Energy Finance Report

Puerto Rico Update: A Busy Week as House Committee Holds Hearing on PREPA Oversight and Reform, and PREPA Reaches Preliminary Agreement with Bondholders

Posted by Jeffrey Karp on 8/6/18 4:18 PM

By Jeffrey Karp and Kevin Fink

As discussed in our posting covering continuing challenges to rebuild Puerto Rico’s electrical grid, the Puerto Rico Electric Power Authority (“PREPA”) has inhibited the recovery and redevelopment of the Island’s energy system. On July 25, 2018, the U.S. Congress House Committee on Natural Resources held an oversight hearing to discuss the “Management Crisis at the Puerto Rico Electric Power Authority and Implications for Recovery.” A panel of five witnesses – Bruce Walker (U.S. Department of Energy, Assistant Secretary of the Office of Electricity), Eduardo Bhatia (Puerto Rico Senate Minority Leader) and three energy and infrastructure advisors and consultants[1] – were present to testify and answer legislators’ questions. Puerto Rico’s Governor Ricardo Rosselló also was invited, but chose not to attend.

The hearing largely served to identify problems the Commonwealth of Puerto Rico currently is facing in seeking to rebuild its electrical grid, and provide perspectives regarding potential management, financial, and technical solutions. An issue repeatedly addressed was PREPA’s mismanagement of the power system, and its appropriate role in future decision-making regarding the system. Senator Bhatia emphasized PREPA’s mismanagement over the past 70 years. While he did not suggest eliminating PREPA entirely, he stressed the need for demonopolization, depoliticization, and the creation of an open energy market in which consumers could obtain energy through the deployment of microgrids. Microgrids allow for renewable energy to be generated and distributed close to the consumer, and may prove a more feasible option compared to traditional fossil fuel energy distribution, which requires transmission lines to cover many miles. If Puerto Rico’s electric grid were rebuilt, it would require construction, maintenance, and repair of transmission lines across the mountainous terrain in the populous northern portion of the island – including the capital San Juan – across to the southern portion of the Island, where most of the power generation occurs. Support for microgrid implementation, as is discussed in our prior posting, was echoed by the panel’s other witnesses.

Puerto Rico

Although absent from the hearing, Governor Rosselló did submit written testimony. On June 20, 2018, the Governor signed legislation, House Bill 1481, that provides a path forward for private sector involvement in energy generation and distribution. Regarding generation, the intent of the legislation is to either fully privatize PREPA’s assets or develop public-private partnerships. The legislation also provides that the electrical assets belong to the Commonwealth, but a consortium of companies would oversee energy distribution. The new law grants a period of 180 days for a special commission composed of the members of the Puerto Rican Senate, House of Representatives, and the Executive Branch to design a public policy and regulatory framework that will be used as a guide to award contracts and govern private sector transactions.

In his written testimony, the Governor stated that private sector involvement in the Island’s electric grid will assure a “modern, reliable, resilient, sustainable, and affordable electric system…catalyz[ing] sustained and long-term economic growth and job creation.” Several witnesses also favored privatization, which they opined may partially resolve concerns about PREPA’s history of mismanagement. The Governor further stated that, while support from the federal government is welcome, “additional legislation vastly expanding the role of the federal government… is simply not warranted.” Senator Bhatia, DOE Secretary Walker, and various House committee members agreed with the Governor’s comments that federalization of PREPA is not – and should not be – a goal of the U.S. government.

Nonetheless, the witnesses and many representatives agreed that some type of additional oversight of PREPA is necessary due to its insolvency, low credit rating, political entanglements, and history of mismanagement. One witness, Thomas Emmons of Pegasus Capital Advisors – who oversees his company’s renewable energy infrastructure investments – stated that PREPA must eliminate its debt and improve its credit to encourage private sector investment to help repower the Island. Following the hearing, on July 31, 2018, PREPA took a much needed step to improve its crippling financial condition; it reached a preliminary agreement with bondholders to restructure $9 billion of its debt. Notably, when asked at the hearing whether debt elimination and improved credit were the solution to the utility’s problems, Mr. Emmons responded that these steps are only a star; depoliticization and oversight of PREPA also are necessary.

Politics has long infiltrated PREPA’s decision-making and contributed to its organizational dysfunction. As recently as July 2018, the then current CEO of PREPA resigned stating it was “very clear [that] politics related to [his] compensation made it impossible for [his] contract to be fulfilled.” The PREPA Board then named a replacement, offering a higher base salary. Governor Rosselló took exception to the deal, publicly tweeting that the PREPA Board members must reduce the offered salary or resign – further illuminating the infusion of politics into the utility’s operation. The Board members offered their resignation, and Governor Rosselló appointed a new CEO who previously had worked at PREPA and was viewed as contributing to the agency’s mismanagement.

