Joseph Krist

Publisher

ENVIRONMENTAL RIGHTS ON THE NYS BALLOT

This year, New York State voters are being asked to approve amendments to the State Constitution.  One proposed amendment is fairly simple – “Each person shall have a right to clean air and water, and a healthful environment.” That’s it. No enabling language, no guide as to what satisfies that right, who is responsible for it, or what constitutes compliance. Should this pass all of the required voter tests, exactly what would this mean for virtually all issuers as there is really no aspect of life that is not touched in some form by government?

A recent editorial in the Syracuse Post-Standard asked some simple but good questions. “Could a private citizen sue a private company over emissions that are permitted under federal and state regulations? Could a county government be sued over combined sewage overflows, and be ordered to spend billions to upgrade sewer systems? Could citizens use the “Green Amendment” to stop “green” developments like solar and wind farms?”

The idea seems to be that the goals of amendment supporters cannot be implemented legislatively. Right now, that is not a serious argument as the State Legislature is currently facing veto-proof supermajorities. From that perspective, it is fair to ask why isn’t this accomplished legislatively? Putting issues to a vote of the people has become an escape valve for unwilling legislators to avoid dealing with contentious issues. Putting them in the hands of the judicial branch is an often drawn out and inefficient method of creating policy.

The simplicity of the proposal will attract people since it’s hard to be against a clean environment. Without any guidance as to which and how various entities would be “responsible” for whatever remedial or compensatory actions might be required, the amendment serves as a dangerous source of operating uncertainty for governments at all levels throughout the State. A potential liability cloud would be likely to emerge. 

As the climate change debate unfolds, the issues of cost, economic impact, environmental impact and legal impact will create challenges and contradictions as the various aspects of competing visions for dealing with climate change become clear. The real costs of much of what passes for progressive infrastructure policy have always been both underestimated and somewhat hidden. The inability to deal with the economic realities of the cost of adapting to climate change has long been a hurdle to implementation. That’s why proponents look to initiatives or referenda to try to impose top-down solutions. It’s why they often don’t advance the cause very far.

It matters because the conflicts are already emerging. Fishing issues complicate over offshore wind and ocean turbine generation. Is one technology more or less fish friendly? Where can it be located? Coastal and island residents have issues with the sight of wind turbines offshore while some inland rural residents object to solar installations on “aesthetic grounds” (yeah, the view). In both cases, “environmentalists” are against renewable energy?! In Maine, a transmission line built to deliver hydroelectric power is being challenged at the ballot on November 2 by environmentally motivated voters.

That is why it takes more than 15 words to make a difference.

PANDEMIC MASS TRANSIT

One of the sectors receiving a lot of concern is the mass transit space. Big city municipal mass transit entities across the country were among the hardest hit credits in the face of pandemic-induced restrictions on life and the economy. The majority of the concern comes from the issue of how permanent lost patronage will be. The systems are essentially demand driven entities and they are emerging from the pandemic with structures and operations which may or may not fit real time realities.

That covers the demand factor in the credit equation. Now, it is becoming clear that mass transit operators are just like any other employer in terms of facing a staffing shortage. Those shortages are leading various mass transit agencies to reduce or eliminate services. The most prominent early example was the Washington State Ferry System which limited service even in high demand periods due to a lack of qualified staff.

The latest example is Metro Transit serving Minneapolis. It has announced that it faces an operator shortage for its two light rail lines. The schedules will effectively lower service from 6 trains per hour to 5 trains per hour. Fewer runs mean lower revenues. All of this makes it difficult to estimate realistic ridership recovery times. The timing of ridership recoveries will be a key factor to determine the longer-term outlook for mass transit agencies.

FUNDING TRANSIT

The City of Charlotte, N.C. has adopted a plan to develop mass transit for the Charlotte metro area known as the Transformational Mobility Network. The Network would include 110 miles of rapid transit corridors for light rail, 140 miles of buses, a 115 mile of a greenway system, and 75 miles of a bicycle network. Now that the plan’s project list is complete, the hard part begins. That would be funding for a multi-billion dollar project cost.

Earlier this year, a dispute arose over how the ultimate cost of the project was being characterized to the public and the market. Proponents cost the project at approximately $13 billion. The dispute comes over whether total financing costs should be included in the cost estimate. Skeptics believe that the all-in cost including financing is $20 billion. It matters due to the size of the discrepancy as well as the perception that the City has been less than candid about the actual cost.

It matters because two votes will determine whether or not the plan is adopted and financed. For the project as conceived to go forward, the city would need the North Carolina General Assembly to grant approval for the city to put a referendum for a one-cent sales tax on the ballot. In a separate election after legislative approval, the plan would need to receive a majority of Mecklenburg County voters to vote in favor of it. If approved in 2022, the sales tax would take effect as of July, 2023. The plan is for 20% of the revenue to go to non-transit allocation like roadways and greenways. The other 80% would go to transit projects, which include buses and the rail system.

If the process unfolds, it will be another test of the willingness of the southeast U.S. region to locally fund and execute mass transit projects. Some of the same issues which plagued the effort in Nashville to develop and fund major transit infrastructure are already being raised. Issues of economic justice and equity are being raised in support of demands for lower fares and/or taxes while service improvements would be provided. Regardless of how the plan fares, it will be an instructive process to watch.

SAN ANTONIO GETS A NEGATIVE OUTLOOK

In the aftermath of the Texas power disaster earlier this year, the San Antonio municipal electric utility confronted a number of issues that transcended the obvious issues the February cold snap exposed. It became clear that the utility had real management issues. There has been a high level of staff turnover and top leadership had come under fire from a variety of sources. It left management in a weakened position as it dealt with the issues raised by the cold snap.

The City of San Antonio appointed a Committee on Emergency Preparedness, which was formed to address communications failures and other issues. The Committee came up with 37 recommendations. To date, none have been completed. The slow reaction reflects a number of factors, none of which are positive. That increased pressure at the utility which saw the CEO announce their retirement, the COO was replaced, and the chief legal officer was replaced in June. The COO office was restructured and the responsibilities divided.

All of this occurred in an environment where the utility would be seeking rate increases (double-digit) in the wake of service disasters. Now, an uncertain management team has not successfully articulated a plan to address the shortcomings identified as the result of the cold snap. It seems unable to estimate the level of needed rate increases. Some of those rate increases will result from the need to fund some $450 million of extraordinary costs incurred during the cold snap. That process will influence rate levels for the next 25 years.

Clearly the utility faces significant financial and operational pressures. The potential for significant staff turnover and the currently weak position of the CEO raises real governance issues. The current environment does not leave much tolerance for management uncertainty as process of moving the utility towards a more environmentally positive track unfolds.

We have watched the moves made by CPS with some concern. The ongoing management upheaval is negative in and of itself. For “green” investors, one has to ask whether the ascension of a member of the board of the Natural Gas Association to a top planning position will create a bias towards support of expanded natural gas generation as CPS manages its system going forward? Wil that be consistent with the goals of “green” investors? All of this added up to a negative outlook from S&P.

SANTEE COOPER CAN’T WIN

At this point, Santee Cooper the South Carolina public power agency must feel somewhat set upon. The effort by some to get the state to sell the utility is alive and well but has been hampered in the pandemic era. Now, it has joined what we believe will be a growing list of utilities to see much higher fuel expenses which will likely lower debt service coverage ratios. The rising price of natural gas and some just plain bad luck are the culprits here. SCPSA projected early this year it would meet energy demand with 58% of its electricity generation coming from coal-fired units.

Higher electric demand generated the need for near term fuel purchases. Natural gas price increases caused prices to rise from $2.50 British thermal unit (BTU) to $5.40 BTU within weeks in late 2020 and early 2021. Santee Cooper could secure enough timely delivered coal to generate only 39% of its electricity during the surge. SCPSA says that if Santee Cooper could have secured $60 million in coal to increase energy generation to meet the early year surge, the utility would have netted $110 million in revenues. Instead, the utility’s fuel costs exceeded projections by $130 million.

The agency is planning on cutting $60 million in capital project expenditures and to reduce $18 million in operations and maintenance expenses to cover some of the revenue shortfall. It will be a concern if necessary upkeep is not funded and executed.

MORE NUCLEAR DELAYS IN GEORGIA

Georgia Power has announced yet another revision to its projected schedule for the two new units under construction at Plant Votgle to commence commercial operations. Now Georgia Power says the third reactor at Plant Vogtle won’t start generating electricity until sometime between July and September of next year. Previously the company said it would start in June at the latest. The fourth reactor won’t come online until sometime between April and June of 2023.

