If a person owes $100 to a bank, bankers say, that person has a problem; but if a person owes $100 million to that bank, those bankers say the bank has a problem.

The U.S. territory of Puerto Rico owes bondholders a cumulative sum of more than $70 billion and continues to run deficits. That means its bondholders have a very big problem.

An overlapping set of bondholders are owed about $9 billion by the Puerto Rico Electric Power Authority (PREPA), the territory’s public utility and only electricity provider. They have a similarly big problem.

Puerto Rico's financial woes began in the 1990s, worsened with the loss of vital tax credits in 2006, and became insurmountable after the 2008 recession. The Obama administration is pushing Congress to alter the Bankruptcy Amendments of 1983-84 to allow restructuring under federal Chapter 9 rules, currently prohibited for states and territories like Puerto Rico. And the U.S. Supreme Court will hear a case this spring that may bypass the need for Congressional action by making bankruptcy legally accessible.

If either happens, those holding Puerto Rico debt may have a much worse problem, as it could allow the territory or utility to reduce their obligations substantially. But PREPA isn't holding out for either of the solutions, which could take months to materialize. Just before the new year, it finalized a deal with many of its creditors. 

“We have said over and over that the debt has become unpayable, but if it is restructured we can repay it just as Puerto Rico has always paid its debts,” Senator Ramon Luis Nieves, Chair of the Puerto Rico Senate Energy Affairs Committee, told Utility Dive about the deal negotiated between the utility and 70% of its creditors. PREPA declined repeated requests for comment on this story.

“If we do this restructuring deal, it will send a message to the world that Puerto Rico is willing to pay its debts without litigation if the bondholders get serious about restructuring and long term agreements," he said. "The legislature will not be an obstacle.”

PREPA’s restructuring support agreement was finalized in late December. It included an Ad Hoc Group of PREPA bondholders made up of traditional municipal bond investors, such Oppenheimer and Franklin Templeton, as well as hedge funds, such as Blue Mountain and Knighthead, along with fuel line lenders and the territory’s Government Development Bank (GDB).

It extends “a number of the termination events,” a PREPA statement reported. The utility will use the time to continue discussions with monoline bond insurers such as Assured Guaranty and National Public Finance Guarantee, which specialize in backing public utilities, and other supporting creditors.

The most important part of the agreement allows PREPA to exchange debt to the Ad Hoc Group for new securitization notes, according to Senator Nieves. They will get 85% of their existing claims in new Option A or Option B securitization bonds, which will be required to have investment grade ratings.

The same options will be available to all other uninsured bondholders, according to PREPA. Fuel line lenders’ debt and the GDB debt can be exchanged for the securitization bonds or for six-year term loans with a 5.75% annual fixed interest rate.

The agreement represents “significant progress” and “solidifies the support of key creditors,” Lisa Donahue, the utility's Chief Restructuring Officer and a manager at the consultancy AlixPartners, which was brought on to supervise the process. "The financial measures and agreements we are working to implement are strengthening PREPA and are in the best interests of all stakeholders."

"We are building support for PREPA's transformation and establishing a stronger entity," a statement from PREPA Board Chair Harry Rodriguez added.

The deal is expected to reduce the utility's obligations by $600 million and postpone another $700 million-plus of its debt for five years. It also includes new standards for operations, a proposed new rate structure, and an investment plan. 

Without ratification of the agreement, Donahue told Congress this week that PREPA would not be able to pay the $1.13 billion owed to its creditors between now and July 1. But whether the deal will be finalized depends as much on the political situation in Puerto Rico and on Capitol Hill as it does the financial needs of the utility.

PREPA's problems

PREPA is the sole electric utility for Puerto Rico. Its 31 generating units with more than 5,800 MW of capacity serve about 1.5 million residential and business customers, according to Greenbrier Capital.

The 2010 Energy Diversification Law, Act 82, mandated that the utility have 12% of its power from renewables by the end of 2015 and then get 15% by 2020 and 20% by 2035. But PREPA is well behind those goals. 

In 2015, PREPA got just under 34% of its electricity from natural gas, about 47% from oil products, and just over 17% from coal. Renewables provided less than 2% of the island’s electricity, with 1.06% coming from wind, 0.33% from central station solar photovoltaic, 0.33% from hydro power, and 0.12% from distributed generation.

Officials from Alixpartners declined to speak on the record for this story, but in an April 2015 presentation to a Puerto Rico industrial group, Donahue said the utility has “deteriorated” in recent years and is now “one of the island’s most challenged public corporations."

The difficulties include a lack of effective processes and procedures, inadequate generation management, damaging customer service and collections, politicization of leadership personnel, power theft, poor inventory control, poor procurement practices, an obsolete vehicle fleet, and safety concerns.