While the recent legislation seeks to partially privatize the Island’s electrical system, changes to PREPA’s management regime were not addressed. Episodes such as described above raise concerns that the utility’s institutional problems will continue to inhibit effective management practices.

The Committee hearing provided an opportunity for knowledgeable witnesses, federal government officials, and legislators to discuss the factors inhibiting the restoration and redevelopment of Puerto Rico’s electrical grid. While the extent of any further federal government involvement remains to be seen, there was a general consensus that oversight of PREPA’s management – removed from political influence – is a necessary starting point. Also potentially helpful is the preliminary agreement reached by PREPA with its bondholders, and approved last week by the Island’s Oversight Board, to restructure $9 billion of debt. If finalized, the agreement would serve as an important first step for PREPA to overcome its insolvency. And, if adequate oversight and management best practices finally are implemented at PREPA, the private sector may find Puerto Rico’s energy sector a more attractive investment opportunity.

Jeffrey Karp is a partner and Kevin Fink is a law clerk with Boston-based law firm Sullivan & Worcester LLP.         

[1] Thomas Emmons, Partner, Pegasus Capital Advisors; James Spiotto, Managing Director, Chapman Strategic Advisors LLC; David Svanda, Principal, Svanda Consulting.

Topics: Puerto Rico, U.S. House of Representatives, Microgrid, privatization

Puerto Rico: The Continuing Challenge to Rebuild the Island’s Power System and the Role of Microgrids in a Sustainable Future

Posted by Jeffrey Karp on 7/12/18 10:34 AM

By: Jeffrey Karp, Zachary Altman and Caroline Lambert

In the nine months since Hurricane Maria, substantial progress has occurred in bringing Puerto Rico’s power grid back online. Some consumers with access to solar microgrid systems regained power as soon as a few days after the storm, while others who relied on traditional energy sources had to wait for the power grid to be repaired. Solar microgrid systems are unique; they offer solar-powered electricity in parallel with the traditional energy grid but can also disconnect from the grid in times of crisis and provide solar-powered energy to a smaller subset of consumers.

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Ninety-five percent of the island’s consumers have had their electricity restored. Those still without power are concentrated largely in rural, hard-to-reach areas. In reality, though, while those without power number around 13,000, Puerto Rico’s entire population still is reeling from the effects of Maria. The damage sustained to homes and businesses remains overwhelming and quick fix solutions such as throwing tarps over gaping holes in roofs have become the status quo. Fear of recurring blackouts and the difficulty of persevering through the recovery process has fundamentally impacted the lives of Puerto Ricans. Thousands have fled the island, and the NY Times reported that many who remain have altered their everyday habits, such as only buying a few days’ worth of groceries at a time to guard against spoilage in the event of another power outage.

A variety of players have assisted in Puerto Rico’s power restoration efforts: the federal government, corporates, states and the Puerto Rico Electric Power Authority (“PREPA”).  Immediately after Maria, the U.S. Army Corps of Engineers (the “USACE”) and the Federal Emergency Management Agency (“FEMA”) spearheaded the restoration and repair efforts. The USACE provided personnel to coordinate and manage those activities and to perform engineering and disaster-related relief, which included the delivery of over 1,000 generators to the island. More than 700 of these generators, including three “mega-generators” large enough to power hospitals and critical facilities, remain on the island ahead of the hurricane season.

Also, the USACE, with monetary and logistical support from FEMA, contracted with companies such as Fluor Corporation to perform restoration projects. Fluor reports that it installed over 493 miles of conductor wire and repaired or replaced close to 7,800 power poles. Several other companies, including Tesla, Sonnen, and Blue Planet Energy, donated and installed solar microgrid systems near community centers, water pump stations, critical infrastructure centers, and hospitals, where power grid resilience is particularly crucial. Six weeks after Hurricane Maria, PREPA requested assistance from a number of mainland states, a process that often begins in anticipation of a natural disaster. Shortly thereafter, crews of engineers, workers, and supervisors, along with equipment and replacement materials, arrived from Arizona, California, Florida, Massachusetts, and New York, and worked alongside the USACE and PREPA. 

Despite its poor procurement track record, PREPA’s primary involvement with restoration projects has been to coordinate private sector contracts. Symptomatic of the ill effects of PREPA’s poor management, one of the companies with whom it contracted, Cobra, a subsidiary of Mammoth Energy, caused over a quarter of the island to plunge back into darkness. Cobra had employed a subcontractor to conduct restoration projects on the southern coast of the island. In April, the subcontractor’s excavator hit a major distribution line, which altered the voltage causing eight major plants to fail and leaving 870,000 people without power for two additional days. Following this incident, Puerto Rico’s Governor Roselló implored PREPA to cancel its contract with Cobra, the cost of which already had been increased on three occasions and ballooned to almost five times the original amount.