The latest delay announcement comes as the Georgia Public Service Commission plans to vote next month on what could be a $224 million rate increase to pay for $2.1 billion in construction costs on Unit 3.  The company said in a recent filing that the latest delay stems from more substandard construction work at Unit 3 that must be redone. It said contractors continue to not meet schedules for completing work. Georgia Power said it’s diverting workers from building Unit 4 to fix Unit 3′s problems.

NEW YORK VS. THE NATION – PANDEMIC RECOVERY

Much attention is being paid to the difficulty that the New York City economy is facing as the recovery from the pandemic unfolds. Recent data from the City’s Independent Budget Office (IBO) confirms some of the factors impeding the “return to normal”.

Here is what they found. Compared with the rest of the United States, New York City lost a greater share of employment in the first months of the Covid-based recession, and to date it has recovered a smaller portion of its job loss. The city’s economy lost 957,000 jobs in March and April of 2020, just over a fifth (20.3 percent) of total employment, which peaked at 4.7 million in February 2020. Total U.S. employment, excluding New York City, also peaked and declined over the same two months. Employment fell to 126.4 million jobs in April 2020, about one-seventh (14.5 percent) less than the 147.8 million peak two months earlier.

Beginning in May 2020, employment began to recover in both New York City and the U.S. In each month from May through December, employment growth was slower in the city than the rest of the nation, though in most months after December, New York City employment grew faster. For the entire May 2020 through September 2021 period, employment grew at an average monthly rate of 0.36 percent in the city compared with 0.39 percent elsewhere in the country.

From April 2020 through September 2021, New York City’s economy added 440,000 jobs, not quite half (46.0 percent) of the jobs lost in March and April of last year. NYC employment in September was 4.2 million, 89.0 percent of the February 2020 peak. Excluding New York City, U.S. employment in September totaled 143.0 million, 97.0 percent of the February 2020 level. Almost four-fifths (79.2 percent) of the jobs lost in March and April 2020 have been recovered.

MANAGED RETREAT AND NYC

The recent severe rainstorms which led to flooding in historically vulnerable residential areas in New York City has sparked renewed discussions of buyouts to relocate damaged homeowners. While the choice to buy housing in well-known areas of vulnerability to flooding is at its core an individual one, governments are in a position of having to decide between restoring neighborhoods or encouraging relocation. Now, the recent storm has led the City to choose managed retreat.

After Sandy, New York State launched a $276 million pilot program to buy out 721 homes in Staten Island and other areas of the state. Of that, $202.8 million was spent to buy out 504 properties on Staten Island. Many of those properties have become permanently under water.  New York City has zoning that designates special coastal risk districts and limits new development in exceptionally flood prone areas in Broad Channel and Hamilton Beach in Queens and in Staten Island.

New Jersey has an ongoing, buyout program (Blue Acres), through which it has purchased property that is or could be damaged from flooding and storms, using federal and state funding. The program started in 2007, accelerated in 2012 after Sandy. The state has since spent over $200 million of $300 million reserved after Sandy and made offers on over 1,000 properties.

The managed retreat concept is not new but we expect that it will be a more frequent topic for consideration and debate. At some point, the numbers just do not support restoration and mitigation. Nevertheless, certain advocates for “equity” do not want to buy out homeowners unless replacement housing is constructed in an effort to merge the environmental and economic issues.  In the case of NYC, much of the at risk housing is also considered affordable. The fact that the housing was “affordable” precisely because of the environmental risk gets lost in the debate.

It just illustrates the difficulty that policy makers face when dealing with climate resilience. While it may not be viewed as such by property owners, much of the housing in question was cheap because of its location.

NATRURAL GAS, NEW YORK STATE, AND ECONOMIC JUSTICE

Natural gas has been the target of many localities and states as the industry fights efforts to regulate and limit the use of natural gas in new construction. Natural gas is the subject of a debate over whether it is a viable long-term replacement for coal or at best, a short-term bridge to a decarbonized world. The debate has led some state legislatures, at the behest of climate change deniers, to enact legislation preempting the right of lower local levels of government from banning the use of natural gas.

One state to buck that trend is New York State. This week state regulators did not approve permits for two new gas fueled generation facilities. In 2020, Astoria Gas Turbine Power, LLC—a subsidiary of the energy company NRG—applied for a Clean Air Act Title V air permit as part of its plans to build a fossil fuel–fired turbine generator in the northwest Queens neighborhood. The plant would replace a 50-year-old high-polluting peaking plant with a gas facility.

The New York State Department of Environmental Conservation (DEC) said that the project was not in line with the state’s Climate Leadership and Community Protection Act, which was signed into law in 2019 and aims to reduce the state’s greenhouse gas emissions by 85% by 2050. The politics of the issue are clear. DEC said it received more than 6,600 comments about the plan, with 85% of those public comments in opposition to the proposal, according to the state.

DEC noted that the project did not comply with a section in the Climate Act stipulating that permits “shall not disproportionately burden disadvantaged communities.”  The same reasoning is at the center of a decision not to approve a second gas plant upstate. In these cases, the state is staking out a stronger position than has been the case with many states as power producers deal with opposition from the public to new natural gas generation.

COLLEGE ENROLLMENTS

Over recent years, college enrollments have been under pressure. Primary factors include demographics which have reduced the supply of applicants. The National Student Clearinghouse Research Center shows undergraduate enrollment down 3.2% since fall 2020. This follows enrollment declines of 3.5%. The data reflects head counts through Sept. 23 at half of the institutions that report to the Clearinghouse, roughly 1,800 schools.

Now, the declining pool of applicants is being pressured by the economic realities of the pandemic. From the fall of 2019 to this semester, the number of undergraduate students has now fallen by a total of 6.5 %. This is the largest two-year drop in enrollments since the 1970’s.

A number of factors contribute to the trend. In the short-term, higher wages are seen as driving potential students, especially poorer ones towards work instead of school. Other data points to the pressure facing low-income students. The institutions which compete on price – community colleges and public universities have seen higher rates of decline than the private institutions at the other end of the tuition spectrum.

Undergraduate enrollment at public four-year institutions and four-year for-profit schools has fallen more this fall than the previous year, down 2.3% from 0.8% and 12.7% from 0.3 percent respectively. Community colleges report a 5.6% decline in enrollments. These declines offset the recovery in enrollments at the expensive private institutions. One other factor we have written about since the start of the Trump Administration is foreign student enrollments. Combined with last year’s numbers, the Clearinghouse reports an overall decline of more than 20% among international undergraduates.

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.

Joseph Krist

Publisher

ESG AND RATINGS

This week we read about an effort to develop a rating system for municipal bond credits based on non-financial criteria. The plan is to introduce several economic and demographic factors into the ratings process which heretofore are not currently weighted. Some of the factors include an analysis of housing affordability. The goal is to try to use the investment process to drive social policies on the behalf of municipal bond investors.

We note a couple of problems with this process. Owning bonds and objectively rating them for someone else seems to be inconsistent.  One of the entities expressed belief that by rating bonds and taking investment positions in bonds, they would somehow have access to officials and information that is not provided now. There seems to be an underlying assumption that bondholders have control over local decision making. Were that true, the municipal market would function much differently.

If the market had that sort of pull, it would be in the position of effectively dictating policy to be carried out by a locally elected entity. Is it the market’s job to achieve general social goals? Would local residents not object to having policies dictated from outside entities against whom local residents have no direct recourse? Do you believe for a minute that the municipal bond investment community wanted to see credits like NYC in the 70’s, Philadelphia and D.C. in the eighties, and Puerto Rico currently be run as poorly and irresponsibly as they were?

Puerto Rico provides the best example. Municipal bond investors would like to see an economy less centered on government employment and income redistribution. They would like to see a solid educational system, a functioning power system, and real development of the local economy. Yet, throughout the process the “bloody shirt” of accusations of colonialism and prejudice weighs down the conversation. Even in the midst of its restructuring, there remains a high level of concern that the Commonwealth will return to its “bad old ways” as soon as outside oversight is ended.

We expect to see more instances of the debate over what constitutes a healthy municipal bond credit as ESG investing moves center stage. One of the current hurdles to development of sound ESG investing criteria is that there is no real definition in the municipal market for what constitutes ESG investments. The industry needs to develop agreed upon standards as well as agreed upon metrics to be established to enable what are at the end of the day, quantitative investment decision making issues.

And it also must be noted that “corporate” approaches to municipal bond analysis are nearly always doomed to fail. Until the Tower Amendment is no longer preventing the imposition of full SEC reporting requirements for municipal issuers, the municipal market will remain unique. Expecting that an investor will receive better disclosure through its ownership of small bond positions reflects a bit of naivete.

