Santee Cooper bond sale raises concerns about costs of nuclear project

  • Posted: Monday, July 22, 2013 3:35 p.m., Updated: Tuesday, July 23, 2013 6:07 a.m.
Crews work on Nuclear Unit No. 2 last month at the V.C. Summer Nuclear Station in Jenkinsville. Buy this photo

Santee Cooper is heading to Wall Street. Its mission, in layman’s terms, is to refinance part of its mortgage and take out a home equity loan, all on a scale never before seen in South Carolina.

Pricing power

The total cost of adding two new units at the V.C. Summer Nuclear Station is projected to top $10 billion.

Business case: Santee Cooper owns 45% of the Summer expansion. The project will increase its reliance on nuclear power to 42% from 8%. It would offset the use of coal plants, which are falling out of favor because of environmental issues.

“Nuclear power stations have high capital costs, but they have very low fuel costs, which already have been proven to be stable and competitive, to balance out the capital expense,” Santee Cooper said in a document that outlines its proposed $1.748 billion bond sale.

Budget: Santee Cooper estimated it will have to spend $5.1 billion on the project. The other 55% is owned by SCANA Corp. and its S.C. Electric & Gas unit. SCE&G said its gross construction costs in future dollars is $5.766 billion.

Future borrowings: Santee Cooper still must come up with another $2.8 billion to pay for the rest of the project, unless it finds one or more buyers for some of its stake. The utility has been in talks with Charlotte-based Duke Energy, which has said it might buy 10%, but no deal has been announced. Absent a sale, Santee Cooper said in the bond document that it would issue more debt between 2014-18, most likely resulting in more rate increases. It also has applied for a loan guarantee through the Department of Energy and could use that money instead “should it be beneficial to do so.”

With interest rates still low, the utility is shopping plans to offer nearly $1.75 billion in long-term bonds to investors.

What rating firms say

Here are slightly edited versions of the written statements issued by Fitch Ratings, Moody’s Investors Service, and Standard and Poor’s Ratings Services about Santee Cooper’s bond sale.

FITCH

Fitch Ratings has assigned an ‘AA-’ rating to the ... South Carolina Public Service Authority (Santee Cooper) bonds.

The 2013 bond proceeds will be used to retire certain commercial paper notes, refinance a portion of outstanding debt and fund a portion of the authority’s ongoing capital improvement program. The bonds are scheduled to price the last week of July via negotiated sale.

The Rating Outlook is Negative.

SECURITY

The revenue bond obligations are secured by a gross lien on system revenues and are paid prior to operating expenses and other outstanding obligations.

KEY RATING DRIVERS

SOLID LONG-TERM CUSTOMER BASE: Santee Cooper is one of the nation’s largest municipal wholesale systems, serving either directly or indirectly nearly one-third of the state of South Carolina. The recent extension of the supply contract with its largest customer, Central Electric Cooperative (Central), to 2058 is viewed positively, in that it provides greater long-term revenue certainty and affords the authority greater flexibility in structuring debt.

RATING OUTLOOK REVISED TO NEGATIVE: The revision in Outlook reflects Fitch’s view that although Santee Cooper will benefit from the Central contract extension, the authority faces a number of challenges over the next several years, including slower growth, a large capital program and the ability to manage its excess ownership share of the new Summer nuclear plant expansion project (units 2 and 3).

REALIGNMENT OF GENERATING CAPACITY: Santee Cooper is actively engaged in restructuring its power supply mix, by reducing its exposure to coal-fired generation and adding to its natural gas and nuclear facilities. However, because of slower demand growth and large capital requirements, the authority is also attempting to reduce its ownership interest in the Summer project from 45% to approximately 20%.

FINANCIAL METRICS EXPECTED TO STABILIZE: Financial ratios for the authority have drifted lower over the past five years, which was a factor in the rating downgrade from ‘AA’ to ‘AA-’ in January 2012. Fitch-calculated debt service coverage (DSC) stood at 1.24x in 2012, compared with 1.68x in 2009. The weaker metrics reflect participation in the capital-intensive Summer project, the slower economy and lower sales, and much higher coal stockpiles. The 10-year financial forecast assumes DSC stabilizing around 1.50x with debt to equity of around 70% to 75%.

