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Securitization, Mach II

Green investments require bulletproof financing.

Fortnightly Magazine - August 2008

Originally developed to compensate U.S. electric utilities for regulatory assets  rendered uneconomic by deregulation, so-called “stranded-cost” securitization techniques are finding new applications. Examples include financing mandatory pollution-control equipment and other similar investments; catastrophic storm reconstruction expenditures; and possibly “synthetic” carbon-emissions reductions for new fossil-fueled power plants or purchases.

For many U.S. electric utilities, deregulation of wholesale power supply markets in the late 1990s rendered substantial plant, equipment, and other regulatory assets economically obsolete. As compensation, the affected utilities, regulators, and consumer representative groups crafted stranded-cost securitizations to permit utilities to recover the related stranded costs through special rates charged to customers and the sale proceeds of bonds backed by such charges. These bonds in many cases were euphemistically referred to as “rate-reduction” bonds, although the securitization charges often increased rates to affected customers. In connection with such securitizations, the primary U.S. rating agencies developed specific criteria and methodologies for such stranded-cost securitizations. 1

To date, utilities have issued approximately $40 billion of stranded-cost securitizations. 2 That number could increase dramatically if the industry applies well-tested securitization techniques to the extraordinary costs it faces in the future.

Stranded-Cost Securitizations

Stranded-cost securitizations represent a refinement of several prior transactions, including: 1) the special transition charges that gas transmission and distribution companies were permitted 3 to collect as part of the resolution of disputes regarding so-called “take or pay” contracts when U.S. gas supply and transportation services were unbundled in the mid-1980s; 2) the securitization of special charges to customers of affected utilities to finance compensation payments to such utilities under legislated nuclear power plant moratoria in Italy and Spain in the early 1990s; 4 and 3) a 1995 securitization by Puget Sound Power & Light 5 to finance a demand-side management program (essentially cash incentives to customers to replace less energy-efficient appliances with more energy-efficient items).

Ideally, the basic foundation for a stranded-cost securitization is a sound legislative and regulatory scheme that provides for the following:

• An adequate hearing on the merits regarding the costs to be recovered and the alternative means of financing these costs—with securitization found to be demonstrably superior to other such financing alternatives. This often will be the case since the securitization will allow a highly rated financing of 100 percent of such costs. Such a hearing will substantially mitigate the risk of later reversal or adverse modification of the related regulatory approval;

• A regulatory approval, usually referred to as a “financing order,” authorizes the issuance of bonds that are secured or otherwise backed by the recovery of the costs, and any related securitization, through non-bypassable charges to the utility’s customers. Sometimes this is referred to as a “network” charge, because the charge is payable by all customers