In the end, the municipal market needs to move more quickly to develop an accepted set of standards to fairly analyze the ESG sector. We need to define our terms and provide an objective way to measure or quantify those issues which define whether or not a bond issue is green or social. Right now, there are more entities providing rivalling definitions of what is green or social or good governance than I have fingers to count. That has to change. Once that framework has been fully established, then the market will be able to evaluate and price risk.

Until then, the ESG concept remains primarily a marketing tool or a “greenwashing” tool.

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OIL AND GAS IN NORTH DAKOTA

In 1889, Congress passed the Enabling Act “to provide for the division of Dakota [Territory] into two states, and to enable the people of North Dakota, South Dakota, Montana, and Washington to form constitutions and state governments, and to be admitted into the union on an equal footing with the original states, and to make donations of public lands to such states.” The Enabling Act provided further land grants to the State of North Dakota for the support of colleges, universities, the state capitol, and other public institutions.

Revenues are generated through the management of trust assets, which include approximately 706,600 surface acres and nearly 2.6 million mineral acres in the state.  Article IX, Section 2 of the North Dakota Constitution directs that the “net proceeds of all fines for violation of state laws and all other sums which may be added by law, must be faithfully used and applied each year for the benefit of the common schools of the state and no part of the fund must ever be diverted, even temporarily, from this purpose or used for any purpose other than the maintenance of common schools as provided by law.”

The Department of Trust Lands conducted an audit in 2016 that claimed that one drilling company was underpaying royalties to the agency that leases rights for grazing and oil, coal and gravel production from state lands.  So, the department sued the company for breach of contract. Previous litigation on similar issues had historically been found in favor of the state up through the state Supreme Court level. The case was sent back to the lower court for retrial.

Now, a state district court judge found in favor of the energy company. The judge said the state’s claim of a breach of contract with the company was in question because the state failed to provide “any contract or lease … that allows this court to meaningfully review the contract obligations and whether a breach has occurred.” If upheld, there are significant ramifications for the state.

The Board had notified more than two dozen energy companies last year that they must pay money they had deducted from royalties owed to the state for developing its minerals. An earlier audit found that some oil companies took improper deductions for transportation, processing and other costs out of royalties owed to the state

NEBRASKA UTILITY PRESSURES

The Nebraska Power Review Board is a five-member body appointed by the Governor created in 1963 to regulate Nebraska’s publicly owned electrical utility industry. As a 100% public power state (the nation’s only), the Power Board is unique. The Board’s operating funds are received entirely from assessments levied on power suppliers operating in the State of Nebraska. The executive director is appointed by the Board. As constructed, the Board puts the Governor in a position of real influence if they choose to be.

One of the Board’s primary responsibilities is the creation and certification of retail and wholesale service area agreements between electric utilities operating in Nebraska. Any amendments to existing agreements must be approved by the Board. The Board maintains the official records pertaining to these agreements, which establish the geographic territory in which each utility operating in Nebraska has the exclusive right to serve customers. There are approximately 390 such agreements maintained by the Board.

Now, likely at the Governor’s behest, the Board is considering whether it should have the final say over contracts reached between power districts and energy suppliers, such as wind farms, and be able to weigh in on whether existing power plants should be decommissioned. The Governor is squarely on the partisan view that coal plants should remain open and his administration is not considered supportive of wind renewables.

This could potentially put the larger generation utilities in a difficult position. The Nebraska Public Power District owns and operates a large coal fired plant that is among the state’s largest carbon emitters. NPPD has been under pressure from customers and renewables advocates as it plans its future. Other utilities seeking to diversify away from fossil fueled sources could see those efforts limited or even thwarted. 

Any recent expansions of capacity in the state have been through power purchase agreements.  Those agreements are currently exempt under state law from review by the Power Review Board. The concern for the utilities is that local control – through elected officials in the case of the large Omaha, Lincoln, and NPPD systems – is the issue. It would be another form of a favorite topic of ours – preemption. It is not a surprise that an ideological governor would seek to so overtly intervene.

FLOOD INSURANCE

The National Flood Insurance Program (NFIP) is managed by the Federal Emergency Management Agency and is delivered to the public by a network of approximately 60 insurance companies. Rates are set in accordance with ratings established by FEMA. Since the 1970s, rates have been predominantly based on relatively static measurements, emphasizing a property’s elevation within a zone. This year, that rating system is undergoing major change.

Risk Rating 2.0 is designed to incorporate more flood risk variables. These include flood frequency, multiple flood types—river overflow, storm surge, coastal erosion and heavy rainfall—and distance to a water source along with property characteristics such as elevation and the cost to rebuild. The changes will be phased in over two years.  New policies beginning Oct. 1, 2021, will be subject to the new rating methodology. Also beginning Oct. 1, existing policyholders eligible for renewal will be able to take advantage of immediate decreases in their premiums.

In one example, Monroe County which covers the Florida Keys — FEMA says more than 90% of homeowners will see their annual flood insurance premiums go up, sometimes by thousands of dollars a year. It would be higher, but annual increases for each homeowner are statutorily at 18%. Congress is apt to make changes more favorable to homeowners if the politics of the issue dictate such an action.

Recently, the First Street Foundation released a report documenting the risk on a local level from flooding. First Street, like many others, is attempting to show modeling which “quantifies” the potential risk from flooding related to climate change over the next 30 years. Like any other model, the variables examined and the precise mathematical strategies are a product of unique circumstances.

First, they define their infrastructure categories. Critical infrastructure includes facilities such as airports, fire stations, hospitals, police stations, ports, power stations, superfund/hazardous waste sites, water outfalls, and wastewater treatment facilities. Social infrastructure includes government buildings, historic buildings, houses of worship, museums, and schools. 

The report’s analysis found that over the next 30 years, risk to residential properties is expected to increase by 10%, risk to social infrastructure will increase by 9%, risk to commercial properties is expected to increase 7% and risk to critical infrastructure facilities is projected to increase by 6%. Additionally, 2.0 million miles of road (23%) are at risk today, expected to increase by 3% over the next 30 years. Distinct patterns of county-level community risk highlight significantly increasing risk along the Atlantic and Gulf Coasts and large increases in risk in the Northwest. Risk is concentrated along the coastal areas of the Southeastern U.S. and the Appalachian Mountain region.

Among counties, Washington County, NC has the most significant county level increase in flood risk; with a 100% increase in critical infrastructure flooding, a 50.8% increase in the flooding of residential properties, a 51.7% increase in the risk of flooding of commercial properties, and a 32.3% increase in the flooding of roads over up to the year 2051. The highest concentration of community risk exists in Louisiana, Florida, Kentucky, and West Virginia, as 17 of the top 20 most at risk counties in the U.S. (85%) are in these 4 states.

At the city level, a large percentage of risk is concentrated in Louisiana (3 cities) and Florida (6 cities). The major population centers of New Orleans, LA Miami, FL (St. Petersburg, FL); and Tampa, FL all rank among the “most at risk” cities.

KAWASAKI SUBWAY CARS

For the last 20 years, U.S. rapid transit systems have been modernizing their rolling stock. With American-owned rail car production essentially a thing of the past, foreign owned producers have become the primary suppliers. New York’s MTA has made six purchases from the Japanese manufacturer, Kawasaki. Other purchasers include the Port Authority Trans Hudson line (PATH) and the Washington D.C. Metro system.

Over the weekend, problems with Washington Metro’s fleet led to derailments. The Metro decided to temporarily pull all of its Kawasaki rolling stock out of service for detailed inspections. For WMATA, this represents some 60% of its fleet. This has led to significant service cutbacks. Safety is a crucial issue for WMATA after a series of incidents over recent years.

WMATA has been aware of wheel set assembly issue since 2017. She said preliminary data showed that since 2017, there have been 31 WMATA wheel assembly failures –including 18 in this year — and 21 failures were uncovered during inspections that began Friday and are ongoing. This has raised concerns at the National Transportation Safety Board. The Board has announced that it may issue an “urgent recommendation” telling transit agencies to inspect Kawasaki train cars.

For the PATH system, such a recommendation could impact its entire fleet of subway cars. The MTA has been the largest buyer. SEPTA, serving Philadelphia is another customer although its Kawasaki rolling stock is some 40 years old.  The transit agencies will want the situation resolved, not just because of the obvious issues, but also because the production of the equipment is in factories in the U.S. Kawasaki and the Canadian builder Bombardier, both produced their U.S. rolling stock in factories in New York State. A Chinese electric bus manufacturer produces for the U.S. market at a California factory.

TRAVEL INDICATORS – AVIATION

United Airlines said on Tuesday that it had $7.8 billion in operating revenue during the third quarter, which was better than Wall Street had expected. The company expressed optimism about the coming months. The airline pointed to the fact that government officials around the world are slowly easing travel restrictions and companies are starting to send employees on more business trips.