DEBT RESTRUCTURING CONTEMPLATED: The recent extension of the earliest possible termination date of the Central agreement should enable the authority to reduce near-term debt service by extending the average life of its debt and better aligning its amortization schedule with the expected lives of its assets.

RATING SENSITIVITIES

INABILITY TO LESSEN INTEREST IN SUMMER NUCLEAR: The authority’s 45% ownership interest in Summer leaves the utility with significant excess generating reserves for an extended period and potentially could weaken financial metrics below targeted levels. The authority’s ability to address these challenges over the next 12 to 24 months will be instrumental in resolving the Negative Outlook.

SIGNIFICANT CONSTRUCTION DELAYS: Fitch will continue to evaluate any changes to the Summer project schedule, design and/or budget and evaluate the effect on the authority’s rating and Outlook.

WEAKENED FINANCIAL POSITION: A primary factor in the current rating is the expectation that financial metrics will stabilize around the 1.50x DSC target established by the authority, supported by rate increases as warranted.

CREDIT PROFILE

Santee Cooper sells electricity directly and indirectly to approximately 2 million retail customers in 46 counties throughout South Carolina. The authority’s direct customers currently include Central, 29 large industrial users and two municipal systems.

In 2012, sales to Central accounted for 59.6% of electric revenues. Large industrial customers represented 20.9% of 2012 sales revenues, and residential, commercial and small industrial customers accounted for about 17.9% of revenues. The authority also has long-term power agreements with Piedmont Municipal Power Agency (PMPA) and Alabama Municipal Electric Authority.

The authority has a long-term power contract with Alumax, providing 400 MW, which extends through Dec. 31, 2015. The contract contains a provision that Alumax must notify the authority by Dec. 31, 2013 if it intends to cease operations after Dec. 31, 2015. At this time, certain conditions have been met that would allow Alumax to terminate the contact with nine month’s prior notice, but Alumax has not given the authority notice it intends to exercise its right to terminate. Santee Cooper believes that a termination of the Alumax contract would not have a material impact on the authority’s future financial performance, but there could be a sizeable loss of area jobs.

The authority and Central adopted an amendment to their existing power supply agreement on May 20, 2013 that better aligns their future interest, formalizes how they will jointly plan for new resources and defers their rights to terminate the agreement prior to Dec. 31, 2058. Central has also entered into requirements agreements with all 20 of its member cooperatives that extend through Dec. 31, 2058.

DIVERSIFIED POWER SUPPLY

Santee Cooper has a wide range of generating resources and purchases, totaling 6,087 MW. Coal generation accounts for the largest component of the summer peak energy mix at 57.2%; natural gas and oil at 20.1%; nuclear 5.2%; owned hydro 2.1%; landfill methane gas 0.5%; and purchases 14.9%. The authority plans for firm power supply from its own generating capacity and firm power contracts to equal its firm load, including a 13% summer reserve margin.

As of May 31, 2012, the authority had 232 days of coal on hand. Coal inventory levels have remained high as a result of reduced usage of the utility’s coal plants due to lower gas prices, the impact of the recession and mild weather conditions. The authority would like to see coal inventory closer to 50 days.

ATTEMPTING TO REDUCE INTEREST IN SUMMER NUCLEAR

In January 2008, the authority’s board approved a generation resource plan that included a 45% ownership interest in the Summer nuclear units 2 and 3; SCE&G owns the remaining 55%. The plan was to acquire a 45% ownership interest (990Mw) in the proposed two-1,100 Mw nuclear units. The participation in the project continues to be a key component in the authority’s strategy to address the potential for increasing costs associated with environmental regulation and carbon emissions.

