The Puerto Rico Electric Power Authority is in a financial crisis and is trying to work through it and find a way to fund a sweeping series of costly changes to how it generates and transmits power.
Testifying Jan. 12 before the Subcommittee on Energy and Minerals Resources at the House Committee on Natural Resources was Lisa J. Donahue, the Chief Restructuring Officer of the Puerto Rico Electric Power Authority (PREPA). Donahue is also a Managing Director and the leader of the Turnaround and Restructuring Practice at AlixPartners, a global business and advisory firm. Prior to her appointment as PREPA’s Chief Restructuring Officer, she served as an executive at a number of other power and energy companies, including as executive vice president and chief financial officer at Calpine Corp. and chief financial officer at Atlantic Power Corp.
PREPA produces and delivers virtually all of the electric power consumed in the Commonwealth of Puerto Rico. Donahue said there are fundamental operational problems that have hindered PREPA for decades. “PREPA is currently in a state of crisis, and for years has been unable to transform into the modern, world-class utility that Puerto Rico deserves,” she added. “In the summer of 2014, PREPA faced a severe financial and liquidity crisis, created by a combination of recurring negative cash flows, an ongoing recession, outdated generation facilities, substantial debt maturities and an inability to access the capital markets. This crisis threatened PREPA’s ability to operate, mainly by threatening its ability to continue purchasing fuel to run its power plants and provide energy to Puerto Rico.
“PREPA’s problems did not arise overnight, or even in a few years—they developed and intensified over a period of decades. During this time, management and other strategic decisions, including staffing and capital investment, were too often based on political or electoral considerations rather than best practices or business imperatives. As a result of this dynamic, PREPA suffered from regular employee reassignments and had difficulty conducting rational long-term planning, which compounded existing challenges.
“Today, PREPA owes approximately $9 billion to its bondholders and fuel line lenders, and continues to face very serious liquidity constraints. Absent a financial restructuring, between now and July 1, 2016, PREPA faces contractual obligations to pay $700 million under its fuel lines of credit and approximately $428 million in principal and interest under outstanding bonds. This is more than twice the amount of cash PREPA currently has on hand, and PREPA will not be able to make up the difference with revenue from operations during this period.”
Restructuring deal is part of the answer
“As part of the recently announced restructuring support agreement (‘RSA’), a group of PREPA creditors recognized PREPA’s liquidity constraints by agreeing to relend to PREPA $115 million of interest paid to bondholders on January 4, 2016,” Donahue said. “Our financial situation would be much worse if our creditors had not agreed to forbearance agreements in August 2014 and more recently, the RSA. These agreements have given PREPA temporary relief from its obligations to creditors, including relief from its obligation to make more than $600 million in sinking fund payments. Absent these agreements, PREPA would already have run out of money.
“One contributing factor to PREPA’s current financial situation is that its existing rate structure does not capture its operating costs and debt service. PREPA’s base rate has not changed since 1989 despite increases in costs and debt service obligations. However, the all-in cost fluctuates based on the cost of fuel and purchased power, and reached highs of approximately 28 cents per kilowatt hour (‘kWh’) in August 2014. Today, the all-in cost has fallen with oil prices to approximately 21 cents per kWh, which is high in comparison to the U.S. mainland, and has a disproportionate impact on Puerto Rico residents given their income levels and other economic factors.
“The ‘rate deficit’ between existing rates and the rates PREPA would need to charge to cover operational costs, including debt service over the next three years, is approximately 7.8 cents per kWh. Closing this rate deficit is critical to PREPA’s sustainability. But PREPA’s customers cannot carry this burden alone. Even the creditors who are party to the RSA agree with this point. To help close the rate deficit, we need to implement operational reforms to improve efficiency, and we need concessions from our creditors.”
Donahue said PREPA has focused its recent operational improvement efforts on core business functions to improve organizational efficiency, increase revenue generation and instill a culture of safety in the workplace. By addressing shortcomings in accounts receivable and collections, fuel inventory, procurement, inventory management and safety, PREPA has begun the process to transform into a modern utility. PREPA has made great strides in its accounts receivable and collections processes with respect to government and private customers alike.
