LUMA Enters Power Utility T&D Gauntlet
Appetite for Generation Assets to be Gauged in Coming RFQ Phase
SAN JUAN — Although the mission to transform the Puerto Rico Electric Power Authority (Prepa)—a poster child for inefficient utilities that is strapped with $9 billion in debt and another $8 billion in pension liabilities—is seemingly in a first stage with the signing of a contract with LUMA Energy LLC, there are yet many kinks to iron out.
At face value, the deal tasks LUMA—a 50 percent owned joint venture created by Canadian Utilities, an ATCO company, and 50 percent owned by Quanta Services, an infrastructure project execution company, in conjunction with Innovative Emergency Management Inc. (IEM)—with the operation and management (O&M) of Prepa’s transmission and distribution (T&D) system under a division of the utility called GridCo. The utility’s 2020 fiscal plan explains that “Puerto Rico’s government established a legal framework requiring the unbundling and separation of T&D operations from generation operations, thereby prohibiting the continuation of PREPA’s existing vertically integrated monopoly structure.” Drafting a term sheet and contract to operate and manage T&D was an exercise steeped in hardship 18 months in the making.
“We knew it was going to be challenging coming in. We knew we were in Title III [section of the Puerto Rico Oversight, Management, and Economic Stability Act (Promesa) that covers court-supervised restructurings],” explained the executive director of the Puerto Rico Public-Private Partnerships Authority (P3A), Fermín Fontanés, who during a wide-ranging interview with Caribbean Business that was also attended by LUMA CEO Wayne Stensby, ATCO CEO Siegfried W. Kiefer and Quanta Services CEO Duke Austin Jr.
“We knew that the system needed a lot more investment and that this was not going to be an easy process along the way. We were goal oriented and we really wanted to take this across the finish line because we felt it was a one-shot deal,” Fontanés said.
The deal took place against the backdrop of Prepa’s efforts to finalize a restructuring support agreement (RSA) that includes a bond exchange program with the utility’s creditors. At this writing, approximately 90 percent of uninsured bondholders and all of Prepa’s monoline bond insurers are on board the RSA, with 10 percent—mostly smaller creditors—still holding out. However, talks among the parties had been put on hold due to the Covid-19 pandemic.
“I think that the RSA conversations are going to move into 2021 because we have to take another look at the macroeconomic numbers post-Covid,” one Prepa adviser with knowledge of both the T&D management contract and the separate RSA negotiations told Caribbean Business.
Prepa put together presentations for the proponents as to what the management team identified as the power corporation’s deficiencies and strongpoints as pertained to what the utility needed. After those presentations, Prepa came up with a draft term sheet and a draft contract. Two of the four remaining proponents dropped out in the request for proposal (RFP) stage.
“Being able to exit Title III is seen as a difficult issue to navigate,” the P3A’s Fontanés explained. “We needed to make certain that everything we set out to do would comply with federal requirements to avail ourselves with the largest amount of federal funding available. Although it is a competitive process, it is a collaborative process with the proponents.”
The P3A chief explained that it took a data room with some 18,000 documents and more than 141 megabytes of information that the proponents had to review.
Significantly, the deal also brought on board the funding experience of IEM, which is tasked with managing a huge windfall in federal funding without which the deal would not have been possible.
“Although IEM was subcontracted by the incoming consortium, think of the company as a representative for Prepa in the administration of these FEMA [Federal Emergency Management Agency] funds,” the Prepa adviser said. “You are talking somewhere between $6 [billion] to $10 billion from FEMA funds. If they are 428 funds, they are for transmission and distribution.
“Section 428 clearly states that you can be flexible with funds as long as you are under budget. For example, if you are going to spend $100 million on 10 substations and you only spend $50 million, you can use the other $50 million for another project during the process. Now, if you spend $150 million on those 10 substations, Prepa is on the hook for the $50 million that are over budget.
“Remember that generation assets have disaster insurance. In the aftermath of Hurricane Maria this historic assignment is for T&D. Some $3 [billion] to $4 billion in Section 404 funds are for generation, T&D and customer service, but it is at the discretion of the governor to solicit those funds for different projects that can strengthen the electric system without having necessarily to do with transmission and distribution.”
The source added that without the federal funds and the ATCO construction projects in the LUMA deal, Prepa would have to take the money from its own operating costs, which are covered by the rates. “For us to cover the capital expenditure for improvements to the electric grid, it would be impossible not to hike rates,” the source told Caribbean Business. “For instance, Prepa pays $3 [million] to $5 million a month in capital improvement. In the case of what is being proposed—where you have federal funds and we start to build the projects that are in the pipeline, we are going to be spending $5 million a day. We are talking about $1.5 billion in expenditures over the first 48 months.”
