Muni Credit News June 28, 2016

Joseph Krist

Municipal Credit Consultant

DOES NEW NUCLEAR MAKE SENSE FOR MUNIS?

The pending sale of debt by the South Carolina Public Service Authority presents us with an opportunity to update the market for nuclear power in the U.S. SCPSA and MEAG are the two municipal utilities with ownership interests in new nuclear generation facilities under construction.

Questions arise as the result of recent news regarding the early closure of operating nuclear facilities due to the unprofitable operating results they generate. Much of the unfavorable cost comparisons are the result of the shale revolution in the US. With natural gas prices so low and supplies so abundant, nuclear just does not compare favorably on a cost basis with natural gas.

In late May it was announced that Exelon’s Quad Cities and Three Mile Island nuclear plants have failed to clear the PJM capacity auction for the 2019–2020 planning year and would not receive capacity revenue for the period. That announcement followed Exelon’s announcement that it would retire its Quad Cities and Clinton nuclear plants if wide-ranging energy legislation to save the two plants and boost solar development was not passed during the spring Illinois legislative session that was scheduled to end on May 31. The legislation failed. The company has said that both the Quad Cities and Clinton plants have lost a combined $800 million over the past seven years, even though they are two of Exelon’s highest-performing plants.

Entergy plans to close its 852-MW FitzPatrick reactor in New York state in January 2017. Exelon last year announced it would shutter its Oyster Creek plant in New Jersey in 2019, about 10 years before its current operating license ends, to avoid costs associated with the Environmental Protection Agency’s cooling water rule. Entergy’s 677-MW Pilgrim reactor in Massachusetts will also be closed in 2019, owing to market conditions. Omaha Public Power District voted unanimously on June 16 to close Fort Calhoun Station, the smallest nuclear power plant in the U.S. OPPD is a municipal utility and municipals at one time owned pieces of FitzPatrick and Pilgrim.  Diablo Canyon, the two-reactor nuclear power plant on the central California coastline, will be permanently shuttered by 2025 under a renewables-boosting initiative announced this week by its owner, Pacific Gas and Electric (PG&E).

Fort Calhoun becomes the twelfth U.S. nuclear unit to close or announce plans to close since October 2012. Many of the plants have been small, single-unit facilities facing economic difficulties similar to Fort Calhoun. But the Quad Cities station, an 1,871-MW dual-unit facility in Illinois, demonstrates that current market prices—driven low by the abundance of natural gas in the U.S.—can affect any size nuclear plant. Electricity supplied by the Fort Calhoun plant cost more than $71/MWh in 2015. The cost is substantially higher than the roughly $20/MWh that OPPD can buy and sell power for on the open market.

So in this environment it is fair to question why the two Southeastern utilities are investing in new nuclear. With so many renewable choices and the regulatory tide steadily tilting away from large scale thermal generation, are these two agencies spitting into the wind? For SCPSA, the issue is complicated by construction delays until the 2019-2020 timeframe (two to three years of delay) and its associated costs. Construction is taking place during a period of declining revenue for the Authority which actually exceeds the decline in its operating expenses. That trend continues through the first quarter of 2016.

All of this suggests a credit on the decline. The downward slope is not steep but it does seem to be increasingly steady. Should we ever get back to a market where rates are higher and spread matters more, we think that the Authority’s debt will likely be an underperforming investment. Nuclear isn’t about politics anymore like it was in the late 20th century, it’s about markets and competitiveness now.

KANSAS SCHOOL FINANCE PLAN MOVES FORWARD

Many have commented on the usefulness of deadlines as a way to focus attention and force solutions. One example of that phenomenon occurred when a special session of the Kansas Legislature ended Friday night with lawmakers passing a school finance bill to avoid a shutdown of the state’s schools next week. The Senate voted 38-1 to approve the bill with only 15 minutes of debate following the House’s passage of the bill, 116-6.

Kansas is in the middle of a process of responding to a lawsuit filed by four school districts, and legislators were fashioning a one-year funding fix ahead of a potentially more contentious legal and political battle over schools next year. The immediate issue was complying with the Supreme Court’s mandate to make the distribution of state aid fairer to poor school districts.

The vote followed action against an earlier school finance plan in favor of another proposal that won’t cut money from every school district in the state. The plan boosts aid to poor school districts by $38 million, just as a previous plan from Republican leaders did. It redistributes some funds from wealthier districts to meet a Kansas Supreme Court mandate to make the education funding system fairer to poor districts. For example, The Kansas City, Kan., school district would end up gaining about $2.6 million in funding, while the three large suburban Johnson County school districts would still lose money, but less than the previous plan.

