is it Lights out for puerto rico?

The Washington Post Sunday - - BUSINESS - BY STEVEN MUF­SON

For a case study in how to run a com­pany into the ground, look no fur­ther than the Puerto Rico Elec­tric Power Au­thor­ity. The is­land’s gov­ern­men­towned elec­tric util­ity has $9 bil­lion in debt, fall­ing sales and ris­ing costs. Its elec­tric­ity rates for con­sumers run 21/ times the na­tional av­er­age and higher than any U.S. state ex­cept iso­lated, oilde­pen­dent Hawaii.

All that money has pur­chased pre­cious lit­tle. The util­ity’s power plants, with a me­dian age of 44 years, lack pol­lu­tion con­trols and vi­o­late En­vi­ron­men­tal Pro­tec­tion Agency mer­cury lim­its. The plants burn dirty resid­ual fuel oil and diesel to gen­er­ate about twothirds of the is­land’s power. And thanks to ag­ing in­fra­struc­ture, fre­quent and costly power fail­ures plague cus­tomers. The calls of cus­tomers bold enough to phone the util­ity to com­plain about ser­vice are dropped more than 50 per­cent of the time. Now, how­ever, PREPA is run­ning out of cash and its cred­i­tors — in­clud­ing the ma­jor bond funds Op­pen­heimer and Franklin Tem­ple­ton— can’t be put on hold.

Deep in debt, hooked on oil, with sales fall­ing and a bloated pay­roll, its elec­tric util­ity il­lus­trates woes of ‘Amer­ica’s Greece’

The util­ity lies at the epi­cen­ter of a mount­ing fi­nan­cial cri­sis in Puerto Rico, fre­quently called “Amer­ica’s Greece.” The ter­ri­tory’s gover­nor re­cently called the is­land’s $73 bil­lion of debts “un­payable.” With hun­dreds of mil­lions of dol­lars of pay­ments loom­ing andl ittle cash on hand, PREPA has been thrust to the fore­front of a fight over whether the Puerto Ri­can com­mon­wealth should be able to re­sort to U.S. bank­ruptcy courts for pro­tec­tion while it re­struc­tures its debts.

That in turn is part of a larger de­bate over the sta­tus of Puerto Rico — teth­ered to the United States ever since it was seized in the Span­ish-Amer­i­can War of 1898, yet treated nei­ther as a state nor as a coun­try. Bank­ruptcy rules are part of that. In 1984, Congress passed leg­is­la­tion bar­ring mu­nic­i­pal­i­ties, agen­cies and gov­ern­ment-util­i­ties in Puerto Rico from declar­ing bank­ruptcy, while al­low­ing those lo­cated on the main­land to do so.

Amid all this, PREPA stands out as what Puerto Ri­can Gov. Ale­jan­dro Gar­cia Padilla in an in­ter­view called “the big­gest mess.”

Are­port is­sued by three vet­eran In­ter­na­tional Mon­e­tary Fund econ­o­mists said the util­ity’s poor per­for­mance not only ru­ined its own bal­ance sheet but also un­der­mined the Puerto Ri­can econ­omy’s com­pet­i­tive­ness be­cause of need­lessly high elec­tric­ity rates.

“As a key in­put cost, this cas­cades down to lo­cally pro­duced goods and ser­vices and stunts po­ten­tial growth sec­tors such as tourism,” the re­port said.

The cost and avail­abil­ity of energy “is prob­a­bly the most se­ri­ous is­sue we face to­day,” said Eric Spackey, chief ex­ec­u­tive of­fi­cer of Blue­wa­ter De­fense, a man­u­fac­turer of uni­forms and pro­tec­tive cloth­ing for the mil­i­tary. “My largest fixed cost is energy, and sadly ser­vice in the area of my plant is in­ter­mit­tent.”

Spackey said that ev­ery time there is a power fail­ure, more than 450 ma­chines in his com­plex just west of San Juan “turn off and pro­duc­tion stops un­til the gen­er­a­tor kicks in and the ma­chines can re­boot — dis­rupt­ing the pro­duc­tion flow, ma­chine cir­cuit boards and ul­ti­mately morale.” He said that while the gov­ern­ment is aware of the prob­lems, he fears the liq­uid­ity cri­sis will only make things worse.

Prob­lems with plants and pol­i­tics

Fix­ing the mess at PREPA — whose chief ex­ec­u­tive and sev­eral other top of­fi­cials re­signed in June — will be no small task.

