numerous permits must be obtained
from both state and federal agencies.A precise estimate of time required to secure these
permits cannot be made,but it would probably range between eight and 18 months.The
shorter time period is based on the most optimistic (but probably unrealistic)assumptions.
The longer time period is based on an Environmental Impact Statement being required but
without legal challenges.Legal challenges could lead to further delays and increased
costs.
In addition to permitting,power sales agreements,legislative approval of the Project,
long-term financing,and other miscellaneous processes and approvals must be obtained.
Presumably,these can occur at the same time as the permitting process.
For purposes of the analysis,R.W.Beck has assumed permitting to take the entire
calendar year 1994.Since field work cannot occur until the spring,the Project schedule is
therefore slipped by one full year from what OESI has assumed.
CONSTRUCTION COSTS/OPERATING COSTS
OESI's estimates of construction and operating costs are used as the basis to R.W.Beck's
analysis.Construction cost estimates are increased by the assumed inflation rate (4.5%)to
compensate for the slippage in schedule described above.Should the permitting process
or other preliminary tasks take longer than expected,construction costs could increase
further to compensate for inflationary effects as well as possible real cost increases due to
additional labor and other expenses not included in the original budget estimate.
The construction and operating cost estimates have not been reviewed by an independent
party.Given the remote location,the difficult terrain,and the local climate,these
estimates should be thoroughly reviewed prior to the State making any long-term
commitments.
INTEREST RATE
OESI has assumed that the Authority will incur an interest rate of 6.0 percent on the
bonds issued for this Project.Even though current investment grade tax-exempt rates are
below this level for bonds with similar final maturities (27 years),there can be no
assurance that these rates would prevail in 1994 and 1995 when OESI assumes the
financings would occur,much less the one-year slippage that we have assumed.
Unalaska Geothermal Project FINAL DRAFT Page 7
Therefore,PFM believes that an interest rate in the 6.5-7.0 percent range would not be
overly conservative for planning purposes at this stage of the Project.
PROJECT ENERGY SALES
In developing estimates of certain future operating costs and the Project costs on a
perkilowatt-hour basis,OESI has assumed annual energy sales of 82 million kilowatt-
hours.Of all the assumptions used in determining the economics of the Project,the
amount of energy that can be utilized from the Project has the most impact on cost of
power and the required rate stabilization fund.Because area load requirements and
patterns have changed significantly in the past several years due to changes in fishing
seasons and other developments,R.W.Beck has updated its estimate of Project energy
sales from that estimated in December 1991.
In large utility systems where a number of resources are used to provide for generating
requirements,a resource such as the geothermal Project would be baseloaded and
operated at full output all of the time.Generation reductions would occur only during
periods of unscheduled outages or scheduled maintenance.In this case however,the
Project will be the primary source of power and output must be increased or decreased to
follow load.Therefore,the amount of energy usable from the Project is a function of
three main factors:area energy requirements,the relationship between the peak demand
and the capacity of the Project at any given moment,and the amount of time that the
Project is inoperational due to maintenance and other factors.Just because total energy
requirements may be increasing on the island does not necessarily mean that more energy
is usable from the Project.If all of the increase occurs during months when the Project
would already be operating a full output,other sources of generation would have to be
used to meet load.
Based on conversations with the area processors,the City of Unalaska,SeaLand,and
others,R.W.Beck has made estimates of the amount of energy that can be used from the
Project.These estimates,shown below in Table 1,are based on present loads,load
patterns,and estimates of peak and energy requirements of future additions.
The basis for Case 1 includes 1.)a centralized dispatch system where the geothermal
Project is utilized to the maximum extent possible and 2.)no loss of geothermal
generation due to maintenance and forced outages.This implicitly assumes that outages
can occur,but only on a unit by unit basis at times when a particular unit is not required to
meet load.
The processors have indicated that they are not interested in a common dispatch where
they are dependent on others for all of their generation requirements.Therefore,a case
was run where the processors take geothermal power up to an assumed contract demand.
Unalaska Geothermal Project FINAL DRAFT Page 8
Above that amount,it was assumed that each processor would use its own diesel
generation.The results of this scenario are shown as Case 2.Again,this case assumes no
loss of generation due to maintenance and forced outages.
During the course of operations,both planned and unscheduled outages will occur.
Planned maintenance can probably be accomplished on a unit by unit basis at periods of
low loads such that the remaining three units can meet load.However,unscheduled
outages due to equipment failures,problems with the wells,or weather-related problems
can affect the entire Project at one time.This probability is accented by part of the
transmission line corridor being exposed to possible avalanche runout.Therefore,another
scenario was run which assumed a 5 percent forced outage rate applied on a random basis
throughout the year.This scenario is presented in Table 1 as Case 3.
Table 1
UNALASKA GEOTHERMAL PROJECT
Project Energy Sales
(Thousands of kilowatt-hours)
Case 1 Case 2 Case3
Geothermal Energy 76,325 74,339 72,995
Diesel Energy 8,688 10.674 12.018
Total Load 85,013 85,013 85,013
In modeling the area loads,exact load patterns were difficult to obtain,and the available
data was not in sufficient detail to discern between "blocked"patterns and "ramped"
patterns over a short period of time.Furthermore,diesel generation may be required at
times when the computer model does not show it due to:
1.The geothermal Project's response time to load changes may be too slow such
that frequency and voltage problems arise.Diesel generation closer to the load
center may therefore be required.
2.Diesels cannot be started instantaneously,so the City and the processors would
probably operate them as load approached the capacity of the geothermal
Project.
These inaccuracies applied over a one-year period can make a difference,and the results
of the computer analysis probably tend to overstate the geothermal usage.
Unalaska Geothermal Project FINAL DRAFT Page 9
Over the life of the Project,a 5 percent forced outage rate applied to the entire Project
may be high.While some outages will occur where all four units are affected,other
outages will probably occur on a limited basis.However all of the factors described
above,the lower end of the range of Project sales shown in Table 1 is probably
reasonable.Therefore,R.W.Beck has assumed for purposes of this report 73.0 million
kilowatt-hours of annual energy sales.
FUTURE LOAD GROWTH
OESI has assumed that future loads will remain the same as present levels.Long-term
projections of area energy requirements are always subject to the difficulties of predicting
future events with accuracy.In Unalaska where the economy is predominantly dependent
on one industry that is subject to numerous actions from outside the community,this
problem is compounded;and even short-term projections are difficult to forecast.The
fishing industry has undergone radical structural changes in past years,both in the
equipment being used and the management of the resource.Therefore,one cannot predict
with any degree of accuracy whether loads will increase,decrease,or remain
approximately the same in the future.However,the risk that the load could decrease in
Unalaska is probably greater than in communities with more diversified economies.
Despite the high degree of uncertainty,we have kept future Project energy sales constant
for purposes of the analysis.
CITY DISTRIBUTION COSTS
The current concept of the Project includes a transmission line from the Project site to a
point of interconnection with the City's distribution system.Project power would then be
carried over the City's lines to the various self-generators as well as the City's own
customers.In order for the City to transmit power to the various self-generators,certain
system betterments must be made.OESI has represented that these costs are included in
the construction cost estimate.However,the City would also incur some additional
annual costs from distributing the power to the other users including both administrative
costs and increased operations and maintenance on their primary distribution lines.
The City has made a preliminary estimate as to the additional operating,maintenance,and
administrative costs they would incur for distribution of Project power.This estimate of
1.5 cents/kilowatt-hour has been included by OESI in their analysis.However,OESI has
not included any future inflationary effects on this annual cost.
