HydroelectricProjectRiskAnalysis& theBradleyLakeFundingModel

SummaryReport

SNW 1420FifthAvenue,Suite4300 Seattle,Washington 98101 Phone:(206)6282882 Fax:(206)3432103 11/15/2010

INTRODUCTION TheStateofAlaskaisanalyzingtheSusitnaandChakachamnahydroelectricprojectsforpossible development.Bothprojectswouldrequiretheinvestmentofsubstantialresourcesandcapitaltomovetothe constructionphase,includingtimeandcostsassociatedwithanenvironmentalreviewandtheFederal permittingandlicensingprocess.Aspartoftheinformationgatheringprocess,SNWhasbeenaskedto performthefollowingspecificworktasks: 1. Listand,ifpossible,assessthepotentialrisksfromaninvestorsperspectiveoftheSusitnaand Chakachamnahydroelectricprojects. 2. Research,compareandcontrasttheBradleyLakeprojectanditsoriginalfundingmechanismstoa potentialsimilarprojecttoday. ContextfortheRiskAssessmentComponentofThisReport Currently,thereareseverallargehydroelectricfacilitiesbeingconstructedaroundtheworld.Manyofthese projectsarebeingbuiltintheBRICnations(Brazil,Russia,IndiaandChina),wheretherearefewerpermitting andenvironmentalchallengestoovercome.NearlyallprojectsofthesizeandscopeofSusitnaand Chakachamnacurrentlybeingdevelopedinternationallyarestructuredwithsomeamountofgovernment assistanceorgovernmentguaranty,andmanyalsoincludeanequityinvestorparticipant.Someexamples includeChinasThreeGorges,BCCanadasTobaMontrose,BCCanadasWanetaExpansion,Thailand/Laos PakChomandBanKoumprojects(similarsize/costs),andBrazilsSantoAntonio.TheWanetaExpansion projectfinancingistypicalofthestructuresusedtodeveloplargehydroelectricfacilities;amoredetailed descriptionfollows: WanetaExpansionProjectDescription FortisInc.,anelectricutilityholdingcompany,hasenteredintoapartnershipwithColumbiaBasinTrust (CBT)andColumbiaPowerCorporation(CPC),both100%ownedcorporationsoftheGovernmentof BritishColumbia,toconstructa$900million335megawatthydroelectricgeneratingfacilityonthePend dOreilleRiver,nearTrail,BritishColumbia.ThepartnershipcallsforFortistoownandoperate51%of thenonregulatedportionofthefacilityandtheCBT/CPgrouptoownandoperatetheother49%ofthe WanetaExpansionProject.TheenergygeneratedbytheprojectwillbesoldtoBCHydrounderalong termpowerpurchasecontract.ThesurpluscapacitywillbesoldtoFortisBCunderalongtermcapacity purchaseagreement.Fortisportionoftheinitialfinancingcostsareexpectedtobecoveredthrough creditfacilitiesandthenthroughlongtermdebtandequitytakeoutfinancing.TheCPCportionisbeing fundedthrougha$500millioncommitmenttobeusedasequityfundingforjointventurepowerprojects. ConstructionontheWanetaExpansionProjectisexpectedtolastfourandahalfyears. Oneimportantdistinctionbetweenthelargegenerationprojectsbeingconstructedgloballyandtheprojects underconsiderationinAlaskaisthattheprojectsbeingbuiltgloballyhaveaccesstolargepopulationsvia transmissiongrids.Thisabilitytobothservetheimmediatepowerconsumptionneedswithinthefacilitys serviceareaandhaveaccesstoothermarketsviaatransmissionsystemimprovesthebaselinefeasibilityofa powergenerationfacilityandcreatestheoptiontodevelopexcesscapacity,whichcanbesoldatmarketrates. Withoutstateorfederalsupport,Alaskasisolatedgeographiclocationeliminatestheabilitytobuildcapacity which,whenaddedtothecurrentgenerationcapabilitieswithintherailbelt,exceedsexistingdemand. 1

