Public power utilities invest more than $10 billion every year to replace aging or outdated facilities, upgrade existing facilities, protect the environment, increase efficiency, improve reliability, and increase security and safety. While renewable power has always been part of our portfolio, the increased need for, and use of, such power will demand additional investments in the future.
In 2014 so far, public power projects have ranged from small (an $815,000 project by the Northeast Nebraska Public Power District to install new electric power poles and lines) to quite large ($318 million invested by the Southern California Public Power Authority in March for its share of the Apex Power Project, a 531 MW combined-cycle natural gas-fired power generator being built in Nevada).
As state or locally owned, not-for-profit entities, public power utilities are limited in how they raise these funds. They cannot allow partners to “buy” into the business and cannot issue additional stock to shareholders. Generally, they do not amass large cash reserves — and spending excess revenues from previous customers to build infrastructure to benefit future customers hardly seems fair. Finally, while a bank loan might work in some limited circumstances, not many banks want to trap their cash into a business loan that can last as long as 50 years.
That pretty much leaves municipal bonds.
A bond is a loan from the bondholder to the bond issuer in exchange for periodic interest payments (generally once or twice a year) and a repayment of the principal at “maturity,” i.e. at the end of the term of the bond. Interest paid on a bond issued by a state or local government (or governmental entity such as a public power utility) for a governmental purpose is exempt from federal income tax. Likewise, interest paid to federal bond holders is exempt from state and local taxes. Because interest is not taxed, bondholders are willing to accept a lower interest rate on their loan. This enables public power systems and other state and local governmental entities to borrow money at lower rates — savings that public power systems pass on to their electric customers.
Over the last 20 years, the average yield of Standard & Poor’s Corporate Bond (Aaa) Index has been 1.3 percentage points higher than that of Moody’s High-Grade Municipal Bond Index. Adjusting for the cost of call provisions common in municipal bonds (but rare in corporate taxable bonds) the municipal bond to corporate bond spread has been closer to 1.8 percentage points. The difference can reduce the overall cost of issuing a municipal bond by 25 percent over the 30-year life of a project.
Bonds can also be used for different purposes. The federal government is largely using its Treasury bonds like a credit card: building up debt because it doesn’t have the cash on hand to pay the ongoing expense of federal programs. State and local governments are largely using municipal bonds like a mortgage. So, for example, municipal bonds allow public power utilities to build long-term projects that are financed upfront by bondholders and repaid by the customers who benefit from those investments over their useful lives.
The municipal bond market also accommodates public power utilities’ size. Certainly, there are large public power utilities: 29 serve 100,000 or more homes and businesses. But, the vast majority are quite small, with more than two-thirds serving 10,000 or fewer homes or businesses. These smaller utilities would be dwarfed in the taxable bond market — where the median bond issue is $210 million – but fit perfectly in the municipal bond market where the median municipal bond issue is just $7 million.
Municipal bonds are good for investors, too. Dire predictions in the wake of the global financial meltdown notwithstanding, the ratings outlook for public power utilities remains stable, with the median rating for a public power issuance of “A+” (compared to “BBB+” for for-profit investor-owned utilities). There is a reason why 59 percent of all municipal bond interest goes to those aged 65 and older (and 84 percent to those aged 55 and older).
If public power systems are going to make the needed infrastructure investments to incorporate new technologies, keep our facilities safe and secure, and deal with new environmental regulations, we need to have continued, unfettered access to tax-exempt bonds.