Monday, November 20, 2017

With Prepa Filing for Title III, Privatization Looming

By on July 15, 2017

Editor’s note: This article originally appeared in the July 13, 2017, print edition of Caribbean Business.

Now that the Puerto Rico Electric Power Authority’s (Prepa) deal has been blown to smithereens and the utility is seeking Title III bankruptcy-like filing, would privatizing the utility end—once and for all—its fiscal and operational inefficiencies? That is a tall order by any measure.

Since the 1990s when privatization of public services became a global trend, dozens of governments and states have privatized or deregulated their electrical utilities, contending it would boost efficiency, reduce taxes and shrink the size of government. Privatization also gives governments a much-needed cash infusion to operate.

While privatizations of public power companies have resulted in better customer service, they have not always gone smoothly. The privatization experiences around the world often have led to higher utility rates for the general population, according to some research. As publicly owned energy plants become investor-owned, private-sector managers are reluctant to engage in practices that can help make power service affordable to the poor because of the need to protect investments. Critics of privatization, on the other hand, contend privatization has not necessarily translated into improved efficiency or eliminated corruption.

Puerto Rico has had its share of successes and failures in the area of privatization of different essential services, most of them enacted to raise funds for the government. Decades ago, the central government sold the Navieras shipping carrier, leaving the shipping of goods entirely to the private sector. Nowadays, and following the debate over the impact of U.S. maritime shipping laws on the cost of goods in Puerto Rico, some have often wondered if it was the right choice to sell Navieras because of the high cost of bringing food and other goods into Puerto Rico using private U.S. shipping companies, with the expense then passed onto consumers.

The sale of the Puerto Rico Telephone Co. in the 1990s to private interests and the increasing competition from other telephone operators have led to a reduction in prices for telephone services, which have led to better service for the population. However, that industry is also being regulated by the Telecommunications Regulatory Board.

Some say that putting the Luis Muñoz Marín International Airport under a private operator, Aerostar, has also improved the quality of services at the airport. However, almost two decades ago, the government put the Puerto Rico Aqueduct & Sewer Authority under the hands of private operators—twice. The government ended up cancelling the contract in 2004 when the then-private operator, Ondeo, had problems with the servicing and billing of customers as well as with the U.S. Environmental Protection Agency.

The current fiscal plan approved by the Financial Oversight & Management Board proposes the privatization of the Highways & Transportation Authority, the Public Buildings Authority and the Municipal Revenue Collections Center, among other entities, as part of the overall restructuring to help pay the island’s $73 billion debt.

Arguments for privatization

More recently, however, four of the seven members of the oversight board rejected Prepa’s restructuring deal, which took three years in the making and had been extended more than a dozen times, arguing that the deal would be costly for customers, both residential and businesses, and the publicly owned utility should be privatized so the funds for much-needed infrastructure improvements could be obtained.

As the Center for a New Economy (CNE), a Puerto Rican think tank, put it in a 2009 report: “Prepa’s operations are substantially less efficient than the operations of its U.S. counterparts and it underperforms in virtually every area of operation under consideration. While mainland utilities have reduced costs by shifting to natural gas, Prepa relies on outmoded oil-fired generating plants. The company also loses 12% of sales revenues to faulty billing and theft, three times the U.S. average.

“Prepa has languished under heavy administrative overhead and politicized management, which contribute to its failure to deliver reliable, cost-effective energy.

We believe that only privatization will enable Prepa to attract the investments it needs to lower costs and provide more reliable power throughout the island. By shifting from a government entity to a well-regulated private utility, Prepa can modernize its power supply, depoliticize its management, reform pensions, and renegotiate labor and other contracts to operate more efficiently,” CNE said.

Would the privatization of Prepa work? “In my experience it should not be a matter of public versus private…. It is best to have a mix because each model has its strengths and weaknesses,” said an energy consultant who wished to remain anonymous.

There are different forms of privatization that run the gamut from privatizing some services offered by the public entity, to putting the public utility under a private operator and selling it. Prepa’s former chief restructuring officer, Lisa Donahue, also proposed putting Prepa under a private operator, arguing that partisan politics were preventing needed changes at the utility, but she did not suggest selling it.

Then there is deregulation, or allowing for private competition. Technically, according to some analysts, Prepa is not a monopoly in the truest sense of the word because 15% of the island’s energy is provided by two private companies that sell energy to Prepa.

