Joseph Krist

Publisher

________________________________________________________________

Now that the stimulus package has been enacted, attention can be focused on an infrastructure bill. We fully expect a package to pass. The stars are certainly aligned more favorably for such a result than has been true for some time. Nonetheless, we do not expect the process to occur in a straightforward manner. It has become quickly apparent that the many disparate issues interest groups are seeking to address through an infrastructure bill may very well result in a less effective package. It will be difficult to satisfactorily address the many issues which could potentially arise.

The infrastructure bill is being hammered out at a time when there is no clear set of initiatives which could satisfy all of these groups. Infrastructure is being linked to  “economic justice”, climate change, and a host of social issues. Unfortunately, a consensus around how best to deal with those issues among advocates remains unclear. As identity politics rule the day, interest groups have been unable to find commonality in a way that generates the most benefit for the most people. We see housing advocates complaining that electrification will be too expensive for low income groups. Carbon taxes are seen as an additional economic burden as well.

The lack of consensus will serve as an effective hurdle for many ideas. Transportation is at the center of this debate. Recently, we have seen advocates for mitigating climate change challenge the notion of electric vehicles. They claim that removing internal combustion vehicles and substituting electric vehicles is not enough to help the climate. That only reducing vehicle ownership will suffice. That would make many think that that issue can be solved through renewable energy production. At the same time, others oppose the siting of renewables on environmental grounds. 

One of the great failures of “the left” in this country over the second half of the 20th century forward has been dealing with the economic realities of what they want. We are not going to be able to fundamentally reorder the economy without expecting disruption and cost. Disruption and cost lead to resistance. The cost of environmental remediation has always been underestimated. A clean environment is not free. And there has to be another answer to the problem away from taxing the wealthy.

Municipal bonds will wind up being at the center of this. This is the only major financial market in a position to address all of the issues which might ultimately become part of the infrastructure debate. Jobs, housing, healthcare, education, transportation are all right in the muni wheelhouse. And don’t look now but there was actually a serious mention of advance refundings and private activity bonds at a Senate hearing on an infrastructure bill. There’s hope!

__________________________________________________________________

CLIMATE RISKS IN 2021

The National Oceanic and Atmospheric Administration (NOAA) has released its Spring 2021 outlook estimating flooding and other natural disaster risk for the upcoming season. Prior outlooks have predicted flooding and wildfire events which have had credit implications for impacted areas. As environmental issues come to have greater rating significance, these outlooks help investors anticipate and evaluate climate risks in their portfolio.

It has already been a difficult winter in many areas and the impacts have been clear. Now, a different set of climate concerns come with the warmer months. Drier conditions in the Southwest U.S. associated with La Niña and the failed 2020 summer monsoon have been contributing factors to the development and intensification of what represents the most significant U.S. spring drought since 2013, which will impact approximately 74 million people.

The precipitation outlook favors above-normal precipitation for parts of the Midwest, the Great Lakes, the Mid-Atlantic, the Northeast and in Hawaii, while below-normal precipitation is forecast across the southern Plains and much of the West.

One big difference this year is the projection of much less flooding. NOAA hydrologists are forecasting limited moderate flooding this spring and no areas with a greater than a 50% chance of major flooding for the first time since 2018. Widespread minor to moderate flooding is predicted across the Coastal Plain of the Carolinas while minor to isolated moderate flooding is predicted for the Lower Missouri and Lower Ohio River basins. Overall, this flood year is not expected to be severe or as prolonged as the previous two years. 

Water supply forecasts through spring are predicted to be below to much-below normal for most of the desert southwest, southern Oregon, and southern Idaho into much of the Rocky Mountains, which will play a major role in drought persistence this spring.

ANOTHER NUCLEAR DELAY

Georgia Power announced another delay in the in-service date for the first of its two new reactors at the Plant Votgle site. After many delays, the first new unit was scheduled to be on line in November of this year. Now the date has been delayed until at least the Spring.

The issue is that the start of hot functional testing for Plant Vogtle Unit 3 will be delayed from the original start date in the second half of this month.  Georgia Power’s had already announced in February  that productivity had slowed into January 2021, which increased the total project budget by $325-$415 million. A rise in active COVID-19 cases at the site delayed productivity, but these abated in February and March. The schedule on the project has been beset by COVID related issues for some time so the January problem was above “normal”.

For each month the plant is able to ultimately unable to open, an additional $25 million in costs will accrue. Georgia Power attributed the delay to “additional construction remediation work” necessary before the reactor undergoes testing and fuel loading. Originally set to occur this month, the testing has been postponed until April. Just to refresh, MEAG Power owns 22.7% of the project and another municipal issuer Oglethorpe Power Corporation owns 30%.

AND A SMALL UTILITY SHALL LEAD THEM

In 2014, the Holland Michigan and county electric utilities issued debt for the Holland Energy Park (HEP). The facility is a natural gas fueled generating station. It was funded with bonds secured by net electric revenues. It was a bit of a gamble since the plant generated power in excess of the utility’s demand.

The move by utilities to look at generation alternatives to coal and oil made the project’s excess power attractive as a “green” source. So all of the excess is sold into the Michigan grid at prices which have enabled the utility to generate revenues for the City’s general fund. That even after Holland BPW was able to reduce electric rates by an average of 6% for customers and it proposes to cut rates some 10% starting in July.

And yet this all highlights one of the emerging dilemmas facing the climate change movement. In Holland, the utility can show that it has reduced its carbon footprint and point to financial success associated with it. Climate change advocates would say that the plant represents little if any progress in terms of fossil fuel dependence. Trying to convince a ratepayer that 6 and 10% cuts in rates are bad won’t fly.

It is part of the economic realities confronting the climate change movement.

