Joseph Krist

Publisher

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P3 IN THE SPOTLIGHT

The troubles which have plagued the long delayed Purple Line P3 rail system in Maryland now appear to be influencing the development of another P3 to expand I-270. Maryland hopes construction would start with the replacement and expansion of  the American Legion Bridge. Work would continue around the Beltway to the I-270 spur, before moving up I-270. It would include tolled express lanes which would be the source of revenue to support the financing of the project. The existing free lanes would also would be rebuilt.

As one of the more favorable states for P3s, it was not unexpected that a P3 would be a likely option for Maryland. However, the impact of the ongoing Purple Line experience shows up in the first proposed contract to deal with “pre-development’ components of the project. In reality, it calls for the winner of the contract to deal with a myriad of issues over design, permitting, and acquisition in association with the needed right of way. Those all have the potential to increase costs and delay the project.

It was due to factors like those that the Purple Line P3 cratered. To address some of those potential liabilities, the State of Maryland is proposing that the state would have to reimburse upfront “predevelopment costs” if the project is delayed for a list of reasons. Among potential delay points are that  land costs more than expected, the federal government withholds environmental approval or the state board that approves major contracts does not do so.

The State would have to compensate the private partner with up to $50 million in the event any of the triggering events occur. The needed environmental permits are not in hand. These are often the most successful vehicles for project opponents to employ to stall or halt projects. There remains significant opposition to the project from a variety of interests.

MORE THAN MEETS THE EYE IN GDP REPORT

The fact that the economy fared so poorly in the fourth quarter relative to the third quarter is not surprising. The reinstatement of lockdown conditions and extensions of existing service limits and suspensions could be anything but positive. What interests us is what the data tells us in terms of what the economy might look like going forward once “normal” life resumes. And that positive spending now could have negative impacts later.

The data reflects current trends. The increase in real GDP reflected increases in exports, nonresidential fixed investment, personal consumption expenditures (PCE), residential fixed investment, and private inventory investment that were partly offset by decreases in state and local government spending and federal government spending. It is the underlying detail that draw attention.

The increase in nonresidential fixed investment reflected increases in all components, led by equipment. That is a nice way of saying that manufacturers were able to take advantage of pandemic induced downtime to rethink their use of labor and automate where they could. The pandemic exacerbated that existing trend and portends that while the economy may resume, manufacturing employment gains may not be as robust.

The increase in Personal Consumption Expenditure was more than accounted for by spending on services (led by health care); spending on goods decreased (led by food and beverages). Disposable personal income decreased $372.5 billion, or 8.1 percent, in the fourth quarter, compared with a decrease of $638.9 billion, or 13.2 percent, in the third quarter. The decrease in PCE in 2020 was more than accounted for by a decrease in services (led by food services and accommodations, health care, and recreation services).

That puts the travel/hospitality/entertainment/culture space at the center of  true recovery. No other sector may have been as impacted and the ability of the sector to reemploy staff let go as these facilities closed will be key to determining the pace and extent of the post-pandemic economic growth. Municipal bond credits supported by entities in this space still provide a source of risk as it is not clear as to the timing of a full recovery. It is the reliance of this space upon disposable income that highlights the risks facing these credits.

NATURAL GAS BANS

One of the more recent fronts in the movement to end dependence for energy and fuel from fossil based sources. Fronts against oil have been opened up with carmakers accelerating efforts to develop electric vehicles. Market realities are driving coal out of the electric generation fuel source menu. Now, efforts are turning towards what has been until know a go to alternative to those fuels – natural gas. While cleaner than oil or coal, natural gas carries with it its own set of environmental baggage.

That environmental baggage has driven several municipalities – primarily in California – to enact laws and/or regulations which would not allow the use of natural gas as a fuel source in new construction. While the number of such bans is few, the industry and its policy allies are moving quickly at the state legislative level to enact laws reserving regulation of the use of natural gas in buildings to state regulators. Indiana is about to vote on one such bill even though there are no known existing or pending natural gas limits in the state.

Kansas and Missouri are set to contemplate similar legislation. There are two broad views of these regulations. Proponents would say “No one is talking about removing existing infrastructure in place, ripping that out and forcing people to go electric. These bans are all about new construction, new development. Furthermore, most of these bans I’ve read about include significant exemptions especially for the manufacturing and industrial sector. This is a one-way bill. This bill is not about choice, it’s about the utility’s right to furnish service regardless of the energy source. … There’s nothing in this bill that protects the rights of private property owners to generate their own energy, or to lease their land to third parties who wish to invest in renewable energy on their property.”

Opponents (energy and development companies) would say builders and manufacturers arguing that it is crucial to ensure competitiveness in Indiana’s manufacturing and construction sectors. Tennessee, Kentucky, and Oklahoma are said to be looking at similar legislation. And similar is the key word as the hand of The American Legislative Exchange Council  (ALEC) is thought to be behind the structure of the legislation as they are so often in conservative state legislatures.