Privatization of energy in other jurisdictions: Chile

In the early 1980s, Chile became among the first countries to embrace privatization not only of energy, but also other utilities. The privatization of its energy sector was completed in the 1990s, according to published reports. There are four separate electricity grids in Chile: the Central Interconnected System, which serves the central part of the country; the Norte Grande Interconnected System, which Serves the desert mining regions in the north; and the Aysén and Magallanes systems, which serve small areas of the extreme southern part of the country.

The privatization helped bring much-needed electricity to rural areas and sparked numerous projects. Right now, almost 100% of the country’s population has reliable access to energy.

Chile ranked 40th in a list of 127 countries in the categories of energy access & security and electricity prices per industry in the 2017 Energy Architecture Performance Index of the World Economic Forum. About 18% of the country’s energy is produced from renewable and Chile expects to increase this number to 20% by 2025. The Energy Forum report, however, ranks the country 77th in its production of carbon monoxide.

The privatization of Chile’s energy sector has not been without problems. From 2000 to 2010, electricity rates rose 166%. In 2014 alone, the cost of electricity for a low-income family making $254 a month was 10% of their income. Much like in Puerto Rico, whenever there is a natural disaster, such as the 8.8.-magnitude earthquake in 2010 off the coast of central Chile, it can take months to get energy restored. However, in general, the level of power outages as well as their duration is low.

Texas

In Texas, a research paper titled, “Deregulation & Privatization: Texas Electric Power Market Evidence,” which used means testing of U.S. Energy Information Administration data from 1970 to 2011 to statistically analyze electricity prices following deregulation Texas, pre- and post-deregulation, relative to U.S. electricity prices, found higher electricity prices following deregulation.

“Relative to U.S. electricity prices, Texas electricity prices during the deregulation and privatization period (2002-2011) rose four times faster than increases in Texas electricity prices before deregulation (1970-2001). The Texas electricity market is much less efficient now as a result of deregulation. Higher relative electricity prices after deregulation are a liability for Texas residential electricity consumers and put Texas at a competitive disadvantage compared with regulated electric utility states when attempting to attract new industry and jobs,” the study stated.

The researcher wrote that during a cold weather period in January 2014, two large powerplants unexpectedly closed down because of incomplete weatherization, which resulted in the danger of rolling blackouts. As a result, Texas wholesale electricity-market prices spiked higher—from a usual $30 to $100 per megawatt-hour (MWh) to more than $4,500 per MWh.

Brazil

Brazil, which has renewed an effort to privatize its electricity sector, recently announced measures that would facilitate asset sales by state-controlled power holding firm Eletrobras. President Michel Temer’s administration wants to attract private investment because the sector has struggled financially, partly because of changes made in 2012 when the previous government administration renewed operating licenses for hydroelectric powerplants at conditions now seen as unprofitable, according to published reports.

Temer’s plan says the state-owned hydroelectric plants “tendered live in a regime of regulated tariffs,” which ends up generating more expensive energy. With the changes, the powerplants will be based on the market principles of supply and demand.

In addition, the Brazilian reform proposes that the resources obtained from competition in the electricity sector be divided equally between the National Treasury and consumers. Brazilian officials acknowledge that this would lead to a 7% increase in energy tariffs, arguing that they would be offset by reducing charges and subsidies currently paid by taxpayers.

Historically, the Brazilian energy sector has changed from private to state, and then back to private hands, with many of the state governments owning much of the energy distribution sector. When privatization was mentioned in Brazil in the 1990s, the generation and transmission sectors were running reasonably well, but it was the distribution sector that was having problems. Privatization of the power sector was seen as a solution to clear Brazil’s debt, but the country became entangled in the debate of its social obligation to provide energy and making the sale attractive to buyers. Right now, there is a mix of private and publicly owned electric companies in the country.

According to the Center for Energy Economics, before Brazil’s power sector reform, energy tariffs were cheap. Fearful that high prices would lead to inflation, reformers used contracts that progressively released the low-cost existing power to be sold at its “opportunity cost.” The effect of this policy was a continuous increase in the average tariff for consumers from 1995 to 2005, from 150 Brazilian reais per MWh to 300 Brazilian reais per MWh. The country also has an energy regulator.

Still, a recent study at the American Journal of Political Science found the public utility model has some setbacks. As a result of poor funding, public utilities can fail to meet federal public regulations, as is the case in Puerto Rico. The study also found that because private utilities prioritize their investors rather than their customers, they have little incentive to create rate structures for low-income households.

