February 21, 2011
Experts Advise Expanded Use of Securitization by Utilities to Finance Range of Cost Recovery
Customers would benefit if electric utilities significantly expanded use of securitization, a “powerful financing tool” that regulators and others said last week gives flexibility in paying for such big-ticket items as environmental mitigation, nuclear plant cost overruns and smart grid installations.
So far, however, securitization has generally been limited to cost recovery for such non-routine events as hurricanes.
Securitization bonds, also known as ratepayer obligation charge bonds, typically get high credit ratings because debt service is covered by legally committed revenue streams from retail rate sur- charges. Securitization provides utilities with immediate cost recov- ery once the bonds are sold, instead of the gradual cost recovery they would see through a rate rider not tied to the bonds.
But ROC bonds traditionally have seen only limited use by utilities because of utility reluctance to remove assets from rate base. Instead, securitization has been used in recent years mostly for recovery of costs associated with major storms in the South and in Texas for stranded cost recovery tied to deregulation.
Until last week, that is, when Entergy Louisiana said it would ask the Public Service Commission for permission to securitize roughly $200 million associated with its now-sus- pended Little Gypsy-3 repowering project. The bonds would be tied to a retail rate rider whose proceeds over 10 years would be committed to paying off bondholders.
That marks what is believed to be the first use of securitization for a terminated power project, but Joseph Fichera, CEO at Saber Partners, a New York City-based financial advisory firm, said Entergy’s plan is really just another use of ROC bonds to recover stranded costs. Securitization should be used much more broadly, he said, and he cited coal-unit environmental improvements, renewable energy, smart meters, and nuclear project cost overruns as examples.
Securitization is “a powerful financing tool that can lower costs for ratepayers without harming [utility] shareholders,” Fichera said. Establishing special purpose entities to issue bonds and pay- ing them off using dedicated rate riders enables utilities to make needed investments without issuing bonds of their own, he said.
Robert Reger, a partner in New York City law firm Morgan Lewis’ business and finance practice, agreed that securitization is underutilized. “You could securitize almost anything if you made the case” that it benefits ratepayers and does not unduly harm the utility, he said.
One possible use, Reger said, would be issuing ROC bonds to enable a utility to recover extra costs of new solar generat- ing capacity. Regulators might permit the utility to finance a portion of a big solar project with its own funds, and the rest through securitization bonds. That, he said, would reduce the project’s total cost, and cut the cost to ratepayers of adding renewables to a utility’s portfolio.
Securitization “lends itself to a wide variety of uses,” but typically requires support from utilities, regulators and other interested parties — plus state legislators to enact the law need- ed to permit the sale of securitization bonds, said Terry Friddle, co-founder and principal at Charlotte-based Pathfinder Capital Advisors, an investment bank and financial advisory group.
Louisiana breaks new ground
That broad support coalesced in Louisiana, which at Entergy’s urging last year enacted Act 988. That law expanded the state’s 2005 and 2006 securitization laws to permit the use of ROC bonds to recover costs of canceled power projects, as well as other investments exceeding $350 million that the PSC determines would be appropriate for ROC bonds.
Entergy Louisiana, which already has used securitization to recover costs of four hurricanes, plans to seek PSC approval to recover the $200 million in Little Gypsy-related costs if, as expected, the commission approves the utility’s plan to cancel it, said Karen Freese, assistant general counsel at Entergy Services, a sister company.
Securitizing Little Gypsy costs would result in “substantial” savings for ratepayers because the likely 4% to 5% interest rate on the AAA-rated securitization bonds would be considerably less than the utility’s general cost of capital, Freese said. The PSC in November 2007 approved Entergy’s $1.76 billion plan to convert a natural gas-fired peaking unit in Montz, Louisiana, to a 535-MW, petroleum coke and coal-fired facility. By early 2009, however, the utility determined that a weak economy, lower natural gas prices and potential federal CO2 legislation had undermined the economic rationale for the project, and asked the PSC to let it suspend project work for three years.
The PSC agreed in May 2009. Five months later Entergy asked that the project be permanently canceled, and that the PSC permit recovery of Little Gypsy costs over five years with a rate hike (EUW, 2 Nov ‘09; 18 May ‘09, 12).
Freese said Entergy’s new plan to securitize Little Gypsy costs with 10-year bonds should cost much less, but it is too soon to know what the details of the rate rider will be.
Securitization would be a “win-win scenario” in a case such as Entergy/Little Gypsy, said Bruce Gebhardt, partner at Pathfinder, which has advised the PSC in past securitizations for Entergy storm costs. With securitization, Entergy would not earn a return on Little Gypsy costs, and the cost to ratepayers would be minimized.
Other uses for securitization are possible, Gebhardt said. For example, if a new nuclear unit were to run several billion dollars over budget, regulators might determine it would be better to remove all or most of the overruns from rate base and permit recovery with securitized bonds. That way, a utility would earn its normal ROE on the originally expected cost of the nuclear project, but not on cost overruns.
Louisiana PSC Chairman Jimmy Field supports the securitization approach because it permits utilities to recover prudently incurred costs while at the same time minimizing the cost to ratepayers.
“It’s never pleasant for a regulator to have to allow a utility to recover the costs of a canceled project” that ratepayers will never see a benefit from, Field said, referring to Entergy and Little Gypsy. He said, however, that the repowering project had been previously approved by the PSC, and changing conditions made proceeding with the project unwise.
“Then the question becomes, ‘How do you let them recover their costs?” Securitization may well be the best answer, he said. — Housley Carr
© 2011, Platts Electric Utility Week, February 21, 2011