The instability of the island’s power grid before the hurricane was further exacerbated by the emergency fixes and stop-gap repairs made in Maria’s wake. PREPA’s CEO Walter Higgins has stated that projects to adequately strengthen the grid will take years to complete and cost between $5 and $8 billion. And, any hope of long-term assistance from USACE or FEMA was dashed when both federal agencies announced, at the start of the 2018 hurricane season, their impending departure from the island, thus leaving PREPA in charge of the daunting grid modernization task.

Fortunately, the Department of Energy (“DOE”) has worked with PREPA and recently released a report entitled “Energy Resilience Solutions for the Puerto Rico Grid.” The report recommends reducing dependence on fossil fuels and increasing reliance on natural gas and renewable energy, along with updating the infrastructure with monopoles, which are single-tower steel transmission towers. Monopoles are much more resilient than traditional lattice towers and withstood Maria’s wrath effectively. The report also urged Puerto Rico to begin establishing renewable energy microgrids for enhanced resilience and reliability. DOE’s report states that “microgrid investment has the potential to be more cost effective than alternative system upgrades to harden the system for improved function and reliability.” Solar energy sourced microgrids also are said to be more resilient in many ways: solar panels are easy to replace, the energy is generated right where it is consumed and does not need to travel long distances to reach consumers, and panels come back online as quickly as the sun can rise after a storm without having to wait for grid repairs.

The DOE’s findings regarding microgrids are consistent with prior experience in Puerto Rico, albeit on a limited scale. Solar-powered microgrids were implemented before Maria, and fared well during the storm. The Casa Pueblo community and ecology center, located in a rural section of Puerto Rico, installed microgrid solar panels over twenty years ago. Although FEMA was unable to reach Casa Pueblo’s mountain city of Adjuntas for weeks after the storm, Casa Pueblo regained power immediately after Maria passed. The community thus had electricity, and could provide food, water, tarps and medical treatment. As the DOE report notes, microgrids sourced by renewable energy can be deployed across the island and have the potential to curtail blackouts and prevent the months-long disruption to the electric system as occurred after Hurricane Maria. The DOE already has acted on its report recommendations, launching a pilot program to install half-a-dozen microgrids on the island in an effort to lessen weather-related risk and attract more outside investment.

Further, noting that the island’s grid is a “highly fragile and vulnerable system,” on June 20, 2018, Governor Rosselló removed from PREPA’s bailiwick the grid restoration by signing a bill to privatize the state-owned utility. The bill enables PREPA to sell its power generation plants and assets, seeks to facilitate public-private partnerships to modernize the power grid, and prevents a single entity from monopolizing the entire energy system. Many legislators view privatization as an opportunity to boost Puerto Rico’s economy while building a resilient and energy-efficient grid. Others prefer that PREPA be overhauled and remain in government hands, fearing that privatization will lead to higher prices for a dwindling customer base. Puerto Rico’s Power Union also has expressed skepticism that the grid’s low consumption rate coupled with its substantial infrastructure needs will dissuade private sector investors from entering into public-private partnerships as the bill envisions. Even some analysts who favor privatizing Puerto Rico’s power system have expressed concern that the bill enables the government to retain excessive controls over the envisioned private electric utilities.

A further concern is that the legislation fails to address PREPA’s and the Commonwealth’s bankruptcy status. The risks posed by the enormous debt make potential private sector investors nervous about repayment, although some of the obligations likely will be satisfied by PREPA’s sale of its assets and power plants. Also, both the DOE and Puerto Rico’s Financial Oversight and Management Board have projected that over $60 billion in federal funding will be provided to the island during the next decade, some of which likely will be earmarked for updating the energy grid.

On the heels of privatization, the Puerto Rico Energy Commission (“PREC”), the independent body created by Puerto Rico’s legislature to oversee the island’s energy policies and reforms, has promulgated regulations for microgrid development. Under these regulations, PREC will oversee a bidding process and select applicants to develop microgrid systems. While it is too soon to prognosticate the manner in which the private sector will respond to these regulations, corporates already have expressed interest in providing the technologies for the next phase of the rebuilding process. AES Corporation, which operates both a coal plant and solar plant on the island, repeatedly has suggested that a regionally-based microgrid system be implemented. Tesla also remains committed to the island’s energy development, and has discussed installing a back-up, high-capacity battery storage system for solar energy sourced microgrids that would provide alternative power in the event of another blackout.

Presently, patience is the name of the game. It is unknown whether recent legislative and regulatory developments will facilitate the necessary level of private sector involvement to successfully rebuild and strengthen Puerto Rico’s power system.