TEXAS POWER CRISIS AND MUNICIPAL UTILITIES

The publicly owned San Antonio, TX electric utility CPS Energy will have a chance to test the market’s reaction to the financial ramifications of the recent power distribution debacle in Texas. The utility and its customers face potentially much higher rate requirements to meet the obligations resulting from the exorbitant bills being delivered to utilities by the state’s grid operator, ERCOT. CPS hopes to issue some $375 million of long term debt to refinance outstanding commercial paper.

The situation with the charges from ERCOT has resulted in Fitch and S&P lowering their CPS bond ratings to AA- and they both joined Moody’s in maintaining negative outlooks. The ultimate magnitude of the ERCOT charges related to February’s difficulties is unclear. ERCOT ran up $20 billion in charges for five days of energy supply to utilities across Texas.

The size of the bills and the limited resources of smaller systems have led to a cumulative shortfall in payments to ERCOT of over $1 billion net dollars. These shortfalls are financed by delivering “short” payments to generating utilities like CPS which sell power through ERCOT. Through 3/22, this has resulted in a revenue reduction from ERCOT of $18 million.

As of now, the potential for increased costs to CPS is unclear. CPS is vulnerable to seeing more of ERCOT shortfalls negatively impacting CPS’ finances. The issue will remain a cloud over the utility as ERCOT’s billing practices are now the subject of multiple legal challenges. In addition, the Texas legislature is considering bills to address the situation. Nonetheless, there are still significant risks to CPS’s financial position. Natural gas costs for CPS related to the storm are estimated at $670 million and purchased power costs assigned to CPS are estimated at $365 million. Some $365 million of the costs of natural gas and purchased power have been paid.

Currently in the absence of legislative or regulatory fixes, CPS is forced to pursue a legal strategy against ERCOT. The goal is to protect CPS from what are generally agreed to be exorbitant rates charged to utilities and their customers during the storm. While the process works its way through the three branches of state government, CPS has had to seek increased credit line capacity and plan for a potential debt program to address the final costs stemming from the storm.

That plan is at the center of the pressure on CPS’ ratings. It would fund the ultimately determined cost resulting from storm-related charges with the proceeds of debt secured by a separate charge on customer bills. It has been shown in the recent past that there is a strong appetite for securitization of costs like this with potential investors. Nonetheless, the overall impact of such a plan would be negative for CPS’ ratings. The official statement may actually summarize the whole situation – “CPS Energy believes that its efforts … to ultimately accommodate the final financial and operating results of the 2021 Weather Event will prove successful, but success has multiple measures.”

That, in a nutshell, summarizes the basis for a negative outlook on the credit.

NASSAU COUNTY OUTLOOK

A locality and its residents may chafe over the limitations imposed by the role of a financial control board but it is hard to argue with their results. Oversight boards have been essential in the fiscal rehabilitation of entities across the country. In the 20 years since the initial legislation creating the Nassau County Interim Finance Authority (NIFA) was enacted, the County has navigated a recovery through several economic cycles and restructuring of its debts. Through the use of control periods, NIFA has had a direct hand in managing the County’s fiscal affairs.  That role addresses any governance concerns that negatively impacted the County’s ratings over the years.

NIFA allowed the county’s ratings to slowly but steadily improve to where they stand today at A2 by Moody’s. This  rating reflects “expectations that sale tax revenues will increase due to Nassau County’s recent economic recovery, supported by a very large tax base with strong wealth and income.” It looks like the county will achieve a third consecutive year of improved financial results in 2021. Governance is also considered a positive factor now because of NIFA’s role. This cushions the rating against the pressure of the County’s relatively high taxes and debt burden.

All of this moved Moody’s to revise its outlook on the county’s rating to positive. The change is based on the expectation that financial results will continue to be balanced and that an economic recovery will drive revenue growth, especially that of sales taxes.

NYS BUDGET

As this piece went to press, the annual budget process for the State of New York is coming to a head. The new fiscal year begins on April 1 so the pressure is on. The process this year has been complicated by the process of passage of the federal stimulus and the ongoing political drama enveloping the Governor. Now that the stimulus has been passed and the State is receiving more than it expected, the push will come to restore spending cuts in the Governor’s proposed budget. The political pressure is coming from the Legislature to raise taxes and increase spending which it believes that the Governor will be in a much weakened position to stave off.

Cuomo’s proposed budget only included temporary tax increases if the state did not receive Covid-19 assistance from the government in that third stimulus package. The Legislature’s plan would cost more — $208.3 billion, an increase of $15.6 billion, or 8.1%, over the current year’s budget. The proposed spending is $12.2 billion, or 6.3%, higher than Cuomo’s proposal. It all would be funded by what progressives refer to as a millionaires tax.

This would come from increasing the top income tax rate from 8.82% for single filers earning more than $1 million and couples earning more than $2 million to 9.85%. And it would establish two new brackets: 10.85% for taxpayers between $5 million and $25 million and 11.85% for taxpayers over $25 million. The plan would also increase capital gains taxes, create new taxes on businesses and increase the state’s estate tax.

New York State’s budget process has often been the accelerant to the overall legislative process on difficult issues. The negotiations follow a well established process and policy decisions through the “three people in the room” process. This year that dynamic along with national trends and the pandemic have led to a breakthrough for advocates of legalized recreational cannabis in NYS.

That process has resulted in an agreement which would legalize recreational marijuana for adults 21 and older, Personal possession of up to three ounces would be permitted. As expected a significant sales tax of tax on sales would be assessed at 13%. The first  9% would go to the state with the other 4% to local governments.