Unalaska Geothermal Project FINAL DRAFT Page 10
City officials believe that part,if not all,of these increased costs will inflate with time;and
therefore this number should be escalated at some rate.For purposes of the analysis,
R.W.Beck has assumed that this number escalates with general inflation.
DEBT SERVICE RESERVE FUND
OESI has assumed that the debt service reserve fund is established at the time of the bond
issue with only six months of debt service.Bond issues by state and local governmental
agencies typically include,in addition to the amount raised for the primary purpose of the
bonds,an amount to fund a debt service reserve fund.The fund is typically sized at an
amount equal to one year's debt service;but for tax-exempt issues,it cannot exceed ten
percent of the bond size.The moneys in this fund can only be used to pay debt service in
the event that annual revenues are inadequate to pay the full amount of debt service.
Thus,it provides a means to pay bondholders while working through problems that may
arise.In large projects such as this Project where the cost of power may exceed the
alternative cost during the early years,bondholders would expect to see the debt service
reserve fund fully funded at the time of the bond issue.
PFM believes the bond issue should establish the debt service reserve fund at an amount
equal to a full year's debt service.The additional annual cost from this will be partially
offset from the additional interest earnings accruing to the Project revenues.
RATE STABILIZATION FUND
OESIT has also assumed that the debt service reserve fund can be utilized as a rate
stabilization fund to lower costs during the early years of operation.This is not a
traditional use of the fund,and a bond issue with such a structure would probably have a
higher interest rate than more traditional financings.Therefore PFM believes that the debt
service reserve fund should be used only for unforeseen shortfalls in revenues available for
debt service,and a separate rate stabilization fund should be established.As will be
discussed in greater detail later,this fund may have to be augmented by the State in future
years depending on Project energy sales,operating costs,general inflation,and other
factors.
BASE CASE
Using the revised assumptions described above,a revised case has been run and is
included in Table 2 as the base case.The differing assumptions from that used by OESI
result in $128.5 million of long-term debt and the establishment of a $28.3 million rate
stabilization fund.The fund size is based on depositing the stated amount on January 1,
1995,and accruing interest earnings at the assumed cost of capital until withdrawals are
made.
Unalaska Geothermal Project FINAL DRAFT Page 11
SENSITIVITY RUNS
Actual Project revenues will vary from that estimated depending on actual Project sales,
operating costs,inflation rates,and other factors.The State may find itself in the position
of having to make additional deposits to the rate stabilization fund in the future should any
of these factors vary in such a manner to reduce net revenues.Similarly,the State may
have a higher return on investment if the actual outcome of these factors increases net
revenues.In order to assist the Authority in assessing the risk of making future deposits,
the results of the base case have been tested for their sensitivity to several assumptions.
The assumptions modified are described below,and the results are shown in Table 2.
Escalation of City Costs -At this time,the cost components of the additional
administrative and distribution costs estimated by the City are not known.Since
different cost components can be affected by inflation differently,the actual
effective escalation may be different from the 4.5 percent general inflation assumed
in the base case.A case has therefore been run (Case 1 in Table 2)that assumes a
2 percent inflation rate applied to the 1.5 cents/kilowatt-hour instead of the 4.5
percent used in the base case.
Cost of Power -The processors have indicated in past meetings that the concept
of paying 12.0 cents/kilowatt-hour in 1992 dollars may be of some interest to
them,and OESI has based their development plan on this price level.However,at
least one processor has indicated that this price may need to be re-visited.At this
time,a specific amount that they would all agree to pay is not available.Therefore
the analysis has been performed using 11.0 cents/kilowatt-hour as a target price
instead of the 12.0 cents/kilowatt-hour.
Project Energy Sales -In order to determine the sensitivity of the results to the
amount of Project energy sales,a case has been run which assumes 75 million
kilowatt-hours instead of the 73 million kilowatt-hours used in the base case.This
figure represents the high end of the range that can be expected in the short-term.
Interest Rate -As will be described in the next chapter,the bonds issued for the
Project could be less than investment grade if certain credit enhancements are not
included.The interest rate for a non-rated speculative bond would be significantly
higher than that described above.Therefore,two alternative interest rates have
been assumed using the revised assumptions described earlier.These interest rates
include:
1.A 6.0 percent interest rate which has been assumed by OESI and
probably represents the lower end of the ranged that could be expected.
Unalaska Geothermal Project FINAL DRAFT Page 12
This also assumes some form of credit enhancement such as the State's
moral obligation and the Authority's general obligation.(For further
details,see "Need for Credit Enhancement"in the following chapter.)
2.An 9.0 percent interest rate which assumes no credit enhancement and
a 3.0 percent interest rate premium from 1.above due to the
speculative nature of the bonds.
Debt Structure -In all of the above cases,a ramped debt service has been utilized
in the analysis in an attempt to minimize rate stabilization.Rate stabilization is
used only at times when Project revenues are insufficient to pay at least the interest
due on the bonds in any one year.However in structuring the debt and rate
stabilization in this manner,Project revenues are insufficient to pay off all of the
debt by the end of 25 years.Additional rate stabilization is then required to pay off
the remaining principal of the bonds,and this additional amount is included in the
rate stabilization fund required (discounted back to January 1995 at the cost of
capital).Another debt structure would be to use the traditional levelized debt
service.Case 6 in Table 2 provides the results of this alternative debt structure.
Inflation -Project revenues are dependent,in part,on the rate at which the energy
is sold.Since the rate is held constant in real terms,actual revenues are therefore
dependent on future inflation.A case has been run using a 3.5 percent inflation
rate insterad of the 4.5 percent used in the base case.
Operating Costs -OESI's estimates of operating expenses,the timing and costs of
well rehabilitation/replacement,administrative expenses,and other costs have not
been confirmed at this time.However,a cursory review shows that well make-up
costs may be somewhat low,and OESI has used certain cost estimates as 1996
price levels whereas in the past these figures were estimated to be at 1992 price
levels.Therefore,a case has been run with operating costs increased by $500,000
per year in 1996 dollars.
Unalaska Geothermal Project FINAL DRAFT Page 13
yooforgFeuLIaYyIOIDBYsETeUL)LIVadTWNplasegTable 2
UNALASKA GEOTHERMAL PROJECT
Results of Analysis
(1)(2)(3)(4)(5)(6)(7)(8)(9)(10)ay (12)
Input Assumptions Analysis Results
Inflation Rate Estimated
Project Cost of of City Target Debt Bond Size Stabilization Return
(MWh)(cents/k Wh)(Millions)(Millions)(Millions)(Millions)
OESI 82,000 6.00%0.0%12 Ramped 4.5%OESI 57.2 57.2 114.4 0.0*N/A
Base 73,000 6.75%4.5%12 Ramped 4.5%OESI 61.0 67.5 128.5 28.3 4%
1 73,000 6.75%2.0%12 Ramped 4.5%OESI 61.0 67.5 128.5 21.7 6%
2 73,000 6.75%45%==211 =_Ramped 4.5%OESI 61.0 67.5 128.5 42.1 2%
3.75,000:6.75%4.5%12 Ramped 4.5%OESI 61.0 67.5 128.5 24.5 5%
4 73,000 ==6.00%4.5%12 Ramped 4.5%OESI 60.0 66.4 126.4 21.0 5%
5 73,000 =9.00%4.5%12 Ramped 4.5%OESI 64.7 70.2 134.9 46.1 2%
6 73,000 6.75%4.5%12 "Level =4.5%OESI 61.0 67.5 128.5 30.8 4%
7 73,000 6.75%4.5%12 Ramped §=3.5%_OESI 60.0 67.2 127.2 38.7 2%
8 73,000 6.75%4.5%12 Ramped 45%=+500 61.0 67.5 128.5 37.4 3%
Column
1 Amount of assumed Project energy sales in thousands of kilowatt-hours.
2 Cost of capital for both bond issues.Reinvestment rate assumed to be
2%lower than cost of capital.