POLICY SHIFTS FROM NEW ADMINISTRATION

One example of the impact of a change in administrations is the clear change in attitude towards infrastructure and its role in resiliency. Federal officials aim to free up as much as $10 billion at the Federal Emergency Management Agency to protect against climate disasters before they strike. The money would be applied to projects like building seawalls, elevating or relocating flood-prone homes and taking other steps as climate change intensifies storms and other natural disasters.

Currently, much preventative work is done through local funding and financing. The FEMA plan would use a budgeting maneuver to repurpose a portion of the agency’s overall disaster spending toward projects designed to protect against damage from climate disasters. Initially, the agency believes that the planned budgetary maneuver could generate as much as $3.7 billion to be available for the program, called Building Resilient Infrastructure and Communities, or BRIC. 

The BRIC program was created in the aftermath of the disaster season of 2017, when the United States was struck in quick succession by Hurricanes Harvey, Irma and Maria, as well as wildfires in California that were then the worst on record. the National Institute of Building Sciences  found mitigation funding can save the nation $6 in future disaster costs, for every $1 spent on hazard mitigation.

The program would not be funded by federal dollars completely. State and local governments must provide 25% of the cost of any projects. The consideration comes in the wake of a bipartisan Congressional request that the monies be used in this manner in 2020. That request was rejected by the Trump Administration OMB. With a different philosophy and personnel in place in a Biden Administration, it is much more likely that this funding could be used.

A second sector to see change is the private prison space. Towards the end of the Obama Administration, the department of Homeland security began moving towards ending contracts with private prison operators to house federal prisoners.  The prisons are a source of jobs to the primarily rural communities where they operate. For many of these facilities, the federal contracts are the difference between financial failure and success.

That policy was reversed by the Trump Administration. Now, in keeping with the policies the Obama/Biden Administration was seeking to impose, the President signed an executive order ending contracts between the Department of Justice and private facilities. The policy does not extend to Immigration and Customs Enforcement contracts. The Bureau of Prisons currently holds approximately 11,000 prisoners in 12 facilities. Three are in Texas and two are in Georgia.

TRANSPORTATION FUNDING ALTERNATIVES

Impact fees are a one-time charge assessed only against those who create additional impacts to the transportation system by virtue of a new development or change of use. Their purpose is mitigate the impacts of development on municipal and county infrastructure systems, and to ensure those who are creating the impact, rather than existing tax payers, foot the bill for the cost of new transportation facilities necessary to serve new development.

The Seminole County FL Road (Transportation) Impact Fee was put in place in 1985. Since its adoption, funds collected under this program have been used to construct roads facilities or provide road improvements to accommodate the demands of new growth. The fee has not been updated for a quarter century. Since its adoption, funds collected under this program have been used to construct roads facilities or provide road improvements. Over that time, what constitutes transportation in the minds of users and providers alike, has undergone significant change. 

Now the County is proposing to levy a mobility fee on new development. Mobility fees were legislated 12 years ago by the State. The mobility fee will replace Seminole County’s current Road (Transportation) Impact Fee and will allow for additional transportation modes, to include roads, sidewalks, and multipurpose trails. Seminole calculates that a new mobility fee could raise as much as $6.5 million annually. The county’s current road impact fee raised about $2.64 million last fiscal year.

The proposal serves to highlight many of the issues emerging in the transportation funding space. Proponents of the fee have structured it in such a way that encourages urban development and adds additional relative cost to rural development. The current fee reflects those same concerns. The new fee does anticipate significantly greater increases in the fee for rural  versus urban development.

SANTEE COOPER

The South Carolina House voted 89 to 26 to continue to receive offers for a sale of the state-owned electric utility Santee Cooper (South Carolina Public Service Authority). The bill, which now goes to the South Carolina Senate provides that lawmakers would vet proposed suitors for the utility, a responsibility previously given to a third-party consultant working with a state agency. A six-person committee comprised of three senators and three representatives would consider offers to purchase all or parts of Santee Cooper directly from potential buyers, rather than having a preferred bidder selected by a state agency.

The House legislation also includes reforms for the Santee Cooper, including shortening the terms of board members, putting in education requirements, and having increased oversight from the Public Service Commission and the Office of Regulatory Staff over the utility’s operations and long term agreements. The legislation also provides for the sale evaluation process to be available for 10 years.

That 10 year time frame is a clue to what is really expected to result if the proposed legislation is enacted. A sale is not anticipated soon reading between the tea leaves. Recent comments point towards a reorganization and restaffing of the management of the utility and the ongoing consideration of the sale is a clear shot across the bow of Santee Cooper management. It has all come down to an issue of control.

The debate comes as Santee Cooper has been identified as one of the nation’s utilities with the largest amount of coal fired generating capacity planned to remain open beyond 2030. Among municipal utilities, Santee Cooper has the largest share and is only one of two municipal utilities to be on the top 20 list. That issue will not go away as the control debate unfolds.

ENERGY TAX INCENTIVES GETTING A NEW LOOK

Louisiana’s severance tax on oil – the amount the state charges on oil extracted in the state – is 12.5%. That rate is higher than any other state except Alaska and triple the rate charged for natural gas. Now, the legislature will consider a proposal under which severance taxes for oil would be lowered to 6%, while the severance tax rate on natural gas would go up from 4% to 6%

The proposal seeks to equalize the rates for oil and natural gas. State tax breaks for drilling certain types of wells would be phased out, including one for horizontal drilling widely used in Louisiana’s highly productive Haynesville Shale natural gas play. Louisiana is the site of the most productive natural gas play in the nation and is the only shale play in the country to add rigs over the past year. Louisiana currently ranks third behind Texas and Pennsylvania for natural gas production. 

