HomeMy WebLinkAboutStaff Report 2312-24693.Discussion of the Northern California Power Agency Issuing Bonds to Prepay for the
Energy Received Under the 2025-2037 Geysers Power Purchase
Agreement (DISCUSSION 7:15 PM – 7:45 PM) Staff: Shiva Swaminathan
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Utilities Advisory Commission
Staff Report
From: Dean Batchelor, Director Utilities
Lead Department: Utilities
Meeting Date: May 1, 2024
Staff Report: 2312-2469
TITLE
Discussion of the Northern California Power Agency Issuing Bonds to Prepay for the Energy
Received Under the 2025-2037 Geysers Power Purchase Agreement
RECOMMENDATION
Staff is seeking the Utilities Advisory Commission’s (UAC’s) input prior to staff completing the
evaluation of the merits and risks of issuing bonds to prepay for the energy received under the
2025-2037 Geysers Power Purchase Agreement.
EXECUTIVE SUMMARY
The difference between tax-exempt and taxable bond yields offers the opportunity for tax-
exempt entities like Palo Alto and other Northern California Power Agency (NCPA) members to
structure prepay transactions to lower the cost of electric supply purchases. The current high
interest rate environment and the 2025-2037 Geysers Power Purchase Agreement (Geysers PPA)
provide a unique opportunity for NCPA members to authorize NCPA to issue non-recourse bonds,
to take advantage of this Internal Revenue Service-approved prepayment mechanism. Such a
prepay transaction is expected to yield a 5% to 8% savings on the cost of energy over the 12-year
contract term of the PPA.
This staff report introduces the topic of NCPA issuing bonds to prepay the Geysers PPA and
discusses the merits and risks of such a transaction. Staff is seeking UAC input on this topic as we
complete the evaluation and prepare for a possible City Council recommendation in the Fall.
BACKGROUND
Geysers Power Purchase Agreement
In April 2023 Palo Alto City Council approved the purchase of geothermal energy from Calpine
Corporation’s Geysers Power Company LLC (GPC) over a term of up to 12 years (2025-2037) for
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a total cost of up to $76.2 Million1. Palo Alto’s purchase was a 10% share of a larger PPA executed
by NCPA with the GPC on behalf of its members. Other NCPA member participants in the PPA are
City of Santa Clara (70%), City of Lodi (10%), City of Alameda (5%), Cities of Biggs, Gridley, Lompoc,
and the Port of Oakland (5%).
Energy Prepay Transactions
An energy prepayment is a long-term financial transaction available for municipal utilities that
enables cost savings on energy purchases. Utilities participating in a 12-year prepaid energy
transaction at prevailing interest rates are currently projected to enjoy a 5% to 8% discount on
their energy purchase cost for the duration of the PPA. Longer duration prepaid PPAs enjoy larger
discounts due to the time value of money and bond yield differentials. Higher market interest
rates also result in larger discounts.
In a typical energy prepay transaction, a tax-exempt municipal electric utility (e.g., NCPA member
PPA participants or Participants), a taxable financial Counterparty (typically a reputable bank that
has prior experience in electricity trading and executing prepay transactions), and a municipal
bond issuer (NCPA conduit - Issuer) enter into a long-term supply agreement. For the Geysers
PPA prepay, this agreement is the Clean Energy Purchase Contract. The conduit bond issuing
entity is set up as a non-profit and is, therefore, able to issue tax-exempt bonds. The municipal
bond Issuer issues tax-exempt bonds to raise the funds for the transaction, and then flows the
funds to the Counterparty.
The Counterparty utilizes the bond funds and provides a discount to the PPA participants on the
power purchases based on the difference between the taxable bond rates available to the
Counterparty and tax-exempt rates available to the Issuer. To enable this, NCPA would assign
some of its rights under the Geyser PPA to the Counterparty, with permission from GPC.
Figure 1 below illustrates a prepayment structure. It depicts NCPA acting on behalf the member
Participants, NCPA setting up a not-for-profit Issuer to issue the non-recourse bonds, and the
Issuer transacting with the Counterparty, a commercial bank. GPC, the entity with which NCPA
executed the 12-year PPA in 2022-23 is not shown in the illustration for simplicity. GPC would
have to agree to this transaction but is not financially impacted by the prepayment.