The 24 U.S. scheduled passenger airlines employed 407,965 full-time equivalents (FTEs) in August 2021, a 1.3% increase from July 2021 (402,561). August’s total number of FTEs was up 5,404 from July but still down 40,295 FTEs, or 10.8%, from the March 2020 (457,260) onset of the pandemic. The August FTE total was also down 9.2% from the most recent corresponding pre-pandemic month, August 2019 (449,461). August 2021 had the lowest FTE total for the month of August since 2015 (397,007).

The employment increase between July and August resulted largely from the four network airlines, which added 4,704 FTEs. This increase was led by Delta Air Lines, which added 2,342 FTEs for a month-over-month increase of 3.3%. Southwest Airlines decreased the most with a loss of 229 FTEs or 0.4%.

NATURAL GAS AND MUNI UTILITY CREDITS

This winter is shaping up as a costly one for utility customers especially if they rely on natural gas. Natural gas prices have been steadily increasing but we have yet to see evidence of the potential impact of rising prices on individual utilities and their customers.  That is beginning to change.

The Colorado Springs City Council established a new rate schedule for its customers for this winter. It takes into effect the rising cost of gas to the utility to generate power and will translate into significant rate increases for customers. The new rates will increase natural gas prices on average by $15.92 per month up to $75.33, or about 26.8%, and electric costs by $12.60 up to $105.82, or about 13.5%. The increases are scheduled to take effect in November and stay in place through February.

For those utilities which use natural gas either directly for heating and cooking or to fuel their generation plants, we expect that increases in rates will be the norm. The city projected in August spending $4 to $4.50 per 1,000 cubic feet of gas over the winter. The actual price of gas is already closing in on $5 per 1,000 cubic feet of gas this month. The Colorado Springs combined utility system spent $140 million in February of this year during the well documented cold snap.

Colorado Springs raised natural gas prices by about $22 per month for residential users and electrical prices by $7 per month through April 2022 to pay off the cold-snap costs.  Natural gas prices are also largely responsible for putting Utilities $280 million over its $1.1 billion budget for this year. 

THE BEIGE BOOK

The Fed’s latest summary of economic activity came out this week. Economic activity continued to increase across all Districts, with the pace of growth characterized as slight to modest in most Districts. Manufacturing activity generally increased at a moderate pace. Residential housing markets continued to experience steady demand for new and existing homes, with activity constrained by low inventories.

Conversely, commercial real estate conditions continued to deteriorate in many Districts, with the exception being warehouse and industrial space where construction and leasing activity remained steady. Consumer spending growth remained positive, but some Districts reported a leveling off of retail sales and a slight uptick in tourism activity.

Demand for autos remained steady, but low inventories have constrained sales to varying degrees. Reports on agriculture conditions were mixed, as some Districts are experiencing drought conditions. Districts characterized the outlooks of contacts as generally optimistic or positive, but with a considerable degree of uncertainty. Restaurateurs in many Districts expressed concern that cooler weather would slow sales, as they have relied on outdoor dining.

We note that much of this period covers a time when a push to require vaccination as a condition of school attendance (teachers), working in an office, or attending public events in enclosed places was still in its early stages. While there have been some prominent examples of resistance, vaccine mandates have proven effective. Once vaccination was attached to employment requirements, vaccination rates in certain jobs (like schools, sports teams) rocketed up.

We note that despite a lot of noise from opponents, legal challenges to vaccination mandates are falling short in the courts. The fact is that vaccination requirements are nothing new. Most school districts require vaccination for mumps, measles, and other diseases so it’s been hard to see how opponents have a case. As vaccination takes hold, there should be real economic benefits.

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.

Joseph Krist

Publisher

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PUERTO RICO FIGHTS REALITY

The Puerto Rico legislature continue its uphill battle with the Oversight Board. The latest example is legislation under consideration which would keep pensioners safe from any cuts to pensions The P.R. House passed a bill with amendments designed to force the Oversight Board to accept zero cuts to pensions, allocate $62 million per year for municipal governments, and provide at least $500 million per year for the University of Puerto Rico for five years.

The Oversight Board’s response was predictable. The Board said the legislation proposed by the House and amended by the Senate would force it to withdraw its support for the proposed Plan of Adjustment. The Board’s view is that the legislation “endangers Puerto Rico’s ability to come out of bankruptcy and repeats the unsustainable spending practices and policies that drove Puerto Rico into bankruptcy in the first place.”

The Board did not stick to that position for very long. It said reducing the remaining modest pension cuts would increase the risk the plan is neither confirmable nor ultimately affordable, since the governor and the legislature refuse to consider a plan with pension cuts, the board said it was willing to take these risks.

It will now see if this move generates support for legislation which many creditors support which would specifically authorize debt issued to refinance existing bonds under the proposed Plan of Adjustment. The agreement on pensions should allow that authorizing legislation to proceed.  The Board could seek to move forward with a Plan of Adjustment which did not include an agreement with the municipalities.

The lack of such an agreement could be a stumbling block as the Commonwealth seeks to finance itself in a post-bankruptcy. The bond insurers expressed concern about a possible lack of authorizing legislation becoming an obstacle to a vote to affirm the Plan of Adjustment. The actions of the government, particularly the legislature, in seeking to concede as little as possible have not developed trust to support confidence in the Commonwealth’s long-term resolve to manage its fiscal affairs. The Commonwealth’s political establishment continues to take a populist approach consistently emphasizing cultural and ethnic issues in an effort to maintain an unworkable status quo. The continued reliance on statehood as the answer to so many of Puerto Rico’s problems conveys a sense of denial.

ARMY CORPS OF ENGINEERS P3

The idea arose during the Obama administration, was chosen as one of the Trump administration’s preferred infrastructure projects, and now has finally come to the municipal market. Fargo, North Dakota has experienced severe floods five times in a 100-year period. The last flood in 2011 was particularly severe. That built momentum for the development of the Fargo-Moorhead Diversion Project. The need for the project was clear but the logistics of the involvement of two states and the US Army Corps of Engineers complicated financing for the project. This created a more open attitude towards the use of less traditional approaches like a public private partnership, something that would be a first for the Corps.

The overall $2.75 billion project relies on $750 million from the federal government, $870 million from North Dakota, $86 million from Minnesota, and $1.1 billion from local tax levies. Now an authority created to access the municipal bond market for the project has successfully issued some $275 million off debt for it. That represents the portion of the share of the project borne by the two municipalities which will benefit from it. The financing is the first for a P3 for an Army Corps of Engineers project.

Initial financing came in the form of a WIFIA loan. The Authority repays its debt from proceeds of flood control and infrastructure dedicated sales tax revenues of the city of Fargo, ND and Cass County, ND. If those revenues are insufficient, debt service (principal and interest) is ultimately secured by the general obligation unlimited tax pledge of Cass County, pledged via the provisions of state statute, should the sales taxes and special assessments prove inadequate to pay debt service.

The Metro Flood Diversion Authority is managing the P3-financed piece of the overall project under a 35-year agreement with the private partners. Fargo and Cass County in North Dakota, Moorhead and Clay County in Minnesota and the Cass County Water Resource District formed the district for the project and all have a fiscal stake. The Red River Valley Alliance LLC is composed of lead contractors Spain-based Acciona (ACXIF) with a 42.5% equity stake; Israeli firm Shikun & Binui (SKBNF) with 42% equity investment; and Canada’s North American Construction Group (NOA) with a 15% equity investment. 

SUPPLY CHAIN ISSUES DELAY MORE PROJECTS

We recently highlighted a project in Maine which will likely be delayed due to difficulties in obtaining building supplies needed to comply with project specifications. It is far from the only project threatened by supply chain issues. The latest example comes from Tennessee.

A bridge replacement project – the completion of Mack Hatcher NW Extension in Williamson County – has been delayed. The lead contractor for the project says that the delay stems from a materials supply shortage of railing on the project’s multi-use path along the roadway. The railing must be completed to ensure the safety of pedestrians and/or cyclists on the path. The company also struggled to find a subcontractor to complete specialty work to the bridge’s surface over the Harpeth River. The contractual completion date is November 30.

These situations highlight one concern that even supporters of a large federal program for infrastructure acknowledge. The current mismatch between the demand for skilled tradespeople and the supply of those workers continues to worsen. The fear is that projects will not be able to be undertaken or will have to face additional costs and extended timelines so long as the imbalance exists. The implication is that schedules and cost estimates going forward will have to be increased.

OREGON MILEAGE TAX EXPERIMENT

Oregon was the first state to begin a pilot program in support of vehicle mileage taxes. The limited test, which started with some 1200 drivers, was designed to study the impact of mileage taxes versus gas taxes and see if a VMT is a viable alternative. Several years into the test, some issues are emerging which are a bit discouraging while at the same time instructive to policy makers.