Topics: Solar Energy, Microgrid, Puerto Rico, Hurricane Maria

Renewables Can Play a Big Role in Puerto Rico's Fresh Start

Posted by Jeffrey Karp on 6/27/17 11:23 AM

This article originally appeared on Recharge.

Just two years ago, the future seemed promising for renewable energy development in Puerto Rico. Much of the groundwork was established, numerous developers had entered into Power Purchase Agreements (PPAs) with the state-owned utility, PREPA, and discussions were ongoing with funding sources.

However, decades of fiscal irresponsibility and bad deals finally caught up with Puerto Rico, leading to a terrible debt crisis. The government defaulted on bonds, sales taxes escalated to 11% (higher than any mainland state), and businesses began fleeing the island.

The generous incentives that initially had attracted development dried up. For the last couple of years, energy investment has been at a virtual standstill, with the exception of Oriana Energy’s solar plant that commenced operations in May 2017.

Despite these setbacks, and with the Commonwealth’s [government's] bankruptcy filing in May 2017, the Puerto Rican government now has a second chance to regain its financial footing, and the development of renewable energy may play an integral part in accomplishing such a task.

In 2010, the Commonwealth enacted Renewable Energy Portfolio Standards (REPS) that required 12% of the island’s electricity to come from renewable sources by 2015 and 20% by 2035. Following the enactment of the REPS, utility PREPA entered into dozens of PPAs with renewable energy developers agreeing to purchase the power to be generated. By the end of 2015, Puerto Rico had 318MW of renewables in place, according to latest available data from the International Renewable Energy Agency.

However, as Puerto Rico became mired in its debt crisis, developers were unable to secure financing as investors grew fearful of funding long-term energy deals with PREPA. Adding to the uncertainty, due to PREPA’s financial woes, the utility serially renegotiated the terms of developers’ PPAs, which only served to make investors more jittery about financing the underlying renewable energy projects. Eventually, most of the agreements expired before the power plants could be financed or built.

Despite its financial travails, Puerto Rico’s commitment to renewable energy has not waned. In June 2016, Congress passed the Puerto Rico Oversight, Management and Economic Stability Act (PROMESA). The legislation, intended to provide Puerto Rico with a pathway out of its debt crisis and establish a baseline for fiscal responsibility, also established the framework within which investment may occur. In providing a blueprint for interested investors, PROMESA also reaffirmed Puerto Rico’s commitment to renewable energy.

Recognizing that PREPA was incapable of shouldering the burden of energy development entirely on its own, PROMESA emphasized the need for public-private partnerships that shifted the initial funding burden to private investors. In April 2017, a P3 Summit was held to encourage developers and investors to collaborate with the Commonwealth on a wide variety of infrastructure projects, including energy, water, waste management, and transportation. The presentation on the energy sector reaffirmed Puerto Rico’s commitment to achieving the REPS of 20% renewable energy by 2035.

In setting the stage for infrastructure investment, PROMESA created an Oversight Board, which has authority over revitalization and infrastructure development. Importantly, the Oversight Board may “fast-track” projects deemed “critical,” such as projects that reduce the Commonwealth’s reliance on oil and diversify its energy sources. Moreover, the Oversight Board gives priority to privately-funded projects.

Following PREPA’s recent settlement with its bondholders, we understand the utility is ready to reengage with developers to amend PPAs that have been in limbo for several years. Many of these developers already have performed much of the engineering for these renewable energy projects. Once PREPA amends the extant PPAs, the underlying projects would qualify as “existing projects,” which would enable the Oversight Board to prioritize them.

In light of these recent fiscal and regulatory developments, investors again are inquiring about “shovel ready” renewable energy projects that require funding. Investors also may have gained a level of comfort having seen Oriana Energy successfully reengage in Puerto Rico. Since May 2017, the company is operating the largest solar plant in the Caribbean at 58MW, the power from which PREPA is purchasing pursuant to a renegotiated PPA.

Puerto Rico appears primed for renewed interest by energy investors. For several years, investors have been unwilling to accept the risks inherent in financing long-term energy projects in which PREPA is the counterparty. More recently, these concerns have shown signs of abating as PREPA has successfully engaged with its bondholders, and the Oversight Board created by the PROMESA legislation appears to have imposed an acceptable level of fiscal discipline on the Commonwealth.

With solar energy on the cusp of coming to Puerto Rico, the question is which financiers will enter the market soon enough to bathe in the sunlight.

Jeffrey Karp is a partner in the Washington, D.C. office of Sullivan & Worcester LLP and leader of the firm’s Environment, Energy & Natural Resources practice group. Zachary Altman, an associate, and Paul Tetenbaum, an intern at the firm, were co-authors of this article.

Topics: Puerto Rico, Renewable Energy, Power Purchase Agreements, Renewable Energy Portfolio Standards, Energy Finance, Energy Investment

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