1 Staff Report: 2301-0706 of April 17, 2023 Packet Item 5 https://cityofpaloalto.primegov.com/Portal/Meeting?meetingTemplateId=1115
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Figure 1: Illustration of a Pre-Payment Transaction Flows
Legality
Prepayment transactions are legal and codified in US Tax Law. Initially, the Internal Revenue
Service (IRS) issued rules allowing tax-exempt natural gas prepayments and Congress enacted
legislation specifically allowing the transactions under the National Energy Policy Act of 2005;
Section 13272.
Impact on Balance Sheets of the Utility
Energy prepayment transactions are not viewed as debt of the public power utility participants
because the utility’s only obligation is to pay for energy received. There is no claim on a municipal
utility by the energy prepayment bondholders who purchase non-recourse municipal tax-exempt
bonds; bondholder recourse is only with the Counterparty that received the prepayment, an
entity that is typically a highly rated major commercial bank.
Historical Gas and Electric Prepay Transactions
Over the past two decades, 100+ municipal gas prepayment bonds have been issued with a value
totaling over $70 billion. More recently, prepaid electricity transactions have dominated the
market with 10 energy prepayment transactions totaling almost $10 billion completed in the last
few years with several Northern California Community Choice Aggregators (CCAs) leading this
effort.
2National Energy Policy Act of 2005; Section 1327 https://www.congress.gov/109/plaws/publ58/PLAW-
109publ58.pdf
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On September 15, 2014, Palo Alto City Council adopted Resolution #94513, authorizing the City’s
participation in a natural gas purchase from Municipal Gas Acquisition and Supply Corporation
(MuniGas) for the City’s entire retail gas load for a period of at least 10 years. The MuniGas
transaction is a gas prepay that has reduced the Palo Alto community’s natural gas bills by about
$1M per year since then.
ANALYSIS
Merits
The 12-year Geysers PPA entered into by NCPA, on behalf of participating members, offers a
unique opportunity for participating members to benefit from a prepaid structured transaction.
The benefit is preliminarily estimated at ~$6/MWh discount, equivalent to ~$60+ million in retail
ratepayer savings over the 12-year term of the PPA. Palo Alto share of savings is ~$6 million or
~$0.5 million per year.
Risks & Mitigation of Risks
The risks associated with a prepay transactions to NCPA and its members fall into three
categories: Bond holder recourse if the prepaid counterparty defaults, volumetric energy delivery
risk, and regulatory risk.
Default by Pre-Paid Counterparty
The proposed deal structure, utilizing a financing conduit of NCPA (Issuer) to issue non-recourse
municipal bonds, significantly minimizes the risks to the Participants. Non-recourse means the
bonds are not secured or guaranteed by the Issuer (NCPA or the Project Participants). If the
prepaid Counterparty experiences distress and fails to service the bondholder repayment
obligation, bondholders have recourse only to the Counterparty that received the prepayment.
Issuing non-recourse bonds reduces the discount Participants would receive through the
prepayment transaction compared to issuing bonds that provide bondholders recourse to NCPA,
but this loss of value is worth the risk mitigation provided by non-recourse bonds.
In the event of a default by the Counterparty, followed by termination, the prepaid Counterparty
is obligated to make a termination payment which will be used to repay the bondholders. This is
the only source of repayment funds available to bond investors in the event of a termination
event. The revenues of the Participants are not pledged to repay the bond investors and rating
agencies do not count prepay transactions as debt or fixed costs of NCPA or the Participants.
During the 2008 financial crisis, Lehman Brothers was the counterparty of several prepayment
transactions. Upon Lehman’s bankruptcy, the bondholders settled directly with Lehman as
opposed to the Issuer of the bonds. The issuer of the transaction(s) was not liable to the
bondholder but rather lost the benefit of the discount or savings when reverting to the original
terms of the PPA.
The Counterparty default risk is further reduced by selecting the Counterparty through a rigorous
RFP process and by hiring a seasoned investment bank with demonstrated experience in the
3 Resolution #9451 https://www.cityofpaloalto.org/files/assets/public/v/1/city-clerk/resolutions/reso-9451.pdf
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commodity business and prepay transactions. Contractual provisions will also be put in place such
that if the Counterparty fails, the PPA rights assigned by NCPA to the Counterparty revert back
to NCPA.
Volumetric Risk
Volumetric risk is the risk that the Counterparty fails to provide the required energy volumes to
sustain the prepay transaction. This risk is sufficiently managed in three ways. First, NCPA is
proactively scheduling only a portion of the contract volumes of the assigned PPA into the prepay
to hedge against potential under-generation. Next, the deal structure allows the Participants to
substitute or add additional PPAs to the prepay transaction to sustain the required volumes of
delivered energy. Finally, the Master Supply Agreement will provide a mechanism to backstop
under-generation in the event of an outage or other unplanned event.