3 Escalation of City of Unalaska distribution and administrative costs incurred
due to the Project and included as part of Project costs.
4 Delivered cost of power in 1992 dollars.Cost increases with inflation.
5 Assumed repayment structure of bonds.
6 Assumed inflation rate during construction and operating period.
7 O&M cost estimate:OESI -estimates provided by OESI;+500 -OESI+$500,000.
8-10 Amount of bonds required to fund construction costs,capitalized interest,
financing costs,and certain other costs.
11.Amount required to be deposited in January 1995 to fund the estimated
rate stabilization requirements.Reinvestment rate assumed to be equal
to the cost of capital.
12 Return on rate stabilization deposit.Based on repayment of fund in years
25 through 30.
*OESI has assumed the debt service reserve fund can be used for rate stabilization.
Denotes change from Base Case
IV.FINANCING STRUCTURE AND
IMPACT ON AUTHORITY CREDIT
GENERAL
As described earlier,the concept being proposed to finance the Project is to fund the
development and construction costs through two bond issues.The first issue would be to
fund the design and construction of the road and dock as well as the drilling and
development of the required wells.Once the availability of sufficient geothermal fluid is
established,work on the Project facilities and transmission line would begin.The second
bond issue would fund these later activities.
Should the Authority decide to participate in the Project,the bond issues can either be
general obligations of the Authority or project revenue bonds.The general obligation
bond essentially combines the credit of this Project with other general obligations that the
Authority has.If Project revenues are insufficient to pay debt service,then other revenues
available to the Authority would be called on to pay any shortfall.A project revenue
bond,on the other hand,does not offer the bondholders the added security of additional
revenues.Only Project revenues are pledged to the bondholders,and shortfalls must be
made up through reserve funds or the rate stabilization fund.
Each type of bond issue offers varying degrees of risk to the Authority,the State,and the
bondholders;and therefore certain advantages of one over another may be offset by
additional costs.Furthermore,either type of bond could impact the Authority's or the
State's bond ratings on future issues.The following is a discussion of the risks associated
with the Project,how they will affect the bonds issued for the Project,and how they could
affect future Authority financings.
RISKS
Credit risks associated with this Project can be categorized into three main areas:
geothermal resource risks,technology and construction risks,and market demand.
Geothermal Resource Risk.Risks associated with the development of the facilities
required to use the geothermal fluid include:
Unalaska Geothermal Project FINAL DRAFT Page 15
e Drilling-related problems with both source and re-injection wells.These
problems can include well blowouts,failure to find the resource (dry hole),and
"communication”between source and re-injection wells.
e Potential resource capacity problems including low pressure flow,low
temperature fluids,inadequate re-injection capacity,mineral deposits choking
off production and re-injection wells,or the existence of foreign matter in
wells.
e Inadequate longevity of geothermal field capacity.
The Makushin geothermal field has been explored and analyzed by AEA and its
consultants,OESI,and others.GeothermEx,Inc.,a geothermal resource consultant,has
provided a written report to AEA which summarizes their analysis of the field.The
conclusions of their February 19,1992,report are as follows:
"The following conclusions summarize our current knowledge of the Makushin
Geothermal project.
e A high-temperature,permeable geothermal resource exists on the eastern
flanks of Makushin Volcano.The available data indicate that a 12 MW (gross)
geothermal project can be supported by this resource.
¢Most geologic hazards which exist can be avoided or mitigated by appropriate
design and location of roads,structures and wellfield equipment.Other
hazards may necessitate periodic maintenance and/or repair;as such,they are
more nuisances than hazards.
e OESThas a legal right,an appropriate infrastructure,and a reasonable plan to
develop the resource."
At this time,no production wells have been installed or tested.Drilling-related problems
could result either from difficulties related to the structure of the steam field itself,
inadequate drilling skill or inappropriate practices,or some combination of the two
factors.
OEST's plan for Project development does offer some mitigation of the geothermal risk.
First,the Project schedule calls for full development and testing of the geothermal field
prior to initiating power plant and transmission line development.Second,if the
geothermal field requires additional wells,OESI has verbally stated that the cost of those
wells would be deducted from their future fluid fees.Additional wells,however,would
require the Authority to invest more in the initial field development.
Unalaska Geothermal Project FINAL DRAFT Page 16
Technology and Construction Risk.As with the development of the resource itself,the
construction and the technology of the generating plant also involve some inherent risks
ranging from short-to long-term.Project sponsors and developers can reduce these risks
by:
e Installing proven generating technology.
e Planning,designing,and budgeting for construction consistent with site
conditions.
Problems during the initial Project operation are generally covered by warranties provided
by the vendors and developer.Mid-term operating problems can be mitigated somewhat
by renewal and replacement funds established by the initial bond financing and future
deposits.However should operating problems require large amounts of money for
corrections,additional bond issues may be required.
Market Demand.The geothermal risk and the technology/construction risk probably do
not offer risks greater than what bondholders are used to accepting so long as the risks are
dealt with in a prudent manner by the owner or developer.The demand for the Project
output,however,may yield a risk that bondholders would require some interest rate
premium for compensation.
Peak and energy requirements in Unalaska are largely driven by the needs of the seafood
processing industry.The current conditions in Unalaska,and the past performance of the
local economy,provide some positive support for the economic base of the Project.
These include:
e Worldwide seafood demand has been rising consistently in recent years.
e Unalaska/Dutch Harbor have a proven track record of production capability.
e The major processors have made significant investment in plant and other
facilities in the area.
e The processors,residents,and City government have common interests in the
development of Unalaska.
e The current reliance on diesel generation may prompt regulatory action in
favor of alternative resources.(See Chapter VI -Regulatory/Environmental
for further discussion.)
Unalaska Geothermal Project FINAL DRAFT Page 17
On the other hand,there are many factors which credit analysts would consider to be
serious negative indicators.These include:
e Unalaska's economic base is clearly dominated by a single industry -seafood
processing.That industry is subject to numerous potentially damaging factors,
including:
-Global market competition
-Potential resource depletion
-Weather and environmental risk
-Regulatory uncertainty
e The fishing industry historically has moved parts of its operations from one
location to another corresponding to resource,market,and regulatory
requirements.
e Unalaska''s isolated location and relatively hostile environment present
significant barriers to diversification of the local economy.
e The "perceived"energy cost using diesel generation is substantially below the
estimated cost of power from the geothermal Project.
-The Processors base their energy cost analyses solely on variable costs
(principally fuel).
-The current perceived cost of diesel generation is estimated at 6 to 9
cents/kilowatt-hour,significantly below the Project costs of 12.0 cents.
Unlike many large,capital-intensive projects where a large percentage of
the costs are fixed,the 12.0 cents/kilowatt-hour will increase with inflation.
