Nov 11 2009
As Chair of the Energy and Technology Committee, part of my job is to make sure my colleagues on the council understand the complexities and policy implications of rate decisions. You may find the internal document I prepared for my colleagues interesting:
RE: Options to address City Light’s financial distress
The Budget Committee is reviewing two different proposals/strategies for your consideration. Both proposals are in response to the Mayor’s rate proposal, which was intended to address City Light’s poor financial performance ahead of a needed $200 million bond sale in early 2010. While these different proposals may contain different rates, each approach is intended to achieve the same core purpose of providing the necessary resources to the utility such that it can remain one of the most reliable and environmentally sustainable power systems in the country.
The Mayor’s Proposal. On September 25, 2009, the Mayor proposed a rate increase of 8.8% for 2010 which, given the Mayor’s budget and assumptions about wholesale revenue in 2010, will give the utility a debt service coverage (“DSC”) of 1.6. This proposal anticipates, but does not include, an increase of 5.4% for 2011 and 6.6% for 2012, which together will bring the DSC up to 1.8. In order to address the potential shortfall of wholesale revenue, the Mayor proposed a Power Rate Adjustment Mechanism (“PRAM”) that would increase rates between 8% and 15% to compensate City Light for any shortfall. If the PRAM were adopted, the first potential increase would not occur until May, 2010.
The Rates Advisory Committee (RAC) Recommendation. 7-8% rate increase. No PRAM for 2010. It wanted more time to consider rate proposal and would like to see stronger linkage between budget setting and rates.
Proposal A. 7.9% rate increase achieved by reducing O&M by $4.8 million. This preserves the DSC of 1.6. No cuts to Mayor’s proposed conservation budget but does not restore $1 million in cuts already assumed in the proposed budget. Revise financial policies to achieve debt service coverage of 1.7 in 2011 and 1.8 in 2012. Also:
- A. A resolution stating that that the financial policies are revised to reflect the worst recession in 70+ years and the effect it has had on wholesale.
- B. Require the Executive to submit a 2-year rate proposal by January 31, 2010 designed to achieve financial policies. If this is not accomplished, the Council will do so. A rate case under review by the Council should be viewed favorably by lenders.
- C. A resolution stating that the Council will study the PRAM and/or the development of a larger reserve in 2010.
Proposal B. 13.8% rate increase. This approach will restore approximately $1 million in conservation cuts that the Mayor proposed. Coupled with approximately $5.2 million in O&M cuts, this achieves a 1.8 debt service coverage ratio in 2010. That may better position the utility for the bond market. It partially front loads the assumed 5.4% rate increase for 2011 allowing a smaller increase then to maintain the 1.8 DSC. It is unclear at this time if any rate increase would be necessary in 2012 if the Council chooses to fix the long-term DSC at 1.8. This approach may also assist the utility in implementing a plan to achieve higher cash reserves to address its wholesale volatility.
Other Factors: City Light is currently rated AA- by Standard and Poor. The Utilities revised financial policies and assumed lighter dependency on market purchases contributed to this higher rating. However, its debt service coverage ratio is currently 1.3, significantly below the 2.0 ratio contained in the financial. In essence, the utility strayed from its financial moorings. A downgrade may occur in all of the scenarios outlined above, but it is advisable to take reasonable precautionary action to preserve its current rating.
However, the following observations should be made:
- • According to Standard and Poor’s utility ratings, from 2001 to 2008 City Light’s rating was either A or A+ and the utility has only been rated AA- for the last 12 months.
- • With respect to all U.S. Electric and Gas Utility Ratings, in 2006, only 3% were “AA.” 28% were “A” and 54% were “BBB”. Similarly, in 2007, 34% were “A” and 56% were “BBB”. Only 3% were “AA”. Similarly, in 2008, 33% were “A” and 58% were “BBB.” Only 3% were “AA”.
Notwithstanding these facts, a higher bond rating will provide a significant advantage to the utility in terms of borrowing new money and refinancing outstanding debt. A higher rate now increases the utility’s ability to pay back debt.