Regulatory Risk
Regulatory risk, though low, may materialize should the IRS change its guidance for the treatment
of energy prepay transactions. Since the IRS issued rules informing the structure of these
transactions 30 years ago, well over 100 such bond issuances have successfully delivered savings
to their communities. If regulations do change, NCPA would assess the continuing viability of the
structure and, if necessary, withdraw. Under those circumstances, NCPA would continue under
the original terms of its PPA with only the downside of unmaterialized savings.
Unlike CCAs which get approval from the California Public Utility Commission (CPUC), municipal
utilities must receive approval from the California Energy Commission (CEC) to preserve the
renewable attributes of a PPA to meet the regulatory requirements of the renewable portfolio
standards (RPS bucket 1 renewable energy credits). While the CPUC has already approved prepay
energy transactions for the CCAs, the CEC has yet to officially adopt similar approvals. However,
it is expected the CEC would take the same position as the CPUC largely due to a recent CEC letter
provided to Anaheim Municipal Electric regarding a similar type of transaction – this aspect needs
to be confirmed in the coming months before a final recommendation is made.
Proposed Prepay Structure
Most prepay transactions are very complex when structured for 20 to 30 years. They generally
require Put Bonds4 and Commodity Swap5 providers to achieve savings of ~10% and require
replacing the original PPA with a similar-sized PPA (or PPAs) upon expiration to match the
maturity length of the outstanding bonds.
However, a preliminary prepaid energy structure currently being reviewed by NCPA creates a
unique opportunity. The transaction is sufficiently long enough to generate a significant
prepayment discount and more importantly, matures/terminates with the expiration of the
Geysers PPA. There is no need to procure a new PPA or PPA(s) to “fill the bucket” unlike a 20 or
4 A put bond is a debt instrument that allows the bondholder to force the issuer to repurchase the security at
specified dates before maturity.
5 A commodity swap is a type of derivative contract where two parties agree to exchange cash flows dependent
on the price of an underlying commodity.
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30-year prepay transaction. In addition, the short transaction allows for it to be sold as an
amortizing structure rather than a put bond structure eliminating premiums to investors. This
removes significant third-party expenses, the potential need for commodity swap
counterparties, and future market uncertainty.
NCPA Member Interest & NCPA Commission Approval
NCPA and its members have been exploring prepay opportunities over the past few years. In
September 2019, NCPA held a workshop educating members on the Clean Energy Savings
Initiative (CESI) but the lower bond yields and lack of suitable PPAs to prepay had hampered NCPA
staff from exploring this option in earnest. The execution of the Geysers PPA and higher market
interest rate has now provided a unique window of opportunity to enter in to such a transaction.
On February 22, 2024, NCPA Commission “authorized the NCPA General Manager to direct staff
to explore the merits and risks of a prepayment bond transaction regarding the Geysers Power
Purchase Agreement; and to return to the Commission with a recommendation to continue
moving forward or to discontinue this effort” (Attachment A). Attachment B contains a
presentation on the topic. Since NCPA Commission approval, NCPA staff’s exploration to date has
not identified any new risks or hurdles.
Next Steps
Upon UAC input, staff plan to discuss the topic with the Finance Committee on June 4th. Other
participating NCPA members are also discussing this transaction with their governing bodies.
Based on member input and NCPA staff analysis, NCPA Finance Committee and Commission is
expected to discuss findings and recommendations in June.
Potential Future Steps
If staff recommends proceeding with a prepayment transaction and the NCPA Commission
approves the recommendation (June timeline), it is anticipated to take 4-6 months for NCPA staff
to prepare. NCPA will need to secure professional assistance to complete the work necessary to
develop, draft, and finalize the Prepaid Energy transaction documents. Professional assistance
includes bond counsel, tax counsel, issuers counsel, disclosure counsel, a financial advisor, and
any other consultant needed to support the completion of the prepayment transaction. The
professional assistance generally works contingent upon a bond sale however, a rating agency or
agencies will need to formalize a review of the proposed transaction.
The prepaid energy transaction “package” would require each Participant’s City Council and/or
Board to approve the transaction before approval by NCPA’s Commission and before any bond
sale.