“PREPA is selling its electricity at less than $0.20/kWh but it costs them $0.22/kWh or more to generate and it has been losing millions per month every month this year,” Marc Roumain, director at Windmar Renewable Energy, a clean energy developer in Puerto Rico, said in a late 2015 interview with Utility Dive. “It is a disaster.”

This logic-defying circumstance is due to a legislatively-established formula by which PREPA’s rates are set, he explained.

“It has to be changed by the legislature, but the legislature wants to do the restructuring act first," Roumain said. "The bill was on the floor but before it got to a vote the possible actions in Washington were announced. Now the legislature seems to be waiting to see what the Supreme Court or Congress will do.”

The restructuring agreement can't be implemented until Senate Bill 1523, the PREPA Revitalization Act (RA) championed by Puerto Rico Gov. Alejandro García Padilla, is ratified by the legislature and signed into law. 

Restructuring the utility's debt so PREPA can make necessary investments is a first step in fixing its long-standing problems. But after introducing the bill briefly in November, the governor has not brought it back up to lawmakers in this legislative session, leading some to wonder if he is holding out for a better deal to materialize from Washington.

Provisions of the Revitalization Act

To begin with, the RA codifies the restructuring agreement, Senator Nieves said. It creates the legal mechanism through which the debt is securitized and restructured. It also creates a public corporation apart from PREPA and the government to issue the restructured debt. And, to further reassure holders of the restructured debt, it sets this public entity beyond the reach of any Chapter 9 bankruptcy proceeding.

“But this is not just a financial issue,” Nieves added. “It is about creating a PREPA that supports Puerto Rico in the 21st century.”

To do that, the RA would impose “significant changes” to the utility’s governance “to attract people with experience in business, engineering, and finance to the pool the governor selects his appointees from,” Nieves said.

The RA would also sustain the role of the Puerto Rico Energy Commission (PREC) in regulating the utility. Theoretically, that will allow regulators to push it toward new generation through commission-approved power purchase agreements (PPAs).

A signifiant part of the utility’s financial difficulties are due its long-standing dependence on expensive fuel oil electricity generation — a common struggle for island power systems looking to modernize. But because of those financial problems, the utility has not been in a position to build new generation infrastructure itself. Reductions in its oil dependence have largely come through PPAs with independent power producers. 

The RA “recognizes that 32% of Puerto Rico’s electricity comes from EcoElectria, which generates electricity from natural gas, and AES, which generates electricity from coal,” Nieves explained.

Law 57, the energy reform act authored by Nieves in 2014, mandated that PREPA get 60% of its power from more efficient sources than fuel oil and coal, he said. It also created the PREC to move PREPA toward PPAs with new natural gas-powered generation facilities like those currently proposed by NRG and General Electric.

PREPA had sought, through the RA, to return such decisions to the utility, Nieves said. But the legislature has rejected any undermining of the authority of the commission granted by Law 57.

An effort to undermine the PREC’s authority over rate-making through the RA was also rejected by the legislature, Nieves said.

PREPA is concerned the six months allotted by Law 57 for the PREC’s review of its 2016 rate case will further aggravate its financial woes, he said. The utility backs a 30 day review proposed for the RA, according to the senator, but he thinks that is not sufficient. 

“A rate case review is a highly technical process,” Nieves said. “A 30 day review would turn the commission into a rubber stamp for PREPA and take away the commission’s autonomy and authority. We will not acceded to that.”

The legislature’s position on these points was validated by the Puerto Rico Supreme Court’s refusal to review a recent appellate court decision on PREC authority, Nieves noted.

PREPA argued the commission did not have regulatory authority to impose new streamlined standards for interconnecting distributed generation to its grid. The appeals court said it did. By its refusal to review the decision, the territory’s Supreme Court agreed. This was widely seen as a final validation of the commission’s regulatory status.

“PREPA did not submit a second motion for reconsideration (which they had the right to file under Supreme Court rules),” wrote Gerardo Álvarez León in El Nuevo Dia. “The agency will be able to proceed with enforcement.”

The original RA included a controversial set of renewables rate changes in the RA, Nieves said. They reduced the net energy metering credit for renewable electricity delivered to PREPA’s grid and allow PREPA to impose monthly fees on owners of distributed generation. Those provisions drew the ire of clean energy developers on the island.

The RA is “not favorable to the [renewable energy] industry,” Roumain told El Nuevo Dia at the time. “PREPA’s Revitalization Bill would scale back the [renewables] goals to 10% by 2024, 12% by 2034 and 20% since 2035.”

With the right policy, Roumain told Utility Dive, “renewables could be 15% to 20% of Puerto Rico’s energy.”