These units are projected to increase the percentage of power generated from nuclear resources from approximately 8.86% to about 41.65% after both units are completed. The authority has evaluated its capital improvement program and long-term power supply plan in light of the economic downturn, the reduction in previously anticipated sales to Central and new environmental regulations. Santee Cooper has decided to retire six electric generating units and is also seeking to reduce its level of participation in Summer nuclear units below its current 45% to as low as 20% to better balance its nearer term capacity needs with the long-term benefits of nuclear power ownership.

The authority is engaged in negotiations with Duke Energy Carolinas, LLC to purchase a portion of its ownership share in the nuclear units (possibly 10%). Santee Cooper is also exploring other opportunities to market ownership interests to potential buyers. Continued 45% ownership of Summer units 2 and 3 would leave the authority with significant surplus reserves, if other ownership or power sales options were not effectuated. Preliminary estimates are that cumulative base rate increases over the 2015-2020 period would range from 6%-18% depending on the level of ownership in the nuclear project.

To date, approximately $1.8 billion has been financed for construction of Summer from bond issues sold beginning in 2008; and the authority plans to finance about $500 million of construction costs from proceeds of the 2013 bonds. The remaining requirements for construction equal $2.8 billion for a total of $5.1 billion. Absent the sale of a portion of its ownership interest in these two units, the authority intends to fund the remaining construction with the proceeds of additional bond sales projected in calendar years 2014 through 2018. Funding is expected to be accomplished with parity debt, but Santee Cooper also has a pending application with the Department of Energy for a loan guarantee to fund construction should it be advantageous to do so.

FINANCIAL RESULTS PRESSURED

Santee Cooper reported satisfactory financial performance for calendar year 2012; with Fitch calculated DSC at 1.24x, versus the authority’s target of 1.50x, and equity to capitalization at 25%. The lower debt-service figure reflects pressures caused by electric industry-wide related issues, such as mild weather and slower economy, and increasing annual debt service requirements on the substantially greater debt. Results for the first six months of calendar year 2013 were tracking slightly below forecast, reflecting softer sales.

MOODY’s

Moody’s Investors Service today downgraded the rating of South Carolina Public Service Authority’s (Santee Cooper) revenue bonds to A1 from Aa3. Concurrent with this rating action, Moody’s has assigned an A1 rating to the planned sale ... of Santee Cooper revenue bonds ..., expected to be sold in late July 2013. The rating outlook for Santee Cooper is stable.

Rating Rationale

The downgrade and A1 rating assignment reflect our belief that the expected sale of a part of Santee Cooper’s ownership interest in Summer Nuclear Units 2 and 3 (Summer 2 & 3) will take longer than initially expected resulting in further tightening of the utility’s financial and competitive position. Santee Cooper’s debt service coverage ratio (DSCR) in 2012 was 1.30x which is below the median for A rated utilities. While Santee Cooper’s planning target for DSCR is 1.50x, forecasted adjusted debt service coverage (including the payment of commercial paper interest) in several of the next few years could potentially fall below that level.

Factored into today’s rating action is the view that the 2013 and 2018 period prior to the commercial start of Summer 2&3 will be challenging. Santee Cooper’s immediate capital requirement is quite significant at the 45% ownership interest level particularly given the current size and customer base of the utility. We estimate that the Santee Cooper’s total capital cost for Summer 2&3 is $5.1 billion, of which $2.8 billion remains to be financed after the upcoming offering. These capital requirements will significantly increase the utility’s leverage, and the nearly doubling of debt service over the next four years will test ratepayer acceptance of Santee Cooper’s longer term power supply plan.

The planned offering of bonds will finance Santee Cooper’s 2013 capital improvement plan including construction costs related to the Summer 2&3. In addition, the planned offering helps facilitate a restructuring of the utility’s debt as it shifts some near-term principal requirements further out on the maturity schedule to provide a closer match to the asset life and to the term of the Central Power Cooperative power supply agreement that expires in 2058. Additionally, the debt service restructuring reduces debt service in the early years prior to commercial operation to ease the financial burden of the incremental debt required to finance Santee Cooper’s share of the Summer construction.