FISCAL/RESOURCE IMPACT
Exploring the merits of the prepay transactions will be undertaken by NCPA staff with existing
resources and minimal consulting expenditure. If directed to proceed with prepay, expenses
associated with preparing and issuing bonds is estimated to range between $1 to $2 million. Palo
Alto will not be directly responsible for the cost associated with bond issuance, since it will be
funded from bond sales proceeds.
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STAKEHOLDER ENGAGEMENT
This prepay transaction is being discussed with the UAC today and will be discussed with the
Finance Committee June 04, 2024 for their input.
If found worthy to proceed and approved by the participating member governing bodies, NCPA’s
Commission and Finance Committee will primarily be overseeing this transaction, within
parameters approved by member City Councils. Palo Alto is represented by Council Member Vicki
Veenker on the NCPA Commission.
ENVIRONMENTAL REVIEW
Consideration of the prepayment transaction does not meet the definition of a project under the
California Environmental Quality Act (CEQA), pursuant to the California Public Resources Code
Section 21065 because it is not an activity that will cause a direct physical change in the
environment.
ALTERNATIVE ACTIONS
The alternate to undertaking a prepay transaction is to do nothing. By not undertaking this
transaction, Palo Alto community will be foregoing $4 to $6 million in value over the 12-year term
of the PPA.
ATTACHMENTS
Attachment A: NCPA Commission Staff Report – February 22, 2024
Attachment B: Energy PrePayment Discussion Presentation by NCPA/PFM Staff
AUTHOR/TITLE:
Dean Batchelor, Director of Utilities
Staff: Shiva Swaminathan, Senior Resource Planner
Geysers PPA and Prepay
Opportunity
Monty Hanks,
CFO NCPA
Michael Berwanger,
Managing Director PFM
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§California Joint Powers Agency
established in 1968
§15 Members and 1 associate
Member serving 700,000
residents in communities
throughout Northern California
(city-owned / special districts)
§Builds and operates jointly-
owned power plants and
operates a power pool for
Members
§Represents Members before
legislative and regulatory
bodies
§Provides Power Management
Services to non-members,
including Community Choice
Aggregators (CCAs)
NCPA Overview
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Power Management
•Schedule/Dispatch loads and resources
•Ensures reliability and stability
•Creates market opportunities
•Provides aggregation savings
•Helps procure green energy
Generation Services
•Operate and maintain generation
resources
•Proactive asset management
•Resource optimization
•Savings for plant owners
•Ensures reliable capacity
Legislative & Regulatory
•Represents member interests in the
legislative and regulatory arena
•Credible solution-oriented leader in
policy debates
•Preserves local control
•Represents needs of consumers
•Protects agency assets
Administrative Services
•Financial administration and IT services
•Manage significant industry complexity
for Members
•Optimize debt service and ratings
•Recruitment of human capital
•Risk oversight of electric and gas
contracts
•Financing and Debt Management
Value of NCPA Functions
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§December 2022 – NCPA’s Commission approved the PPA and Third Phase
Agreements with Geysers Power Company
•Palo Alto’s UAC recommended Council approval in Feb 2023
•Palo Alto’s City Council approved in April 2023
Background
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Geysers Power Company PPA
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Geysers Power Company PPA
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Financing Assumptions and Results
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§Goal – Reduce cost of power purchases by 5% to 8%
§How – Leverage the use of tax-exempt bonding capacity to secure long-
term supply
Background
§Codified in the U.S. tax law
§Used since the 1990s largely for natural gas transactions
§Over 100 transactions totaling over $70 billion completed in the U.S. –
mostly for gas
§Ten energy prepayment transactions totaling $9.8 billion were completed
last few years for five California Community Choice Aggregators:
Prepayment Transaction Background
Ø East Bay Community Energy Ø Pioneer Community Energy
Ø Silicon Valley Clean Energy Ø Clean Power Alliance
Ø Marin Clean Energy Ø Central Coast Community Energy
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History of Completed Prepayments by CA Utilities
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History of Completed Prepayments by CA CCAs
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§PPA assignment and prepayment – will represent a percentage of power (~90-
95%) to account for maintenance or unplanned outages
§Investment Bank’s Credit Rating – bonds are non-recourse to the Issuer and
Participating Members meaning if the Prepayment Counterparty fails, they are
responsible for a termination payment which would cover the bondholders
§Timing is key – interest-rate sensitive meaning prepaid energy transactions rely on
the relationship between the tax-exempt market and the taxable market to provide
benefits to both the municipal utility and the counterparty
§Savings – driven by interest-rate spreads, term of prepay, and size
§Potential counterparties – Goldman Sachs, RBC, JPM, Morgan Stanley
Prepayment Transaction Overview
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Entities Involved in an Energy Prepayment Transaction
§Participants/NCPA – Have an existing Power Purchase Agreement for
clean energy.