The discouraging part is the lack of participation in the program. The current enrollment is around 750 drivers and the original 1200 participants remains the program’s high water mark. Observers attribute the low participation to a lack of incentives for drivers to try the program and the amount of the fee – currently 1.8 cents per mile. The problem is that at 1.8 cents cars which get more than 20 miles per gallon pay more under the VMT than they would paying current gas taxes at the pump.

That highlights one of the major hurdles VMT proponents will have to overcome. There is a great suspicion that a VMT is merely an under the radar way to raise revenues. This issue is complicating efforts to move Pennsylvania away from fuel taxes to a VMT model. If the Oregon numbers hold up and motorists feel that they are the recipients of a tax increase, support for the VMT concept diminishes. 

Proponents admit that unless legislatively mandated, participation in the currently voluntary program will remain low. A bill which would have forced Oregonians whose vehicles get more than 30 miles per gallon into OReGO no later than July 2026 was not enacted. We expect that other states will have similar experiences if their programs are not voluntary. The politics of VMT remain very difficult.

In Pennsylvania, a commission appointed by the Governor has recommended a phase out of gas taxes and their replacement with revenues from an 8 cent per mile VMT. If drivers can’t make the numbers work in Oregon than an 8 cent per mile charge is likely less favorable for Pennsylvania drivers. The Pennsylvania plan would also increase tolls on highways, double registration fees and impose fees on packages delivered in the state.

UTILITIES AT THE CENTER OF DEVELOPMENT

The availability of power, water, and roads has always been a factor in the location of any large industrial facility. Now, as the economy moves more and more towards a renewables-based utility grid, the actual cost of power becomes more of a factor. The latest example of this phenomenon is the recently announced electric vehicle production facilities to be located in Kentucky and Tennessee.

The chairman of Ford has been explicit in explaining the role of electric costs in Ford’s decision. He said that Ford for the first time considered electricity prices in deciding on a site and that the company wants to work with states that are “giving you access to that low-energy cost.” One analysis found that the TVA offers an average industrial rate of $4.58 per kWh. This compares to DTE’s and Consumers Energy’s average rates for its largest users of $7.59 and $10.94 per kWh.

As pressure increases on industrial facilities to run on electricity instead of fossil fuels, this kind of decision process will likely repeat itself across the country. Municipal utilities will be well positioned to compete on a cost basis given their lack of a need to return profits to shareholders as well as their more favorable tax position.

SOME UTILITY UPDATES

Seven municipal utilities and the federally owned TVA are founding members of a new entity to market power more efficiently in the Southeastern U.S.  The Southeast Energy Exchange Market (SEEM) is designed to facilitate sub-hourly, bilateral trading, allowing participants to buy and sell power close to the time the energy is consumed, utilizing available unreserved transmission. That is meant to provide a more flexible environment for the absorption of increasing amounts of energy generated by sun and wind. 

The public power entities in the group are Associated Electric Cooperative, Dalton Utilities, MEAG Power, N.C. Municipal Power Agency No. 1, NCEMC, Oglethorpe Power Corp., Santee Cooper, and TVA. The founding members represent nearly 20 entities in parts of 11 states with more than 160,000 MWs (summer capacity; winter capacity is nearly 180,000 MWs) across two time zones.

A new Montana law empowering the state attorney general to order power plant repairs and imposing fines of $100,000 a day against noncompliant Colstrip owners was stayed in federal court.  The law attempts to prevent the majority owners of the coal-fired power plant from winding down maintenance as they prepare to exit in 2025. The pressure on the plants comes from the fact that they are 70% owned by Washington and Oregon utilities. Those states have strict mandates requiring utilities to reduce their fossil fuel exposure.

The fully political nature of the law was underlined in the court decision. “The PNW owners have presented evidence, uncontroverted by the state and other defendants, that the purpose of SB 266 is to protect Colstrip Units 3 and 4 from ‘out-of-state corporations’ and ‘woke overzealous regulators in Washington state,’ as evidenced by the Governor’s signing statement and transcript of SB 266 hearings.’’  The judge also noted that the State of Montana did not offer any arguments against the plaintiffs.

The wind power industry is benefitting from tail winds in the regulatory space. Vineyard Wind, the large project planned for the New England coast, has announced a “first-in-the-nation partnership” with 20 municipal electric systems in Massachusetts which would purchase some of the project’s output.  Massachusetts enacted a new law this year which would apply the state’s Renewable Portfolio Standard, which governs the increasing amount of clean energy that utilities must purchase each year, to municipal light plants (MLPs) for the first time. The 41 MLPs in Massachusetts must get 50% of their power from “non-carbon emitting” sources by 2030 and achieve net-zero emissions by 2050 under the new law.

TIDE COMES IN FOR PORTS

They were on the front line of entities impacted by pandemic induced limits on travel and demand but now ports are at the center of the effort to reinvigorate the nation’s clogged supply lines. The high demand issues facing ports have been in the news lately and they are getting more scrutiny in the wake of the oil spill of the California coast. The need for ships to anchor while they wait for capacity to open up at the Ports of Long Beach and Los Angeles has been cited as the possible cause of the pipeline rupture causing the spill.

Now, the ports are going to shift to 24 hour a day operation in an effort to eliminate the current backlogs at the West Coast ports. Long Beach and L.A. have long been the nation’s busiest ports and so now they will bear the brunt of the supply chain effort. The plan not only moves goods to market but also opens the revenue spigot wider as increased volume is processed more smoothly. There will likely be some additional costs associated with the increased activity but these will likely be more than offset by volume driven revenue flows.

CARBON CAPTURE STRUGGLES

Earlier this year we discussed the potential for the municipal bond market to be targeted to finance the development of carbon capture projects in the fossil fuel industry’s effort to save itself.  We expressed concern that these projects could not obtain private financing and that this would lead developers to the market they always turn to for its low financing costs – the municipal bond market.

One project that received federal support from the Trump Administration was Project Tundra in North Dakota. This $1 billion project is being undertaken in support of the 692-MW Milton R. Young coal-fired power plant. The plant is owned by the Minnkota Power Cooperative. The project has lost its lead engineering partner which left the project in 1Q 2021. Minnkota has also acknowledged that its efforts to obtain “private financing” for the project is lagging.

Financing is being complicated by the limits on the ability of potential financiers to invest in projects designed to support the use of coal. Those policy limits overcome the fact that investors in Project Tundra could reap $50 in tax credits for each ton of carbon that is captured and sequestered underground near the plant, a figure that could be higher in the future if Congress boosts the credit.  Project Tundra received $43 million in initial DOE grants under former President Donald Trump. The electric co-op said earlier this year it is seeking a $700 million DOE loan guarantee and expects to tap into a new $250 million state loan program designed specifically for Project Tundra that was signed into law in May.

Cooperatives are finding themselves increasingly under pressure as they are some of the largest participants in large base load coal generation plants across the country. They need to diversify their generation bases and accelerate the move to renewables. The early signs for carbon capture, at least financially, are not good. The carbon capture effort seems to be following a path blazed by any number of environmentally sound but financially unfeasible technologies which have run through the municipal market. Caution is appropriate.

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.

Joseph Krist

Publisher

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TRANSIT IN NEW YORK CITY MOVES FRONT AND CENTER

The first significant capital project to fall victim to a different political calculus in the face of abrupt “regime change” in Albany is the proposed Air Train project in Queens to LaGuardia Airport. The chief political proponent of the project was former Governor Andrew Cuomo. In reality, the project was not clearly supported by advocates while opponents were vocal and relentless. Once Governor Cuomo was out, there was no true core support for the $2.1 billion project. Opponents were successful in taking advantage of the upcoming gubernatorial election in November, 2022. Without clear support for the project, it was harder to justify the proposed cost and disruption.

On the private vehicle front, the dispute between New York and New Jersey over congestion pricing is growing more acrimonious. New Jersey has long been concerned that its residents who commute into Manhattan will be asked to pay the fee without any of the revenues being applied to agencies other than the MTA. Now, Governor Murphy of New Jersey is threatening to put the Port Authority of New York and New Jersey in the middle of the fray. One way that a governor can influence PA activities is by vetoing the minutes of Port Authority meetings.

Such an action could prevent the Authority board from approving all budgets and contracts. For bondholders it is a procedural issue which should not impact the availability of revenues for debt service repayment. As a practical matter, it is an issue in that the Port has been a central player in recent large scale transportation projects (bridges and airports) and that the Authority is being counted on to finance various regional projects. Even Governor Murphy called the tactic a “nuclear option”. The fact is however, that it is one of the few points of leverage a New Jersey governor has over a governor of New York is the Port Authority.