PREPA working on changes to fuel inventory management
PREPA has also worked to improve fuel inventory controls. In September 2014, PREPA’s controls were sporadic at best, Donahue noted. PREPA did not consistently measure based on industry standards or test for variations in consumption. Additionally, PREPA lacked a uniform process to forecast its fuel requirements based on optimized dispatch and deliver power at the lowest possible cost, leading to unnecessarily high fuel inventory levels and limitations on PREPA’s ability to negotiate better terms.
“Our team has worked with PREPA to implement an integrated process that addresses these issues,” said Donahuie about the fuel problems. “We measure and track fuel inventory and investigate variances point to point. We have also improved inventory controls and reduced inventory levels with respect to all inventory. In addition, we have implemented a Request for Proposal (‘RFP’) process and negotiated with fuel suppliers to secure more favorable fuel purchase terms.
“One issue of importance to PREPA, especially as it transitions to burning a significantly higher percentage of natural gas, is the Jones Act, which increases the cost of transporting fuel from the mainland to Puerto Rico. The impact of the Jones Act on PREPA’s operations today is in the range of $3 to $5 million per year, due to the required use of Jones Act-compliant barges to distribute fuel oil between units. Based on current operational assumptions, this impact could increase by approximately $20 to $30 million per year if the Aguirre Offshore Gas Port (‘AOGP’) is constructed and PREPA elects to source liquefied natural gas from the mainland. Relief from the Jones Act’s stringent requirements could allow PREPA to save these amounts over time, and those savings would be passed along to its customers.”
AOGP is a project of an outside contractor to build a liquefied natural gas (LNG) import terminal on Puerto Rico’s south coast, supplying LNG to the adjacent Aguirre power plant of PREPA and displacing much of the plant’s current oil use.
$2.4 billion in new investment eyed to update the system
Donahue told the congressional panel: “The system is under extreme stress. Generating units are old, and PREPA has not made the investments necessary to maintain their reliable service. PREPA’s median plant age is 44 years, compared to a U.S. industry average of 18 years. Approximately 80% of PREPA’s generating fleet is more than 25 years old, and PREPA’s oldest thermal unit is 56 years old. Its heavy reliance on fuel oil creates price volatility for consumers and environmental compliance challenges for PREPA under federal Mercury and Air Toxics Standards (‘MATS’) and other regulations. PREPA’s outdated transmission system makes it difficult to accommodate unplanned unit outages and integrate renewable generation sources. Overall, PREPA’s outdated infrastructure is a key cause of high forced outage rates, poor efficiency, low reliability and high costs.
“We have developed a comprehensive long-term capital plan that assumes $2.4 billion in new investment—funded either through cash resources or new public-private partnership investments. Our capital plan is driven by PREPA’s integrated resource plan (‘IRP’), which was undertaken in response to local law requirements. To help develop the IRP, PREPA engaged Siemens Industry, Inc., an industry leader. The IRP was filed with the Puerto Rico Energy Commission (‘PREC’), a newly established regulatory body, in July 2015 and was updated in August 2015. PREC is currently reviewing the IRP with input from other stakeholders.
“Importantly, PREPA’s capital plan includes the construction of the Aguirre Offshore Gas Port (‘AOGP’), which will allow PREPA to receive natural gas directly and efficiently at the Aguirre complex, as well as the conversion of the Aguirre generation facility to burn natural gas. This transition from fuel oil to natural gas will improve fuel diversity and enable the Aguirre steam power generating units to comply with environmental regulations like MATS. Construction on AOGP has been delayed given certain permitting issues and PREPA’s financial situation, but we anticipate that PREPA will be in position to commence construction in the second or third quarter of 2016, and to complete the project by late 2017 or early 2018.
“PREPA is pursuing cost-effective financing for AOGP, including through discussions with the U.S. Department of Energy (‘DOE’) regarding a potential loan guarantee under DOE’s Section 1703 program. At this time, PREPA understands that DOE and other potential financing partners are awaiting a resolution of PREPA’s overall financial situation before committing to invest in the project.