In terms of potential future sales to third parties, we understand that Duke Energy Corporation (Baa2 RUR upgrade) may be interested in a 10% ownership interest in Summer 2&3, but should a transaction occur, it appears that may take longer to finalize than once considered. (See Moody’s Credit Focus dated June 25, 2013 on South Carolina Public Service Authority). We further believe that Santee Cooper will not be able to sell output contracts until the plant reaches commercial operation. The utility remains open to finding partners to reduce its ownership interest to between 20 and 30%. At the 20% level the utility’s financial metrics appear to be more manageable. Should that effort be less than successful, not only will the utility’s financial metrics and competitive position be pressured, current estimates indicate that Santee Cooper will have over 1,000 MWs of surplus capacity in 2018.

We do observe several positive longer-term considerations regarding Santee Cooper’s approach to financing its power resource strategy including the ongoing funding of interest rather than the capitalization of interest along with the recently signed power sales agreement with Central Power Cooperative (Central: unrated). The power sales agreement includes monthly rate adjustments and the requirement Central covers its share of costs (including debt service on the Santee Cooper bonds issued for Summer 2&3) through 2058. Wholesale sale revenues from Central represent close to 60% of Santee Cooper’s revenues. Also, Santee Cooper’s share of the two nuclear units will provide significant long term fuel diversity from non-carbon sources, and once the nuclear units are operational, the lower nuclear fuel costs will enhance the utility’s competitiveness.

Santee Cooper is owned by the state of South Carolina (Aaa) and serves about one-third of the population of the state providing service to every county in the state. The utility management has had a sound record of electric generation management including building and operating several coal and gas fired facilities. Santee Cooper has 5,700 MW of owned generation. Generally, the state has been supportive of the utility and there has been limited revenue transfer to the state provided by the utility. Santee Cooper also has established a sound past financial record including strong liquidity and debt service coverage metrics (median 1.67 times between 1993-2012) , although leverage ratios have always been above average. Santee Cooper’s rates on an historical basis have been very competitive versus South Carolina Electric & Gas Company (SCE&G: Baa2 stable) on a retail basis.

The South Carolina economy continues to transition to a more diversified employment base as heavy manufacturing lost overseas during recession has not returned. Job growth in education health services, aerospace, and autos have been positive with the state’s unemployment rate close to the national average in 2013 and personal incomes improving. Migration of retirees has factored into new population growth. Santee Cooper does not anticipate significant demand growth but its role in the state to help attract new industry could factor into new job creation.

Outlook

The rating outlook for Santee Cooper is stable factoring several of the challenges facing the utility as it finances a very large capital program.

What Could Change the Rating UP:

In light of the recent downgrade, size of the capital program, and the continued outsized interest that Santee Cooper has in Summer 2&3, the rating is not likely to be upgraded in the near-term. The rating could face positive pressure should financial metrics such as adjusted DSCR improve above 1.50x and Santee Cooper is able to reduce leverage with the sale of a portion of the capacity of its current ownership in Summer 2&3.

What Could Change the Rating DOWN:

The rating is well placed given the near-term challenges facing the utility. The rating could be lowered if customers over the next several years react negatively to the increase in retail rates and Santee Cooper’s financial margins weaken. The rating could also be lowered should new NRC regulatory changes significantly impact the cost of the expansion program or significant new changes to the construction budget take place. The rating could also be lowered if there were political interference in the way Santee Cooper operates, affecting its financial strength or operating flexibility.