One twist in the proposal is for distributors to pay an excise tax, which could be as high as three cents per milligram of THC.  It would be levied according to a sliding scale, based on the type of product and how strong it is. In a reflection of the division of opinion in the state along geographic lines cities, towns, and villages may also choose not to approve retail and delivery weed within their jurisdiction.

The plan also addresses many of the issues which typically inform debates on the issue. Tax revenue from sales would fund the operations of the newly created Office of Cannabis Management and police officer training to detect impaired driving. Forty percent of the remaining revenue is targeted for school aid.  A 40% share would be put into a fund establishing grants for social equity which has been a significant issue in the NY debate. The remaining 20% would fund drug-treatment and public-education programs.

FLORIDA TRANSPORTATION TAX RULING

Hillsborough County voters approved a 1% sales tax in 2018 with nearly 60% of the vote. The charter amendment initially included references to exact percentages allocated to the Hillsborough Area Regional Transit Authority and the three cities within Hillsborough County. It also struck specific references to how much money can be spent on certain types of projects like roads or transit. That wording provided an opening to opponents of the measure.

They cited the removal of that language in subsequent litigation that struck down portions of the amendment and argued that these changes had so fundamentally changed the amendment such that it was no longer consistent with what voters approved in 2018. By a margin of 4-1, the Florida Supreme Court agreed.

Hillsborough residents and visitors have paid the sales tax since the beginning of 2019. To date, the county has collected nearly $500 million in taxes from the sales surtax. The status of those funds is unclear at present. The irony is that the effort to fund the transportation plan could be another pandemic victim. Hillsborough County commissioners originally were moving towards putting an amendment on the ballot to address the legal concerns but like many things in 2020, it was thought that the pandemic and impacts on voting might not result in approval. Now the County will have to attempt what would effectively be a corrective ballot question in 2022 under different circumstances.

PREEMPTION

Legislation to block local governments in Georgia from limiting what fuel sources offices, houses and other buildings can use is poised to clear the Legislature. The State Senator  who carried the bill in the Senate, said “its intent is to stave off future efforts in Georgia to abolish the use of fossil fuels like coal and natural gas going forward.” In Georgia this bill received bipartisan sponsorship and support although it is ultimately a move “against” the climate change movement.

This bill joins another under consideration in Indiana which has the same goals in mind. (It’s what happens when outside advocacy groups write legislation.) One local legislature there has taken a very public stance against preemption calling it “an assault on local home rule”. The issue here is limitations on new solar and wind.  

Alabama law says revenue from gasoline and other motor fuel taxes levied by the state can only be used for infrastructure and similar uses, but there are no such restrictions on the local gas taxes collected by hundreds of governments. A pending bill would alter that. It says that all taxes on motor fuels, “whether called an excise tax, license tax, or otherwise, levied by a municipality or county or by local law may be used only for road and bridge construction and maintenance.”

USC AND A FINANCIAL RECKONING

USC has had its share of bad press in recent years reflecting its place at the center of a number scandals. Most of the public attention has been on events which while negative, did not present significant financial implications. Now, the university faces a real financial hurdle in the wake of its latest problem.

USC announced that it has resolved outstanding litigation against the University in connection with its employment of a doctor at its student health facilities who was eventually charged with sexual assault. The resolution comes with a cost – USC will pay more than $1.1 billion through a combination of three sets of settlements with more than 700 accusers. The sum dwarfs to prior settlements at Penn State and Michigan State. The U.S.C. claims cover a 2018 federal class action already settled for $215 million, a second group of several dozen cases in which the amount of the settlement was not made public and a third settlement for $852 million.

USC has a strong resource base and Aa1 and AA ratings. Nevertheless, the University’s financial response will result in a weaker credit. The university president said, according to press reports,  the university would fund the settlement over two years through a combination of “litigation reserves, insurance proceeds, deferred capital spending, sale of nonessential assets, and careful management of nonessential expenses.” Press reports indicate that no philanthropic gifts, endowment funds or tuition would be redirected to pay the costs.

We’re not saying it’s the end of the world but the ratings need to reflect the fact that the total sum is equal to 25% of FY 2019 net assets and essentially equal to net student revenue for the FY 2019. By any measure it is a serious hit. At least a one notch downgrade seems more than appropriate. 

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Publisher

________________________________________________________________

PREEMPTION

We recently discussed the issue of preemption of the rights of local governments by state legislators seeking to prevent localities from imposing restrictions on things like the use of natural gas. As localities have increased their use of their regulatory powers to dictate local energy policy, Republicans have turned to state level preemption legislation in an effort to stem that regulatory tide.

Now the recent stimulus bill includes what might be considered a form of preemption. As enacted, it includes a provision that could temporarily prevent states that receive government aid from turning around and cutting taxes. They are prohibited from depositing the money into pension funds and cannot use funds to cut taxes by “legislation, regulation or administration” through 2024. The law says that states and territories that receive the aid cannot use the funds to offset a reduction in net tax revenue as a result of tax cuts because the money is intended to be used to support the public health response and avoid layoffs and cuts to public services. 

Republicans in Congress don’t like the requirement. They are invoking states rights as an argument against the provision. At the same time, they worked very hard against the plan to prevent a so-called blue state pension bailout. States are required to submit regular reports to the Treasury Department accounting for how the funds are being spent and to show any other changes that they have made to their tax codes. The treasury is expected to offer guidance on the eligible purposes which the funding could be spent on.

The debate sheds light on the emerging divide between state governments and their fiscal interests and county and municipal governments who have not fared as well as pandemic restrictions hurt local sales tax and property tax revenues. These are often key sources of revenues for localities.