Moreover, the model’s reliance on public support can compromise its ability to make crucial infrastructure upgrades or increase rates to make them a reality. For instance, residents of a small, poor town in Fresno County, Calif., recently voted down a proposed $30 monthly increase to their water bills, even though it may mean having their water cut off.

But that is not always the case. This month, Boulder City, Colo., residents will see a slight rise in electricity costs that is part of a series of increases approved by the city for the next few years. The new rates go into effect July 1 and are the second of a four-year phased increase that began in October. The amount the electric rates will increase is $0.0043 per kilowatt-hour (kWh), which the city estimates will cost a family about $4 more a month.

The need for an energy regulator

If the island’s energy sector becomes privatized and is deregulated, there will be more need for an energy regulator.

José Román, head of the Puerto Rico Energy Commission, said the entity, which regulates the energy sector, including power rates, has the “responsibility to regulate all public and private service companies and under any kind of structure, whether with competition or as a monopoly.” Román was answering a question from Caribbean Business on what its role would be if Prepa were privatized.

Carlos Gallisá, a former consumer representative on Prepa’s board, said there is no study showing the utility’s situation will improve with privatization. However, Prepa does have a study that shows energy demand will go down by 23% in a few years, which will bring electricity rates up to 28¢ per kWh. “I talked to many technicians and all of them told me it is impossible to bring power rates down to less than 16¢,” he said, adding that he does not know how privatization can put a stop to a hike in energy rates if demand goes down.

He supports Prepa’s bankruptcy process because he said the restructuring support agreement would have been disastrous. “They should have done that a long time ago,” he said about killing the deal.

A Chronicle of Prepa’s RSA Saga

There are few things more emblematic of complexities ensnaring Puerto Rico’s debt crisis than the Puerto Rico Electric Power Authority (Prepa)—much as the island itself, the ailing public utility is bankrupt and has numerous creditor constituencies. The restructuring of Prepa’s $9 billion debt was essential for Puerto Rico because it would have provided a showcase for the art of the possible. More importantly, without sealing the restructuring support agreement (RSA) achieved in October 2016, Prepa would not be able to implement an Integrated Resource Plan (IRP) that requires access to capital for the overhaul of an obsolete and bureaucratically bloated public agency.

Time and again, the reform of Puerto Rico’s energy apparatus came to the forefront in public debate over Puerto Rico’s debt crisis—early in Gov. Alejandro García Padilla’s administration when the Energy Relief Act was passed; again, in May 2014 when the former Deputy Managing Director of the International Monetary Fund Anne Krueger pointed to exorbitant electricity costs as a categorical impediment to economic development in Puerto Rico; and later on Capitol Hill when the Prepa RSA was debated in hearing after hearing during the months prior to the passage of the Puerto Rico Oversight, Management & Economic Stability Act (Promesa) in June 2016.

Such was the importance of Prepa’s overhaul that House Natural Resources Committee Chairman Rob Bishop (R-Utah) tried to have his staff director Bill Cooper codify the Prepa deal into the law, but they found opposition from the Dems across the aisle. Then the final draft of the bill came down the pike, language stipulated that all deals done prior to Oct. 18, 2016 would qualify as prearranged protected deals heading down a path to Title VI for consensual negotiations.

The last thing Bishop expected was for the incoming administration of Gov. Ricardo Rosselló to take another crack at the deal and in so doing, toss the protections of the original deal into the trash. In one fell swoop, the Rosselló administration blew to kingdom come a deal four years in the making. Ahead are the defining moments of a Prepa RSA that cost Puerto Rico far too much—about $100 million in legal and financial fees—with far too little to show.

Here we come to save the day (May 2014)

Gov. García Padilla takes office, knowing that credit-rating agencies are bound to downgrade Puerto Rico credit to junk status. At the top of the heap in Puerto Rico’s towering debt is Prepa with a whopping $9 billion debt load. The administration sets out to transform its energy apparatus through Act 57. The bill enables the creation of the Puerto Rico Energy Commission (PREC), which is ultimately tasked as the watchdog of the people, for the people and by the people to throttle the affronts of a utility that behaved as an oligarch gone wild—forgiving public agencies their electric debt and overcharging consumers to cover those costs.