CREDIT STRENGTHS:

*Management team with experience and a sound record to execute generation projects

*Signed power supply agreement with Central Power Cooperative through 2058

*Competitive rates now for wholesale and retail customers in the service area

*Governing board sets rates without external rate regulation; customers including the Central customers bear fuel cost risk with a monthly fuel cost adjustment mechanism

*Below-average power production costs and strong generation performance of existing generation portfolio

*Authority is owned by the Aaa-rated state of South Carolina; authority fiscally separate from state

CREDIT CHALLENGES:

*Regulatory risk post Fukushima about safety of US nuclear fleet; thus far, new regulation has been reasonable and well managed

*AP 1000 reactor design used in Summer 2&3 has first-in kind engineering risk

*Exposure to environmental regulatory uncertainty since a significant amount of energy is from coal-fired generation

*Significant large industrial load that may be more susceptible to retail competition or customer relocation

*Construction risk is present as Santee Cooper implements its share of the substantial new nuclear generation plan

*Future interest rate risk on completion financing for Summer 2&3

STANDARD & POOR’s

Standard & Poor’s Ratings Services has revised its outlook on South Carolina Public Service Authority’s (Santee Cooper) long-term debt to stable from negative.

At the same time, Standard & Poor’s assigned its ‘AA-’ rating to Santee Cooper’s proposed $788.4 million revenue obligations 2013 series A (tax-exempt), $369.5 million revenue obligations 2013 series B (tax-exempt) and $212.9 million revenue obligations 2013 series C (taxable). Standard & Poor’s also assigned its ‘SP-1+’ short-term rating on the authority’s 2013 series D senior-lien LIBOR index bonds that mature within three years.

In addition, Standard & Poor’s affirmed its ‘AA-’ rating on Santee Cooper’s $5.3 billion of existing long-term revenue bonds, its ‘SP-1+’ short-term rating on the authority’s $168.3 million 2011A senior-lien LIBOR index bonds that will be redeemed in December 2013 and its ‘A-1’ short-term rating on the utility’s subordinate-lien commercial paper (CP).

The outlook revision reflects our assessment of the benefits of Santee Cooper’s extending its wholesale power sales contract with its leading customer, Central Electric Power Cooperative Inc. That utility accounted for close to 60% of Santee Cooper’s 2012’s operating revenues. “In addition to

enhancing the predictability of the authority’s revenue stream through 2058, the 28-year extension also allows Santee Cooper to better align the amortization of existing and proposed debt with its assets’ useful lives,” said Standard & Poor’s credit analyst David Bodek.

The 2013A-D bond proceeds will fund a portion of the utility’s capital program and refinance a portion of its existing long-term debt, short-term LIBOR notes and CP. This transaction will lengthen the maturities of about 15% of its existing debt. Santee Cooper will share debt service savings with Central on a

pro rata basis. The bonds are payable from the authority’s retail and wholesale electric system’s net revenues.

Santee Cooper, based in Moncks Corner, S.C., is a state-owned electric and water utility, although water sales have historically represented less than 1% of operating revenues. The utility serves about 167,000 residential, commercial, and industrial electric customers directly, and another 744,000 customers indirectly through wholesale electric supply arrangements with cooperative and municipal utilities. Central serves most of the latter group.

The stable outlook reflects our view that that extending the Central contract by 28 years and reamortizing a portion of existing debt and matching debt maturities to the lives of the assets the utility is financing bolsters capacity to service existing debt and the substantial debt it plans to issue.

There could be negative implications for financial performance and our ratings on Santee Cooper if the authority is saddled with nuclear development costs and debt that are disproportionate to its load requirements or it bears onerous emissions remediation costs for its coal fleet. We do not expect to

raise the ratings during our two-year outlook horizon.

It would be the largest debt issue in state history by a public agency.

It’s also prompted three big credit rating firms to point out concerns they have about Moncks Corner-based Santee Cooper. In particular, they’re worried about the $5.1 billion the state-owned power and water company is borrowing to help pay for its share of the V.C. Summer Nuclear Station expansion in Fairfield County.

The utility, which provides electricity to 2 million South Carolinians either directly or through local power cooperatives, is looking to sell four types of bonds with the help of Goldman Sachs and other big banks. The interest rates have not been set yet, but the proceeds are already allocated.

Santee Cooper said in presentations to potential investors last week that about $541 million would pay for work at the Summer nuclear plant in Jenkinsville, north of Columbia.