Itistheisolatedgeographiclocationoftherailbeltcustomerbase,incombinationwiththescopeand complexityoftheChakachamnaandSusitnaprojects,thatleadustoconcludethatneitherofthesefacilities canbecompletedthroughaprojectfinancevehicle(i.e.,thesecurityforthefinancingwouldbeexclusively revenuefromthesaleofprojectgeneratedpower).Inourview,theseprojectswillrequireStatefunding, whichcouldbedirectlyviacapitalinvestmentand/orindirectlythroughsomeformofcreditsupportor backstop,inordertoobtainsecuritiesmarketaccess.ItisalsoourviewthatitisreasonablefortheStateto considerinvestinginrailbeltgenerationassetswiththeobjectiveofdevelopingalongtermstablesourceof baseloadpoweratacostthatwillpromoteeconomicstabilityandgrowthwithintherailbeltregion. Nevertheless,theprocesstheStateshouldgothroughindeterminingwhethertoinvestadditionaltimeand resourcesintoeithertheSusitnaorChakachamnaprojectisanalogoustothediligencethatanequityinvestor wouldperformpriortothecommitmentofcapital. ThefollowingsectionidentifiesmanyoftherisksinherenttoaninvestmentineithertheSusitnaor Chakachamnaproject.SNWisnotqualifiedtoadviseAEAonthesusceptibilityofSusitnaorChakachamnato mostoftherisksidentified.Manyoftheserisksarefocusedonengineeringorgeologicalelementsspecificto theprojects,andwearenotanengineeringfirm.Forthisreason,wehaveconfinedourworktojustthe identificationandexplanationofrisks,andforthemostparthavewithheldanyopinionastowhethereitherof theprojectsismoreorlesssusceptibletoaparticularrisk.TheState,withitsengineeringandgeotechnical resourcesandsignificanthistorywitheachoftheseproposedfacilities,isinthebestpositiontoriskweightthe projects.Ourobjectiveistohelptoidentifyasmanyoftheprojectrisksaspossibleandprovidesome frameworktoassistAEAwithitsriskassessment. FINANCINGCRITERIA:DISTINGUISHINGRISK Throughareviewofpubliclyavailablewebsitesanddocumentsfootnotedorsourcedthroughoutthisreport, wehaveevaluatedandcategorizedsomeofthedifferentrisksassociatedwiththetwoselectedprojects.As withtheanalysisofanyprojectfinancetypestructure,aninvestorwillrelyonaprojectfeasibilitystudyto outlinethevariousengineeringriskfactorsandriskmitigationeffortsthatarebeingundertakenthroughout thestagesofprojectdevelopment.SNWhasnotspecificallystudiednorarewesuitedtoevaluatethetwo projectswithrespecttothedifferenttypesofgeological,volcanic,environmentalrisks,etc.froman engineeringperspective.However,itistheserisksthatprimarilydistinguishSusitnaandChakachamnafrom oneanother. Somepotentialriskfactorsarediscussedbelow: OverallProjectTimeline BothSusitnaandChakachamnaareexpectedtotakemultipleyearstopermitandconstruct.Thephased executionoftheprojectsovermultipleyearshastheeffectofamplifyingtheelementsofconstructionriskand reducingtheoverallconfidenceinprojectfeasibility.SpecificallywithregardtoSusitnaandChakachamna, theremotelocationoftheprojectswillalsobeafactorintimelycompletionoftheprojectsandtherefore projectfeasibility.Alargeriskfactorassociatedwitheitherprojectistheunknownsiteorgeologicalissues thatcouldmaterializeduringtheconstructionphase.Allotherfactorsbeingequal,ashorterproject permittingprocessandconstructiontimelineislikelytoresultinlessprojectrisk. PermittingandLicensing Therewillbesignificantpermittingrisk,atboththeFederalandlocal/Statelevel.Projectsofthisscopeandsize wouldexpectstrongenvironmentaloppositiontothefacility,transmissionlines,roads(evenifonly 2

temporary),and/orrailroads.Anyprojectfinancingwouldoccuronlyafterallpermits/licenseswereissued andallcourtchallengeswereexhausted,soinvestmentofcapitalleadingtothepermittingofeitherproject willbesubstantial.Anyriskassessmentoftheprojectsunderconsiderationbasedonpermittingandlicensing shouldbedonewhilesimultaneouslyconsideringthefeasibilityofconstructionandthelongtermoperating viabilityoftheproject. Development/Preconstruction Thereisasignificantportionofpreconstructiondevelopmentworkthatneedstobecompleted,atasizable cost.Theseexpendituresarerarelyrisksthatinvestorswillcarry.Preconstructioncostswouldhavetobepaid bytheStateoranindependentdeveloper. ConstructionRisk BoththeChakachamnaandSusitnaprojectsaresubjecttoavarietyofconstructionrisks.Thethreeprimary creditconcernsrelatingtoconstructioninclude(1)thecostoftheproject,(2)theschedulefortheproject,and (3)thequalityofthecompletedproject.Eachcannegativelyimpacttheavailabilityoffundingand/orthedate thattheprojectcomesonlineandbeginsproducingrevenue. Projectcostriskisinfluencedbyawholehostofrisksinherenttobothprojectsinvariousdegrees.Asnoted above,thedurationofconstructioncanamplifytheriskofmanyofthesecostfactors.Someoftherisk elementsthatcaninfluenceprojectcostare: InflationRisk.Theriskthatthefuturecostofmaterialsand/orlaborwillexceedestimates. SupplyRisk.Theriskthatmaterialsrequiredforconstructionwillbeunavailableduetocompeting constructiondemandand/ortheinabilitytodelivermaterialstothejobsiteduetoaremotelocationor problemsalongthesupplyroute. LaborRisk.Theriskthattherewillbeeitherashortageofthelaborrequiredtomovetheproject forwardonscheduleoraworkstoppagedelayingcompletion. EngineeringRisk.Theriskthattheprojectwillencounterunanticipatedand/orunderestimated constructionchallenges.Whilewearenotanengineeringfirm,itisourunderstandingthatmanylarge projectcostoverrunsarecausedbyunforeseenundergroundconditions.Thescopeandnatureof undergroundworkatbothSusitnaandChakachamnashouldbecarefullyassessedandfactoredinto overallprojectfeasibility. ContractorRisk.Theriskthatacontractorwillfailtoperformonitscontractualobligations.Thisrisk canbemitigatedbyallocatingconstructionrisksamongthevariousprojectparticipantsthroughthe useofdesign/buildcontractsandtheimplementationoffixedprice/fixedscheduleagreements,andby includingpriceincentivesanddisincentivesinconstructioncontracts.Nevertheless,itisimpossibleto completelyinsulateaprojectfromcontractorrisk,andtheoverallcomplexityoftheprojectincluding projectsightingandengineeringshouldbefactoredintotheriskassessment. GeologicalRiskFactors Therearesignificantpotentialgeologicalrisksassociatedwiththetwoprojects,whichhavebeenidentified anddiscussedinthefollowingdocuments: SusitnaProject,WatanaandHighDevilCanyonRCCDamCostEvaluation,preparedbyR&M Consultants,HatchAcres,andJackLinnardConsulting(whichsourcedtwootherstudiesincluding 1982FeasibilityStudy(Acres),and1983LicenseApplication(HarzaEbasco1983)). 3