“This is not some­thing where a few tweaks will do,” said Anne O. Krueger, for­mer chief economist at the World Bank and for­mer No. 2 of­fi­cial at the In­ter­na­tional Mon­e­tary Fund. She helped write the re­port on Puerto Rico’s fi­nances.

One of the main prob­lems is PREPA’s over­whelm­ing de­pen­dence on oil for power gen­er­a­tion, a func­tion of poor plan­ning. More­over, its an­ti­quated power plants burn the oil in­ef­fi­ciently. As a re­sult, high oil prices over the past 10years have helped stran­gle the util­ity and at one point drove elec­tric­ity rates over 30 cents a kilo­watt hour.

But PREPA’s prob­lems run deeper than that and are rooted in the is­land’s po­lit­i­cal cul­ture.

The Krueger-led re­port called PREPA “an in­ef­fi­cient and over staffed public en­ter­prise us­ing tech­nolo­gies decades out of date.” Three-quar­ters of the util­i­ties ser­vice trucks are “ob­so­lete” and fre­quently out of ser­vice, said a pre­sen­ta­tion by Lisa J. Don­ahue, a man­ag­ing di­rec­tor of New York-based Alix Part­ners who is now act­ing as the util­ity’s restruc­tur­ing of­fi­cer.

Don­ahue has vowed to fix the trucks and shrink the bloated pay­roll, which is twice as big as the av­er­age util­ity pay­roll on the main­land, ac­cord­ing to a June 2010 re­port by the Cen­ter for a New Econ­omy.

Both of the is­land’s po­lit­i­cal par­ties have been com­plicit; they have padded the pay­rolls with loy­al­ists in equal num­ber as part of an un­writ­ten pact to feed off the util­ity’s rev­enues. More than a thou­sand of these “trust em­ploy­ees” work more — and earn more — when their party is in power.

“So when your party is in the ma­jor­ity, you might be given more re­spon­si­bil­i­ties, and if it is out of power then you are sent to the base­ment for four years,” said for­mer lieu­tenant gover­nor Ken­neth McClin­tock, who tried in vain to re­form PREPA when he was in of­fice. He said that the po­lit­i­cal par­ties also raised money by press­ing the util­ity’s sup­pli­ers to buy tick­ets to util­ity raf­fles or so­cial events whose earn­ings go to the par­ties.

The EPA’s ex­pe­ri­ence with PREPA sug­gests not just po­lit­i­cal med­dling but a pat­tern of dis­re­gard of laws and reg­u­la­tions. In 1993, the util­ity was found to have com­mit­ted mul­ti­ple vi­o­la­tions of air, wa­ter and stor­age-tank reg­u­la­tions. In 1997, it was fined for fail­ing to fix those. In 1999, the EPA won a crim­i­nal case un­der the Clean Wa­ter Act to force the util­ity to com­ply with or­ders af­ter a sul­fu­ric acid spill. In 2004, PREPA was fined again for fail­ing to meet terms of an ear­lier con­sent de­cree.

Not all of PREPA’s woes are of its own mak­ing. The Puerto Ri­can gov­ern­ment, no mat­ter what party was in power, has in the past used its own­er­ship of public util­i­ties to ex­tend sub­si­dies to lure new in­vestors or keep busi­nesses from leav­ing, Eu­ge­nio J. Alemán, se­nior economist of Wells Fargo, wrote in a May 24, 2012, note to in­vestors.

“In the past, some of the ho­tels that have gone bank­rupt over the years on the is­land had been delin­quent in their public util­ity bill pay­ments and phone bills for years be­fore the bank­ruptcy, but state-owned public util­i­ties never en­forced the col­lec­tion of their bills from those ho­tel chains,” Alemán said.

“This meant that public util­i­ties would have to re­coup the costs of these sub­si­dies ei­ther by not in­vest­ing or by charg­ing a higher rate toot her busi­nesses or in­di­vid­u­als or a com­bi­na­tion of both strate­gies,” he wrote. “For many decades, they did not do ei­ther. This is one of the rea­sons why public util­i­ties are in such dis­mal con­di­tions to­day.”

As the com­mon­wealth’s fi­nances have crum­bled, PREPA also has had trou­ble col­lect­ing money owed by the gov­ern­ment it­self. Ac­cord­ing to the last re­port, from 2013, the gov­ern­ment owed the util­ity $250 mil­lion.