The Energy Relief Act tasked PREC with oversight of Prepa’s functions, “particularly the adoption of energy rates, energy generation and interconnection, compliance with the renewable portfolio standard adopted by Act 82-2010.”

Forbear with me (August 2014)

Led by former Chief Restructuring Officer (CRO) for the U.S. Treasury Jim Millstein, consulting firm FTI and Cleary Gottlieb, Prepa strikes a forbearance agreement with its creditors on debt payment of some $671 million, which was due in August 2014. The deal includes the Ad Hoc creditors, which hold some 40% of Prepa debt, fuel line lenders and bond insurance companies Assured, MBIA’s National and Syncora. The forbearance agreement stipulates the need to hire a CRO to oversee Prepa’s financial and operational overhaul.

In Lisa we trust (September 2014)

Prepa’s governing board appoints Lisa Donahue as CRO in September 2014. The newly appointed official is tasked with overseeing negotiations with the utility’s various creditor constituencies to achieve a sustainable debt-restructuring plan and overhaul the utility. Her first task is to look deep into the entrails of Puerto Rico’s energy beast to draft a five-year business plan by December 2014.

‘Si no me dan de beber, lloro’ (December 2014)

Puerto Rico’s never-ending Navidades arrive and Donahue fails to deliver the business plan because, say some sources with knowledge of negotiations—“there was not enough time granted for the due diligence to put together a solid plan.” Instead, Donahue presents a document that lays out Prepa’s status quo; the disclosure of what could best be described as worst practices is intended to open the eyes of creditors, but fails to impress. Creditors insist on a concrete five-year plan, which Donahue calls a work in progress that will have to wait until March 2015 because an incomplete plan could affect the price of Prepa bonds. Suffice it to say that Prepa bonds did not rally.

Speak softly and carry a big PREC (February 2015)

PREC issues a Feb. 12 order for the establishment of a new rate structure to be delivered for review in July 2015. The Puerto Rico Energy Relief & Transformation Act of 2014 stipulates that the new rates should be in place by mid-July, but will be in effect by mid-September. A tiny nagging impediment in the process, legislation demanding that “the commission shall guarantee that the approved rate will be sufficient to guarantee payment of principal and interest on bonds and other financial obligations,” is a harbinger of doom in negotiations that will manifest itself two years down the road.

I will gladly pay you Tuesday for a utility today (April 2015)

The Prepa Ad Hoc bondholders, composed of investors represented by Oppenheimer Funds, Franklin Templeton and Blue Mountain Capital, make a $2 billion offer to help finance Prepa’s first phase of converting its powerplants from oil to combined cycles using natural gas. Prepa rejects the offer calling it premature and insufficient, based on AlixPartners’ calculations that the utility’s overhaul would cost $4 billion. The offer comes on the heels of a 15-day extension of the forbearance agreement, which was scheduled to expire March 31. In those days, sources close to the negotiations admit it is likely Donahue’s restructuring brigades and Prepa’s creditors would be living “from extension to extension.” How self-prophetic.

An offer you just cannot refuse (May 2015)

Puerto Rico New Generation Partners (PRNGP), a consortium composed of York Capital Management, Transmission giant ITC and NRG Energy, a leading power generation company, make a $3.5 billion offer to overhaul Prepa’s infrastructure. PRNGP proposes to enter into a 30-year power-purchase agreement with Prepa, backed by the Government Development Bank (GDB). Replacing Prepa’s antiquated inefficient oil-fired fleet with state-of-the-art combined-cycle gas-fired units and utility-scale solar units would save the state-owned energy company up to $1.52 billion annually. Prepa rejects the deal as it pushed forward with preparation of its five-year plan that would include requests for proposal (RFP) for competing offers.

The woman with a plan (June 2015)

Donahue makes Prepa’s business plan public in June 2015. The plan details a 15-year capital improvement program of the utility’s powerplants. The report proposed repowering Units 5 and 6 at the Costa Sur powerplant and using diesel fuel for Units 1, 2 and 3 at the Palo Seco powerplant instead of the immediate construction of a natural gas powerplant at Aguirre and Costa Sur.

My name is Bond—Mirror Bond (November 2015)

Donahue’s brigades at AlixPartners strike a restructuring support agreement (RSA) with creditors on Nov. 5, 2015. The deal brings into the fold the Ad Hoc bondholders holding nearly 40% of Prepa bonds, fuel line lenders and the GDB; those holding out include bond insurance companies Assured, MBIA’s National and Syncora, who have billions in Prepa exposure. The RSA contemplates a transition charge to securitize bonds through a special-purpose vehicle that will allow some bondholders to exchange their credits for new bonds at a 15% haircut. The new bonds, however, require an investment-grade rating from the credit-rating agencies. Tough sledding ahead.