ChakachamnaHydroelectricProjectInterimFeasibilityAssessmentReport,preparedbyBechtelCivil& MineralsInc.,1983. Bothprojectsentailsignificantprojectriskanditisouropinionthattherisksassociatedwithbothprojects wouldrequiresubstantialfinancialbackingintheformofcreditsupportfromtheStatetobefeasible.For Chakachamna,thepotentialimplicationsofMt.Spurrvolcanicactivity,thecloseproximityoftheCastle Mountainfault,andthegeologicalnatureofthelaketapwouldbesignificantareasofconcernforinvestors. Fromacapitalmarketsperspective,andnotbasedonanyengineeringexpertise,itisouropinionthatthe seismicandgeologicalriskfactorsconnectedtotheSusitnaprojectseemtobeconsiderablylessthan Chakachamna,neverthelessSusitnawilldemandextensiveseismicandgeologicalanalysispriortoobtaining outsidecapitalfunding. Environmental(Fish,Plant,Wildlife)RiskFactors Bothprojectswillincurenvironmentalissuesintheformoffishpassage,changesinwaterqualityand temperature,vegetationremoval,wildlifehabitatlossoralteration,andreservoirfluctuations.Theserisks maynotbelimitedtotheconstructionperiod.Postconstructionenvironmentriskcouldmaterializeduetoan unanticipatedenvironmentalimpact.Again,basedsolelyonourcapitalmarketsperspective,thedesignofthe Chakachamnaproject,whichwillnecessitatethediversionofwaterflowfromonedrainagetoanother, appearstohavetheincreasedpotentialforenvironmentalrisk,particularlythepotentialforpostconstruction environmentaldamageandpossiblecorrespondingoperatingrisk. Regulatory/LegalRiskFactors Whiletherearesignificantfederalhurdlesassociatedwiththepermittingofahydroproject(ofanysize),there havebeensomerecentpositivelegaldevelopmentsoutofWashington,D.C.TheU.S.DepartmentofEnergy, DepartmentofInterior,andtheArmyCorpsofEngineersrecentlysignedaMemorandumofUnderstanding intendedtopromotethedevelopmentofhydropowerintheUnitedStates.TheMOUisintendedtoincrease cooperationamongthedifferentagenciesandtointegratepoliciesandproceduresatthefederallevel.This potentiallycreatesefficienciesthroughtheregulatoryapprovalprocessandanimprovementinthetimeframe inwhichrequiredapprovalsareobtained. Notwithstandingtheabove,itwouldbeamistaketoproceedwitheitherprojectundertheassumptionthat thereisnopoliticalrisk.Whilepoliticallystable,theUnitedStateshasalonghistoryofchangingrulesand regulationsduetoapoliticalshiftingovernanceorgeneralpublicsentiment. TechnologyRisk Hydroisatriedandtruetechnologycapableofprovidingverystablebaseloadpower,butitiscapital intensive.Thepossibilityoftechnologicalimprovementsinothersourcesofbaseloadpowerleadingto greateroutput,lowerenvironmentalimpact,andreducedgenerationandtransmissioncostswouldbeafactor foranyinvestor.ThisriskfactorcanbemitigatedthroughthestructureofthePowerPurchaseAgreement. BRADLEYLAKECOMPARISONANALYSIS DescriptionandHistory TheBradleyLakeHydroelectricProjectislocatedinsouthcentralAlaskaatthesouthernendoftheKenai Peninsula.Theprojectincludesa610feetlong,125feethighconcretefacedandrockfilledgravitydam,a 3.5milepowertunnelandasteellinedpenstock.Theprojecthas126megawattsofinstalledcapacity.Two 4