UBI AND STOCKTON

The concept of universal basic income programs is getting a wider hearing especially given the leading position in polling for the office of New York City Mayor by Andrew Yang. Mr. Yang has been the most prominent proponent of the concept and it is the cornerstone of his campaign. He is selling it as a cure for homelessness and a significant cutback in local social service spending. Proponents of a UBI cite a recent report documenting the results of an experiment in Stockton, CA which provided a UBI to some 125 residents of the city.

Prior to this, Stockton was likely best known to municipal bond investors as one of the California cities which filed for bankruptcy in the aftermath of the Great Recession. It was a particularly contentious process and it shed light on the economics of the city and its residents. You will hear a lot about the Stockton UBI experience so it is worth it to see just what happened.

The Stockton Economic Empowerment Demonstration, or SEED, was the nation’s first mayor-led guaranteed income initiative. Launched in February 2019 by former Mayor Michael D. Tubbs, SEED gave 125 Stocktonians $500 per month for 24 months. The cash was unconditional, with no strings attached and no work requirements. The report focused on several key questions. How does guaranteed income impact income volatility? How do changes in income volatility impact psychological health and physical well-being?

To qualify or be considered for SEED, recipients had to be at least 18 years old, reside in Stockton, and live in a neighborhood with a median income at or below $46,033.The study came to several primary conclusions. Guaranteed income reduced income volatility, or the month-to-month income fluctuations that households face. Unconditional cash enabled recipients to find full-time employment. Recipients of guaranteed income were healthier, showing less depression and anxiety and enhanced wellbeing. The guaranteed income alleviated financial scarcity creating new opportunities for self-determination, choice, goal-setting, and risk-taking.

Whenever programs like this are proposed, issues over what the money would be spent on arise usually in opposition to them. The study addressed those concerns directly. Consistently, the largest spending category each month was food, followed by sales/merchandise, which were likely also food purchases at wholesale

clubs and larger stores like Walmart and Target. Other leading categories each month were utilities and auto care or transportation. Less than 1% of tracked purchases were for tobacco and alcohol. In February 2019, 28% of recipients had full-time employment. One year later, 40% of recipients were employed full-time.

In the end, it was clear that the recipients were benefitted in ways which bode well for the program. The author’s however point out that there are many issues facing eligible communities. The study concludes that guaranteed income should not be considered as a singular approach for household stability, “Additional policies to implement alongside a guaranteed income include: protection against predatory financial actors and instruments like caps on adjustable interest, second-chance banking, third-party targeting of financially vulnerable populations, and exorbitant fines and fees from the criminal justice system; address the unique barriers that women face in the market through paid family leave and universal child care.

We take the same approach to this issue that we take with new technologies or processes. The studies to date have involved small numbers of individuals. It is comparable to a technology which works on a prototype but is not as successful when it is attempted at scale. UBI opens a debate about a variety of issues starting with how it is funded. Mr. Yang proposed a national value added tax (VAT) which many see as regressive. This study did not address the issue of how to fund such a program. If a UBI comes at the expense of a variety of other approaches, it is not clear what the net benefit is.

AFTER THE FIRE

Last week saw public transit begin to show signs of a comeback. New York, the MTA reports said subway ridership on Thursday was the highest single day total since the pandemic began, with 1,863,962 paid trips taken. There were an additional 1.13 million daily trips recorded on MTA/NYCT buses, putting the overall system trip total at around 3 million for the day. 

Pre-pandemic daily ridership regularly exceeded 5 million rides per day. So the current ridership represents an overall rate of 46% of pre-pandemic levels. As the economy reopens, we do not expect a full return to pre-pandemic levels but a steady increase in ridership is to be expected. This is especially true if the currently closed cultural and entertainment facilities reopen as planned in the fall.

That could become even more likely if current trends in air travel take hold. The Transportation Security Administration screened 1,357,111 passengers at airports across the country on March 12, the highest number since March 15th, 2020. It’s an indicator of why these businesses are counting on pent up demand driving the economic recovery.

WHAT A DIFFERENCE A BILL MAKES

The scope of the recently enacted stimulus legislation has triggered a reboot for the credit outlook for states. Moody’s has announced that its overall outlook for state credit ratings is now stable. They expect state fiscal positions to be maintained and even bolstered in light of the relief package and the fact that revenues held up better than almost anyone expected.

That perception of a stronger fiscal position created a real stumbling block that hindered passage. Ironically, there has been much huffing and puffing over the issue from “red state” politicians. The package includes restrictions on what the money can be spent on. While the “red state” politicians complained about a bailout for what they saw as poorly managed states and pension funds, those same parties are now complaining that the bill stands in the way of tax cuts in those states.   

Underpinning all of this is the fact that we have recently witnessed what happens when Keynesian economics are applied in full measure. The majority of Americans have seen their economic experience shaped by the idea of government as an impediment to growth and that any tax is likely a bad tax. That image helped to support a less tempered approach to the recovery from the 2008 recession. There were complaints at the time that the federal recovery response was inadequate.

While state and local government fared relatively poorly in that recovery – many services never returned to pre-2008 levels and employment at the state and local level reflected that – there were significant reserves built up because of those aggressive cost control actions. It can be argued that in the short term, state government is much better positioned to benefit from the expected economic recovery.

CULTURAL FACILITIES

The combination of vaccine availability and the warmer weather is giving cultural institutions a chance to reestablish themselves in the post-pandemic economy. Those which are able to operate in some fashion outdoors – music and the other performing arts – mostly did not in the summer of 2020 but are gradually announcing summer shows. Now that the industry received direct aid in the stimulus, they are in a better position to determine their best course forward.

The Los Angeles County Museum of Art announced that it will reopen April 1 after a yearlong closure. Museums are allowed to reopen indoor spaces at 25% capacity with safety protocols in place. LACMA will require guests to wear a face mask, undergo online health screenings and make an online reservation for timed entry. In New York, the famous Shakespeare In The Park summer series will occur this summer after it was cancelled in 2020.