Steal­ing elec­tric­ity has grown more preva­lent too, by some es­ti­mates drain­ing as much as 15 to 25 per­cent of out­put.

Re­fus­ing to in­no­vate

Many in­vestors have put forth a dif­fer­ent vi­sion of PREPA, of­fer­ing to build a va­ri­ety of so­lar, wind, hy­dro and nat­u­ral-gas-pow­ered plants to make the util­ity’s elec­tric­ity cheaper and greener.

Yet PREPA, re­luc­tant to re­lin­quish its grip on power sup­plies, has turned away many of those in­vestors. Although sun­light is plen­ti­ful and breezes steady, the is­land has only about 150 megawatts of wind and so­lar in­stalled — barely 1 per­cent of to­tal con­sump­tion. Al­though­many wind and so­lar de­vel­op­ers have signed con­tracts with PREPA, vir­tu­ally all of them have shelved the projects fornow.

In late 2012, Robert Stern­thal, pres­i­dent of Cohn Reznick Cap­i­tal Mar­kets Se­cu­ri­ties, pre­dicted that Puerto Rico would be­come “the next hot de­vel­op­ment spot in the U.S. so­lar mar­ket.” Af­ter all, with na­tion­wide tax in­cen­tives and the high cost of oil-fired elec­tric­ity, so­lar would be sig­nif­i­cantly cheaper than busi­ness as usual.

To­day, a frus­trated Stern­thal ad­mits he was wrong. PREPA de­manded that in­de­pen­dent so­lar power de­vel­op­ers meet “min­i­mum tech­ni­cal re­quire­ments” or PREPA would close off the so­lar pro­ject’s ac­cess to the grid for an un­spec­i­fied amount of time, with no clear guid­ance on when a pro­ject could come back online, Stern­thal wrote in a Novem­ber 2013 online so­lar in­dus­try pub­li­ca­tion.

Com­ply­ing with PREPA’s re­quire­ments “is a near im­pos­si­bil­ity” and “would make nearly all of the projects un­eco­nomic to build,” wrote Stern­thal, whose firm has ar­ranged fi­nanc­ing for more than $4 bil­lion in re­new­able energy projects. By the time PREPA’s fi­nances are sorted out, the fed­eral tax in­cen­tives for so­lar will prob­a­bly have ex­pired.

“To me it’s as­tound­ing that you look at the world and the cre­ation of re­new­ables, at how­many mega watts are built ev­ery­day, and these guys can­not get out of their own way,” Stern­thal said in an in­ter­view. “They would save mil­lions, if not hun­dreds of mil­lions of dol­lars, a year.”

Now PREPA is at­tract­ing con­ven­tional firms and fi­nanciers who see the po­ten­tial for big sav­ings and prof­its.

York Cap­i­tal, a New York-based in­vest­ment firm, and NRG, one of the coun­try’s largest elec­tric util­i­ties, teamed with ITC Hold­ings, a trans­mis­sion com­pany, and re­cently came up with a grand vi­sion for Puerto Rico’s elec­tric­ity sec­tor. The three firms said they would in­vest $3.5 bil­lion to in­stall a nat­u­ral-gas­fired plant, about 400 megawatts of so­lar, and trans­mis­sion lines to take power from the gas plant in the south of the is­land to the north.

The group would sell elec­tric­ity to PREPA — with­out get­ting in­volved in the util­ity’s debt headaches, its four trade unions or its ag­ing power plants.

Within a cou­ple of years, the group says, the is­land would save $1.5 bil­lion an­nu­ally, or 9 cents a kilo­watthour, more than 40 per­cent of re­tail rates— enough to pay cred­i­tors and still slash con­sumers’ bills.

“Our in­ter­est in the pro­ject comes from be­ing dis­tress in­vestors and restruc­tur­ing ex­perts,” said Wil­liam Vrat­tos, part­ner and head of global credit at York. “At PREPA, we­felt that not only would more value be cre­ated for the PREPA bank­ruptcy es­tate or the com­pany but also for the is­land and all the stake­hold­ers.”

Try­ing to re­or­ga­nize

For now, PREPA is at the mercy of its cred­i­tors while a team hired by the Puerto Ri­can gov­ern­ment scram­bles to re­struc­ture — and get some fi­nan­cial re­lief.