20mile,115kilovolttransmissionlinesconnecttheprojecttoatransmissionsystemontheKenaiPeninsula. TheprojectprovideselectricpowertothemostpopulousareasofAlaska,includingtheKenaiPeninsula,the MunicipalityofAnchorage,theMatanuskaSusitnaBorough,andtheFairbanksarea.UnderaPowerSale Agreement,AEAhassold100%ofthecapacitytothefollowingpurchasers: ChugachElectricAssociation,Inc.(30.4%); MunicipalityofAnchorage(25.9%); AlaskaElectricGeneration&TransmissionCooperative,Inc.(25.8%)actingonbehalfofHomer ElectricAssociation,Inc.(12.0%)andMatanuskaElectricAssociation,Inc.(13.8%); GoldenValleyElectricAssociation,Inc.(16.9%);and CityofSeward(1.0%). 1

The power generation potential of Bradley Lake was first studied by the U.S. Corps of Engineers and presented in a report dated March 1955. The project was authorized by Congress in 1962, but, despite its feasibility, federal funds were not available for its construction. The Alaska Energy Authority (then Alaska Power Authority) assumed responsibility for the project in 1982. Preliminary plans and field investigations started in 1982. In April 1984, AEA submitted a license application to the Federal Energy Regulatory Commission. The FERC license is the primary regulatory approval governing project development. The license to construct the project was issued on December 31, 1985, under the Energy Program for Alaska. In additiontotheFERClicense,AEAappliedforandreceived170federal,Stateandlocalpermitsandlicenses requiredtosupportconstructionandoperations.Anumberofstudiesandinvestigationswereperformedto ascertain the geologic and geotechnical conditions of the site and structures. Seismic design considerations andtheresultsoftheinvestigationswerereviewedandfoundprudentbytheprojectstechnicalreviewboard and the FERC board of consultants. 2 In addition, a number of environmental studies were done, including studies of the effects of the project on wildlife, fish and winter ice conditions. 3 Construction of the project commenced on June 17, 1986, with site preparation work. Construction was suspended, however, after the completionofPhaseIinMay1987duetothependingnegotiationsofasatisfactorypowersalesagreement.In December 1987, AEA and the railbelt utilities entered into a Power Sales Agreement, and legislation was introduced in January 1988 to exempt the Bradley Lake power sales agreements from review by the Alaska Public Utilities Commission.4 Construction of the project resumed on March 12, 1988, and the project was declaredincommercialoperationonSeptember1,1991.Fromtheprojectscompletionin1991through2009, theprojecthashadanaverageannualoutputof386.4millionkilowatthours. OriginalFinancing Projectcostintheamountof$357.2million(includingreserves,capitalizedinterest,andcostofdebtissuance) was funded longterm by (1) appropriations from the State in the initial aggregate amount of $175 million (later reduced to $163.6 million), (2) proceeds from the sale of AEAs bonds issued in the amount of $165.3million,and(3)approximately$28.3millionofinterestearningsduringconstruction.Aportionofthe

AlaskaEnergyAuthorityBradleyLakeHydroelectricProjectFactSheet(2010) AlaskaEnergyAuthorityPowerRevenueBonds,SecondSeriesOfficialStatement(1990) 3ThrowingtheswitchatBradleyLake,AlaskaBusinessMonthly(1991) 4ThrowingtheswitchatBradleyLake,AlaskaBusinessMonthly(1991)

1 2

State appropriations funding was provided by the Railbelt Energy Fund, which was established from the PowerDevelopmentFundandseededwithappropriationsforthecanceledSusitnaHydroelectricProject. 5 AEA issued approximately $267.5 million of Variable Rate Demand Bonds during the project construction phase to be used for construction cost. The Variable Rate Demand Bonds were sized in an amount that, together with interest earnings, would be sufficient to completely cover construction of the project. This approach created the ability to earn the maximum amount of interest earnings during construction. The VariableRateDemandBondsweregeneralobligationsofAEAandweresecuredbybanklettersofcreditand a capital reserve fund under an Indenture of Trust from AEA to the Bank of New York. Following construction, the Variable Rate Demand Bonds were redeemed using a combination of Stateappropriated fundsandtheproceedsoflongterm,fixedratebondsissuedintheamountof$165.3million.Theinitialbond saleswereissuedinveryflatyieldcurveenvironments,withinterestratesrangingfrom6.1%ontheshortend to7.25%onthelongend. 6 Theoriginalfinancingplanfortheprojectisoutlinedinthetablebelow:
FINANCINGPLANFORBRADLEYLAKE
AvailableFunds LongTermBondIssuances StateAppropriations InterestEarningsfromVRDBs Total ApplicationofFunds ProjectConstruction CapitalizedInterest CapitalReserveFund RenewalandContingencyFund BondInsurancePremiums BondIssuanceExpenses OperatingReserveAccount NetOriginalIssueDiscount Total $ 312,500,000 17,418,182 13,392,890 5,000,000 1,302,839 3,339,175 625,000 3,662,607 $ 357,240,693 $ 165,260,157 163,605,157 * 28,375,379 $ 357,240,693