§Prepay Counterparty – Typically a financial institution with a commodity
presence or a financial institution partnered with a commodity market
participant
§Issuer – A bond issuing entity formed for the sole purpose of selling the
prepayment bonds, typically a Joint Powers Authority (“JPA”).
§Existing Power Supply Counterparty – Agrees to partial assignment of the
existing PPA
§Bond Investors – Purchase the non-recourse prepayment bonds
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Summary of an Energy Prepayment Structure Mechanics
1)NCPA partially assigns PPA to
Counterparty
2)NCPA and Issuer execute a
Clean Energy Purchase Contract
3)The Counterparty delivers power
to Issuer via a Master Power
Supply Agreement
4)Issuer delivers power to NCPA
5)The Issuer issues non-recourse
tax-exempt bonds
6)The Issuer makes a prepayment
to the Counterparty for power
supply
7)NCPA makes payments to the
Issuer net of savings
8)Issuer makes debt payments
with payments from NCPA
1
Non-
Recourse
Tax-
exempt
DebtDebt
Service
Bond
Proceeds
NCPA
Counterparty
MWhs
Prepayment $$$
PPA Price
less Discount
MWhs
Issuer
Clean
Energy
Purchase
Contract
2
3
4
5
6
7
8
PPA to be
“Partially
Assigned”
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Favorable Risk Allocation – “Take and Pay” Structure
Worst Case –> Transaction terminates and NCPA/Participants no longer receive
expected savings
Counterparty default on energy delivery
NCPA receives too much energy and is
unable to have Qualified Use and/or has to
meet new renewable mandates in the future
Debt obligation could obligate NCPA over
long-term
Rating agency treatment of prepay debt
Debt is non-recourse to NCPA, and NCPA’s
obligation is take and pay. Rating agencies do not
count prepay transactions as debt or fixed costs
of NCPA
Counterparty will remarket the energy to qualified
entities to ensure NCPA compliance with Qualified
Use
NCPA only pays for energy if/when Counterparty
delivers the energy
Counterparty assumes debt obligations in the
event of Supplier default
Risk Mitigation
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Why this is a Unique Opportunity?
§Non-Recourse Bonds
•Prepay Counterparty will owe a termination payment which is what secures
bondholders should the transaction terminate before PPA expiration
•Ratings are of the Prepay Counterparty
•Does not impact Participating Members’ balance sheet
•If terminated, reverts to the original terms of the PPA (no savings)
§12y Term vs. 30y Term
•This transaction ends with the expiration of the Geysers PPA
•No need to “replace” the Geysers PPA with other liked-sized PPA(s)
§Bond Issuance
•~$450m to cover prepayment and cost of issuance
§Estimated Savings
•Approximately ~$45-50m in savings (~7%) subject to interest-rate sensitivity
•Palo Alto share ~$4-5m over PPA term (12y)
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Next Steps
§Education of a prepayment transaction to the staff, advisory
boards, and/or councils of the Geysers PPA Participating Members
•Seek feedback/guidance if NCPA should keep the process moving forward
§Continue discussions with the California Energy Commission (CEC)
•CEC has not provided official guidance on prepays and RPS but stated:
-It’s still a long-term contract
-The product is unchanged
-No substitution
-RECs are not unbundled and still posted in the participants’ WREGIS account(s)
§NCPA’s Finance Committee / Commission in May 2024
•Seek recommendation/approval to form the financing team
•Determine “Bond Issuer” options with bond counsel
•Solicit RFP for prepayment counterparty
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Next Steps
§Palo Alto – Finance Committee Input – June 4th
§NCPA – August 2024 for an informational update
•Status of CEC discussions, Anaheim Electric prepay transaction
•Status of bond financing docs, update of est. savings, market conditions,
and review of the schedule
§Fall/Winter 2024, seek Geysers PPA Participants’ City Council
approvals and NCPA’s Commission approval to issue bonds
•Finalize legal documents, obtain ratings
•Seek approval for a target and minimum savings
-e.g. target 7%, 4% minimum
•Issue bonds at an opportune time to maximize savings (above minimum
target approved)
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