Another $340 million would go toward meeting new environmental regulations and other expenses.

The bulk of the money, $867 million, would be used to refinance older, higher-interest bonds that come due as soon as December. The new debt would extend those obligations three or four decades into the future, said Mollie Gore, Santee Cooper’s director of corporate communications.

“We can take debt we previously had to repay by 2030, refinance it and pay it out over many more years,” Gore said. “That’s the goal on this.”

Overload?


Wall Street’s big three credit ratings firm had mixed reactions to the deal, which would increase Santee Cooper’s long-term debt load by about 17 percent, to $5.9 billion. All three last week assigned the fourth-highest ratings their firms use to grade the quality of bonds.

Gore pointed out that Standard & Poor’s Ratings Services upgraded the utility’s long-term debt to stable from negative, citing a new contract extension with Central Electric Power Cooperative, its biggest customer. S&P credit analyst David Bodek said the long-term agreement provides a predictable source of revenue through 2058 and enables Santee Cooper to “better align” the repayment of its existing and new debt.

Gore added that Santee Cooper “remains highly rated among our utility peer group, and we are moving quickly on the opportunity to extend debt over the life of our assets, an opportunity that comes from successfully negotiating a contract amendment with our largest customer.”

The two other big rating firms, Moody’s Investors Service and Fitch Ratings, also view the deal with Central Electric as a positive move, but both issued downgrades on Santee Cooper. Moody’s knocked the outlook on the utility’s debt down one notch, which could trigger slightly higher interest rates on the new bonds, while Fitch revised its ratings outlook to negative.

Their shared concern — and S&P agrees with them on this point — is whether the utility can sell more than half of its ownership stake in the Summer nuclear plant, as it’s been trying to do since at least 2011. If it can’t, Santee Cooper, also known as the S.C. Public Service Authority, would be saddled with excess power and higher debt repayment costs once the expansion is completed.

“The authority’s 45 percent ownership interest in Summer leaves the utility with significant excess generating reserves for an extended period and potentially could weaken financial metrics below targeted levels,” Fitch wrote in a report last week. “The authority’s ability to address these challenges over the next 12 to 24 months will be instrumental in resolving the negative outlook.”

As for Moody’s, it said it believes Santee Cooper’s efforts to find a buyer for part of the nuclear plant and reduce its exposure to Summer “will take longer than initially expected resulting in further tightening of the utility’s financial and competitive position.”

It also predicted a “challenging” period for Santee Cooper between now and the completion of the project in 2018. Its main worry is the enormous costs of adding the two new reactors. Even after the bond sale, Santee Cooper will still need to raise another $2.8 billion to pay for its $5.1 billion share, unless it finds a partner to pick up some of the tab.

“These capital requirements will significantly increase the utility’s leverage, and the nearly doubling of debt service over the next four years will test ratepayer acceptance of Santee Cooper’s longer term power supply plan,” Moody’s wrote.

Paying it back


Mark Cooper, senior fellow for economic analysis at Vermont Law School’s Institute for Energy and Environment, has taken the cost issue further.

Cooper has said nuclear plants are too expensive to build and operate. He also argued it would be more economical to halt construction and mothball the Summer expansion.

South Carolina Electric & Gas, which owns the other 55 percent of the project, has said the new reactors ultimately will save ratepayers billions of dollars because nuclear fuel costs almost nothing compared with coal and other fossil fuels.

Santee Cooper will be repaying the new debt with revenue from its electricity business. Gore said the utility previously approved a two-part rate increase totaling 7 percent to generate more revenue. Half went into effect in December. The rest kicks in at the end of this year.

“A big part of that was focused on debt associated with environmental compliance and with the nuclear build-out,” Gore said.

Santee Cooper has not announced any future rate increases.

The utility’s board is expected to vote on the bond sale July 31.

Gore said it would be by far Santee Cooper’s biggest debt sale in its 79-year history. Based on that, it also would be the largest ever for a public agency in South Carolina, according to the State Treasurer’s Office.

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