*Theoriginalappropriationwasintheamountof$175,080,000,but$11,474,843wasrefundedtotheStateafter construction.

5 6

AllureoftheRailbeltEnergyFund,AlaskaBusinessMonthly(1990) ElectronicMunicipalMarketAccessandAlaskaEnergyAuthorityPowerRevenueBonds,SecondSeriesOfficialStatement(1990)

The Variable Rate Demand Bonds were refunded through two longterm issuances, the first in 1989 in the amount of $105 million and the second in 1990 in the amount of $60,259,015. The sources and uses for the permanentfinancingoftheprojectareoutlinedinthetablebelow.
1stSeries RevenueBonds Sources PrincipalAmountofBonds ExistingFunds* Total Uses RedemptionofVariableRateDemandBonds DeposittoConstructionFund DeposittoInterestAccount DeposittoCapitalReserveFund DeposittoRenewalandContingencyReserveFund DeposittoOperatingReserveAccount BondInsurancePremium UnderwritingDiscountandCostsofIssuance NetOriginalIssueDiscount Total $76,600,000 12,245,356 8,423,148 1,524,466 798,839 2,030,445 3,478,888 $ 105,101,142 $ 190,900,000 82,300,919 3,840,138 4,969,742 3,475,534 625,000 504,000 1,308,730 183,719 $ 288,107,782 $ 267,500,000 82,300,919 16,085,494 13,392,890 5,000,000 625,000 1,302,839 3,339,175 3,662,607 $ 393,208,924 $ 105,001,142 100,000 $ 105,101,142 $60,259,015 227,848,767 $ 288,107,782 $ 165,260,157 227,948,767 $ 393,208,924 2ndSeries RevenueBonds Total

ComparisonofCurrentFinancingEnvironment The project was an innovative deal at the time that it was originally built and financed, and was the first instance of a state agency financing a power project on a longterm basis. 7 While the current financing environmentisverydifferentfromthatof25yearsago,whentheprojectwasdeveloped,thesize,scopeand success of the project makes it a relevant standard to analyze when considering a comparable large scale hydroelectric project. For this comparison, we have focused on highlighting the key components of the originalfinancingrelativetowhatcouldbeexpectedintodaysmarket.Thesecomponentsinclude: Arbitrageandinvestmentearnings Rateenvironmentandpricing Equity Security Powersalesagreement Regulatoryreviewandwaivers Financingtermsandconditions

ArbitrageandInvestmentEarnings:DuringtheconstructionphaseoftheBradleyLakeproject$267.5million of Variable Rate Demand Bonds were utilized as interim funding and were later repaid through the
7

AlaskaHouseJudiciaryCommittee,ActionNarrative,January26,1988.Tape88Side1.