With indoor dining (albeit limited) returning in jurisdictions including New York City and even California’s Disneyland scheduled to soon reopen, the outlook for the local economies they support improves. The symbiotic relationship between these larger entities and their surrounding economies and dependent businesses drives a more positive outlook. As generators of retail sales taxes, those dependent businesses are especially important to local economies and employment.  

PUBLIC PRIVATE BROADBAND INITIATIVE

Vermont has approved a plan to help more Vermonters in some of the hardest-to-reach corners of the state get connected to broadband quickly and cost-effectively.  It is a problem confronting many rural locations which was highlighted by the need to run schools on line rather than in person. In this case,  the plan provides for offering up to $2,000 per unserved location for infrastructure connection costs. If broadband companies fully enroll for the discounts, more than 10,000 customers who currently do not have broadband could be connected by the end of next year. It seeks to address the costs of extending basic infrastructure to support broadband to widely dispersed customer bases in rural areas.

Vermont Electric Cooperative (VEC), established in 1938, is a non-profit, member-owned electric distribution utility that provides safe, affordable, and reliable electric service to approximately 32,000 members in 75 communities in northern Vermont. We have long advocated for federal support for expanding the role of rural electric co-ops to achieve the same positive results with broadband which their service areas enjoyed with the connection  to electric power.

ELECTRIC VEHICLE ECONOMICS

At the current global average battery pack price of $135 per kilowatt-hour (kWh) (realizable when procured at scale), a Class 8 electric truck with 375-mile range and operated 300 miles per day when compared to a diesel truck offers about 13% lower total cost of ownership (TCO) per mile, about 3-year payback and net present savings of about US $200,000 over a 15-year lifetime. This is achieved with only a 3% reduction in payload capacity. 

This is according to research from the University of California and the Livermore Lab. The estimated average distance traveled between 30-minute driver breaks is 150 miles and 190 miles for regional-haul and long-haul trucks respectively in the US.  Thirty minutes of charging using 500 kW or mega-Watt scale fast-chargers would add sufficient range without impairing operations and economics of freight movement. 

Realizing the full economic potential of electric trucks therefore requires surviving a long period of infancy marked by low demand for vehicles and charging, and consequently, higher cost of new vehicles and slow return on charging infrastructure. Binding targets for vehicle sales, supported by targeted subsidies indexed both to international battery prices and cumulative sales can deliver the scale of adoption needed to launch this new industry on a sustainable future trajectory.

THE ELECTRIC GRID AND MUNICIPALS

The recent ice storms and resulting power outages in Texas have rightly focused much attention on “the grid”. One of the major issues which arose in Texas had to do with its lack of connection to other sources of transmission outside of the state. The issue is forcing consideration of alternative sources of generation and transmission. Increasingly there are more examples of local government initiatives to address the concern.

The latest is found in Camarillo, California. There the City Council approved a contract with the Clean Coalition to oversee the design of solar-based microgrids at five critical city facilities that will incorporate Tesla batteries. The city council also directed city staff to enter into a contract with Tesla for a 1-MW/ 4-MWh battery to be installed at the city’s wastewater treatment plant.

The battery will be paid for by the California Public Utilities Commission’s Equity Resiliency Self-Generation Incentive Program (SGIP).  Without the rebate, the battery would cost about $2.2 million, with permitting and other costs increasing its final price to $3 million installed. The battery, which can power the wastewater treatment plant for about 11 hours before being recharged, comes with a 15-year warranty and 10 years of O&M coverage.  By charging the battery during off-peak hours and using it on peak, Camarillo will save at least $90,000 a year.

Tesla has contracted for about 160 battery projects under the California SGIP, of which 125 are with public entities. In Camarillo, the sites will be typical municipal facilities – city hall, a police station, a wastewater treatment plant, a library and the public works yard. Now the issue, is how to fund the full project.

The city council will have to decide if the city should pay for and own the microgrids or use a power purchase agreement (PPA) model.  Private providers can take advantage of federal investment tax credits for the facilities. However, the city applied for grants from the Federal Emergency Management Agency’s (FEMA) Building Resilient Infrastructure and Communities $500 million grant program that could cover up to 75% of the project’s capital cost.

PENNSYLVANIA GAS TAX PROPOSAL

Pennsylvania, Gov. Tom Wolf (D) has proposed phasing out the gas tax as the main funding mechanism for the state’s highway fund, and he has established a commission to recommend options for replacing it with alternative revenue sources. It is likely that much attention will be focused on vehicle mileage taxes (VMT) as the likely replacement.

A flat fee per mile based on vehicle weight and measured by the odometer would be the simplest version of a VMT tax to administer and avoids most privacy issues. The concern about “tracking” drives much opposition. Odometer readings could be done at yearly inspections or by installing an on-board-unit (OBU) that electronically transmits VMT to a central computer.

Today, about 56 percent of the state’s transportation tax revenue is raised through motor fuel taxes. The Tax Foundation estimates that a VMT would, if we assume a flat rate, need to be levied at 8 cents per mile to raise $8.4 billion.  That would be some 56% of the Commonwealth’s estimated annual revenue requirement to cover transportation funding. And funding via the gas tax is getting harder. In 1994, a passenger car averaged 20.7 miles per gallon (MPG) and drivers paid 3.2 cents in state and federal tax per vehicle mile travelled. In 2018, a passenger car averaged 24.4 MPG and drivers only paid 2.1 cents per vehicle mile traveled.