“Other key projects in the capital plan include the construction of new units at PREPA’s Palo Seco plant, the installation of new transmission and distribution equipment throughout PREPA’s system, and the long-term repowering or replacement of generation units at Aguirre and Costa Sur. These investments, which will include flexible generation units, will improve PREPA’s ability to utilize existing and incorporate additional renewable energy sources, which are a key component of PREPA’s vision for efficient, sustainable energy in Puerto Rico.
“Execution of the capital plan will also help PREPA comply with MATS for steam power generating units and reduce reliance on fuel oil. These initiatives will dramatically improve the efficiency of PREPA’s system and reduce its environmental impact. The installation of newer and more efficient units will reduce the volume of fuel needed to power Puerto Rico and minimize the price volatility that results from relying on fuel oil for so much of Puerto Rico’s supply.
“In addition, the shift to cleaner fuel sources will yield significant benefits. Today, 52% of total electricity generation in Puerto Rico is powered by fuel oil and coal, with 44% powered by natural gas and only 4% from renewable sources. Under PREPA’s capital plan as contemplated in the IRP, by 2030, 83% of total electricity generation will be powered by natural gas and renewable sources (with renewables increasing to 14% of the total) and only 17% will be powered by fuel oil and coal (with fuel oil driven down to below 1%).”
The coal portion of the fuel mix is supplied by an AES Corp. (NYSE: AES) power plant that is contracted to sell power to PREPA.
PREPA wants to push renewables up to 1,193 MW in 2030
Donahue added: “PREPA is focused on facilitating an increase in the usage of renewables as a means to further diversify energy sources in Puerto Rico and contribute to PREPA’s environmental compliance efforts. The IRP forecasts renewable capacity growth from 207 MW in 2016 to 1,193 MW in 2030, an increase of almost 600%. Power produced from renewable sources is expected to increase by an average of 9% annually, which will reduce overall demands on PREPA’s system and displace traditional thermal generation.
“PREPA’s capital plan is comprehensive and achievable. We intend to fund the plan with enhanced liquidity from operational savings, creditor concessions and a new transparent rate structure. PREPA will also pursue bids from third parties to finance and build new power generating units through an open and competitive RFP process to ensure that we are attracting the most efficient capital and expertise to help us execute the plan.”
Governance reforms embedded in the PREPA Revitalization Act that is currently pending before Puerto Rico’s Legislative Assembly include the appointment of an independent board, which will promote independence in PREPA’s leadership and management to ensure that the changes we are implementing and planning are sustainable, Donahue said.
At present, creditors representing approximately 30% of outstanding PREPA debt are not party to the RSA. In order to consummate the bond exchange contemplated by the RSA, additional bondholders (who are not parties to the RSA as of this point) holding more than $2 billion in bonds (i.e., all but $700 million) must voluntarily choose to exchange their existing bonds for securitization bonds at a discount. If these holders do not choose to exchange their bonds, the deal will not work for PREPA, and the parties will be forced to return to the drawing board in hopes of developing a new, workable restructuring plan, Donahue said.
Access to a restructuring regime would allow PREPA to implement the restructuring contemplated by the RSA, without so many contingencies and open issues, said Donahue. In fact, the RSA contemplates implementing the restructuring transactions by using the federal Bankruptcy Code or a proceeding pursuant to Puerto Rico’s local restructuring law, if either becomes available to PREPA. If PREPA cannot execute on the RSA, agreed-upon creditor concessions will be lost and the governance improvements, cost savings measures and capital projects that form the core of PREPA’s recovery plan will not go forward.
If these financial issues can’t be worked out, creditors would begin to take enforcement actions against PREPA, and fuel and other suppliers would tighten credit terms and refuse to deliver goods, Donahue warned. PREPA could be forced to ration its existing fuel supply and employ rolling blackouts, and its ability to carry out core functions such as meeting payroll, and conducting critical maintenance on plants and distribution networks, would be in doubt.