The source put the math in these relatable terms: “Prepa’s capital improvement fund is $200 million and, of that, some $100 million is for T&D. Those are operational and maintenance projects, there are no capital improvements. 1 cent per kilowatt-hour [kWh] equals $170 million in costs. So, with the savings in construction you are talking about a bit less than 2 cents per kWh. Construction will help fund about $300 [million] to $350 million. You would have to raise the rates by 6 [cents] to 7 cents to fund the construction works.”
Talkin’ ’Bout My Generation
It is not lost on any of the energy experts negotiating Prepa’s overhaul that ATCO possesses significant expertise in the transmission and distribution of natural gas, a key component to square the numbers in Prepa’s generation equation.
The question is “whether ATCO has identified opportunities on a generation side that has seen no appetite from investors for the generation assets under GenCo.”
“Yes, we have,” ATCO’s Kiefer told Caribbean Business. “One of the things that attracts us to the region is that there will be the opportunity for ATCO to deploy some of its broader skills in the energy space over time, while LUMA is focused on T&D operations. We will be setting up a separate office as well as looking for other opportunities to deploy our skills.”
Just last month, the Title III court certified Prepa’s deal with Naturgy (former Gas Natural Fenosa) to supply natural gas for power plants EcoEléctrica and Costa Sur, which was devastated by earthquakes at the beginning of the year. That latter facility is being rebuilt and fortified. The work on Unit Five will be complete by mid-August and the work on Unit Six is projected to be final by mid to late October, one source who is working at the facility told Caribbean Business. This is important because Prepa will achieve $180 million in savings from the Naturgy deal while keeping rates from hitting the stratosphere.
An Institute for Energy Economics and Financial Analysis (IEEFA) report found that New Fortress Energy didn’t seek Federal Energy Regulatory Commission (FERC) approval to build and operate a liquid natural gas terminal (LNG) in a $1.5 billion deal “plagued by irregularities that provided unfair advantage” to convert the diesel-fired San Juan power stations.
Prepa understands that FERC does not have jurisdiction over that asset. “Those units are almost complete and now FERC comes into the picture and claims it has jurisdiction,” the Prepa adviser told Caribbean Business. “So, now New Fortress has 30 days to show why that project does not have to be under FERC jurisdiction. In the worst-case scenario, if they prove to have jurisdiction, there is a process involved.
The advice that we have been given is that the FERC written permit is not required. My impression is that New Fortress found language in the Natural Gas Act that gave them the confidence that they did not need the FERC written permit to start building the terminals.”
Stensby seemed unconcerned with the FERC issues hovering over New Fortress as he stated: “Well, the work that New Fortress is doing is quite separate from the work that we have been brought in to do. We at LUMA and our partners on this—ATCO and IEM—are really focused on the LUMA opportunity and so, we really don’t have a view on the New Fortress issues with FERC. We really focused on getting this transition done and engaging the Prepa employees.”
At this writing, LUMA is in a 12-month transition phase doing planning and organizational development, recruitment and getting ready to operate and manage the Prepa grid.
“After that transition period, that is really when we become responsible for management of the transmission and distribution, LUMA’s Stensby said. “At that point, Prepa is no longer responsible. We have commenced recruiting personnel over this period of time. We will be responsible for customers. So we will rebrand the business that way. We have the responsibility for connecting new customers with our people, our trucks and our crews.”
Quanta, the specialty contractor that is a part of the LUMA consortium, “is on board and much needed federal funding will be obtained through IEM, a company the expertise of which is to facilitate and tap into and help administrate what is likely to be a huge financial windfall,” the CEO said.
“LUMA will be responsible for prioritization and effective execution of all capital improvements. We will be responsible for going to the Puerto Rico Energy Bureau [the island’s energy regulator] on all of our rate applications on all of our budgets, on everything that a conventional utility would go to a regulator,” Stensby added. “We will handle all of that but the generation is staying with Prepa. In addition, we will have a system control center, and as we work through the evolving of the integrated resource plan (IRP), there will be a pressing procurement process to attract new generation into the system as required.”
Prepa will pay LUMA $60 million for the first year of the transition. From that point on, the contract fluctuates between $105 million and $125 million annually across 15 years; the ceiling on what they can be paid is $130 million.
Prepa is in the process of preparing the request for quotation (RFQ) process for the management contract of the GenCo side. Sources close to the process tell Caribbean Business it is not yet clear whether Prepa assets will be managed separately or in one fell swoop. What is known is that federal funding will once again play a big part in the equation.
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