ANOTHER NEW TECHNOLOGY FOR THE MUNI MARKET

Global aluminum production reaches 50 million tons per year.  When processing bauxite by various methods, red slurries are formed, which are removed from the process in the form of pulp and stored in sludge storage.  Now, a Canadian company has developed a technology for the integrated processing of red mud with the production of target valuable products – iron-containing pigments and coagulants, aluminosilicate materials, amorphous silicon dioxide, precipitated calcium carbonate, titanium, zirconium, scandium and other rare-earth elements.

The plan would be for a plant to process the mud and develop a source of rare earth elements. Developers are looking forward at space and cost limitations at existing storage sites and deciding that the economics of storage will be less favorable than the economics of mud processing. It is also being sold as a green technology reflecting its role as a reducer of waste.

Given those characteristics, such a project would seem to be ripe for tax exempt private activity bond financing. And the State of Louisiana seems to agree. The board of trustees for the Louisiana Public Facilities Authority approved a “significant allocation” of tax-exempt private activity bonds that will be used to fund the construction of the new facility in St. James Parish.  The authorization by the board is for no more than $850 million. Governor John Bel Edwards approved private activity bonds up to $250 million for the project so far. 

The project would be built in Gramercy, LA at an existing aluminum smelter where there are 35 million tons of bauxite residue at the site. The residue is estimated to contain 10 rare earth elements and 15 minerals — among them titanium, iron and other metals — that have been identified as strategic and critical by the U.S. Defense Logistics Agency. 

Every project stands on its own. One can’t help but look back on previous projects which sought to address widely agreed upon environmental problems. The nature of the problem, the apparent lack of other solutions, and regulatory mandates all pointed to real markets for products which ultimately failed to support successful investments.

This would not be the first non- U.S. technology to find a home in the municipal market during its developmental phase. For those of us with significant high yield experience projects like this make one remember medium density fiberboard, paper deinking, plant waste processing, and nuclear waste processing. Waste management in its broadest sense has been a continuing source of investment risk in the high yield space and this is just its latest manifestation.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Publisher

________________________________________________________________

STIMULUS MONEY FOR STATES AND LOCALITIES

As we go to press, the Senate has passed its version of the stimulus bill and it awaits an expected vote in favor in the House. It is important to note that the $350 billion of aid to state and local government does not include additional funding under individual categories like vaccine distribution costs, school reopening costs which alone get an additional $144 billion. Medicaid gets a boost. Under the stimulus bill, states newly expanding Medicaid under the ACA would also receive a 5 percent bump in the federal funding match for their traditional Medicaid programs for two years. Because the traditional Medicaid population is significantly larger than the expansion population, the funding increase  is projected to cover a state’s 10 percent match for expansion enrollees and then some over those two years.

There are finally more specific numbers available to let us see how much of the $350 billion included in the pending stimulus legislation for state and local governments will reach individual governments. The bulk of the money goes to state governments with $216 billion of the $350 billion in the package for state governments. California will receive the largest share at $26.264 billion, followed by Texas at $16.824 billion, New York at $12.6 billion, and Florida at $10.3 billion. So much for the blue state bailout aspect of the debate as the largest shares are split among the colors.

Counties in California will receive $7.6 billion, the largest county share of the $65 billion available for those entities. Notable county shares include Alameda at $324 million; Los Angeles at $1.947 billion. Other major county allotments include Cook County, IL at $999 million; Nassau County, NY gets $398 million and neighboring Suffolk County gets $286 million. City totals include $1.345 billion for the City of Los Angeles, $636 billion for San Francisco; $880 million for Detroit, $435 million for Boston; $1.982 billion for Chicago; $4.3 billion for NYC; $500 million for Cleveland; Philadelphia would see $1.3 billion. Puerto Rico and its municipalities would receive a combined $4.3 billion.

One of the key issues underpinning opposition was doubt about the needed amount of aid to state and governments. Opponents seize on data from states like Minnesota (see our comments below) to support their cause. There also were issues with how initial aid was spent in that some recipient cities were pretty clear that they were using the funds for general budget relief rather than direct pandemic mitigation. It did not help the case but was not enough to stop the bill.

THE PANDEMIC ECONOMY – TWO DISPARATE EXAMPLES

As one of the largest municipal bond issuers in the country, the outlook for the NYC economy is of prime interest to investors. So we saw with interest the latest analysis of the city’s economy from its Independent Budget Office.

Based on Bureau of Labor Statistics data through December, New York City lost 557,000 jobs for the year 2020. During the first two quarters of 2020, with New York State as the epicenter of the pandemic in the U.S., the city lost a total of 889,000 jobs, or 19.0 % of total employment. A relatively strong initial recovery followed, with the city adding 210,000 jobs in the third quarter as the pandemic eased over the summer.

But job growth subsequently slowed through the fall and even turned negative in December; during the entire fourth quarter of 2020, the city had a net increase of just 122,000 jobs. In 2020, the largest losses were concentrated among major sectors closely tied to services and consumer activity, including leisure and hospitality (202,000 jobs), administrative and support services (53,000 jobs), and retail and wholesale trade (49,000 jobs). IBO forecasts employment growth of 152,000 jobs in 2021, 149,000 in 2022, 107,000 in 2023, and an average of 53,000 per year in 2024 and 2025.

That would leave the City just below pre-pandemic employment peaks. That reflects  an outlook which sees leisure and hospitality as having the weakest projected recovery of any sector, with jobs at the end of the forecast period still down from pre-pandemic levels by 23.2% (466,000 jobs in 2019 versus 358,000 jobs in 2025).

