DALLAS — Arizona’s Salt River Project Agricultural and Power District forecasts a 20% increase in debt to $5.3 billion by the end of fiscal 2016, even after reducing its capital program.

The debt increases are primarily due to $1.5 billion in purchased power agreements that will be treated as capital leases as they are phased in through 2016 and will add to fixed obligations, according to a Standard & Poor’s report.

“We’re not issuing any new debt to cover it,” SRP treasurer Dean Duncan said of the new accounting procedure. “Right now, in terms of new money, we’re planning to issue about $700 to $800 million over the next six years.”

Next week, the district plans to issue about $240 million of electric system refunding bonds for savings. The advance refunding of 2002 bonds is expected to provide a net present-value savings of at least 7%.

The upcoming deal is led by Goldman, Sachs & Co. as senior manager. Bank of America Merrill Lynch, Citi, JPMorgan, Morgan Stanley and Ramirez & Co. are co-managers.

Public Financial Management is the district’s financial advisor. Drinker Biddle is bond counsel.

In its last refunding in September, SRP achieved 12.3% savings, or about $58 million, on a $441.5 million deal. Based on recent rates in the market, SRP expects to save about $25 million in the upcoming deal.

“Even though rates have moved around on us a little, we’re still looking good,” Duncan said.

Despite recent weakness in Arizona’s economy, SRP remains one of the nation’s highest rated power utilities. Standard & Poor’s assigned a rating of AA with a stable outlook to the electric system refunding bonds. Praising SRP’s management practices and strong debt-service coverage, Moody’s Investors Service rated the bonds Aa1 with a stable outlook. Fitch Ratings does not rate the issue.

“The rating also factors in operating cost reductions and other efficiency steps taken to partially mitigate the effects of slower demand growth in its service area resulting from the slowdown in the regional economy,” said Moody’s analyst Kevin Rose.

Based in the Phoenix suburb of Tempe, the Salt River Project is a vertically integrated electric utility providing retail electric service in parts of Maricopa, Gila and Pinal counties.

The district also provides raw water to municipalities and for agricultural irrigation in areas surrounding Phoenix. However, water operations represent less than 1% of operating revenues.

The district now has $4.3 billion of senior debt, $175 million of certificates of obligation, and $475 million of commercial paper, according to S&P.

“Although the slowdown appears to be tapering off to some degree, the pace of recovery is expected to be slow and gradual over a multi-year period,” Moody’s Rose wrote. “As a result, capital spending plans have also been scaled back and related new debt financing needs are expected to be correspondingly reduced.”

Coal is the fuel for more than 50% of SRP’s energy sales, which exposes it to potentially higher operating costs as the regulation of carbon and other emissions progresses, analysts said.

The utility is adding renewable resources and began using an environmental programs cost-adjustment factor that allows SRP to recover costs from customers.

“These strategies will reduce coal’s contribution to energy production on a percentage basis but not in absolute terms,” said Standard & Poor’s analyst David Bodek. “Renewable resources could also add costs that could erode ratemaking flexibility.”

The utility added 86,000 customers from 2006 to 2008, but only 20,000 customers from 2009 to 2011 as the housing market collapsed.

Growth translated into higher operating costs and capital needs, analysts said. Operating costs in 2011, net of depreciation, were about 27% higher than in 2005 and total debt increased by about 62% to $4.4 billion from $2.7 billion during the same period as the utility added generation resources and increased its distribution capabilities.

About 28%, or $800 million, of the past few years’ new debt was issued for the 400-megawatt coal-fired Springerville Unit 4, which entered service in December 2009.

Because of the recession’s impact on growth, the utility does not expect to add conventional generating capacity before 2018, but is likely to add power purchases and renewable resources before then, according to Standard & Poor’s.

The district projects $3.8 billion of capital spending from 2013 to 2018, with generation emissions controls and plant rehabilitation accounting for about one-fifth of that.

SRP projects funding about 30% of the capital program with debt and the balance with internally generated funds. However, U.S. Environmental Protection Agency actions could lead to greater emissions spending in these years, analysts add.

SRP has a 488-megawatt interest in the coal-fired, 2,250-megawatt Navajo Generating Station, whose three units could be particularly susceptible to EPA regulations, co-owners’ aversion to long-term commitments to coal resources, and coal supply contract renegotiation, Standard & Poor’s analysts said.

“The resolution of these several issues will influence the plant’s long-term viability, SRP’s resource needs, and its capital spending requirements,” Bodek wrote.

According to a study prepared for SRP and the Navajo Nation by the L. William Seidman Research Institute at the W.P. Carey School of Business at Arizona State University, loss of the Navajo Generating Station could cost Arizona $18 billion.

Located on the Navajo Nation, near the city of Page, NGS’ lease and rights of way are set to expire around 2019. The tribe and SRP are currently negotiating extensions.

The plant’s owners are also renegotiating the coal supply contract with Peabody Energy.

“Perhaps most significantly, potential additional and costly environmental rules from the U.S. Environmental Protection Agency could also force the plant to shut down prematurely,” the study said.

The EPA is considering whether to require additional emission-control technology at the Navajo Generating Station for the purpose of improving visibility in nearby national parks by reducing emissions of nitrogen oxides.

“This study makes it very clear that as the EPA considers what actions are necessary at NGS to address environmental concerns, it is critical that their process take into account the economic implications of any new regulatory requirements,” said John Sullivan, chief resources executive at SRP, which manages NGS.

“The owners of NGS have already made significant voluntary investments in environmental controls that have reduced emissions from the plant,” he said. “Any further costly controls would have little visibility benefit, but could threaten the plant’s viability.”

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