Texas power grid weighs on Lower Colorado River Authority bonds

BY SourceMedia | MUNICIPAL | 09/27/21 01:34 PM EDT By Richard Williamson

The largest wholesale public power provider in Texas is coming to market with a refunding deal colored by the weakness the state?s main power grid demonstrated in a cold snap earlier this year.

The Lower Colorado River Authority, which provides energy services in a 55-county service area in Central Texas, expects to price $248 million of revenue bonds the week of Oct. 4. Barclays (BCS) is book runner on the deal, with Specialized Financial Management as financial advisor and McCall Parkhurst & Horton as bond counsel.

The transaction includes a forward refunding that is expected to close in February.

Fitch Ratings ahead of the deal affirmed its AA-minus rating and negative outlook on the LCRA. Its analysis included the same cautionary comments that it has on other utility bonds regarding the faulty Electric Reliability Council of Texas.

After a widespread failure in February that led to more than 200 deaths, lawsuits and bankruptcies, Texas has taken a patchwork approach to fixing the grid, analysts say.

Fitch placed all Texas public power utilities on negative watch in February following the near-statewide blackouts; it removed LCRA from negative watch in May but assigned a negative rating outlook.

S&P Global Ratings also has a negative outlook on its rating of A, two notches lower than Fitch?s.

?We could lower our long-term rating if our view of LCRA's operations deteriorates, if the authority's predominantly fossil-fuel-fired fleet exposes it to extraordinary costs, or if the authority is unable to manage the risks associated with its participation in the ERCOT market,? wrote analyst Doug Snider.

As a Texas power generator and transmission company, LCRA shares in the Environment, Social, Governance (ESG) risks that are rising in the Lone Star State, Snider wrote.

?The severe winter storm event in February 2021 has brought into sharper focus a spectrum of ESG-related risks that may inform our credit analyses and ratings over the longer term,? he said. ?In our view, the specter of climate change may weigh more heavily as a credit risk factor for Texas utilities in U.S. public finance. In particular, we expect to consider the adequacy of management's counterbalancing measures to plan for, mitigate, or adapt to risks associated with extreme weather conditions that have the potential to disrupt its power supply and cause a short energy position.?

One aspect of LCRA?s particular ESG risks, Snider said, is the fact that it derives about half of its energy needs from coal-fired assets, ?which exposes the authority to elevated environmental risk related to carbon emissions regulations, in our view.?

ERCOT is in the process of borrowing $3 billion from the state to clear the power sales that came during the freeze, when prices soared from the average $22 per megawatt hour in 2020 to $9,000 per megawatt hour.

The loan will be repaid from ?default charges? assessed to wholesale market participants for a term of up to 30 years.

Brazos Electric Cooperative, Texas? largest and oldest electric generator serving 1.5 million customers, filed for bankruptcy amid ERCOT charges of $2.1 billion for power during the storm.

Brazos missed a monthly payment to LCRA Transmission Services Corp. in March, but payments resumed shortly thereafter when the bankruptcy court authorized Brazos to pay pre-petition transmission claims.

Brazos remains current on amounts owed to LCRA TSC for transmission services, analysts said.

Gov. Greg Abbott, a champion of the state?s oil and gas industry who is facing re-election next year, touted the Legislature?s success in passing Senate Bills 2 and 3, requiring both Texas Railroad Commission and ERCOT to inspect power stations to ensure weatherization compliance and issue penalties for non-compliance.

The legislation also created the Texas Energy Reliability Council is to improve coordination between state agencies and the industry during extreme weather situations.

?During the winter storm, too many Texans were left without heat or power for days on end, and I immediately made reforming ERCOT and weatherizing the power system emergency items,? Abbott in his June signing statement. ?We promised not to leave session until we fixed these problems, and I am proud to say that we kept that promise. These laws will improve the reliability of the electric grid and help ensure these problems never happen again.?

The Federal Energy Regulatory Commission last week made more dozens of recommendations to improve the Texas grid and blamed natural gas power plants and suppliers for most of the problems.

Abbott blamed renewable energy for the blackouts though the failure of coal- and natural gas-fired plants in the severe cold was largely responsible for the crisis.

FERC said the federal government might further regulate natural gas wells and gas-providing systems within Texas. The February crisis showed that the stability of power grids is dependent on gas supplies.

"Change is required for ERCOT to continue to reliably serve the millions of customers and businesses that depend on us," said ERCOT Interim President Brad Jones in a June statement on the new plan to protect the grid.

LCRA receives no revenue from the state but relies on income from 33 retail utilities. Wholesale power contracts allow LCRA to recover all power supply costs and extend through 2041, although customers can reduce purchases over time by up to 35% under certain conditions.

?The purchaser credit quality of LCRA's wholesale customers is very strong, with financial profiles supportive of the AA-minus rating,? Masterson said.

On June 28, Moody?s Investors Service revised the outlook on its A2 LCRA rating to stable from negative, affecting $1.1 billion of debt. On the same day it also revised the outlook to stable from negative on the A1-rated LCRA Transmission Services Corp., revenue bonds. The transmission corporation has approximately $2.5 billion of revenue bonds outstanding.

?The affirmation of the A1 rating considers the overall low business risk as an electric transmission provider operating within the credit supportive regulatory framework of the Public Utility Commission of Texas,? Moody?s said.

?The stable outlook reflects our expectation that LCRA TSC will maintain a healthy financial position and will continue regularly filing interim capital additions updates, and eventually a transmission cost of service rate filing when needed, as it implements its largely debt-funded capital improvement plan in order to maintain healthy debt service coverage ratios.?

For the current fiscal year that began July 1, The LCRA board of directors approved a budget of more than $395 million and authorized capital investments of more than $517 million for energy, water and public service projects.

In addition to its role of generating and transmitting power, LCRA manages the lower Colorado River and six lakes.

LCRA Transmission Services Corp. plans to invest more than $2 billion in the next five years to improve and build transmission facilities.

Over the next five years, LCRA plans to invest more than $59 million in development of new water supply projects and more than $47 million in dam rehabilitation projects to help ensure the dams continue to operate safely and effectively, meeting all state regulations for dam safety.

Correction: Barclays (BCS) is the book-runner on the LCRA deal. The original version of the story named the incorrect underwriter.

In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.

Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.