Safe to go back in the water? (November 2015)

In testimony before the Puerto Rico Legislature on Nov. 11, Donahue explains how the extensions on the original forbearance agreement that took place through November 2015 had saved the utility $1.3 billion in liquidity relief. She makes an urgent plea for passing the Prepa Revitalization Act, which includes amendments to wrest control of RFPs from PREC. The amendments receive staunch opposition from then-Senate President Eduardo Bhatia, who insists on keeping PREC’s Good Housekeeping seal of approval on all things Prepa.

A deal they cannot refuse (June 2016)

In the run-up to passing Promesa, Rep. Bishop is intensely lobbied by hedge funds, bond insurance companies and other creditors holding Prepa debt to codify the Prepa RSA into the law. Bishop’s Staff Director Cooper attempts to codify the deal into the law with language that would have made the Prepa RSA automatic once Promesa was signed into law by President Obama, but he meets stiff opposition from Dems. When the final bill comes down the pike, the language merely contemplates that all deals signed prior to Oct. 18, 2016 conform as prearranged deals qualifying to enter Title VI for consensual negotiation. What Bishop did not foresee was that a new administration may take another crack at the deal, rendering the old deal null and void.

The monolines join the party (July 2016)

After more than two years and 18 extensions on a forbearance agreement that included relending some $215 million and maturities extended, monocline bond insurance companies Assured, MBIA’s National and Syncora join the Prepa RSA, thus bringing nearly 70% of the utility’s creditors into the fold.

The second coming of Macri (October 2016)

Before the 2016 election, gubernatorial candidate Rosselló pipes in live via Skype during a conference on Puerto Rico debt hosted by the Association of Financial Guaranty Institutions. Heavy hitters in the audience include the CEOs of monoline bond insurance companies, fund managers and financial news outlets. The general impression of those in attendance is that Rosselló could become the poster child for the creditor community. The upstart candidate promises to produce audited financial statements within months of taking office and payment of debt as it comes due—music to their ears.

A last hurrah (February 2017)

The moment the Rosselló administration made public that the Fiscal Agency & Financial Advisory Authority and the government’s lead financial adviser Rothschild & Co. would lead negotiations with Prepa bondholders, observers knew that AlixPartners was finished in its role of leading the utility’s restructuring process. That exit was put on a faster track than expected when a Feb. 1 letter of resignation signed by Prepa CRO Donahue established that the firm she leads would not be submitting a contract extension proposal. Prepa, according to a source, is expected to be run by a full-time CRO with the help of smaller consulting firms that will help out in the operations.

Putting a Denton in the deal (March 2017)

With only months at the helm of Puerto Rico’s government, Rosselló commences to sound the voice of alarm over the potential impact of debt restructuring on essential services—a scenario that he claims to avert at all costs. His concerns over the potential for crushing electricity rates contained in the Prepa RSA are addressed by advisers at Dentons, who take another crack at the Prepa deal to achieve a more stable rate structure in the securitization of a bond exchange mechanism and achieve greater liquidity. Although the Rosselló administration claimed to have achieved a better deal for Puerto Rico, those close to the negotiations know that as it was structured, Puerto Rico was exposed to potentially crushing electricity costs down the road if oil prices spiked and the consumer base continued to shrink.

We can’t go for that—no can do (June 2017)

With a June 29 deadline for certification of the Prepa RSA fast approaching and no movement in the Financial Oversight & Management Board’s (FOMB) bullpen, Republicans on the Hill begin to get antsy. The first sign of the board’s reluctance to certify came in veiled statements by FOMB Executive Director Natalie Jaresko during board hearings held at El Conquistador Resort in Fajardo. As word of the board’s resistance grows—Andrew Biggs, David Skeel, Ana Matosantos and Arthur González were particularly vocal—Republican leadership sounds the alarm in a missive from Bishop that fails to persuade the FOMB. Just before the stroke of midnight on June 27, the board makes public its refusal to certify the Prepa RSA under Title VI of Promesa. The utility’s debt is filed under Title III for bankruptcy proceedings. All told, Prepa’s negotiations cost Puerto Rico about $100 million.

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