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Fixed-Income Insights

For Santee Cooper and MEAG, much of the costs already have been passed on to ratepayers.

[Note: This article appears in the July 2017 edition of The Muni Quarterly.]

During recent years, public power has tended to be one of the quieter sectors within the tax-exempt municipal-bond market. Almost every municipal electric utility in the United States holds an investment-grade rating because of strong credit fundamentals and considerations such as the essential public services they provide, their monopolistic advantages, and unregulated rate-setting authority.

However, over the past several months, two municipal entities have been making the headlines: South Carolina Public Service Authority (known as Santee Cooper) and Municipal Electric Authority of Georgia (MEAG). MEAG and Santee Cooper are minority owners of two nuclear projects originally being constructed by Westinghouse Electric Company. MEAG is a 22.7% owner of the Alvin W. Vogtle Electric Generating Plant (Vogtle) in Georgia, and Santee Cooper is a 45% owner of the Virgil C. Summer Nuclear Generating Station (V.C. Summer) in South Carolina.

Under the construction contracts with the projects’ respective owners, Westinghouse and its parent company, Toshiba, agreed to pay the majority of any cost overruns out of their own pockets.

Unfortunately, there were significant construction delays and billions of dollars in cost overruns, due in part to Westinghouse’s use of new and unproven technology and to its alleged general mismanagement of the construction process. As a result of this history, on March 29, 2017, Westinghouse filed for Chapter 11 bankruptcy protection, and Toshiba, which provides guarantees for Westinghouse’s obligations associated with the projects, may follow suit in the near future as well. So, to be clear, it was the firm responsible for building the new plants that declared bankruptcy, not the municipal bond public power credits, which are still rated well into the investment-grade range of the market.

Generating Uncertainty
Westinghouse’s bankruptcy filing has resulted in significant uncertainty for both nuclear projects, and has given MEAG and Santee Cooper, as minority owners, some unwanted publicity. With both projects projected to be several years away from completion, the owners currently are in the process of determining whether to abandon or to proceed with construction. If they decide ultimately to continue, it likely will be under new con­struction terms and with a new contractor, as Westinghouse is not expected to stay on in that role. There also may be a new and longer construction time frame, at much higher projected costs.

Billions of dollars already have been spent on construction, and much of the costs already have been passed onto constituents (ratepayers) within the owners’ service areas through higher power rates. In reaction, there has been a growing outcry from constituents as they realize that they have been pre-paying for the construction of a generating asset that may, ultimately, never provide any service to them, but it has always been a part of their contracts to absorb these costs. The owners will have to weigh very significant short-term costs versus long-term gains that could be derived from new, state-of-the-art nuclear plants.

Despite the headlines, MEAG and Santee Cooper both continue to hold strong investment-grade ratings from the credit rating agencies. Since Westinghouse’s bankruptcy filing, none of the rating agencies have downgraded outstanding MEAG or Santee Cooper bonds. As such, their ratings remain in the ‘AA’/‘A’ categories. Although such ratings cannot be guaranteed in the future, for decades now, both MEAG and Santee Cooper have been reliable wholesale electric utilities, with a plethora of operational generating assets. Both utilities serve broad, preexisting service areas, and have, without needing regulatory approval, the ability to pass on costs to ratepayers. Under contractual agreements (known as power sales contracts) municipalities purchase power from MEAG and Santee Cooper on a long-term basis; the municipalities then charge their ratepayers, as needed, in order to repay MEAG and Santee Cooper.

We hold the municipal bonds of Santee Cooper and MEAG in market weights of less than 1%, as of May 31, 2017, in some of our mutual fund tax-exempt portfolios. (See table.)

 

Up to this point, we have been discussing the inherent credit strengths of MEAG and Santee Cooper as though there were little differentiation between the two. However, in our internal credit analysis, we do differentiate between their relative strengths and weaknesses.

Power Positions
MEAG’s relative advantages over Santee Cooper are 1) its lower exposure to nuclear project construction; 2) stronger power sales contracts; 3) greater perceived flexibility to raise rates; and 4) a smaller industrial revenue base.

Santee Cooper’s relative advantages over MEAG are its currently slightly stronger financial profile, driven by a higher debt service-coverage ratio and generally stronger municipalities.

In our opinion, the main credit risk in the immediate term is related to the potentially significant cost overruns of the nuclear projects. With Westinghouse’s bankruptcy filing, cost overruns going forward may need to be absorbed by owners. In turn, these owners would have to pass on the additional costs to ultimate ratepayers. While Santee Cooper and MEAG have unlimited rate-setting authority, they are no doubt cognizant of the political implications of significant rate increases on ultimate ratepayers especially if they never finish the plants. So, while both Santee Cooper and MEAG theoretically can raise rates as high as necessary, in practice, this may not necessarily be desirable.

We expect MEAG and Santee Cooper to remain in the headlines for the medium term, given the uncertainty that remains regarding the state of the projects and the ongoing Westinghouse bankruptcy. As we mentioned earlier, these types of headlines are not the norm for the typically sleepy public-power sector, but we emphasize again that, even with ongoing headline risk, we continue to view MEAG and Santee Cooper to be sound, investment-grade credits and we expect them to stay that way after the ultimate decisions on completion of the plants are reached.

 

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THE MUNI QUARTERLY

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The July 2017 edition offers insights from our analysts on key topics for municipal bond investors, along with essential market information.

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