Where are the hopeful signs? Health care, information, professional/technical services, and financial services are cited as the sectors which may reach levels of employment above their pre-pandemic levels. The lag will come in sectors tied to tourism and high levels of disposable income.  It should be noted that despite the pandemic, personal income—the total of all sources of income received by city residents—increased by an estimated 2.9 percent in 2020, to $701.8 billion. Yes that reflects a high level of transfer payment from among other things, the federal stimulus payments and unemployment insurance. That is reflected in wage and salary data which shows in 2020, a decline of 3.4 percent from 2019.

The apparent incongruity between employment levels and wage impacts reflects the continuing split in the City’s economy – the so-called tale of two cities. Many of the lower-wage industries that saw the steepest employment losses also suffered large declines in aggregate wages, including leisure and hospitality (41.2%), administrative and support services (19.7%), and trade (13.4%). Meanwhile, certain higher-wage industries saw increases in aggregate wages, including information (10.5%), securities (6.1%), education (3.3%), professional/technical services (3.1%), and health (1.6%).

It is impossible to discuss the NYC economy without mentioning real estate. IBO estimates total taxable real estate sales of $61.3 billion for 2020, down from $99.8 billion in 2019. Going forward, the commercial real estate sector appears poised to be the area of the most risk for declining property valuations and property tax collections. Businesses in consumer-facing sectors have seen the largest losses in employment and earnings, and many existing jobs in professional and technical sectors have shifted toward alternative working arrangements.

The NYC numbers accompany a similar analysis of the economy of Minnesota which accompanied a favorably revised state budget estimate. In March and April 2020, as the pandemic was taking hold and economic activity was being restricted to slow spread of COVID-19, Minnesota lost 388,000 jobs, approximately 13 percent of February 2020 employment. The state began adding jobs in May, and through December 140,000 of the jobs lost in the early spring had been recovered.

As of December, Minnesota had 248,000 (8.0 percent) fewer jobs than in February. Between February and December 2020, Minnesota’s leisure and hospitality sector—made up of accommodation and food services and arts, entertainment, and recreation—lost 123,400 jobs, 44 percent of the sector’s February employment.  Since the onset of the pandemic, Minnesota’s labor force has fallen by 102,000.

TEXAS POWER CRISIS

Texas’s largest and oldest electric power cooperative – Brazos Electric Power Cooperative Inc, which supplies electricity to more than 660,000 consumers – filed for bankruptcy protection, citing a disputed $1.8 billion bill from the state’s grid operator (ERCOT). The move highlights the risk facing many of the Lone Star State’s electric utilities, especially municipal utilities.

One such utility- the City of Denton’s electric system – last week sued ERCOT in a state court to prevent it from charging it for fees unpaid by other users of the grid. The situation highlights the increased risk that local utilities face as the result of the difficulties at ERCOT, the manager of the single state Texas grid. We expect to see more stories like this. What will matter is how these issues are resolved.

One municipal utility – San Antonio – has gone on record as blaming the grid situation and its now clearly attendant financial risk as the basis for delaying renewable energy investments. The initial reaction of state government was to blame renewable resources for the inadequate supplies of power even though the impact of the storm was as great or greater at legacy fossil generating sources. This all reflects the pressure being put on by the state’s natural gas producers.

So now we are not surprised to see that in the wake of the recent power outage, some cities with municipal electric systems are reacting to this pressure by scaling back their plans to move to a fossil free generation environment. San Antonio and Austin are extending the period of time before natural gas in new buildings is banned and they are reducing their reduced emissions goals.

CARBON CAPTURE AND MUNICIPAL BONDS

While the infrastructure debate continues, a variety of proposals are being floated which could allow tax-free municipal bonds to be used to finance the development of carbon capture technologies. Carbon capture is controversial. Many would argue that it is not a proven technology. So we find it somewhat troubling that some in Congress are willing to advantage their favored industry with private activity bond status while not moving forward on items like advance refunding.

The proposal comes shortly after the only operating carbon capture facility in the U.S. was shut down. NRG Energy, which owns the project, announced that it would be shut down indefinitely. This Texas project was the largest in the world and it did not work. Reliability and performance issues doomed the plant. Another effort in Mississippi failed financially and never operated.

The CCS technology at the required so much energy that its owner and operator  (NRG) had to build a natural gas generator—the emissions of which were not offset by the technology employed at the plant—just to power the scrubber. Other economic issues included the fact that NRG actually wanted to use the carbon to extract oil at other properties. The economics of the CCS plant depended on the use of the carbon for oil production. When oil prices tanked, the plant was taken off line as it was uneconomical.

All of this reminds of the many other technologies presented to the municipal bond market – medium density fiber from wood waste, paper deinking just to name two – which took advantage of tax exempt financing to provide at least some portion of project economics.  They did not work either. Those projects left a trail of default wreckage throughout the tax-exempt high yield fund space. Like amusement parks, waste technologies, and other projects which needed tax exempt financing because at market taxable rates the project economics do not work, CCS projects look like they are next to take their place among those failures.

FOSSIL FUEL LIMITS

A move towards local bans on the use of natural gas in new building construction was enough to motivate the gas industry to try to override local rules through state legislation. (See last week’s edition on PREMPTION) In Vermont, the state’s largest city, Burlington has just elected to take a different approach. Rather than restrict through regulation, the city chooses to use taxing power This year’s town meeting vote saw the regulation of thermal energy systems in the city of Burlington pass by 8,931 to 4,910 votes or about 65%-35%. This is the first step in a multi step process.

The result allows the city to ask the state Legislature if it can draft legislation to tax new developments if they choose to use fossil fuels in their heating. This vote will come back to residents if the Legislature approves, and then the City Council will draft another resolution for voters to vote again on a potential carbon fee. The experiment will bear watching as it merges a liberal city like Burlington with an idea most prominently advanced through the University of Chicago. We expect municipal issuers to face similar choices in light of the efforts to stymie a regulatory approach.

