December 16, 2009

Pollution Bonds Signal Funding for $50 Billion Utility Cleanup

By Michael Quint and Jeremy R. Cooke

December 16 (Bloomberg) — Dec. 16 (Bloomberg) -- Two West Virginia utilitie's sale of $89.5 million of securities backed by a monthly charge on consumer electric bills shows how U.S. power producers may raise the $50 billion needed to reduce sulfur and other emissions over the next 15 years.

Taxable debt tied to dedicated customer charges is authorized by utility regulators in 19 states, and about $40 billion has been sold to pay for storm repairs, canceled power plants and environmental improvements without sharply increasing customer bills. So-called ratepayer bonds carry the highest ratings because regulators, backed by law, have promised to keep the monthly levies high enough to pay principal and interest.

"They are a cheaper way to finance certain types of projects than the traditional mix of company bonds and equity," said David Boonin, a principal at the Silver Spring, Maryland- based National Regulatory Research Institute, funded by state utility commissions.

Two subsidiaries of Allegheny Energy Inc., which derives 78 percent of its generating capacity from coal, sold 19-year bonds backed by a surcharge on the bills of 500,000 West Virginia customers at a yield of 5.13 percent.

The debt yield is 0.46 percentage point less than an index of AAA-rated taxable municipal securities due in 19 years, according to data compiled by Bloomberg. The bonds were issued by MP Environmental Funding and PE Environmental Funding with an average life of 19 years and a final maturity in 2030.

Removing Sulfur

The debt, top rated by Moody's, Standard & Poor's and Fitch Investors, will pay for equipment to remove sulfur at a coal- fired power plant owned by the Monongahela Power Co. and Potomac Edison Co. subsidiaries of Greensburg, Pennsylvania-based Allegheny. The financing allows the utilities to buy more locally mined coal, and is less expensive than the company's weighted average cost of capital of 6.68 percent, according to Bloomberg data.

With ratepayer bonds, all of a utility's customers, including state and local governments, are obliged to pay the extra charge and "share in the liabilities of all other electric service customers," according to the issue prospectus. That means if customers default or leave the area, those remaining must pay more.

Since first issued in 1994, ratepayer bonds have been among the safest of debt securities, with no reductions in their AAA ratings, even when the parent utility went bankrupt, a Standard & Poor's report said. Moody's hasn't reduced any of its Aaa rankings of the bonds, said Tom Lemmon, a spokesman for the rating company.

Treasury Bonds

The Monongahela and Potomac bonds yielded 62 basis points, or 0.62 percentage point, more than U.S. Treasury bonds due in 2039 and eight basis points less than AAA-rated Johnson & Johnson bonds due in 2033.

The West Virginia Public Service Commission ordered in September that its financial adviser be given authority to select and negotiate with underwriters. The agency also said the transaction was to be carried out at the "lowest cost" unlike many municipal-bond issues that are governed by a "fair and reasonable" standard for expenses.

"We created a competitive, negotiated process to get a yield lower, relative to benchmark securities, than similar sales for other utilities," said Joseph Fichera, chief executive officer of Saber Partners, the commission's New York- based adviser. Fichera provides independent analysis for Bloomberg News.

After the West Virginia regulators used Saber to select underwriters and negotiate terms of a $459 million sale in April 2007, the agency concluded the arrangement resulted in the "lowest" financing cost, according to state documents.

The previous sale of ratepayer bonds, by CenterPoint Energy Houston on Nov. 18, included $279.9 million of bonds due in about 11 years at a yield of 4.24 percent, or 0.87 percentage point more than the 10-year Treasury note.

Smart Meters

Costs of installing so-called smart meters, renewable- energy projects and conservation or efficiency programs might also be financed with ratepayer bonds, analysts at Moody's said in a November, 2008 report.

U.S. electric utilities may spend almost $50 billion for equipment to reduce sulfur and other emissions by 2025, according to Dan Riedinger, a spokesman for the Washington-based Edison Electric Institute, which represents power generators.

The low cost of ratepayer bonds to utilities and their customers may also lead to their use in construction of nuclear power plants, S&P analysts led by Weili Chen in New York said in a July report.

--Editors: Michael Weiss, Pete Young

To contact the reporters on this story:
Michael Quint in Albany, New York, at +1-518-426-9921 or mquint@bloomberg.net;
Jeremy R. Cooke in New York at +1-212-617-5048 or jcooke8@bloomberg.net.

To contact the editor responsible for this story:
Michael Weiss at +1-212-617-3762 or mweiss13@bloomberg.net.