-Diesel fuel costs have not been subject to constant inflation and at certain
periods have decreased in price.
e The inability to acquire take-or-pay contracts may emphasize some of these
negative indicators to credit analysts.
e The requirements-type contract would not carry payment obligations similar in
duration to debt service on the bonds.(For more discussion on the
requirements-type contract,refer to Chapter VII -Contract Provisions.)
e Recent estimates of the overall level and patterns of energy demand have
indicated a reduced revenue capacity for the Project.
Unalaska Geothermal Project FINAL DRAFT Page 18
On balance,these factors indicate a very high level of uncertainty regarding the initial and
on-going levels of demand for the Project output or ability to pay debt service from
Project revenues.Even if the issues related to business decisions by major individual
customers and the aggregate estimates of demand were resolved,the downside exposure
from dependence on the fisheries could present a formidable barrier to credit market
acceptance of the Project.
NEED FOR CREDIT ENHANCEMENT
Based on the foregoing discussion and a requirements-type contract,it appears that a pure
project revenue bond without any credit enhancement,such as the moral obligation of the
State,the general obligation of the Authority,or both,would incur a significant interest
rate premium,if such a financing was available at all.Without the credit enhancements,
bondholders would perceive the risk to be significant enough such that the bonds would be
rated less than investment grade.PFM believes that the interest rate premium would be
approximately 1.25-2.25 percent as shown in the table below.
Table 3
UNALASKA GEOTHERMAL PROJECT
Interest Rates
Investment Grade Non-Rated
Enhanced')Speculative
Interest Rate 5.75%7.0-9.0%
(1)Enhanced with the moral obligation of the State and the general obligation of the
Authority.
EFFECT OF BONDS ON STATE
If the State's moral obligation were pledged for the Project,the amount financed would be
added to the State's existing indebtedness and would be included in credit analyses of the
State's debt.The addition of $115+million of relatively high risk moral obligation debt
would certainly be considered a negative for the State's overall credit.
In order to ensure against a negative rating action,the State would have to demonstrate
both the importance of the Project to the State,the self-supporting nature of the debt,and
the ability to meet the moral obligation without adversely affecting the State's operations
or finances.
Unalaska Geothermal Project FINAL DRAFT Page 19
EFFECT OF BONDS ON FUTURE AUTHORITY FINANCINGS
Prior to the acquisition of the AEA's operating projects,the Authority had a portfolio of
approximately $450-500 million of loans and projects,all of which were intended to be
self-supporting project financings.A certain portion of that total (approximately $125
million)was financed through general obligation bonds.The Authority's board adopted a
strategic financial policy in 1992 which favors the use of project revenue bonds over
general obligations and which promotes only the most credit worthy projects for the
Authority general obligation financing.
The addition of $115+million of general obligation debt for such a relatively high risk
project would certainly endanger the Authority's credit rating.The reduced credit rating
would adversely affect the cost of financing future high priority Authority projects.
It is not possible to quantify the specific impact this financing would have on the
Authority's bond rating.However,the risks associated with this financing would likely
result in a drop of at least half a grade in the Authority's credit rating.If the Authority's
rating was dropped half a grade,its interest costs could increase in the range of 15-30
basis points (.15-.30%).A full-grade drop could mean increased interest costs in the
range of 35-60 basis points.
With its credit rating lowered by half a grade,the Authority's annual debt service on a
$100 million,25-year bond issue would increase by $78,488 -$157,869.A full
downgrade would result in $184,543 -$319,463 higher annual debt service on the same
type of issue.In today's low interest rate environment,the spread of interest rates
between different ratings is compressed.However at times of higher interest rates,the
spread would widen,and the impact of a drop in the Authority's credit rating would be
more costly under those circumstances.
The effect of the Project in future years on the Authority's rating and borrowing costs
would be dependent on the success of the Project.Should there be insufficient Project
revenues to pay debt service,there could be further rating and market access
deterioration.On the other hand if the Project is successful,the Authority could develop
an upgrade strategy based on the Project's demonstrated self-sufficiency and
creditworthiness.
Unalaska Geothermal Project FINAL DRAFT Page 20
V.LEGAL ISSUES
GENERAL
Although OESI is proposing to develop the Project,the Authority retaining ownership
presents certain legal issues that must first be resolved.The following presents a
preliminary discussion of 1.)awarding a sole-source contract to OESI for the development
of the Project and 2.)certain other matters regarding the financing of the Project.Other
legal issues will arise if the Project is developed,and this should not be considered a
complete list.
SOLE-SOURCE TURNKEY CONTRACT
The Authority is subject to the State procurement code with respect to development
contracts,unless specifically exempted by statute.There is no provision,at this time,
exempting the Project.
State law provides general standards for the circumstances which justify execution of
solesource relationships.Essentially,the question is whether a single entity is uniquely
situated to perform the service.To obtain approval,the Authority would document its
basis why one specific entity can perform the work in a timely basis and submit the request
to the Commissioner of the Department of Transportation and Public Facilities for review.
In general,most of the development projects undertaken by the Authority involve,at least
in part,limited or sole-source procurement.The primary basis for the Authority's use of
sole-source contracting arises where the project sponsor is uniquely situated to assume the
risk of constuctability or completion.Similarly,sole-source contracting has been
approved in situations where the Authority did not want to compromise the absolute
nature of user fees or where the unqualified indemnification for environmental conditions
could be implicated.
In the immediate case,the Project sponsors'control of the geothermal resource offers
perhaps the most compelling basis for sole-source authorization.However unlike OESI's
original proposal to AEA wherein OESI would completely develop the well field and plant
with its own financing and then sell the Project to AEA,the present proposal is based
entirely on construction funding provided by the Authority with little risk to OESI.The
Unalaska Geothermal Project FINAL DRAFT Page 21
sponsors'offer to undertake development on a fixed-price,tumkey basis may be
supportive,but other parties may also be willing to undertake the Project on comparable
terms.The sponsors'basis for sole-source entitlement would be substantially enhanced
were the sponsors to bear any significant financial exposure.In recognition of this,some
risk may be transferred to OESI during contract negotiations.
The preliminary answer,in sum,is that,absent express statutory authorization,general
State procurement standards and procedures will govern as to whether a sufficient basis
exists to award a turnkey development contract to the Project sponsors on a sole-source
basis.While a somewhat credible argument can be advanced,the justification is not as
strong as in other situations where sole-source authorization has been obtained.
ISSUER OF BONDS
Since the Alaska Energy Authority ("AEA")is nowa part of the Authority,the question
has arisen as to what entity would issue the bonds for the Project.At this time,the
Authority has the requisite statutory authority to own the Project and issue debt while
AEA does not.
MORAL OBLIGATION
The Authority,pursuant to AS 44.88.130,has the right to issue debt and pledge in its"
support the moral obligation of the State should such a credit enhancement be required.
INDUSTRIAL DEVELOPMENT BOND ALLOCATION
In order to obtain the lowest interest costs,tax-exempt bonds should be obtained for
Project financing.Since several of the major users are private industry and not local
governments,tax-exempt financing would probably have to be obtained through the
issuance of industrial development bonds ("IDB's").
Under current law,only a certain amount of IDB's can be issued in any year in any
particular state.Allocations can be made to qualified projects by submitting to the
Internal Revenue Service a list of projects that are being elected to be financed through
IDB's.Once an allocation is made to a specific project,it can be carried forward for a
period of time.
The State has requested that an $80 million allocation be made to the geothermal Project.
This allocation is not a set-aside of funds but only allows for the issuance of tax-exempt
IDB's.