The Regional Plan Association, a major influencer on economic policies in the NY metropolitan area has suggested that New Jersey drivers get credit for the high tolls they pay to enter into Manhattan. The proposed congestion plan has some unforeseen consequences for regional policy. Take the case of a doctor who would commute to work at a hospital outside of the congestion zone and pay no more than they do now. The same doctor would have to pay the $15 congestion fee if his hospital employer was located south of 60^th Street. You could have individuals working for the same hospital system but facing different transit costs just by virtue of where their hospital is located.

UNEMPLOYMENT LOAN PAYBACK

With the end of extended federal unemployment benefits and the process of economic recovery underway, attention now focuses on the need for states to reimburse the federal government for loans made to the states to fund unemployment benefits. According to an analysis from the Tax Foundation, states have paid out $175 billion in UI benefits since the pandemic began in March 2020, with the federal government providing an additional $660 billion in extended and expanded benefits.

States often initially finance sudden growth in unemployment claims through borrowings from the federal government. If a state maintains a loan balance at the beginning of two consecutive calendar years, federal law triggers a series of automatic unemployment insurance tax hikes on businesses in the state. The federal government waived interest payments on state UI loans until September 6 to aid states struggling to pay UI benefits because unemployment rates soared during the height of the pandemic.

Every major recession creates liabilities for states which have had significant spikes in unemployment. The loans are repaid from the proceeds of assessments levied against businesses in those states. They can be paid in one sum from the proceeds of borrowings undertaken by states issuing bonds which are repaid from those assessments.

What is different this time is the magnitude of the unemployment problem which resulted from the pandemic. Those assessments become a cost to businesses in those states and weaken their competitive position.  Ohio officials cited a potential 50% increase in 2022 federal UI taxes for Ohio employers if the state’s loan was not repaid. Borrowing for funding repayments of federal unemployment insurance loans is a tried-and-true practice and not considered to be credit negative. 36 states and territories borrowed from the federal UI trust fund during the 2008-09 recession. Eight states issued bonds to repay the loans.

So, Ohio decided to be one of the states which found funds to repay their unemployment insurance loans before the federal interest waiver expired. It joined Hawaii, West Virginia, and Nevada in the group of states which repaid their loans. 31 states applied at least some portion of federal Coronavirus Aid, Relief and funding to replenish their UI trust funds, for a total of $15.4 billion in transfers. At the end of September, 11 states and the US Virgin Islands began to make interest payments on amounts borrowed from the federal government.

SALT, CONGRESS, AND THE COURTS

In a 3-0 decision, the 2nd U.S. Circuit Court of Appeals in Manhattan said the federal government had authority to impose a $10,000 cap on the state and local taxes that households’ itemizing deductions could deduct on their federal returns. New York, Connecticut, Maryland and New Jersey challenged the so-called SALT cap implemented as part of a $1.5 trillion tax overhaul in 2017.

The decision comes in the midst of the debate over the bipartisan infrastructure and reconciliation bills. The states’ arguments centered on the idea that eliminating the SALT cap was “coercive”.  The Court found that the states did not show that their injuries were significant enough to be coercive. The Court pointed to many federal provisions which do not have even impacts on the states. “We do not mean to minimize the plaintiff states’ losses or the impact of the cap on their respective economies but we find it implausible that the amounts in question give rise to a constitutional violation.”

On the legislative front, Congress’ nonpartisan Joint Committee on Taxation has said repealing the SALT cap could cost the U.S. Treasury $88.7 billion this year. That could make the deduction a casualty of the horse trading which will apparently be required to get an infrastructure bill.

TVA AND CLIMATE CHANGE

A coalition of TVA distributors has requested that Congress amend the proposed Clean Energy Performance Program (CEEP) to alter the potential penalties facing cities and power coops that rely upon TVA for nearly all of their power if the federal utility doesn’t meet the new standards to cut its carbon emissions. The CEEP would impose a $40 per megawatt hour penalty on any utility that does not boost its share of carbon-free energy by 4% a year. The penalty payments cannot increase customer bills.

There are 153 municipal and coop distribution customers of the TVA. They do not have direct control over how the TVA manages the generating assets which provide for the overwhelming bulk of their power supplies. Most of TVA’s distributors have signed 20-year power purchase agreements to buy 95% or more of their wholesale power from TVA.

The Southern Alliance for Clean Energy (SACE) has analyzed the integrated resource development plans for the four large utility holding companies in the Southeast. That includes the TVA. TVA has set a long-range goal of being carbon free by 2050. That is on the longest end of most target dates. It plans to achieve at least a 70% reduction in carbon by 2030 and an 80% reduction by 2035 while keeping electric rates stable. TVA says it has already cut its carbon emissions by 63% since 2005.

SCAE has calculated that among the four, the TVA (and by extension its customers) are the most exposed to the need to pay penalties under the plan. The annual increases in clean electricity under the TVA plan range from 0.2-0.3% at TVA. This would require TVA to pay the largest penalties.

Two major municipal utilities are at the center of the issue. TVA’s two largest local power companies (LPCs) — Memphis Light, Gas and Water Division (“MLGW”) and Nashville Electric Service (“NES”) — have contracts with a five-year and a 20-year termination notice period, respectively. Sales to MLGW and NES each accounted for 8% of TVA’s total operating revenues during the nine months ended June 30, 2021. Sales to MLGW and NES accounted for 9% and 8%, respectively, of TVA’s total operating revenues during the nine months ended June 30, 2020.  

ALABAMA PRISON FUNDING

In the summer, the State of Alabama tried to execute a public/private partnership to build new prisons. The State has long operated under federal consent decrees to address overcrowded and squalid conditions at its maximum security prisons. The plan originally would have funded the construction of the new facilities by a private contractor but the prisons would have been staffed, managed, and operated by Alabama Department of Corrections staff. The facilities would have been leased to pay off debt issued for the prisons and then the facilities would become fully owned state property.

Political considerations drove pressure on the state and the underwriters of the proposed debt to finance the project. There were objections to the fact that the proposed builder also operated private prisons. Opponents felt that the company should not profit in any way from the construction contract even though they were only acting in the capacity of builder. That pressure caused underwriters to drop out of the financing and the public/private plan was scrapped.

That did not end Alabama’s obligation to comply with consent orders and it did not improve conditions. Now, the Alabama Legislature has approved the use of $400 million in CARES Act monies to fund the project. This has met with predictable outrage from anti-prison activists. They believe that the use of these funds for this purpose violates the Act. Those arguments are offset by the actions of some states to fund tax cuts with the CARES money.

ILLINOIS ENERGY FALLOUT

Coal fired generating assets owned by the Springfield, IL municipal electric utility were at the center of this summer’s debate over Illinois’ clean energy plans. The city’s three generating plants along with the Prairie States generation plant were prime targets of the legislation. While a compromise was reached allowing the plants to gradually close, the effects of the legislation are still having impact.

Springfield has announced that one of three plants which are not operating and scheduled for future retirement has now been retired permanently. The cost of compliance with new legal requirements drove the decision. The plant be will be decommissioned two years ahead of schedule and will never run again. An outside entity reviewed the plants and established that the cost of repairs needed to operate the plant again were prohibitive given that the plant is scheduled for retirement in 2023.

HUDSON YARDS

The massive Hudson Yards development area on Manhattan’s west side has managed to be able to cover its debt service obligations in spite of the effects of the pandemic on office occupancy, retail demand, and tourism which benefits the development. Now that it has survived the pandemic and managed to achieve a level of critical mass, the area is better able to fully meet its obligations to support Hudson Yards Infrastructure Corporation’s (HYIC) $2.7 billion outstanding revenue bonds.

This improvement is reflected in the Moody’s upgrade of Hudson Yards debt by one notch to Aa2. The project is now generating enough revenue such that the expectation is that the City will no longer need to appropriate monies any interest support payments for the remaining life of the bonds. The City is not yet off the hook entirely. When the original bonds were issued the city committed to pay interest on the bonds if the underlying Hudson Yards revenues were insufficient. That commitment will remain in place for the life of the bonds. The city’s obligation to make interest support payments, if required, is net of any available HYIC funds, and like the Tax Equivalency Payments, is absolute and unconditional, subject to annual appropriation.

WORKER SHORTAGES, SUPPLY CHAINS AND MUNICIPAL OPERATIONS

As is the case with so many industries, municipal governments are facing some worker shortages as well. This weekend, you need to have a reservation for some Washington State ferry (WSF) routes. Beginning in mid-week, the system had to cancel 16 scheduled sailings impacting residents of the San Juan Islands. WSF officials said there were not enough Coast Guard Documented Crew Members to continue some services. The staff shortage has been an ongoing issue since this spring.

