Fitch Upgrades Caithness Coso's Sub Secured Notes; Watch Positive.

CHICAGO -- Fitch Ratings has upgraded to 'BB+' from 'BB-' the rating of Caithness Coso Funding Corp.'s (Coso) $90 million subordinated secured notes due 2014. Both the subordinated notes and the 'BBB-' rated $375 million senior secured bonds due 2019 remain on Rating Watch Positive.

The rating actions are due to the extension of the fixed price period through 2012. The extension agreement, which was granted final approval by the California Public Utilities Commissions (CPUC) in October 2006, requires Southern California Edison (SCE) to purchase contracted energy output from Coso at a fixed price of 6.15 cents/kWh (kilowatt hour), escalating annually at 1%. Coso's current power purchase agreements (PPAs) expire in 2010, 2011, and 2019. Consequently, Fitch expects Coso to receive a highly stable stream of cash flow over the next five years with minimal price volatility. Separately, Coso and SCE have executed long-term, fixed-price PPAs that will replace the current PPAs when they expire; the CPUC must review and approve the new agreements before they take effect.

The credit quality of the subordinated notes is considerably enhanced by the extension of the fixed price period, which will provide strong cash flow stability through 2012. Furthermore, consolidated debt service declines by approximately 30% after 2011, enhancing Coso's ability to withstand a low price environment upon expiration of the fixed price period. Fitch's projections indicate that consolidated debt service coverage ratios (DSCRs) in a low price environment could range from 1.2 times (x) to 1.4x, depending on Coso's ability to stabilize the geothermal resource.

While Coso's financial performance prior to 2012 has strengthened, the credit quality of the senior bonds continues to be constrained by the long-term risk of geothermal depletion. Coso has experienced administrative delays that have held back the construction of the Hay Ranch project, which is intended to stabilize the geothermal resource and prevent depletion through a program of supplemental water injection. While Coso could potentially resolve outstanding permitting issues in the short term, it is uncertain whether the Hay Ranch project will encounter further delays; Coso originally planned to complete construction of the Hay Ranch project in Fall 2006. If the Hay Ranch project remains incomplete or does not operate as planned, revenues could steadily decrease as output declines, leaving Coso vulnerable to a year of low prices. In such a scenario, Fitch-projected senior DSCRs could fall to approximately 1.60x after 2012. Alternatively, the credit quality of the senior bonds would be enhanced by the successful implementation of the Hay Ranch project; accordingly, Fitch has maintained the Rating Watch Positive on the senior bonds.

Both the senior and subordinate ratings remain on Rating Watch Positive pending regulatory approval of the new PPAs, which would minimize price risk and provide Coso with extremely strong cash flow stability over the long term. The new agreements, which would extend through 2030 and take effect with the expiry of the existing PPAs, require SCE to purchase Coso's output at a fixed price. It is uncertain whether the PPAs will receive the CPUC's final approval, and the duration of the regulatory process cannot be determined at this time.

Coso is a special-purpose company formed to issue debt on behalf of the Coso partnerships, the owners of the Coso projects, and the guarantors of the rated debt. The projects consist of three interlinked 80-MW (megawatt) geothermal power plants and their transmission lines, steam gathering systems, and other related facilities located at the Navy Weapons Center in Inyo County, CA. Electric energy and capacity are sold to SCE (Fitch long-term issuer rating of 'A-') under separate SO4 (Standard Offer No. 4) contracts expiring in 2010, 2011, and 2019. Coso provides royalty payments to the U.S. Navy and the Bureau of Land Management for use of the geothermal resource.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.