Unalaska Geothermal Project FINAL DRAFT Page 22
LEGISLATIVE APPROVAL
State statute provides that the Authority must obtain legislative approval prior to funding
$10 million or more for projects.The geothermal Project must,therefore,be approved by
the state legislature prior to the issuance of bonds or other financing.
Unalaska Geothermal Project FINAL DRAFT Page 23
VI.REGULATORY/ENVIRONMENTAL
REQUIRED PROJECT PERMITS
Should the Project be built,a number of permits,certifications,and reviews will be
necessary.OESI has assumed that the process will require approximately seven months,
which is probably overly optimistic.Furthermore,they have assumed that engineering on
the road,dock,and wells will commence prior to the securement of all the permits,which
may save time but also offers certain risks.The length of time required to obtain the
permits can vary from project to project,and it is difficult to determine with any degree of
accuracy how quickly they can be obtained for the geothermal Project.However,a range
between eight and 18 months could be considered.The shorter time period is based on
the most optimistic (but probably unrealistic)assumptions.The longer time period is
based on an Environmental Impact Statement being required but without legal challenges.
Legal challenges could lead to further delays and increased costs.
The list of permits and authorizations required have been preliminarily identified as
follows.(For more detail,refer to Appendix A to this report.)Any of the major permits
may be obtained without undue delay if the applicant does a thorough job of marshaling
needed information and if the Project does not arouse public opposition.Especially with
NEPA review,NPDES permits,and Corps of Engineer permits,public opposition can
lengthen the regulatory process manyfold.This should be recognized in any project
timeline.
MAJOR STATE PERMITS:
Alaska Dept.of Environmental Conservation
Air Quality Control Operating Permit
Solid Waste Disposal Permit
Domestic Wastewater Disposal Permit and Plan Review
Wastewater Disposal
NPDES Certification
Large Scale Fuel Storage
Unalaska Geothermal Project FINAL DRAFT Page 24
Department of Natural Resources
Geothermal Operations Plan Approval
Water Rights Appropriation
Tidelands Lease
Uplands Lease
Division of Governmental Coordination (Governor's Office)
Coastal Zone Consistency Determination
Department of Fish and Game
Title 16 Stream Crossing Permits
Alaska Public Utilities Commission
Certificate of Public Convenience
MAJOR FEDERAL PERMITS:
U.S.Environmental Protection Agency
NPDES Permit
NEPA Compliance
RCRA Compliance
Oil Spill Prevention Control and Countermeasure Plan
U.S.Corps of Engineers
404 Permit
USS.Fish and Wildlife Service
Section 7 Consultation (Endangered Species Act)
Unalaska Geothermal Project FINAL DRAFT Page 25
MINOR PERMITS
City building permits,Coast Guard navaid reviews,fuel transfer checks,fire
marshal reviews,CPCRA listings (community right-to-know listings of
hazardous substances),OSHA safety reviews,and others will be required
during the course of Project development.
AIR QUALITY BENEFITS
The Unalaska/Dutch Harbor area presents unique air pollution problems.Because of its
nature as one of the busiest fishing and fish processing ports in the world,it is an industrial
area in the middle of the North Pacific Ocean,with few other sources of air pollution
within hundreds of miles.The air pollution problem,however,could be significant due to
the fact that electric energy is produced through diesel generation.Diesel generation is,
compared to other generation methods,"dirty"in its production of nitrogen oxides (NO,)
and particulate matter.For years,the U.S.Environmental Protection Agency and Alaska's
Department of Environmental Conservation were less than strict in requiring prompt
permitting of new generators and in mandating strict emissions controls.The result is that
both agencies are now concerned with possible violations of ambient air quality standards
for nitrogen dioxides (NO,).
The Division of Environmental Quality now limits the amount of air pollutants emitted by
local sources through a cap on the amount of electricity generated.Both the City and the
processors have applied for permission to generate greater amounts and are in the process
of trying to demonstrate to the agency through the use of computer modeling that the
additional generation will not produce pollutants in excess of the ceiling on additional
pollutants imposed under federal law by Prevention of Significant Deterioration ("PSD")
standards.Three-hour,24-hour,and annual limitations are established;and if the com-
puter models show higher emissions than allowed for any particular geographic location,
then generation will be limited from the source or sources contributing to the problem
area.
The problem facing the City and the processors is that their current emissions very nearly
exceed PSD limitations,especially for NO,Unless they find some way to reduce their
emissions,the PSD cap on NO,will result in a prohibition on additional electric generation
in specific areas.
One of the benefits of the Project may be to provide an alternative source of energy if the
City or the processors must curtail diesel generation.However,the Project may not
eliminate the problem altogether due to the following two reasons.
Unalaska Geothermal Project FINAL DRAFT Page 26
1.Should generating requirements exceed the capability of the Project by a sig-
nificant amount for a short period of time,the three-hour limitation may be the
controlling limitation,and diesel generation could still be curtailed even with
the Project.
2.The geothermal Project may not be able to follow load changes quickly
enough,and voltage and frequency problems could arise.Therefore,diesel
generators may be required to be operated (albeit on a reduced basis)to pro-
vide for voltage and frequency stability.
A number of alternatives to construction the Project exist which could reduce emissions or
assist in alleviating the problem.A brief description of each of these options and the
approximate cost of implementing it is provided below.For a more detailed discussion of
each option,refer to Appendix B to this report.
Emissions Control -Emissions from the existing facilities can be reduced through certain
combustion modifications or post-combustion techniques.These include:
Fuel Injecting Timing Retard ("FITR")-This is the most common method of
reducing NO,emissions.The technique delays the injection of fuel,thereby
limiting peak temperatures and pressures and the associated NO,formation.
Minimal up-front costs occur with FITR.Annual costs include increased fuel con-
sumption of approximately 5 percent and increased maintenance costs due to
engine wear.
Water/Fuel Emulsion -With this technique,fine water droplets are dispersed in
the fuel oil prior to injection to the cylinder.Water reduces combustion tempera-
tures in the engine and may also influence the chemistry of the conversion of
nitrogen and oxygen into NO,during the combustion process.Costs of
implementing this option would probably be less than $75,000 per engine.
Exhaust Gas Recirculation ("EGR")-The theory behind EGR is the
displacement of oxygen and nitrogen in the intake air by redirecting a portion of
exhaust gas back into the inlet ports.There is little experience with this technique,
and it is not recommended without further study.
Aftercooling -Aftercooling decreases the inlet air temperature after the
turbocharger,thus reducing peak temperatures and the associated NO,formation.
Some of the engines in Unalaska are likely already turbocharged and aftercooled.
Selective Catalytic Reduction ("SCR")-SCR is one of the least common of
control techniques for diesel engines.Although it can reduce NO,emissions in
Unalaska Geothermal Project FINAL DRAFT Page 27
excess of 80 percent,it has high implementation costs and maintenance
requirements.For a 2-megawatt diesel generator,the capital expenditure for SCR
would be approximately $1.0 -1.2 million ($500 to $600 per kilowatt),and
Operating and maintenance costs are estimated at $75,000 to $100,000 per year if
the diesel is operated at baseload.
Alternative Generation -Another potential way to reduce emissions and alleviate the air
quality issue in Unalaska would be to install different types of generators.When burning
either No.2 fuel oil or natural gas,combustion turbines emit less NO,than medium-speed
diesel engines,and exhaust temperature and flow of combustion turbines provide better
dispersion in a modeling analysis.Combustion turbines cost approximately $700,000 for a
used 3-megawatt unit or $1.2 million for a new unit.