It does not rely as heavily on reshuffling of existing education dollars as prior plans, however the bill does take money from the planned sale of assets of the Kansas Bioscience Authority to cover $13 million of the aid to poor schools. The authority was set up a decade ago to nurture bioscience businesses. If the sale doesn’t cover that cost, money will be taken from the state’s K-12 extraordinary needs fund. The bill also  uses  motor vehicle fees and a portion of  the state’s share of the national legal settlement with tobacco companies in the 1990s.

The lawyer for the districts whose lawsuit led to the Supreme Court order, said he supported the new legislation. The plaintiff districts will now submit a brief to the court, saying they consider the equity portion of the lawsuit satisfied with this bill. That would effectively guarantee that schools will stay open in August. The Court had suggested in its recent ruling that schools might not be able to reopen after June 30 if lawmakers didn’t make further changes. Many have programs, serve meals to poor children and provide services to special education students during the summer.

The court is considering separately whether Kansas spends enough overall on its schools — and could rule by early next year. Meanwhile senators debated a constitutional amendment to keep the state’s Supreme Court from putting them in this position again. The amendment failed by one vote.

LOUISIANA

A three week second special legislative session of 2016 closed after three weeks with lawmakers raising only $263 million during the special session  less than half of what the governor sought. They set aside no money for a projected $200 million budget deficit in the 2016 fiscal year that ends Thursday. That shortfall was caused by a drop in corporate tax collections due either to the economy being in recession, to an excessive number of corporate tax giveaways, or both. State officials must eliminate any deficit in the upcoming fiscal year, which begins July 1. The second special session was the longest stretch in the history of the Louisiana Legislature.

Lawmakers — reflecting the rigid ideology of House Republicans — also delayed to next year a total overhaul of the tax system by rejecting interim tax reform measures backed by independent economists on a special task force studying the state’s tax and spending policies. State finances are challenged due to temporary taxes imposed by lawmakers in 2015 and earlier this year that will fall off in 2018. Those revenues total $1.1 billion, according to the state Division of Administration.

There is a significant block of  anti-tax lawmakers who will be asked to support a proposed reform that likely would eliminate tax loopholes, lower tax rates and raise enough money to end the chronic budget shortfalls that Louisiana has experienced since early in former Gov. Jindal’s administration. The governor’s position is that he inherited a $900 million shortfall that had to be plugged immediately, as well as a billion-dollar shortfall for the upcoming fiscal year that he also had to fill.

The recent process included an effort to raise $88 million more by ending the provision that allows taxpayers to deduct their previous year’s state and local tax payments on the  middle-income taxpayers, although studies show that taxpayers who earn over $100,000 would shoulder 75 percent of the cost.

One expected area of contention is the Taylor Opportunity Program for Students scholarships. Because of the overall funding shortfall, parents will now have to pick up 30 percent of the cost of tuition for students receiving the scholarships. That means the average student will have to pay $1,500 in tuition to make up the difference.

EDGING TOWARDS THE CLIFF

Sen. Robert Menendez (D-N.J.), one of the leading opponents of Promesa as passed by the U.S. House critics, has prepared amendments that he says he will try to attach even if it means passing the debt-relief package after July 1, when the commonwealth faces a $2 billion debt payment. Amending the bill would require sending it back to the House of Representatives for approval, yet the House is adjourned until July 5.Though Menendez is a member of the minority party, he could place a hold on the bill, which the Senate leadership would need 60 votes to break. He declined to say whether he would use that parliamentary maneuver, though he didn’t rule it out.

He will propose that the island’s government and agencies be able to restructure their debt without a supermajority vote of approval by a federally appointed oversight board that the legislation will set up. He also wants to add two seats to the board to be nominated and approved by Puerto Rico’s governor and senate. And he or another Democrat will propose eliminating overtime and minimum wage provisions.

Menendez has been at the leading edge of efforts to weaken the board and eliminate the minimum wage and overtime portions of the bill. Delaying passage of the bill past July 1 may play into the hands of some creditors, who could file an emergency injunction to prevent Puerto Rico from spending money on anything other than its debt if no stay is passed before then. That fear has been expressed by the U.S. Treasury. Parliamentary maneuvers could force cloture, or a limit to debate, which could force a vote in the Senate by Thursday. The House is out of session until July 5, so the Senate will have to pass the House bill unchanged for it to head to the president’s desk for his signature before the Friday deadline.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

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