Colorado’s DOT is facing pressure with the onset of snow season. They report that they are nearly 200 workers short, a 150% increase above the normal average of unfilled spots. The shortfall is attributed to the shortage of licensed commercial vehicle drivers that is impacting all sorts of businesses and school transit all over the country. Colorado DOT is already making plans to prioritize roads for plowing which will extend the time needed to clear roads.

The Maine DOT is delaying some major projects including a bridge replacement due to an inability to garner sufficient building supplies. In Maine, the issue is components being not available for construction to conform to specifications. “A national resin shortage is slowing our ability to obtain the additional material we’ll need in order to get the site ready for the accelerated bridge construction process.” The project may have to be delayed until the Spring as a result of the product shortage.

This highlights a concern that the recovery could be held back by a lack of sufficient labor and supplies to effectively undertake many of the projects proposed in the infrastructure and reconciliation bills. There are a number of instances where worker shortages have limited the ability of many municipal services to return to desired levels. It has only been a couple of weeks since the widespread adoption of vaccination mandates and the of extended unemployment benefits. We will see if this remedies some of these situations. 

SOUTH CAROLINA NUCLEAR FOLLOWUP

The aftermath of the ill-fated Sumner nuclear plant expansion continues to leave a trail of wreckage. Former SCANA Corp. CEO Kevin Marsh becomes the first criminal casualty of the effort to conceal problems and delays at the project. He reached a plea agreement which will result in a two-year federal prison term. He plead to conspiracy to commit wire and mail fraud. Marsh has also pleaded guilty in state court to obtaining property by false pretenses. He awaits sentencing on that charge.

A second former executive at SCANA and a Westinghouse Electric official, the lead contractor to build two new reactors at the V.C. Summer plant, have also pleaded guilty.  One more Westinghouse employee has been indicted and is awaiting trial. The CEO blamed Westinghouse for misleading him.

NEW YORK CITY AND TAX INCENTIVES

We have historically viewed the use of tax incentives negatively. We question the real impact of these programs and the lack of good comparative data has always complicated the analysis. Now, the NYC Independent Budget Office (IBO) has delivered an analysis of the City’s Industrial Program. The program was established under the Giuliani administration to respond to the fact that from 1990 through 1995, the number of manufacturing jobs in New York City fell by about 55,000 to reach 206,000.

The program provides tax breaks, primarily property tax reductions over 25 years, to encourage the preservation of industrial space in the city in order to retain and create manufacturing, warehousing, and other industrial jobs and to diversify the local economy. The same sorts of property tax breaks for development have been a constant since WWII in New York. The program provides for the Industrial Development Agency to acquire nominal title to the site and then lease it back to the firm seeking to develop the property.

Ownership of the site by the IDA allows the firm benefit from a tax break on the land and building. The firm then makes a reduced property tax payment in the form of a payment in lieu of taxes. The firm also becomes eligible for sales and mortgage recording tax breaks.

Since its inception in 1995, 370 projects have benefitted from the Industrial Program. In 2019, 200 projects received tax breaks, at a cost of $31.5 million in foregone revenue for the city.  For the first 21 years of the program, manufacturing and wholesale trade accounted for well over half of the new projects nearly every year. Since 2016, though, these two sectors have typically made up less than half of the new projects and the number of projects entering the program has been declining. 

While recent attention to tax breaks has focused on efforts to attract new businesses, most of the firms receiving benefits from the program were already located in the city and had fewer than 100 employees. IBO estimates that about 60% of the firms were expanding employment in the years leading up to receiving Industrial Program assistance, while around 20 % were contracting. 

Just over half of firms (54%) that had employment in New York City in the year of project start expanded their employment in the three years following the completion of their capital project. Another 9% maintained the same size, while about 37% contracted. Overall, IBO found that less than a third of these firms met or exceeded the employment goals set when they applied for the program.

IBO did find that the majority of firms that received assistance through the program either expanded employment or stayed about the same size three years after completing the construction or renovation of their industrial space. They did offer evidence to support one complaint of critics of tax incentives. The Industrial Development Agency could not provide detailed information on the actual capital investments at the site made by participating firms. Lack of hard data has always complicated both sides of the debate about tax incentives. 

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

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.

Joseph Krist

Publisher

As we go to press, the infrastructure and reconciliation legislation is hanging in the balance. The ultimate outcome of the legislative process remains in doubt. The House and Senate did pass — and Mr. Biden signed — legislation to fund the government until Dec. 3, with more than $28 billion in disaster relief and $6.3 billion to help relocate refugees from Afghanistan. The issues are coming down to a question of what is infrastructure and what is social engineering.

The tax changes contemplated seem likely to survive as they appear to have support. They call for raising the corporate tax rate to 25%, up from 21%; setting a top individual income tax rate of 39.6%, up from 37%; and increasing the capital gains tax rate to 28%.

It’s energy policy which becomes a major stumbling block. Senator Manchin’s demands include means-testing any new social programs to keep them targeted at the poor; a major initiative on the treatment of opioid addictions that have ravaged his state; control of shaping a clean energy provision that, by definition, was aimed at coal, a mainstay of West Virginia; and assurances that nothing in the bill would eliminate the production and burning of fossil fuels.

The process as it unfolds, highlights the difficulties which hold back a serious systematic approach to the funding and financing of infrastructure.

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POLICE FUNDING

With just over a month to go before Election Day, we see several items on local or state ballots which will go some way to judging the staying power of certain trends. Minneapolis voters will decide on whether they wish to effectively shut down the City’s police force and replace it with a Department of Public Safety. That department would include a variety of medical and mental health practioners along with some traditional law enforcement who would answer many of the mental health situations which police are currently called on to deal with.  

The initiative would provide for joint oversight of the resulting organization by both the executive (the Mayor) and the legislative (City Council). This has raised concerns over day-to-day management and the split in final executive authority. The proposed plan may actually result in more public safety spending than is currently the case. It would however reallocate funding among services provided resulting in “effective” police defunding.

This vote occurs against a backdrop of generally rising urban crime. Cities which had some of the most violent public actions over the issue of police conduct in 2020 are actually increasing police funding. We recently noted the increase in funding through a very generous labor negotiation in Chicago. Now the outgoing Mayor of Seattle has proposed a budget which increase the number of officers on the city police force on a net of attrition/retirement basis.

This past two years have seen a dramatic reduction in the size of Seattle PD’s uniformed force as resignations and retirements reached unprecedented levels. The 2022 Proposed Budget for SPD includes funding sufficient to add a net of 35 new officers. This increase would increase the average officer count to 1,230 still well short of the 1,343 officers that had been funded for 2021.

THE ELECTRIC ECONOMY

Ford said it would build two battery plants in Kentucky and one in Tennessee, all in a joint venture with its main battery cell supplier, SK Innovation of South Korea. It will also build an assembly factory in Tennessee. In combination, the four facilities are scheduled to create 11,000 jobs.

Half of those jobs will be created at Stanton, about 50 miles northeast of Memphis. The campus is expected to employ 6,000 people and will house suppliers and a battery recycling operation as well as the truck and battery factories. Ford and SK Innovation will invest $5.6 billion at the site. Two plants in Kentucky will be in Glendale, about 50 miles south of Louisville, and are expected to create 5,000 jobs, at a cost of $5.8 billion. 

The plants will be at the center of the debate over the potential impact of electric cars and incentives to be provided by the federal government. It has been proposed by labor interests that government incentives be provided for electric cars produced at unionized facilities. Initially, it seemed to be an effort to target companies like Toyota who are both foreign owned and non-union.

Those provisions might be problematic. “Right to work” laws in Tennessee and Kentucky bar union membership as a condition of employment. Efforts to unionize workforces in the South have historically failed. So, the issue becomes – good green jobs vs. unionized green jobs. The Republican-controlled Legislature has voted to put Tennessee’s right to work law as an amendment to the state Constitution by placing a measure on the next gubernatorial ballot.  That sets up a conflict as the manufacturing facilities to be established have been announced as union shops.

PUERTO RICO PENSIONS

One of the major stumbling blocks on the route to a final Plan of Adjustment for the Commonwealth of Puerto Rico has been that of pensions. The Commonwealth has been very resistant to changes in pension payments for its government retirees. Now, in an effort to move talks forward and increase the likelihood of Plan approval, the Oversight Board has softened its stance. The Board announced it “is willing to agree” to increase the threshold of beneficiaries exempt from any reduction from $1,500 to $2,000 per month.