combination of State appropriations, which, in effect, acted as equity in the transaction, and longterm fixed raterevenuebonds,whichwouldbebackedbythepowersaleagreement.Onesignificantaspectofvariable ratedemandbondsissuedatthetimeisthat,becausetheywereissuedpriortotheTaxReformActof1986, unspent proceeds from the bonds could be invested at a higher, taxable rate of interest. This interest rate arbitragewasusedasadditionalsourceofcapitalfortheproject.Investmentearningsonthisarbitrageover the life of the Bradley Lake variable rate demand bonds equaled $28.3 million or approximately 9.0% of the totalprojectcosts.The1986TaxActeliminatedanyabilitytousetaxexemptbondproceedstoearninterest arbitrage,sointerestratearbitragewouldnotbeavailableforasimilartransactiontoday. RateEnvironmentandPricing:The1980ssawadeclininginterestrateenvironmentwithrelativelyflatyield curves.Whileratesdidnotdecreaseinalinearfashion,duetosomevolatilityinthedecade,theoverallrate decreasewasfairlydramatic.Forexample,the10yeartreasuryratewentfromalmost15%in1981toaround 8%in1989,whilethe2yeartreasuryratewentfromalmost16%toaround8%overthesameperiod.Long termrateswereinthe10%rangein1985whenthevariableratedemandbondswereissued.Thepermanent takeoutbondswereissuedonaserialbasis,withinterestratesrangingfrom6.10%ontheshortendto7.25% on the long end. This environment is very different from the one we are currently experiencing, with historicallylowratesandaverysteepyieldcurve.Ratesonthe2yeartreasuryarecurrently0.38%,whilethe 30yeartreasuryisaround4.12%. The combination of historically high longterm tax exempt interest rates and a declining interest rate environmentmadevariableratebondsduringtheconstructionphaseofBradleyLakeagoodchoice.Asnoted above,priortobeingexpendedontheproject,proceedsofbondsissuedduringtheconstructionphasewere investedabovethevariableratecostofcapital,creatinginterestearningsthatexceededtheinterestcostofthe construction financing. The Bradley Lake funding structure took full advantage of the arbitrage strategyby borrowingforthefullamountoftheproject,includingtheamountthatwasexpectedtobeloanedbytheState. Additionally,theuseofvariableratebondsservedtominimizeborrowingcostduringconstruction.Asbond proceedswereexpendedandthereforenolongerabletobeinvestedtocreatearbitrageearnings,thecostof interestwasminimizedsince,inthetypicalupwardslopingyieldcurveenvironment,shorttermvariablerates were lower than longterm fixed rates. The combination of arbitrage earnings and low rates once bond proceedswerespentservedtolowerthefundingcostoftheprojectduringtheconstructionphase. TheBradleyLakefundingcostwasadditionallybenefittedbyfallingratesduringtheconstructionperiod.As constructionwrappedup,thevariableratebondswererefinancedwithlongtermfixedratebondsinalower interest rate environment than the longterm rate environment that existed when the project was started, as illustratedinthetablebelow.

TreasuryYieldCurve
11% 10% 9% 8% 8.7% 7.0% 10.0% 8.3% 10.2% 8.4%

InterestRate

7% 6% 5% 4% 3% 2% 1% 0% 2Year 10Year 30Year 0.4% 2.6% 4.1% Nov85 Jul91 Nov10

TreasuryMaturity

Interest rate risk is always a concern for project feasibility. Rising rates during project construction can substantiallyjeopardizeprojectfeasibility.Byutilizingvariableratefundingduringtheconstructionphaseof theproject,BradleyLakewasexposedtoraterisk;however,thiswasacalculatedrisk,sincetheprojectwas startedinahighinterestrateenvironment.Variableratefundingcouldalsobeatoolutilizedtofinanceeither SusitnaorChakachamnatoprovideextremelylowcostcapitalduringtheconstructionphase.Ofcourse,the projectswouldbeexposedtointerestrateriskuntilthelongtermfixedratefundingissecured.Contraryto 1985, todays longterm interest rates are historically low, creating an incentive to use fixed rate funding duringtheconstructionphaseandeliminatetheriskofrisingrates. While eliminating rate risk, fixed rate funding would likely result in additional cost in the form of negative arbitrage,ortheinabilitytoinvestconstructionproceedsatorabovethelongtermborrowingrate,duringthe construction phase. Since negative arbitrage would only exist during the construction phase, it should be considered as an additional cost that, at least in the current rate environment, is outweighed by the risk of risingrates. Equity:AnotherkeycomponentoftheBradleyLakefundingstructurewasthelargepercentageofequitythat wasprovidedthroughappropriationsfromtheState.Stateappropriationsfortheprojectendedupaccounting forapproximately50%ofthetotalprojectcosts.TheStatesparticipationintheBradleyLakeprojectallowed thesubstantial capital cost oftheproject to be spread over a period of timethatexceededwhatwouldhave beenavailablethroughthebondmarket. Security:TheVariableRateDemandBondswerebackedbyaletterofcreditaswellasageneralobligationof AEA. The permanent take out bonds were backed by revenues of the power sale agreement, the general obligationandfullfaithandcreditofAEAaswellasamoralobligationoftheState.Intodaysenvironment, aninvestorwouldexpecttoseeatleastthislevelofcreditsupportforadealofthissizeandcomplexity. PowerSalesAgreement:Thepowersaleagreementissimplythebusinessdealbetweenthepowergenerator andthepowerpurchaserandcanbeusedtoshiftriskfromthegenerator/developertothepowerpurchaser. ThepowersaleagreementintheBradleyLakeprojectwasheavilynegotiatedbythevariouspartiesandatone pointwasactuallythecauseofasignificantconstructiondelayontheproject. 8 Asthemainsourceofpayment andsecurity,thepowersaleagreementwasintegralinarrangingthepermanentfinancing.Auniqueattribute
8