PANDEMIC POLICY IMPACTS

The pandemic and its impact on revenues at the state level generated some unexpected results. With all of the emphasis on job losses and high unemployment rates during the first few months of the pandemic, the impact of lockdowns and reduced economic activity on state revenues was not estimated correctly. The budget season and the need to generate revenue estimates to support the budget process have documented the pandemic’s effect.

One of the trends to emerge is that the pandemic’s impact on incomes was wildly unequal. It turns out that the structure of a state’s taxes had real impacts on the effect of the pandemic on revenues. Because the impact of job losses was concentrated to a great degree among lower wage job categories as opposed to white collar workers who could work remotely, the expected pressure on income tax collections just has not materialized to the extent anticipated.

This has led some to look at changes to their state’s tax structure and propose changes. In New Mexico, a bill is being offered that would raise the state’s marginal income tax slightly. Senate Bill 89 would increase the percentage rate on taxable income for people earning the most. The top bracket would tax at a 6.5% rate, up from the current 5.9%. It is estimated to bring in $100 million in incremental revenue. State statistics say only 4% of the state’s households earn more than $200,000 a year.

PUERTO RICO AND MARKET CREDIBILITY

The executive director of the Puerto Rico Fiscal Agency and Financial Advisory Authority spoke at a high yield conference this week. The comments were supposed to reflect positively on the outlook for Puerto Rico’s efforts to regain access to the municipal bond market. Depending on your viewpoint, you may react positively to them. We however, beg to differ.

“Not only were we able to gain credibility through restructuring issuers COFINA [Puerto Rico Sales Tax Financing Authority], Government Development Bank, Puerto Rico Infrastructure Finance Authority Ports  but we were able to gain more credibility when we went back to the market in September and December 2020 with both the Public Housing Administration and the water utility.”  That is indeed questionable.

Neither of the two issuers referenced issued debt backed by governmental as opposed to enterprise revenues. They both refunded more expensive existing debt so the debt service payment on those bonds should be more likely. We see a real distinction in that water debt historically performs very well in bankruptcy and the housing debt is paid from revenues from the federal government.

It is the area of governmental versus enterprise debt with which we have a problem. The government’s opposition to any adjustment in pension payments – even temporary – is a warning sign that the stomach to achieve real reform is not there. The economy still reels from hurricanes, earthquakes, and floods. The tourist economy remains pandemic bound. And many of the structural weaknesses of the local economic environment remain unaddressed. But to date, much political capital is wasted on the quest for statehood in a political environment where that is not soon achievable.

The government has dug in on pensions. It has always been our view that the Commonwealth has to act responsibly on its own before it can have credibility. The pension issue should be viewed as a test. Like the Christmas bonus, it is a sign of an entity which will not accept reality. The Title III process is one quarter away from being four years along and yet it’s clear that there remain significant hurdles to overcome before that process can end. Then the Commonwealth can begin to consistently deliver on its own the necessary financial and economic information investors need in order to rebuild trust.

THE FUTURE OF WORK

Much has been posited about the future of work in the face of technological change. In addition to the obvious impacts of the pandemic on employment from economic activity restrictions, a number of pre-pandemic factors became more real as businesses adapted to pandemic economic realities.

The issue of technology or its older name automation is not new. It has already had profound effects on the nature of work and the hierarchy of employment which has resulted. For those preexisting factors, the pandemic served as an accelerant. Diminished traffic accelerated the full automation of tolls on the Pennsylvania Turnpike. The NYS Thruway completed automated toll equipment on additional segments of the road.

On the corporate side, pandemic restrictions increased reliance on machine based contacts with customers – banks, grocers, restaurants. It has come out that even the kids taking your drive thru order at McDonald’s are being replaced in a trial. There are plenty of other examples. The pandemic exposed structural issues with the economy. A new report from the Future of Work Commission, a 21-member body appointed by Gov. Gavin Newsom in August 2019, notes that Among California’s low-wage workers, 53% are employed in essential occupations, which are most vulnerable to the virus compared with 39% of workers in middle- and high-wage occupations, many of whom are able to work from home.

Combine this with the newfound attractiveness of remote work to many in the workforce. The result is fewer people commuting and occupying offices further pressuring service jobs. That then increases the disconnect between work and residents of lesser means. This comes as there is much focus on the potential for property tax pressures stemming from lower demand for commercial spaces. All of this points to more uncertain environment for general obligation tax supported credits. It is manageable, but uncertain.

NUCLEAR FALLOUT IN OHIO CONTINUES

The Ohio Senate voted unanimously to repeal the nearly $1 billion in subsidies that were to have been sent to two Ohio nuclear plants owned by a former FirstEnergy subsidiary. The bill also would eliminate the fees on Ohioans’ electric bills that pay for the subsidies. A court ruling has stayed the collection of these fees pending appeal.

The Federal Energy Regulatory Commission ruled in 2019 that if power generation companies receive state subsidies like the ones offered by HB6, the commission would make it harder for those companies to sell electricity from the two nuclear plants. That ruling said that new resources receiving subsidies will now be subject to the Minimum Offer Price Rule (MOPR), which raises the price floor for those resources attempting to sell their power into the wholesale market.  The result effectively penalizes nuclear power even though the intended target is wind and solar generation.

The subsidization of nuclear and the efforts of the  nuclear industry to obtain these subsidies are at the core of ongoing scandals in Ohio and Illinois. The Ohio House Speaker was indicted and the Illinois House Speaker retired in reaction to pressure related to efforts by utilities owning  nuclear assets to obtain subsidies. There is irony that legislation designed to support legacy generation actually hurt in this case.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.