THE WOODLANDS, Tex. - Turbulence in the financial markets sidelined many prepaid natural gas deals this year, but public utilities are lining up billions of dollars worth of bonds to capture discounts on the volatile commodity when conditions improve, officials told The Bond Buyer's third annual Prepaid Energy Contracts conference yesterday.
Among utilities preparing for their first prepaid gas purchase is Colorado Springs Utilities, which has been working on a $600 million deal for more than a year.
"When the market changed, that sort of interrupted our process," said Joe Holmes, lead energy trader at the Colorado utility. The $600 million deal with Merrill Lynch & Co. has all the necessary approvals and is simply waiting on acceptable market conditions. But Holmes said he does not know when that will be.
"It changes so much, it may be next week," he said.
Paul Vinson, manager of gas supply for San Antonio's CPS Energy, said he has been told that about $12 billion of prepaid deals are in development or waiting to go to market, including CPS'. The city-owned utility did its first deal through a conduit issuer last year and is taking responses to its request for proposals from bankers.
Vinson said the utility feels fortunate to have used Goldman, Sachs & Co. as a counterparty because the banker has withstood the credit crunch and market turmoil, retaining a double-A credit from the rating agencies.
Indeed, counterparty risk is one of the major concerns in prepaid energy transactions, which can last as long as 30 years, officials and industry executives said.
"As we come out of the credit crisis - or nearly do - there is a level of comfort with the gas suppliers you have represented here," said Randall Finken, vice president of Goldman Sachs, who shared a panel with Mark Widener, managing director of Merrill Lynch and Lance Etcheverry, managing director of JPMorgan. Another major player in the prepaid market is Citi.
Etcheverry said that energy prepayments transactions began in the 1990s but that interest has surged in the past 24 months as natural gas prices have soared. In the past five years, price for natural gas have nearly tripled. For deals completed since 2006, prepaid deals have accounted for about 20% of load, he said.
Although demand for prepaid transactions is robust, the subprime housing crisis, the dramatic downgrades of bond insurers, and the collapse of the market for auction-rate securities have roiled the sector. The yield spreads between taxable and tax-exempt bonds is another critical factor, and earlier this year, the yield curves were actually inverted.
"Stabilizing the credit markets should reduce supplier credit spreads," Etcheverry said. "But the municipal market typically lags the taxable market."
Although utilities are somewhat insulated from risk through the structure of prepaid deals, they still must consider how daring they want to be.
Noreen Roche Carter, treasurer of the Sacramento Municipal Utility District, closed a $750 million deal last year in which SMUD was the only buyer of the gas from the conduit nonprofit issuer.
Although the utility is not the actual issuer of the debt and the bonds' credit is that of the investment bank, going it alone is not something SMUD would do again, Carter said.
"One consideration is reputational risk," she said. "Our board asked if we there was any risk to our reputation. In our case, I'd say there is. We were one of the first to do a standalone deal, and there was a lot more disclosure than we expected."
The Municipal Gas Authority of Georgia, one of the pioneers in prepaid energy, builds alliances between municipal utilities for its deals, said chief financial officer Susan Reeves.
One vehicle for building market power between several public utilities was a nonprofit that MGAG created called Main Street Natural Gas Corp.
"We like the idea of munis working together to create economies of scale," Reeves said. "Main Street was just another way of making that happen."
Main Street got caught up in the market turmoil in February when its $496 million 2007 issue was downgraded by Standard & Poor's to A from A-plus because XL Capital Assurance provided a surety bond for the reserve fund.