Favorable market conditions are prompting a surge in municipal gas prepayment bonds, according to a new report from Moody’s Investors Service.
Public power utilities are looking to the bonds to lock in cost savings on future natural gas purchases, and investors see opportunity in wider spreads between tax-exempt and taxable yields that enable them to obtain low-cost financing.
Moody’s says it is on track to exceed the high-water mark of rated municipal gas prepayment bonds reached last year with 11 transactions rated so far this year. In 2018, Moody’s rated 12 of the municipal gas prepayment bonds that closed in 2018, exceeding the mark set in 2007 when it rated 10 gas prepayment bonds and far exceeding the number of issues rated in 2017 and 2016, three and two, respectively.
Moody’s rated over $9.5 billion of gas prepay bonds in 2018, and so far this year it has rated over $5.9 billion. The combined amount tops the prior peak issuance levels seen in 2006 and 2007, when the firm rated $6 billion and $7.6 billion of gas prepayment bonds, respectively.
With gas purchases constituting one of a utility’s largest budget items, Moody’s noted the costs saving realized by several public power utilities. The Metropolitan Utilities District in Omaha, Nebraska, estimates it will save about $6.9 million over the initial five-year term of its 30-year gas prepayment bond issuance. Florida’s City of Tallahassee Electric Enterprise realizes savings between $153,000 and $200,000 each month, amounting to between 1.8% and 2.4% of its net annual operating income. And Tennessee’s Jackson Energy Authority is saving about $175,000 annually, or 1.8% of its net operating income.
Typically, a municipal gas prepayment bond involves tax-exempt bonds issued by a conduit entity, such as a large financial institution or the commodity subsidiary or a large financial institution. The proceeds from the bonds are channeled through the conduit entity, which buys the gas and immediately resells it to the utility. The conduit entity is set up as a non-profit and is, therefore, able to issue tax-exempt bonds.
The utility or utilities participating in the transaction are offered locked-in gas prices discounted to the market price for terms of up to 20 or 30 years. Utility participants can also benefit from receiving priority treatment in the event of shortages or curtailments. Public power utilities are also able to participate in more than one prepayment transaction simultaneously as a way of diversifying their sources of natural gas supplies. Starting in 2018, some gas prepayment transactions were structured to include a pool of smaller public power utilities.
Typically, gas prepayment transactions are not viewed as debt of the public power utility participants because the utility’s only obligation is to pay for gas received. There is no claim on municipal revenues on behalf of gas prepayment bondholders. Municipal utilities are also permitted to reduce participation in the prepayment transaction by providing notice, usually a few weeks or days. That allows utilities to lessen or eliminate the amount of gas they are required to buy, if their needs fluctuate or they can find better pricing.
“Gas prepay bond transactions provide municipal gas or electric utilities with significant cost savings as purchasers of discounted gas,” Ashley Staropoli, Moody’s Analyst and lead author of the report, said in a statement.