Darkness Visible: A Financial Analysis of the Puerto Rico Electric Company
Published on June 1, 2010
The Center for the New Economy released its latest analysis of the Puerto Rico Electric Power Authority on June 1. This is CNE’s third look, since 2005, at the electricity sector in Puerto Rico. Some of the highlights in this report include the following:
- Financial losses continue. For fiscal years 2009, 2008, and 2007, PREPA incurred losses before contributed capital of $163 million, $323.7 million, and $96.9 million, respectively.
- Insolvency is a risk in the short term. As of June 30, 2009 and December 31, 2009, PREPA had unconsolidated net assets (on a stand-alone basis, excluding subsidiaries) of negative $9.8 million and negative $109.9 million, respectively. This means that as of each of those dates PREPA’s core operating company was technically insolvent, on a balance sheet basis, because its total liabilities exceeded its total assets.
- PREPA is implementing a financial stabilization plan to address these issues. The plan consists of several actions intended to reduce costs, increase liquidity, and cut back its dependency on fuel oil. The principal elements of the cost reduction plan include (1) reducing the number of employees through attrition and the elimination of temporary and vacant positions; (2) reducing expenses associated with its retirees’ health care benefits; and (3) reducing overtime and miscellaneous expenses.
- Electricity sales stall, but revenues jump. Electric energy sales, measured in gigawatt hours, decreased from 19,887 gWh in 2003 to 18,516 gWh in 2009. This decrease represents a negative growth rate of 1.18%. At the same time, revenues from sales of electric energy grew at a CAGR of 8.02%. Thus, between 2003 and 2009 electricity consumption declined by 1.2% per year, but electricity bills increased at an annual rate of 8%.
- Industrial clients have declined significantly. The number of industrial clients declined from 1,668 in 2005 to 898 in 2009, a reduction of 770 industrial clients, or 46%.
- Capital expenditures have been trimmed. The proposed capital expenditure program in the amount of $1.7 billion for the next five fiscal years is significantly lower than the previous one, which totaled some $2.8 billion. Capital expenditures have been refocused on improving the reliability of the generation system and the efficiency of the transmission and distribution system. In addition, a significant portion of the capital spending on generation will be used for substituting older oil-fired generation units with more efficient generation units fired with fuels “other than oil.”
- Energy losses continue unabated. Energy lost or unaccounted for increased from 2,754 gWh in 2003 to 3,247 gWh in 2009, an increase of 493 gWh or 17.9%. These losses amounted to almost 15% of total electricity production in 2009, a rate that is 3.7 times the average loss rate for government-owned utilities in the United States. PREPA claims to be working on a new plan to reduce losses due to theft.
- Net assets decreased by $147.5 million (79.0%), $284.7 million (60.4%), and $39.8 million (7.8%) as a result of operations during fiscal years ended June 30, 2009, 2008, and 2007, respectively.
- Operating income increased. For the fiscal year ended June 30, 2009 operating income was $362.6 million, which represents an increase of 100% over fiscal year 2008; this increase is due mostly to a significant reduction in expenses related to PREPA’s Other Post-Employment Benefits for its retirees.
- Operating expenses decreased by $541 million, or 12.9%, for the fiscal year ended June 30, 2009, when compared to the previous fiscal year.
- Cash flow has improved. Cash generated from operating activities increased by $458.51 million, from $114.24 million in June 2008 to $572.75 million in June 2009. This increase in operating cash flow was due to a reduction in cash paid to suppliers and employees, which in turn was due mostly to a $384 million reduction in fuel costs.
- PREPA remains a highly leveraged company: its leverage ratio, measured as total assets divided by total equity, was 223.91 in June 2009, a significant increase from the 49.45 reported in June 2008; its long-term debt ratio was 99.33% in June 2009, which is slightly higher than the 97.21% reported in June 2008; and its debt-equity ratio was 99.55% in June 2009, which is also higher than the 97.98% reported in June 2008.
- Profitability remains elusive. PREPA’s return on equity for fiscal year 2009 was a negative 78.99%, substantially worse than the negative 60.4% return obtained for fiscal year 2008.
- Accounts receivable from government and municipalities increased from $357 million in 2008 to $471 million in 2009, an increase of $114 million, or 31.95%. However, PREPA claims that “during the first seven months of fiscal year 2010, the central government paid all its past due accounts owed as of June 30, 2009 and had an outstanding balance of less than $28 million.”
- Credits, subsidies, special rates, contributions in lieu of taxes, and energy losses are a dead weight on PREPA. In 2008 these items totaled $995 million; about 22% of the revenues generated that year.
- PREPA continues to substantially underperform its U.S. counterparts in terms of operation and maintenance expenses per kWh sold and in terms of operation and maintenance expense per customer. PREPA also reports higher administrative and general and sales expenses per customer when compared with mainland public power producers. These higher ratios seem to be indicative of the existence of a relatively larger administrative and support staff at PREPA.
- PREPA has plans to reduce its dependence on oil. It seeks to convert several existing oil-fired units to natural gas and perhaps add new coal-based generation.
- In our opinion, adding new coal generation capacity is not a good option for Puerto Rico, because: (1) coal is the dirtiest of the fossil fuels and it is currently the cheapest only because its price does not include the costs of negative externalities it generates; (2) financing could be difficult to obtain on reasonable terms; (3) there are significant regulatory risks at the federal level; and (4) coal ash presents a serious disposal problem in a small island such as ours.
- If Puerto Rico is to become a leader in the green energy field and to generate significant economic activity and employment in this sector, then it needs to think big and out of the box. Every country wants to get into the green energy game; everybody is offering incentives of every kind. If Puerto Rico wants to attract big investments in this sector it will have to differentiate from everyone else. One way to do this would be to establish a cap-and-trade system in Puerto Rico.
- There has been significant action at the federal level, in both the legislative and executive branches, regarding the regulation green house gases. While it is difficult at this time forecast the final form of the laws, rules and regulations that may eventually be enacted or adopted, it is reasonable to assume that any such regulatory action could have amaterial adverse effect on PREPA’s operations. Thus, PREPA would be well advised to (1) reduce its dependence on fuel oil; (2) decrease its overall carbon footprint; and (3) move towards and adopt renewable fuel technology for the generation of electricity.
- Generation from renewable sources is unlikely to come on line in the short term.PREPA states that it has entered into power purchase agreements with developers of renewable energy projects with the long-term goal of increasing the use of renewable energy. The introduction of new generating capacity using renewable energy sources, which we understand may be difficult to implement, should be a top priority, even if the short-term impact on price is modest, because (1) it would help stabilize costs; and (2) it helps PREPA to prepare for compliance with future limitations on greenhouse gases.
- It is highly unlikely that PREPA will be able to significantly reduce the cost of electricity in the near future, because (1) it depends on oil for 68% of its electricity generation; (2) it is required to grant several credits, subsidies and special rates to some of its clients; (3) it is subject to a rate covenant under the 1974 Trust Agreement, which requires PREPA to fix, charge and collect reasonable rates and charges so that revenues of the system will be sufficient (a) to pay current expenses and (b) to provide an amount at least equal to 120% of the aggregate principal and interest requirements for the next fiscal year; (4) it is required to make substantial contributions in lieu of taxes; (5) it loses close to 15% of its generation, mostly due to theft; and (6) it has significantly higher administrative, accounting, and customer support costs relative to its peers.
In sum, PREPA needs to undergo a radical restructuring if it is to become a positive net contributor, instead of a hindrance, to Puerto Rico’s economic growth over the next few years.