On July 13 at Cit­i­group’s midtown Man­hat­tan head­quar­ters, ad­vis­ers to PREPA spelled out to a room crowded with cred­i­tors how dire the is­land’s sit­u­a­tion is.

Jim Mill­stein, for­mer head of restruc­tur­ing at the Trea­sury dur­ing the fi­nan­cial cri­sis, warned at the meet­ing that “if this turns into a don­ny­brook, with cred­i­tors lit­i­gat­ing against one another and lit­i­gat­ing with the com­mon­wealth,” it would hurt the econ­omy and tax rev­enues needed to meet pay­ments. Mill­stein’s firm has been work­ing with Puerto Rico’s Gov­ern­ment De­vel­op­ment Bank.

PREPA pro­posed de­fer­ring prin­ci­pal pay­ments and most in­ter­est pay­ments for five years, de­lay­ing more than $600 mil­lion a year in pay­ments and pro­vid­ing the util­ity with enough cap­i­tal to build more ef­fi­cient power plants that would be cheaper to op­er­ate be­cause they wouldn’t burn petroleum.

The big­gest cred­i­tors ini­tially in­sisted that the util­ity could cover in­ter­est costs by rais­ing elec­tric­ity rates about 4 cents a kilo­watt hour. The util­ity’s ad­vis­ers replied that higher rates would only ac­cel­er­ate the fall in de­mand, which has slid­ing about 2.5 per­cent a year for the past decade.

Franklin Tem­ple­ton and Op­pen­heimer have about $10 bil­lion in Puerto Ri­can bonds, val­ued by in­vestors be­cause in­ter­est on such bonds is ex­empt from fed­eral, state and lo­cal taxes. To­gether with Blue Moun­tain, a hedge fund, Franklin Tem­ple­ton and Op­pen­heimer won an ap­peals court rul­ing that threw out Puerto Ri­can leg­is­la­tion that would have al­lowed gov­ern­ment en­ti­ties there to use bank­ruptcy, say­ing that power be­longed to Congress.

But on Thurs­day, a group rep­re­sent­ing hold­ers of 40 per­cent of PREPA’s bonds— in­clud­ing Franklin, Op­pen­heimer, Blue Moun­tain and Knight­head, another hedge fund — made a coun­ter­pro­posal, of­fer­ing to ex­change old bonds for new ones with lower av­er­age in­ter­est rates and a mix­ture of de­ferred pay­ments.

For PREPA, it would be a mixed bag. It would still pay $1.6 bil­lion in the first five years but would save $2.5 bil­lion in in­ter­est and prin­ci­pal pay­ments over 10 years. Elec­tric­ity rates would be lower than Hawaii’s but would re­main high com­pared with rates on the main­land.

A big ob­sta­cle to a com­pro­mise could be the two com­pa­nies that in­sured much of PREPA’s bonds — Na­tional, for­merly known as MBIA, and As­sured. They have guar­an­teed $10 bil­lion of Puerto Ri­can debt; about $3 bil­lion of that was is­sued by PREPA. If PREPA and its bond­hold­ers agree on terms, Na­tional and As­sured, which also guar­an­teed mort­gage se­cu­ri­ties caught in the hous­ing col­lapse of 2008, would still have to pay in­vestors in in­sured bonds the short­fall.

To Wolfe, co-au­thor of the Krueger re­port, the PREPA cri­sis echoes the ear­lier U.S. fi­nan­cial cri­sis.

“To me, this is sec­ond ex­am­ple of where fi­nan­cial mar­kets have com­pletely failed be­cause of bad in­for­ma­tion,” Wolfe said. Just as rat­ings agen­cies rated sub-prime mort­gages with­out any idea what they were rat­ing, he­said, “here in­vestors were lend­ing to a gov­ern­men­tal agency, and no one knew what its fi­nan­cial sit­u­a­tion was.”



The Palo Seco power plant stands in San Juan. Puerto Rico’s power au­thor­ity is $9 bil­lion in debt. Last week, a group rep­re­sent­ing hold­ers of 40 per­cent of PREPA’s bonds — in­clud­ing Franklin, Op­pen­heimer, Blue Moun­tain and Knight­head, another hedge fund — of­fered to ex­change old bonds for new ones with lower av­er­age in­ter­est rates and a mix­ture of de­ferred pay­ments.

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