ThrowingtheSwitchatBradley,AlaskaBusinessMonthly(1991)

oftheBradleyLakepowersaleagreementwasthattheagreedpaymentscontinuedforanadditional20years afterbondsusedtofundtheprojectwerescheduledtoberetired.Thisstructurewasdesignedtorepaythe Statefortheconsiderablecapitalthatwascontributedtotheprojectbutalsoservedtoextendthetimeframe for amortizing the cost the project. 9 SNW believes that this aspect of the Bradley Lake contract has applicabilitytofuturegeneratingprojectswithintherailbelt. RegulatoryReviewandWaivers:WhilenoonewouldarguethattheBradleyLakeprojectwasfasttracked, giventhetimespentonanalysisandtherigorousregulationprocessthatwasrequired,twokeywaiverswere obtainedintheprocess.Thefirstwasaspecialfederalexemptionthatallowedtheprojecttousetaxexempt financingdespitethefactthatitwouldservethreecontiguouscounties.Normally,privateactivitybondsfor electric facilities are exempt only if the facilities are used by a utility serving no more than two contiguous counties.Secondly,thesaleandpurchaseagreementwasexemptfromAPUCreview,whichremovedagreat dealofuncertaintywithintheinvestorcommunityandseemstohavebeeninstrumentalinmovingtheproject forwardatacriticaljunctureintime. 10 Whilethesespecificwaiversmaynotbenecessaryforasimilarproject intodaysenvironment,itisimportanttorememberthataprojectofthissizeandscopehasthepotentialto requirevariousagenciesandlevelsofthepublicsectortoworktogethertoachievesuccess. FinancingTerms ThetablesbelowoutlinethekeytermsandconditionsachievedintheBradleyLakefinancingscomparedto whatmightbeachievableforasimilarprojecttoday.

9 10

AlaskaHouseJudiciaryCommittee,ActionNarrative,January26,1988;tape88side1 AlaskaHouseJudiciaryCommittee,ActionNarrative,January26,1988;tape88side1

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INITIALCONSTRUCTIONFINANCING FUNDINGMECHANISMS ConstructionCosts Equity(StateAllocation) InterimFinancing ORIGINALBRADLEYLAKEPROJECT $312,500,000 $175,000,000 VariableRateDemandBonds POTENTIALPROECTTODAY Dependentonproject Likelytobegreaterthan50%or moreoftotalprojectcost Statefundingpotentiallyin combinationwithconventional bondfunding Dependentonproject Dependentonproject Permitting,licensing,construction Dependentonproject;however,fora largescaleproject,investorswould expecttoseesignificantcredit support Dependentonproject Dependentonsecurity,interest rateenvironment,taxstatus,size, creditrating Possiblerequirement Necessaryrequirement

AmountofBonds DateIssued UseofFunds Security

$267,500,000 11/20/1985 Construction GeneralObligationofthe Authority,LetterofCreditand CapitalReserve VariableRate

FinancingCosts InterestRate

LetterofCredit CapitalReserve CompletionBonds

Required Required Allowedwithoutcompliance

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PERMANENTTAKEOUTFINANCING FUNDINGMECHANISMS BondResolution ParAmountIssued ORIGINALBRADLEYLAKEPROJECT POTENTIALPROECTTODAY

CreditRating Type Underwriters

DatesIssued UseofFunds FinancingCosts InterestRate SecurityforBonds

Insurance PowerPurchaseAgreement

PowerPurchaseDefault

CapitalReserveFund StateObligation

CompletionBonds AdditionalBonds

Maximumof$175,000,000 $165,260,157 $105,001,142Series1 $60,259,015Series2 MoodysAaa(enhanced) S&PAAA(enhanced) Negotiated/TaxExempt JohnNuveen&Co;Goldman Sachs;MerrillLynch;Paine Webber;andLehmanBrothers 9/1/1989Series1 7/15/1990Series2 RefundVRDBandcapitalize reservefunds Directandgeneralobligationsand fullfaithandcreditofthe Authorityandrevenuesreceived fromoperationoftheproject underPowerPurchaseAgreement YesandprovidedbyMBIAC Likelydifferentstructurethan Fiveutilitiespurchase100%of BradleyLake,buttherewillneed AnnualProjectCosts,including tobeastrongPPAinplace debtserviceandannualreserves betweentheprojectownerandthe railbeltutilities StepupprovisioninthePPAwill Ifinsufficientfundsavailable beanecessarysecuritystructure becauseofpaymentdefaultof feature;however,itcouldbe PowerPurchaser,ADAmay structureddifferentlythanBradley increaseeachotherPower Lake Purchasersshareofcostsupto 25% EqualtoMaximumAggregate Required,butcouldbestructured DebtService differentlythanBradleyLake MoralobligationoftheStateto WilldependonPPAstructure,but restoreCapitalReserveFund Statepledgeofanykindwould benefitthecredit Allowedonparity Yes,typicallyupto10%oforiginal bondsissuedtofundtheproject Dependentupontypeofdebt.Itis Maybeissuedonparityforthe nottypicaltoallowadditional costofacquisitionand bondsforaprojectrevenuebond constructionofanycapital improvementrelatedtotheproject structurehoweversystemdebt wouldpermitadditionalbonds withapprovalfromtheproject