“There is public and published opposition to the renewables provisions in the RA,” Sunnova Policy and Government Affairs VP Meghan Nutting said. Sunnova owns about 80% of Puerto Rico’s distributed solar market. “The commission seems to want more renewables.”

After the backlash, Senator Nieves told El Nuevo Dia this week that the governor's final version of the RA will not incorporate PREPA's proposed changes to the NEM policy or the renewables mandate. Renewable energy policy will instead be dealt with in separate legislation.

Both the governor's office and PREPA declined to comment on the legislation and the associated issues, but Nieves, Nutting and Roumain expect the bill to be introduced this month, if the governor decides not to hold out for actions in Washington.

Delays in restructuring 

The RA was introduced in November, only a few days before the end of the last legislative session and “it would have been irresponsible to try to pass it quickly,” Nieves explained. There was talk of a special legislative session to complete work on it until events in Washington, D.C., by Congress and the Supreme Court made Chapter 9 bankruptcy a real possibility.

Bondholders would like to see the RA enacted so the restructuring of their debt can be completed ahead of a bankruptcy action. But the governor, who is the bill’s leading supporter, has not yet put it before legislature, Senator Nieves said. Some stakeholders say the governor may be considering waiting for the outcome of events in Washington to see if PREPA and the territory at large can get a better deal.

It is like a giant chess game, Nutting said. “Everyone is waiting for another piece to move before they move their own piece.”

The restructuring agreement and PREPA’s rate case await enactment of the RA. The agreement cannot be enacted and the energy commission cannot set new PREPA rates until the legislature acts.

Donahue, however, told a U.S. Congress hearing this week that work on the restructuring agreement is "far from complete" and a three-year, $0.078/kWh rate increase is needed to cover operational costs and debt service.

The Supreme Court will not hear the Puerto Rico case until March at the earliest and will not rule before June. Congress, according to House of Representatives Speaker Paul Ryan, will not take any action beyond holding hearings until March.

“We have to wait for the governor to move because it is his bill,” Senator Nieves said. “But both houses have completed their hearings, introduced their amendments, and are ready to consider it.”

There is an interim agreement between the utility and its bondholders that will last through Jan. 23, he added. “We can act before that. It all depends on the governor’s marching orders.”

If PREPA defaults, the only way bondholders can recoup their losses is through district court action and the district court is likely to defer any ruling because of the pending Supreme Court case. This means the utility and the territory could escape their financial burdens until the decision on bankruptcy. And bankruptcy could be a less costly solution than restructuring.

The road forward

The governor and Puerto Rico’s lawmakers may, however, want to demonstrate to the world’s investors that the territory is willing to meet its obligations.

That seemed implicit in Gov. Padilla’s commitment to divert $174 million in payments on lower-grade bonds to meet legally protected general obligation bond debt. Defaulting on general obligation bonds, according to the New York Times, could set off a constitutional crisis in the territory.

PREPA’s bonds are not a part of the governor's debt reshuffling, however, leaving a clear path out of the utility's immediate crisis through either restructuring or a Chapter 9 proceeding.

“There is no danger of interruption of electricity delivery because before paying bondholders PREPA will use its cash flow to buy fuel,” Roumain said. “Nobody wants to stop them from supplying electricity because that is where the money will come from to repay the debt.”

The RA’s support for sourcing generation from IPPs could attract powerful players like NRG and GE and give PREPA access to increased supplies of lower-priced fuel, he added. “Their energy is much cheaper, anywhere from $0.09/kWh to $0.12/kWh.” Roumain said.

Windmar built Puerto Rico’s first utility-scale solar project, a 4 MW installation, and is building a second of 15 MW. Because federal tax credits for renewables were extended in December, it is also planning a 50 MW wind project, the territory’s third wind installation, to be co-located with a 20 MW solar array.

“We can sell wind or solar at $0.15/kWh,” Roumain said.

Though Puerto Rico is “at a dead end,” U.S. Treasury Secretary Jack Lew told Congress recently, there is a way forward. “This increasingly urgent situation demands swift congressional action to give Puerto Rico access to an orderly restructuring regime paired with independent oversight.”

The RA’s prohibition against bankruptcy for the public entity charged with overseeing PREPA’s restructuring should, Nieves said, give both Congress and the Supreme Court more confidence in making the Lew-proposed option available.

The real threat of bankruptcy would likely leverage further bondholder compromise.

“We are for restructuring but nobody can expect that we would destroy the possibility of economic recovery in Puerto Rico or that we would consent to an agreement that would hurt the quality of life here,” Nieves said. “If the governor decides to go forward with this bill, we will be ready to pass it in January.”