Another alternative is the use of gas-fired diesel engines,although the reduction of NO,is
not expected to be significant.The use of gas (such as propane)may make catalytic
controls more viable.Non-selective catalytic reduction (NSCR),comparable to a catalytic
converter on an automobile,can be used on certain engines burning clean fuel and
operating with very little excess air.Up-front costs of using gas as a fuel essentially
include the cost of storage tanks,piping,and controls.Operating costs,as compared to
diesel fuel,would include the price differential of the delivered costs of fuels.
Relocation of Generation Facilities -One solution might be to relocate existing generating
units or constructing new units at a different physical location where emissions would not
flow into a problem area.This option,however,would probably require construction of
new buildings,distribution lines,and other support facilities.The costs of implementing
this option have not been estimated,but it is expected to be significantly less than
construction of the geothermal Project.
Centralized Dispatch -Presently,the processors do not exchange power among
themselves,but instead rely on their own generation and occasional purchases from the
City.The City relies on its own generation with some purchases on a periodic basis from
one of the processors.A centralized dispatch with exchanges or purchases of power
could help reduce the pollution problem by generating in areas that are not as severely
limited by emissions.Capital expenditures would include equipment for a central dispatch
system and upgrading the distribution system so unlimited transfers could occur.
In summary,the geothermal Project may not be economically justifiable if air quality
benefits are cited as the sole reason for constructing the Project.Several technological
alternatives can be considered to alleviate air quality problems in Unalaska,and the costs
for implementing tuese alternatives appear to be an order of magnitude less than the
geothermal Project.Until careful review of these alternatives is made,assessments of air
quality benefits of the Project may be misleading.
Unalaska Geothermal Project FINAL DRAFT Page 28
VII.AGREEMENTS
GENERAL
Should the Authority decide to pursue the development of the Project,certain contracts
must be negotiated.The following discussion provides the major aspects of a turnkey
contract that would be used in developing the Project and the power sales agreement used
during Project operation.
TURNKEY CONTACT
By definition in a turnkey structure,the Project Purchaser (in this case the Authority)
would have no financial involvement or risk until the completed project is delivered at a
pre-determined price after having demonstrated that it performs to the specified standards.
Using that model,the:
Developer is responsible for:
«Design
e Engineering
e Licensing and permits
e Construction financing
e Construction/construction management
¢Resource/fuel contracts which meet pre-determined standards
e Transmission/transportation contracts which meet pre-determined
standards ,
e Demonstrating that the completed facility performs to specified
standards
Project Purchaser is responsible for:
e Initiating the process with well-defined and comprehensive project
specifications,including environmental safeguards and performance
standards
Unalaska Geothermal Project FINAL DRAFT Page 29
e Assuring that moneys are available to acquire the project when
complete and has demonstrated performance
OESI's development plan is somewhat less than a turnkey structure with respect to
financing Project construction and the associated development risks.The contract would
have to be written carefully to clearly define the obligations and responsibilities of the
various parties.
POWER SALES AGREEMENT
Based on past discussions with the processors,it appears that a requirements-type
contract would be the only power sales agreement they would find acceptable.This type
of contract differs from the "take-or-pay"type of contract in that the obligation of the
power purchaser is limited to acquiring project output to the extent it is available and to
the extent it is required.There is no implied or actual pledge of customer financial
resources to the energy supplier.As mentioned earlier in this report,take-or-pay
contracts are not acceptable to the processors.
Major aspects of a requirements contract are as follows.
The Authority,as Owner:
e Accepts Project risk and financing responsibility.
e Has the freedom to "shop”for other purchasers at expiration of each
contract period.However,the ability to do this in Unalaska is limited.
e Must maintain sufficient amounts in the rate stabilization fund
throughout the life of the Project.
The City and Processors,as Power Purchasers:
e Take the Project output when needed.
e Have no direct responsibilities beyond paying for output purchased.
e Rely on the performance of the developer/operator in terms of resource
reliability.
e Periodically face the risk of losing the resource.
In this case,it is recommended that the requirements contract provide for preferential
treatment of Project output.Each purchaser would be required to take Project output
whenever it required energy before using any of its own generating capacity up to the total
amount available.In return,each purchaser would have preferential access to power
comparable to the pro-rata share it represents of the total Project output.This scenario
would provide much greater security for potential lenders,and partially mitigate one of the
Unalaska Geothermal Project FINAL DRAFT Page 30
major risk factors.However because there is no underlying purchaser commitment
beyond "requirements,"there is no long-term commitment or obligation by purchasers.As
such,the Project is still susceptible to,and the Authority would bear all short-and long-
term risks inherent to the fishing industry and the economy of Unalaska.
Unalaska Geothermal Project FINAL DRAFT Page 31
VIII.SUMMARY
Based on the foregoing analysis and discussions,certain observations can be made
regarding the Unalaska Geothermal Project.These include the following:
1.The Project output can be used to offset,in part,diesel generation on the
island.However due to daily and seasonal load variations,the Project's output
capabilities cannot be fully utilized at all times.
The Project would reduce diesel generation,and therefore NO,and other
emissions,in the area and therefore may help offset air quality imposed
generating limitations likely to be faced by the City and the processors.
Even with the Project,diesel generation will be necessary;and generating
limitations due to air quality may still occur.
Justifying the Project largely on reducing harmful emissions into the
atmosphere from diesel-fired generation may not be warranted.A number of
alternatives exist which could ease possible diesel generating restrictions,and
the capital costs associated with implementing these solutions are potentially
considerably less than the capital costs of the geothermal Project.The
increased operating costs of these alternatives,however,have not been
investigated but should be compared to the operating costs of the Geothermal
Project.
To hold the cost at 12.0 cents/kilowatt-hour in 1992 dollars,a rate stabilization
fund is required.This fund must be sized using conservative assumptions to
ensure bondholder acceptance.
The rate stabilization fund may need to be increased periodically depending on
the initial size,the level of power sales,operating costs,general escalation,and
other factors.
Unalaska Geothermal Project FINAL DRAFT Page 32
10.
11.
12.
13.
The target price is expressed in cents/kilowatt-hour and is therefore dependent
on energy sales.If energy sales are less than that assumed,Project revenues
would be reduced,and the required rate stabilization would increase above that
estimated herein.Similarly if energy sales are greater than expected,the
required rate stabilization would decrease.
Absent load growth,the ability to repay long-term debt is highly dependent on
future inflation rates.
Development of the Project does not insulate the users from general inflation
but does insulate them from fluctuations in fuel prices.
The transient nature of the fishing industry coupled with a requirements-type
contract would most likely make bonds issued for the Project speculative with
a high interest rate,if available at all,without some form of credit
enhancement.
The inclusion of the Project financing with the Authority's general obligation to
enhance the sale of Project bonds would probably result in at least a half a
grade drop in the Authority's bond rating.
The Project offers certain risks that could affect future financings on other
unrelated Authority projects.The State must decide how the risks of financing
the Project should be balanced with the possibility of providing certain benefits
to the power users on the island.
The Project development plan as presently proposed by OESI places the
majority of the associated risks upon the Authority and the State,including
construction completion,well field development,financing,operational,
inflationary,and power sales risks.The only risks being shared,at present,are
OESI's fixed-price cost of Project design/construction and well field
development.Well field development risk is only partially assumed by OESI.
