Puerto Rico Electric Downgrade Brings Price Upgrade: Muni Credit
Boilers run day and night for eight months of the year to transform sugar-cane molasses into liquor at Bacardi Corp.’s facility in Puerto Rico.
Heating tanks soak up the most energy in making the spirit, with 20 percent of the company’s expenses coming from electricity, said Joaquin E. Bacardi III, 48, chief executive officer of Bacardi Corp., whose parent is the world’s biggest rum maker. To supplement energy use, the company relies on methane gas and wind turbines.
From Bacardi to Wendy’s, businesses in the U.S. commonwealth are finding ways to ease energy costs, which are double the levels on the mainland. Lawmakers may create a board that would limit rate increases to spark business investment and revive an economy that has shrunk 14 percent since 2006. For bond investors, $9 billion of debt repaid with electricity revenue is at stake.
“It’s a very strong first step towards helping the island become more competitive and be more seriously considered for new business,” Bacardi, great-great grandson of Don Facundo Bacardí Massó, who founded Bacardi in 1862, said about a possible oversight panel. “It would be very helpful for the island to make investment in bringing down the cost of energy.”
Legislators are debating creating an independent committee for the Puerto Rico Electric Power Authority, called Prepa, the island’s sole electricity supplier. While the proposed body may curb rate increases, which would restrict Prepa’s ability to repay debt, it would also lower energy costs and boost the economy, Bacardi said.
Prepa, the biggest U.S. energy supplier by customers and revenue, was downgraded along with the commonwealth last month. The utility was cut to junk by two of the three largest credit-rating firms, as it has 11 days of cash on hand. The agency’s dependence on oil increases energy prices, leading it to switch power plants to natural gas.
Even with the credit-rating reductions and the possibility that Prepa may lose control over rates, its debt has gained.
Investors looking for extra yield on an essential-service credit and the potential for the utility to reduce operating costs makes the debt attractive, said Tom Metzold, co-director of munis for Eaton Vance Management. The company oversees about $28 billion of local debt.
“As they convert to natural gas, they’re actually going to lower their costs, which is going to make them that much more profitable,” Metzold said in an interview last month in Manhattan.
Puerto Rico’s finances affect the broader $3.7 trillion municipal market because 70 percent of U.S. mutual funds that focus on state and city debt hold its securities, which are tax-exempt nationwide, according to Morningstar Inc.
Prepa revenue bonds maturing in July 2042 traded yesterday with an average yield of 8.35 percent, the lowest in about two weeks, data compiled by Bloomberg show. That’s down from about 10 percent on Feb. 7, when Moody’s Investors Service lowered the rating to Ba2, two steps below investment grade.
The authority’s bonds have benefited from a rally across Puerto Rico debt. Investors have been adding Puerto Rico securities since the island had its general obligations cut to speculative-grade, opening the door to buyers who had been waiting for the move. The bonds have traded at junk-grade levels since at least September on concern that a shrinking economy would make it harder for the territory and its agencies to repay $72 billion of debt.
Bonds from the commonwealth have gained 9.3 percent this year, compared with 3.4 percent for the whole municipal market, according to S&P Dow Jones Indices. Benchmark 10-year munis yield 2.48 percent, close to the lowest since June.
A new regulatory board that would review Prepa’s rates or possibly set such fees independently would restrict its ability to raise funds to repay $9 billion of debt, said Rick Donner, an analyst at Moody’s in New York.
“It would just add an additional step of public oversight of Prepa’s freedom to raise rates,” Donner said in an interview.
The business community, lawmakers and Prepa should find a way to repay the agency’s debt while lowering energy fees, Bacardi said.
The commonwealth needs to “tackle such a huge issue and ensure that the debt is secure, that we don’t have a default,” Bacardi said from San Juan, the Caribbean territory’s capital. The company’s parent, Bermuda-based Bacardi Ltd., is the world’s biggest rum maker.
An index that tracks the island’s economy has contracted in six of the past seven fiscal years. Puerto Rico’s 15.4 percent jobless rate in December was more than double the national average.
Reducing energy costs is the most important way to lure companies and help businesses create more jobs, Waleska Rivera, president of the Puerto Rico Manufacturers Association, said from San Juan.
“Our first tactic is energy costs and the importance of reduction of the energy costs to re-energize the economy,” said Rivera, who is also president of Danosa Caribbean Inc., a roofing supplier based in Bayamon. “It’s not only the commercial and industrial sectors, it affects the government. It affects the people and that makes them have less money to invest in other things.”
Bacardi’s distillery, about nine miles (14 kilometers) from Old San Juan, produces 83 percent of the world’s supply of its namesake spirit.
The rum maker captures methane gas created from its fermentation process to use as fuel to offset almost 80 percent of energy needs during production, Bacardi said. Two wind turbines supply as much as 7 percent of energy at the site, where 240,000 tourists annually come to learn about making the liquor and sample rum.
For Wendco of Puerto Rico Inc., which owns 100 franchise restaurants on the island, such as Wendy’s, Applebee’s and LongHorn Steakhouse, keeping the lights off is one strategy.
When employees arrive in the morning to open the eateries, they keep some areas dark and without air conditioning until they’re in use, Jorge Colon-Gerena, chief executive officer of Wendco, said from San Juan.
The company’s restaurants pay $12 million yearly in energy bills combined, almost double the cost 10 years ago, he said. While Wendco has opened about 20 restaurants in that time, the added power expense reduces profits, hiring, salary increases and infrastructure investment, he said. Return on equity is half what it was 10 years ago, Colon-Gerena said.
“Until Prepa resolves those issues, they’re basically holding hostage the whole development process, in the case of our company,” Colon-Gerena said. “I’m sure that this replicates to other companies in Puerto Rico.”
Juan Alicea Flores, Prepa’s executive director, was unable to discuss potential changes at the agency, said Abimael Lisboa Felix, a spokesman.
“High energy costs take money out of consumers’ pockets and make it difficult for businesses to expand and invest,” Ingrid Vila-Biaggi, chief of staff for Governor Alejandro Garcia Padilla, wrote in an e-mail. “Energy reform will enable us to stabilize Prepa’s finances, reduce costs for consumers and businesses and become a model for energy policy in the region.”
With 1.48 million customers and $4.94 billion in revenue in 2012, Prepa is the biggest U.S. electric utility, according to the American Public Power Association. The average cost per kilowatt hour is 24 cents to 25 cents in Puerto Rico, compared with 12 cents on the mainland, said Donner, the Moody’s analyst.
Prepa wants to use oil to power 2 percent of its energy production in 2017, down from 61 percent in 2012, Alicea Flores said at a presentation in May at a conference in San Juan hosted by the Government Development Bank, which handles the island’s debt transactions.
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