The Bond Buyer

While the California Public Utilities Commission‘s proposed plan to set rates that would back up to $13.4 billion in power bonds is a step in the right direction, many legal questions must still be answered before any debt can be sold, market participants said.

The PUC last week said it would set two separate charges on a customer’s utility bill that would pay operating costs incurred by the state’s Department of Water Resources in its power-buying operations and pay debt service costs on the power bonds to be issued by the DWR.

While Gov. Gray Davis praised the proposal, seen as a major step in ending a standoff between the governor and the PUC over how to secure the debt, rating analysts and others warned that the agreement may not go far enough to win sufficient ratings for the bonds to be sold.

While the PUC agreed to set rates at levels sufficient to cover debt service and adjust those rates within four months after the DWR notifies the commission of a draw on reserves or if funds are drawn to pay operational costs, some analysts questioned the strength of such a commitment.

“What it comes down to is, is this an unalterable covenant in which there’s no wiggle room on the part of the PUC? Or, are there situations where the PUC could fail to act, or take more time, which could impair the bonds?” asked Joseph Fichera, chief executive of Saber Partners, an advisory firm and former adviser to Davis. “What if they fail to act? What are the remedies? Is it just ‘so sue me?’ ”

To compensate for any perceived risk that the PUC may not act promptly, investors may ask for larger debt service reserves before they will buy the bonds, he said. Additionally, any action taken by the PUC will likely be subject to appeals, though charges may be collected subject to refunds.

Other bond deals have overcome similar concerns about delayed setting of rates by including a “trigger” mechanism that would automatically adjust rates, he said.

To satisfy holders of long-term energy contracts with the state, who under the original legislation authorizing the bond sale had first dibs on rate revenue, the PUC says power purchased under the contracts can be paid with revenue collected under the bond charge but not yet deposited into the debt service account. Sufficient reserves will be built in, so that would be a rare event, sources familiar with the deal said.

The bond deal has been delayed for months because the PUC has balked at allowing the DWR to dictate what rates need to be charged to pay off the bonds and buy power under the long-term power contracts negotiated by the state. The commission has indicated it would like to see those contracts renegotiated because they commit ratepayers to pay top dollar for power. At the same time, sources say investors won’t buy the bonds if the debt service is subject PUC regulations in the same manner that other rate requests are.

The question of how fast the PUC would raise rates in response to a request from DWR to do so is also a major concern to rating agencies.

“It has to be an ironclad agreement for the PUC to act by a given period of time to raise rates to pay bondholders as needed,” said Dave Hitchcock, director at Standard & Poor’s. “We’re going to have to look at this with our legal counsel with a fine-tooth comb. It does not appear absolutely clear that’s the case.”

Needing lawyers to take a look at it is the wrong thing to hear, according to Fichera. It leaves open the possibility that after the PUC votes on the rate agreement, credit analysts could deny an investment-grade rating and restart the process.

“The PUC seems to be just shooting for a barely investment-grade rating,” he said. “They’re not trying to make it the lowest cost to ratepayers.”

Basically, the more discretion the PUC has, the higher the cost to ratepayers.

Consumer advocates see it very differently. They say the rate agreement hands over too much control of rates to DWR.

“While the importance of oversight of the energy system becomes more evident each day, the PUC has proposed to hand over scrutiny of electricity rates to an unaccountable agency,” said Doug Heller, an advocate with the Foundation for Taxpayer and Consumer Rights.

The state was accused last year of hiring people with conflicts of interest to negotiate the very expensive long-term contracts.

While the rate agreement is important to rating the bonds, other factors such as the deal’s structure and eventual role of the PUC will also be considered, said Donna DiDonato, a director at Fitch Ratings.

“Investors want things as predictable as possible,” she said. “Any uncertainty or options is very much a concern.”

Rating analysts from at least two agencies plan to meet with the state and PUC next week to get questions answered.

“It’s a good start, with everyone on the same page,” said Dan Aschenbach, senior vice president at Moody’s Investors Service. The bond covenants discussed provide some sort of a timeline on when the PUC would act to revise rates if needed. But he said the financing documents expected to be released before the PUC takes action will be key in determining what reserves are established and what debt service coverage will be.

While welcoming the progress, many steps remain before bonds can be marketed, said state Treasurer Phil Angelides. The PUC must adopt the rate agreement, set for its Feb. 21 meeting, and amend servicing agreements with the utilities concerning sending funds to DWR in two streams. The commission also has yet to cover DWR’s revenue need for the first year of power purchases. The final financing structure must be legally validated and court challenges must be satisfactorily resolved, he said.

California officials and market participants now speculate the bonds won’t be issued before the second half of this year, which would not be soon enough to reimburse the state in this fiscal year for power purchases made last year during the energy crisis. A minimum of about $11 billion in bonds must be sold to repay the general fund and DWR’s bridge loans. California’s current budget plans assume the bonds will sold and the state reimbursed.