Unalaska Geothermal Project FINAL DRAFT Page 33
APPENDIX A
Permits
Maj T Permits:
Alaska Dept.of Environmental Conservation
Air Quality Control Operating Permit -Although the Project design does not call
for venting of primary or secondary fluids during normal operations,ADEC will
look at the potential for emissions from upsets and from auxiliary and backup
diesels or other fossil fuel components.If the Project owner can convince ADEC
that the Project is essentially emissionless in operations,the facility could avoid
needing an air quality permit to operate for the operations phase.Since the Project
site is outside the area affected by emissions from the Unalaska/Dutch Harbor
generators,the new facility would not be subject to the same tight restrictions as
the existing resources are as they attempt to expand.If it were truly emissionless,
it would not even be necessary to comply with federal "new source standards"for
new electric generating facilities.However,at present the ADEC Air Quality staff
is skeptical about the ability to avoid operational venting of secondary fluids,
which have had human health effects in geothermal projects in other states.
Solid Waste Disposal Permit -The Project design calls for reinjection of thermal
fluids.It does not appear that the design calls for underground injection of other
substances.OESI believes solid waste during operations will be minimal and
limited to normal industrial process wastes such as used oil and solvents.However
during drilling,substantial amounts of drilling muds and cuttings will be generated;
the current plan is to bury them nearby,presumably in an approved lined disposal
pit.A State solid waste permit is necessary,including a plan showing how the
disposal method will prevent contamination of aquifers or surface resources by the
toxic components of the drilling muds.
Domestic Wastewater Disposal Permit and Plan Review -Required for domestic
sewage.
Wastewater Disposal Permit and Certification -The federal government has not
delegated to the State of Alaska the authority to issue permits for discharge of
pollutants into federal waters,as it has in many other states.Hence,the
wastewater disposal permit,or National Pollutant Discharge Elimination System
("NPDES"),must be issued directly by the U.S.Environmental Protection
Agency.(See below under federal permits.)The State's role is to certify that the
federal permit will result in compliance with state water quality standards.Both
the federal permit and the state certification can be appealed by parties who
disagree with the decisions.
Unalaska Geothermal Project FINAL DRAFT Page A -1
Large Scale Fuel Storage -OESI believes that the on-site storage of fuels should
be limited to very small quantities of diesel fuel for local backup generation.If so,
there will be no need for ADEC approval of oil spill contingency plans or financial
responsibility demonstrations,which become applicable with storage capacity of
10,000 barrels.
Department of Natural Resources
hermal rations Plan Approval -State statutes require a detailed plan of
operations for geothermal activity,in both exploration and production phases.
There has been little preliminary work done in this area.The great uncertainty on
the scope of this approval arises because such reviews are very rare,and in fact
DNR's Division of Oil and Gas,which administers the program,has never
reviewed a geothermal plan of operations since it took over the program several
years ago.The Division developed a set of standard forms for use in permitting
and monitoring geothermal well drilling and production,but again,it has not had
occasion to use them.The concerns which the statute requires to be addressed are
basically the same as those for petroleum production,namely a.)safety of field
operations,b.)conservation of the resources (i.e.,prevention of waste),and c.)
fairness to competing holders of rights to a common reservoir.If the petroleum
model is used for geothermal resources,the Division will require a fairly detailed
plan which addresses in some detail the geological structures and the potential for
contamination or waste of geothermal fluid through the extraction and reinjection
process.Since there is no track record in this area,the largest unknown is the time
frame for DNR review and approval.
Water Rights Appropriation -The generation process itself is designed to be
entirely air-cooled,so process cooling water will not be necessary.A temporary
appropriation for construction will be needed,as well as a permanent appropriation
for domestic needs during the operational phase.OESI believes there will be not
need for any other large appropriation.This assumption needs to be investigated
further.If there is a need for a large quantity of water,the capacity of the area to
provide it must be assessed.
Tidelands Lease -The State owns the tidelands upon which the new dock would
be built.At this point,OESI prefers the alternative of not building a new dock or
pier to support the facility construction and operation.If even temporary use of
the tidelands is made for logistical support,a tidelands lease is needed from DNR.
Apparently there is some preference by DNR for a permanent dock facility.
Uplands Lease -According to OESI,there is no need for any State lease of
uplands because the entire Project site and transmission line right-of-way are
owned by private entities.The power plant site is owned by Battle Mountain Gold
Company;the road and transmission lines and materials sites are owned by two
Native corporations (Ounalashka Corp.owns the surface,and Aleut Corp.owns
Unalaska Geothermal Project FINAL DRAFT Page A -2
the subsurface).However,negotiating the full use of surface,subsurface,
geothermal resources,and construction material sites with these entities will itself
be far from simple.Note that the owner of subsurface rights can choose to disturb
the surface to gain access to subsurface resources,so it may be necessary to
negotiate an agreement to guarantee permanent use of the surface areas.
Division of Governmental Coordination (Governor's Office)
Coastal Zone Consistency Determination -The Division of Governmental
Coordination will conduct a review of the Project to determine whether it is
consistent with standards of the Alaska Coastal Management Program.The
standards are designed to protect environmental and public use values associated
with coastal areas,including water quality and subsistence opportunities.
Department of Fish and Game
Title 16 Stream Crossing Permits -These permits will be necessary for several
crossings by the road of anadromous fish streams.
Alaska Public Utilities Commission
Certificate of Public Convenience -The APUC conducts a proceeding to review
the need for new power generation and the effect on consumer rates and issues a
certificate of public convenience to the utility.This certificate is necessary whether
the project owner sells energy directly to consumers or wholesales it to the City
for resale.
Major Federal Permits:
U.S.Environmental Protection Agency
NPDES Permit -EPA issues permits for discharge of pollutants into federal waters
under the NPDES (National Pollutant Discharge Elimination System)mandated by
the federal Clean Water Act.OESI claims that the Project can be built and
operated without a wastewater discharge.For a project this size,avoiding a
wastewater discharge seems extremely unlikely,and OESI's conclusion should be
reviewed further.Even without use of water for cooling and for direct processing
of any kind,construction phase discharges and storm water discharges seem likely.
As noted below the need for a NPDES permit will affect the need for NEPA
review.
NEPA Compliance -If a federal permit is necessary,the Project must undergo
review under the National Environmental Policy Act ("NEPA").The result could
be a cursory environmental assessment ("EA")and finding of no significant impact
("FONSI"),or it could be a full environmental impact statement.OESI's Project
Unalaska Geothermal Project FINAL DRAFT Page A -3
estimates for both time and cost are predicated on the assumption that a full EIS
will not be necessary;in fact,OESI believes that it may be possible to avoid any
NEPA review by avoiding all federal permits.These assumptions --that a NEPA
review can be avoided altogether and that if a review becomes necessary,it can be
limited to an EA and a FONSI --are both questionable.As noted above,it would
be unusual for a project his size to avoid an NPDES wastewater discharge permit.
It also seems probable that some areas in which fill is necessary would be classified
as wetlands under current EPA criteria.Such fill sites might include areas for
drilling platforms,plant construction,powerline construction,road construction,
and dock facilities.If so,a NEPA review will be necessary.Its scope and results
could also differ depending on whether the review is carried out by the Corps of
Engineers or the EPA.The agencies themselves will decide which one will take
the lead role and actually conduct the review.The assumption that a lengthy EIS
process can be avoided is one of the key weaknesses in OESI's Project proposal.