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managementcommitteeaswellas subjecttomeetingcertainfinancial thresholds.BradleyLakeisa proofthattheadditionalbonds hybridadditionalbondsprovision. willnothinderdebtservice paymentsontheoriginalbonds ConsultantEngineer Required Reportestimatingtheprojected costsandrevenuerequirementsfor a10yearperiodaswellas opinionsontheproject Renewal and Contingency Yes Required ReserveFund OperatingReserveAccount Yes Required OptionalRedemption Willdependondebttype.Taxable 102%(7/1/006/30/01) bondswouldtypicallynotpermit 101%(7/1/016/30/02) optionalredemption,whiletax 100%(7/1/02thereafter) exemptbondswouldallowfor optionalredemption. NoticeofRedemption Atleast30daysbutnomorethan 60days

StateFinancialAssistance Asidentifiedinpreviousreports 11 discussingpotentialfinancingstructuresforlargegenerationassets,State financialassistanceinaformsimilartotheBradleyLakeprojectmodelwillbeanecessarytoolforeitherofthe potentialhydroelectricprojectsbeingevaluated.Statefinancialassistanceoffersanumberofadvantagesnot availablethroughtraditionalutilityenterprisebondfundingorprojectfinance.Statefunding,whetherinthe formofagrantorloan,canbeutilizedtodeferhighercostconventionalrevenuebondfunding.Obviouslya grantfromtheStateprovidesthecheapestformofcapital,butevenwhenstructuredasaloan,Stateassistance candramaticallylowertheoverallcostofcapital.Statefundingintheformofaloanhasthreesignificant advantageswhencomparedtorevenuebondsoraloanfromacommerciallender: Repaymentflexibility. Statefundingcanbeutilizedtoextenddebtrepaymentbeyondtheterms availableinthepublicorcommercialdebtcapitalmarkets.Additionally,aStateloancaneasilybe restructuredordeferredtoachievesystemrateobjectives. Creditsupport/riskmitigation. Statefundingcanbeusedtomitigateprojectconstructionriskto investors.Thisisparticularlyrelevantforprojectswithextendedconstructiontimelines,suchasthe SusitnaorChakachamnahydroprojects.Riskmitigationisalsorelevantinsituationswherepermitting isanissueoranewtechnologyisbeingused.Asdiscussedearlier,investorswillnotacceptthe significantconstructionandpermittingrisksinherentwithlargescaleprojectswithoutsomeformof supportfromtheState. Potentialinterestcostbenefit. Statefundingcanprovidealowercostsourceofcapital.TheStates highinvestmentgradecreditratingallowsittoborrowforlessthaneventhemostsecureutility enterprise,andthislowerborrowingcostcanbepassedontotheproject.Alternatively,theStatecan usecashreservestoinvestinalargescalegenerationprojectlikeSusitnaorChakachamna.Byusinga fundingmodelsimilartoBradleyLakes,thiscapitalinvestmentcanbereturnedtotheStateoveran extendedperiodoftime.Extendingthereturnofcapitaltoatermthatmorecloselymatchestheuseful
11

RegionalIntegratedResourcePlanFinancialAnalysisSummaryReport,2/3/2010

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lifeoftheassetlowerstheratesandchargesforutilitycustomersandspreadsthecapitalcostofthe projectoveralargercustomerbase. CONCLUSION Inconclusion,SNWdoesnotbelievethatitispossibletodifferentiatebetweentheSusitnaandChakachamna projectsonthebasisofcapitalmarketsaccess.Aswehaveunderscoredinthisreport,thescopeofboth projects,combinedwiththeuniquenatureoftherailbeltregion,willnecessitateafundingstructureforeither projectthatissupportedbyStatecreditoraStatecapitalcommitment.Wethinkthatitislikelythatwewould reachthissameconclusionforanyprojectwithsimilarcomplexityandcostdevelopedwithintherailbelt. Thereareengineering,geotechnicalandseismicfactorsspecifictoeachoftheprojectsthatwouldberelevant fortheStatetoconsiderinriskweightingtheprojectspriortoinvestingadditionaltimeandresourcesin furtherdevelopment.Wevehighlightedsomeofthoserisksinthisreportbutdonothavethetechnical expertisetoadviseAEAontheimportanceoftheserisks. Finally,webelievethatelementsoftheBradleyLakefundingmodelhaveapplicabilitytofundingnewlarge hydroelectricfacilitieswithintherailbelt.Marketconditionsandthelegalconstraintsunderwhichanynew projectwouldbefundedaredramaticallydifferentthanwhenBradleyLakewasfunded,sotheBradleyLake structurecannotbereplicatedasawhole.However,theabilitytocollaboratewiththeStatetomitigatecertain risksandspreadthecapitalcostoveranextendedperiodoftimewillbecriticaltofundingamultibillion dollarproject.

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