“The Oversight Board is also willing to support restoring any reduction in pension benefits should Puerto Rico receive federal Medicaid funds in excess of amounts projected in the 2021 Certified Fiscal Plan for Puerto Rico and should such funds generate enough savings in the government’s general fund budget to permit a restoration of the benefit reduction.  The Oversight Board said it could also accept “contingent on the commonwealth obtaining and maintaining adequate Medicaid funding.” The fiscal office said it would accept these proposals “if the Puerto Rico Legislature adopted the necessary legislation for the Plan of Adjustment and the Governor signs that legislation into law.”

One has to question the use of increased Medicaid funding to prevent reductions in pensions. That would seem to complicate the Commonwealth’s historic use of the Medicaid funding imbalance between it and the states. One of the main arguments for statehood is that it would address the historic funding imbalance. It’s not clear how using Medicaid to cover pension costs exactly makes the case for statehood or increased aid.

These strategies which rely on status and the resulting inequalities to address shortcomings in the management of its fiscal affairs become more tired each year. Oversight and financial responsibility will continue to be prerequisites for success in the restructuring process. The resistance encountered throughout this process bodes poorly for the Commonwealth’s fiscal future. The real question is: Has the bankruptcy been truly transformational on will the Commonwealth quickly return to its old ways once the bankruptcy process comes to an end?

CALIFORNIA WATER WAR TRUCE

The Imperial Irrigation District, the largest single recipient of Colorado River water, and the Metropolitan Water District have settled a lawsuit that once threatened to derail a multistate agreement governing the use and apportionment of Colorado River water. Under the agreement, Imperial can store water in Lake Mead on the Arizona-Nevada border under Metropolitan’s account. Imperial will contribute water under a regional drought contingency plan.

The dispute was rooted in negotiations under the Drought Contingency Plan developed in response to the long-term drought in the Colorado River basin. Imperial sued Metropolitan, alleging the water agency that serves Los Angeles violated a state environmental law when it did not negotiate directly with Imperial in the drought contingency talks. The Los Angeles County Superior Court ruled against Imperial, which appealed to the California Court of Appeals earlier this year.

Imperial sued Metropolitan, alleging the water agency that serves Los Angeles violated a state environmental law when it sidestepped Imperial in the drought contingency talks. The Los Angeles County Superior Court ruled against Imperial, which appealed to the California Court of Appeals earlier this year.

The new settlement agreement commits both agencies to seeking additional state and federal funding for restoration projects. At the center of this issue is the Salton Sea. The area around it is a mix of potential (brine deposits filled with lithium) and pollution wreaking havoc on the lives of those who live nearby. The seabed itself is the site of an increasing number of industrial facilities. How they would be impacted by efforts to refill the sea through a restoration program is unclear.

HOTELS BACK IN THE MUNI MARKET

The hospitality business was among the hardest hit by the restrictions and realities of the pandemic. Once again, a major economic disruption has disrupted that industry. While the circumstances of the Great Recession and the pandemic are very different, the net result on the operation and finances of projects within that space is quite similar.  Several hotel projects developed in the first half of the 2000 decade ran into serious problems requiring defaults and restructurings which led to real investment losses.

So, we are intrigued by the latest effort to obtain financing for a startup hotel project which comes out of North Carolina. A hotel/conference center project located adjacent to the UNC-Charlotte campus is the latest example. The project was conceived after the Great Recession and construction started in 2019. Who was to know that the greatest public health disaster in a century was just around the corner?  The positive view points out that the worst of the initial phase of the pandemic coincided with the bulk of the construction period.

The facility began operations at the end of 1Q21, just as vaccines were taking hold. The operations since then have been unsurprising in that occupancy opened in the mid-30% range which is well below the projected average occupancy for fiscal 21-22. Going forward, the hotel assumes an average 75% occupancy rate five years out. Already the facility has seen the impact of a negative turn in the pandemic as occupancies which had risen a bit over the summer took a downward dip as the pandemic resurged especially in the South.

What really got our attention is the use of the issuer, Public Finance Authority. This issuer seems to be the one to turn to when the typical in-state issuer of bonds for what are essentially commercial projects chooses not to associate with the risk. This always raises a red flag for us. Public Finance Authority is a Wisconsin issuer but often issues debt for other jurisdictions. That is the case when local considerations (usually political) interfere with financing, PFA often steps into the breach.

This deal goes to great ends to maintain the tax exemption for the bonds. The facility is owned by the UNC-Charlotte endowment. Neither of the institutions is designed to draw customers from has any ownership interest. The ownership by the endowment of a tax-exempt entity is designed to clear the tax exemption hurdle.

In the end, you won’t see this risk if you are an investor directly in bonds. The retail investor who owns a high yield fund is likely to see that risk. In today’s environment of historically low rates, it will be an opportunity which those funds will be attracted to.

MTA

New York State Comptroller Thomas P. DiNapoli annually reviews the financial outlook for the Metropolitan Transportation Authority, the state agency responsible for the mass transit system in the New York metropolitan area. The MTA may be the most heavily impacted issuer in the market as the result of the pandemic. It has been bailed out financially in the near term by the receipt of some $1o billion in federal pandemic assistance.

In February 2021, the MTA projected cash deficits before gap-closing actions of $5.7 billion in 2021, $4.8 billion in 2022, $4.1 billion in 2023 and $4 billion in 2024. On July 21, 2021, the MTA released a midyear update to its 2021 budget and a four-year financial plan based on the preliminary budget for 2022 (the “July Plan”). Fare and toll revenue is expected to increase by $1.7 billion in 2021, $1.6 billion in 2022, $831 million in 2023 and $395 million in 2024. Dedicated taxes and subsidies also improved by $1.8 billion during the financial plan period.

Despite these improvements, the July Plan still forecasts substantial gaps of $4.8 billion in 2021, $2.9 billion in 2022, $2.5 billion in 2023, $2.8 billion in 2024 and $3.3 billion in 2025. The report clearly highlights the variables facing the Authority as it plans ahead. The Office of the State Comptroller estimates that fare revenue in 2022 could be $300 million higher than planned if workers telecommute an average of 1.5 days per week starting next spring, but could be $500 million lower than planned if workers telecommute an average of 3 to 4 days per week.

The longer-term risks facing the MTA are clear. One is that two potential revenue sources remain uncertain. The first is the potential for more federal money under the pending reconciliation bill. The other is the reliance on congestion pricing in Manhattan which is currently under review. Congestion pricing is expected to generate $15 billion for the MTA’s 2020-2024 capital program. The starting date of the program is still unknown, although the MTA now assumes it to be in 2023.

The report sums up the import of a financially viable MTA. “The greater New York City region cannot achieve a full economic recovery without a financially stable MTA.” No, it cannot.

ZERO EMISSIONS CREDITS

So called Zero Emissions Credits (ZECs) are the primary vehicle which states use to support the operation of existing nuclear generating plants. They are most recently in the news as one of the difficult issues to deal with in the legislation supporting state initiatives to support clean energy. Laws were enacted from 2017 to 2019 to fund zero emissions credits (ZECs) in Connecticut, Illinois, New Jersey, New York and Ohio.  It happens that nuclear is often the primary source of carbon free power. According to Exelon, nuclear provides 85% of the clean energy in Maryland and Illinois, 91% in Pennsylvania, and over 50% in New York.

One item in the pending reconciliation legislation in the U.S. Congress would provide federal funding for ZEC credits. (American Nuclear Infrastructure Act (S. 2373)) As the reconciliation process unfolds, $6 billion to fund ZECs from 2022 to 2026 where they are demonstrated as economically necessary to limit emissions is included in the Senate approved bill. 

COAL SUBSIDIES?

The legacy of the effort to support legacy generating assets in Ohio continues manifest itself. The 2019 legislation which was passed as the result of illegal efforts to influence legislators has been seen as an effort to support nuclear power. Tucked into that legislation were subsidies for two World War II era coal fired plants. Now, the Ohio legislature is considering a bill to repeal those subsidies. The bill is sponsored on a bipartisan basis in one house and by Republicans in the other.

The two plants are owned by investor-owned entities through the Ohio Valley Electric Corporation. Before the bill, only customers from AEP Ohio, Duke Energy Ohio and AES Ohio, formerly Dayton Power & Light, were charged for the plants, paying $176 million from 2016 through 2019. The 2019 legislation enlarged that customer base to pay for the subsidies. The plants were built in the 1950s to provide power to a uranium enrichment facility in Pike County. The contract with the U.S. Department of Energy ended in 2003.

OVEC took over the distribution of power from the plants since that time. The Ohio Manufacturers’ Association, representing commercial and industrial ratepayers has said the plants lost $1.3 billion from 2012 through 2019 and continue to lose money. We are big believers in the idea that the market should be allowed to deal with issues like this. In this case, the market is speaking loudly and clearly.

Unfortunately, the debt issued for the two plants extends to 2040. OVEC does not effectively have other revenue generating assets to support that debt.

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