RCRA Compliance -OESI believes that the Project would generate few
substances classified as hazardous wastes,and that in any case,any solid waste
would be exempt from coverage under the Resource Conservation and Recovery
Act under the exclusion for wastes "associated with exploration,development,or
production of oil...,gas...,or geothermal energy”[42 USC §6921(b)(2),40 CFR
§261.4(b)(ii)(5)].EPA has ruled,however,that the exclusion does not apply to
wastes which are not "uniquely associated"with geothermal production,so
ordinary industrial wastes such as used solvents,paints,etc.,would be covered by
RCRA [53 Fed.Reg.25,445,25,454].OESI needs to makea realistic inventory
of wastes likely to be generated in order to assess RCRA applicability and the
costs of RCRA compliance.
Qil Spill Prevention Control and Countermeasure Plan -This is required under the
Oil Pollution Act of 1990.Unless significant quantities of fuel oil are to be stored
On site,there should not be a problem with this requirement.However,it will take
an affirmative showing that fossil fuel requirements are minimal.
U.S.Corps of Engineers
404 Permit -A COE permit is necessary to fill wetlands,including privately owned
wetlands.OESI claims that drilling will not require fill,at least if the helicopter
option for access is used instead of a road.It is unclear how they can support a
drilling rig,a helicopter landing area,or a heavy equipment storage area without
laying down a pad,however.Moreover,site preparation for the facility itself may
require filling wet tundra.They also believe construction can be accomplished
without a new road,using only the existing airstrip,no dock facility will be
required,and apparently no fill will be required for transmission line construction.
If any of these assumptions is wrong,it is likely that a Corps permit will be
required.OESI also needs to verify that its definition of wetlands is the same as
that used by the COE,where wet tundra,even when subject only to seasonal
Unalaska Geothermal Project FINAL DRAFT Page A-4
inundation,can constitute a wetlands.Ifa dock facility is needed and requires
permanent structures in navigable waters,a separate COE permit would be needed
for that purpose as well.
U.S.Fish and Wildlife Service
Section 7 Consultation (Endangered Species Act)-OESI must verify through
consultations with the U.S.Fish and Wildlife Service and other experts,that the
construction and operation of the Project would not impact the habitat or
migratory pathways of endangered or threatened species.If an endangered or
threatened species is encountered,Project designs may need to be altered to
eliminate adverse impact.
Minor Permits
City building permits,Coast Guard navaid reviews,fuel transfer checks,fire
marshal reviews,CPCRA listings (community right-to-know listings of hazardous
substances),OSHA safety reviews,and others will be required during the course
of Project development.
Unalaska Geothermal Project FINAL DRAFT Page A -5
APPENDIX B
DIESEL EMISSION REDUCTIONS
Emissions Control -Emissions from the existing facilities can be reduced through certain
combustion modifications or post-combustion techniques.These include:
Fuel Injecting Timing Retard ("FITR")-This is the most common method of
reducing NO,emissions.The technique delays the injection of fuel,thereby
limiting peak temperatures and pressures and the associated NO,formation.The
delay is set based on the crankshaft angle of rotation from top-dead center.Our
recent experience indicates that most permits are issued requiring between 2°and
10°retard.Tests have demonstrated from 30 to 40 percent NO,reduction with 6°
to 8°of retard on medium-speed diesels.Disadvantages include 1.)a resulting 5
percent increase in fuel consumption and 2.)additional maintenance costs related
to increased engine wear.Engine design must be evaluated to verify FITR is
technically feasible for the unit in question.
Water/Fuel Emulsion -With this technique,fine water droplets are dispersed in
the fuel oil prior to injection to the cylinder.Water reduces combustion
temperatures in the engine and may also influence the chemistry of the conversion
of nitrogen and oxygen into NO,during the combustion process.Engine tests on
low-speed diesels have resulted in reductions of NO,well beyond 15 percent with
little degradation in fuel consumption.Drawbacks include 1.)significant engine
modifications for more than about 20 percent water in fuel,2.)instability of
emulsion with distillate oil requiring mixing immediately prior to injection or
chemical additives which can be corrosive,and 3.)a requirement of good quality
potable water.This method can be used in conjunction with FITR.
An oil/water emulsion system will consit of an ultrasonic homogenizer,
demineralizer,controls,modified injectors,and miscellaneous piping,pumps,and
valves.Other indirect costs will be incurred such as the engineering,design,and
installation costs.Total costs are expected to be less than $75,000 per engine.
Inlet Air Humidification -In this method,water is sprayed into the intake to
"humidify"the air charge.The method offers a lower degree of control than FITR
and water/fuel emulsion due to the small amount of water that can be carried into
the combustion chamber via the combustion air.However similar to water/fuel
emulsion,the method can be used in conjunction with FITR.
Exhaust Gas Recirculation ("EGR")-The theory behind EGR is the
displacement of oxygen and nitrogen in the intake air by redirecting a portion of
exhaust gas back into the inlet ports.This reduces power output and combustion
efficiency and can foul or plug flow passages due to build up of solid and
condensable particulates.There is little experience with this technique.
Unalaska Geothermal Project FINAL DRAFT Page B -1
Aftercooling -Aftercooling decreases the inlet air temperature after the
turbocharger,thus reducing peak temperatures and the associated NO,formation.
The engines in Unalaska are likely already turbocharged and aftercooled.
Selective Catalytic Reduction ("SCR")-A post-combustion technique,SCR is
one of the least common of control techniques for diesel engines due to the
expense of the systems and the maintenance requirements.It is susceptible to
chemical and physical deactivation when firing distillate fuel oil.Further,the
catalysts are subject to high physical stress due to mechanical vibration and
pulsation of the diesel engine.Other issues include the on-site storage of ammonia
and disposal of the catalyst as a hazardous waste.Reductions of NO,emissions
with SCR are typically in excess of 80 percent.For a 2-megawatt diesel engine,
the capital expenditure for SCR would be approximately $500 to $600 per
kilowatt,and operating and maintenance costs are estimated at $75,000 to
$100,000 per year if the diesel is operated at baseload.
Alternative Generation -Another potential way to reduce emissions and alleviate the air
quality issue in Unalaska would be to install alternative generation technology.The
current permitting trends indicate that agencies favor combustion turbines over diesel
engines.When burning either No.2 fuel oil or gas,combustion turbines emit less NO,
than medium-speed diesel engines,and exhaust temperature and flow of combustion
turbines provide better dispersion in a modeling analysis.Many used combustion turbines
are expected to be available due to the tightening emission limits in ozone non-attainment
areas.One drawback of combustion turbines,however,is that they are generally slightly
less efficient than diesels.
Another alternative is the use of gas-fired diesel engines,although the reduction of NO,is
not expected to be significant.The use of gas (such as propane)may make catalytic
controls more viable.Non-selective catalytic reduction (NSCR),comparable to a catalytic
converter on an automobile,can be used on certain engines burning clean fuel and
operating with very little excess air.Issues to consider would include available engine
capacity,fuel type,emissions and performance characteristics,and economics of the
control technology.
Relocation of Generation Facilities -One solution might be to relocate existing generating
units or constructing new units at a different physical location where its emissions would
not flow into a problem area.This option,however,would probably require construction
of new buildings,distribution lines,and other support facilities.
Centralized Dispatch -Presently,the processors do not exchange power among
themselves,but instead rely on their own generation and occasional purchases from the
City.A centralized dispatch with exchanges or purchases of power could help reduce the
pollution problem by generating in areas that are not as severely limited by emissions.
Unalaska Geothermal Project FINAL DRAFT Page B -2