Fitch Ratings said Oct. 2 that it has downgraded two Lower Colorado River Authority ratings in large part due to a threatened exodus of some of LCRA’s major wholesale power customers.
Fitch downgraded the following ratings on LCRA outstanding obligations: $1.6bn of revenue bonds to ‘A’ from ‘A+’; and $175m in authorized commercial paper notes, series A, to ‘F1’ from ‘F1+’. The rating on LCRA’s transmission revenue bonds is unaffected.
Fitch also has assigned an ‘A’ bank note rating to LCRA’s electric system revenue commercial paper notes, series B. The bank note rating reflects LCRA’s parity repayment to the bank providing the liquidity facility, in the event of a draw on the facility to support the series B commercial paper notes. The Rating Outlook on the long-term bonds is Stable. Long-term bonds and commercial paper notes are secured by a gross revenue pledge of the LCRA system, Fitch noted.
The downgrade reflects near-term revenue pressure resulting from the decision by some customers to terminate their contracts early and cease purchasing power from LCRA as of Sept. 13, as well as longer-term changes to LCRA’s overall customer profile, the rating agency said. LCRA management expects to preserve financial margins through expenditure reductions and market energy sales. But, the needed expenditure reductions are meaningful and come on top of cost reductions already implemented, Fitch said.
LCRA’s scheduled loss of ten of its wholesale generation customers in 2016 (nine of which are the subject of contractual disputes), and load release provisions in the 2041 contracts already had potential to place pressure on revenues, Fitch said. The unexpected loss of load in fiscal 2013 has accelerated the pressure.
While LCRA may ultimately prevail in the legal cases with the seven customers that have terminated their contracts early, LCRA’s energy sales going forward will undoubtedly be lower following the loss of about 37% of its load in 2016, Fitch wrote. Nearly half of this load (17%) has terminated early, and load release options for the remaining customers that may reduce purchases to 65% of their all requirements over the longer term.
Seven customers ceased purchasing power from LCRA in mid-September despite LCRA’s challenge of their right to do so, Fitch noted. “LCRA’s request for a temporary restraining order was withdrawn, which would have prevented contract termination while the legal right of the customers to terminate was considered by the courts,” Fitch added. “The seven customers account for 17% of LCRA’s general load, or $138.8 million in fuel and non-fuel revenues in fiscal 2012 (excluding GenTex 1). The contracts that were terminated early all have original termination dates of June 2016 and are court-validated. The seven customers include the City of Boerne, Central Texas Electric Cooperative, Fayette Electric Cooperative, the City of Georgetown, the City of Kerrville, San Bernard Electric Cooperative, and the City of Seguin.”
Fitch says rate equity apparently the key issue
The fundamental issue in question in these disputes appears to be rate equity and whether LCRA’s decision to offer a provision that allows customers to purchase a portion of their load from a provider other than LCRA to customers that have signed amended and restated wholesale power agreements through 2041 constitutes a breach of contract by LCRA, Fitch said.
“The terminating customers allege that it does, and that LCRA’s breach of contract allows them to terminate the contracts early,” Fitch wrote. “LCRA does not believe it is in breach of contract. Four of the seven utilities rated by Fitch began purchasing power from other providers following the termination on September 13, 2012. In addition to the seven, two other customers (Guadalupe Valley Electric Cooperative and the City of New Braunfels) have legal cases pending or have alleged breach of contract regarding the same issues and collectively account for another 19% of load. These customers have not provided notice to terminate to date although Guadalupe Valley has notified LCRA of its intent to do so if the issues are not resolved.”
There are multiple lawsuits pending between LCRA and these various customers. Timing for resolution is uncertain given multiple venues and time involved in potential appeals, Fitch pointed out.
LCRA has stopped purchasing energy on behalf of the seven customers that have provided notice of termination but continues to bill them for contract costs, Fitch said. “LCRA plans to mitigate the net revenue loss from the early contract termination through further expenditure reductions and does not anticipate increasing its non-fuel rate to remaining generation customers,” Fitch added. “LCRA had committed in its 2013-2017 business plan, released prior to the contract terminations, to hold the non-fuel component of rates flat through fiscal 2017. Nevertheless, LCRA has the ability in its wholesale power agreements to increase rates with notice to customers and pass through costs, if necessary.”
One of the notable provisions in the 2041 contracts is a load release provision that allows customers to gradually adjust downward or upward the amount of load purchased from LCRA through annual stepped adjustments, Fitch reported. A customer may notify LCRA of its intent to reduce load once every 12 months but the load reduction is not effective until two years after the notice, it said. Any one-year decline in requirements cannot exceed 10% initially and then 5% per year thereafter to a minimum of 65% of that wholesale customer’s full requirements.
Several customers have already provided LCRA with an initial notification to release 10% of their load in the initial year and some for additional percentages in subsequent years, Fitch said. “As these options are exercised by a number of customers, it could escalate the rate pressure associated from recovering fixed costs on fewer sales,” it added.
LCRA has a mix of generation resources that provide 3,045 MW of net dependable capacity, with the largest resource being the coal-fired Fayette Power project at 1,035 MW. Historically, the resource portfolio was supplemented with market purchases during brief periods of peak demand to meet overall load. Market purchases may be used less following the load loss, Fitch noted.
Current generation investment includes 200 MW of new coal-fired capacity at the planned Sandy Creek plant and replacement of an older simple cycle natural gas unit, the Ferguson plant, with a new 540-MW combined-cycle plant. The investments are being funded, in part, with debt issuance, which will increase LCRA’s fixed costs over time, Fitch said.