The proposal comes as officials are projecting $293 million in excess revenue for the current budget year that ends June 30, which legislators can use to make supplemental appropriations when they are back in session. The state also has a $270 million surplus left over from last year, though the state constitution limits the use of those dollars to one-time expenses such as construction projects, paying down debt and shoring up the “rainy day” fund.

The budget debate will unfold as the damage done by pandemic limits on activities is measured. One example is that Louisiana’s casino revenue was down more than 21 % in December compared to December 2019. Under current restrictions meant to control the spread of the coronavirus that causes the illness, casinos are limited to half of their normal capacity and must end alcohol service at 11 p.m.

Virginia is among the 15 states (out of 23 that produced coal in 2018) that offer tax credits to the coal industry. Virginia offers two major tax credits aimed at boosting coal mining in Virginia. The state has spent $225 million between 2010 and 2018 on the Coalfield Employment Enhancement Tax Credit and the Coal Employment and Production Incentive Tax Credit. A report from the Virginia Joint Legislative Audit and Review Commission (JLARC). That report concluded that the tax credits no longer serve their purpose and should be eliminated.

The coalfield tax credit was adopted in 1995 to encourage coal production and coal employment and provides a tax credit to “any person who has an economic interest in coal” mined in the state, which generally is the mining company that extracted the coal. Coal mining companies and electricity generators saved $291.5 million in income taxes because of the coal tax credits between FY10 and FY18. Both of the coal tax credits are among the state’s 10 largest incentives, with the coalfield tax credit being the second-largest incentive. 

The Credit is no longer warranted to maintain competitiveness because Virginia’s coal mining productivity has met that of other nearby coal-producing states. The Coal Employment and Production Incentive Tax Credit, which is designed to encourage electricity generators to use Virginia coal, no longer serves a purpose because all but one of Virginia’s coal-fired plants will close by 2025, and the remaining plant is already dependent on Virginia coal. Legislation to scrap the tax credits next January is moving through the Virginia legislature.

A 2012 JLARC report that said coal production declined at the same rate or faster even with the state-issued credits designed to slow the demise of Virginia’s coal industry. Even industry groups like the Metallurgical Coal Producers Association and Virginia Coalfield Economic Development Authority did not object to the proposal to end the credits 18 months before their scheduled sunset.

The debate is driving a  number of proposals to offset the economic impact of the decline of coal. One would set up a fund to provide grants to renewable energy companies to clean up previously developed but contaminated land and place renewable energy sources there. There is more than 71,000 acres of land affected by coal mining and brownfields in Southwest Virginia that could be redeveloped.

OIL LEASE SUSPENSIONS

The state which looks to be most affected by decisions like this week’s by the Biden Administration which suspended new oil and gas leasing on federal lands is the Cowboy State. In Wyoming, about 51% of oil is drilled on public land, along with an overwhelming 92% of natural gas. In 2019, , according to the Petroleum Association of Wyoming, the oil and gas industry provided $1.67 billion to state and local governments.

A University of Wyoming study projects that if a full leasing moratorium went into effect, the state could be out $304 million in annual revenue. According to the Wyoming Department of Education, the state relies on roughly $150 million each year in oil and gas federal mineral royalties to fund K-12 schools. 

The U.S. Bureau of Land Management auctions parcels of this land to oil and gas companies for development, typically four times a year. If a company obtains the lease, it still needs to secure a permit to drill. Lease terms vary, but typically range from five to 10 years. Permits to drill last two years. The industry “stockpiled” permits in the end of the Trump Administration in anticipation of the possibility of a Democratic administration. The real policy test will come when the leaseholders apply for drilling permits.

The change in federal leasing policy comes as the state is dealing with the long term decline of coal as a generating fuel and the realities of its natural gas industry. The Wyoming State Geological Survey, which is a state entity, recently released its view of the fossil fuel industry in the state. In reality, rise in natural gas production during the Trump years was an aberration. “Wyoming’s natural gas production has been in a gradual decline since the collapse of the coal bed natural gas industry in 2009. Despite Wyoming’s advantages— some of the nation’s largest natural gas reserves, two of the nation’s 10 largest gas fields (Jonah and Pinedale), demonstrated success using horizontal drilling technology in these large fields, and abundant associated gas production from unconventional oil wells.

From 2010 to 2019, Wyoming’s natural gas production declined an average of 4.4 percent each year, with a 13% decline in the first nine months of 2020. Although some of the 2020 decline is due to short term reactions to the pandemic, the overall drop is a result of longer-term trends, including fewer new gas wells being drilled and the natural production decline of older wells.” So the reality is that economics and not ideology are driving Wyoming’s fossil fuel outlook. It is a reflection of national realities.

HEALTHCARE PRESSURES

Labor shortages and higher wages are leading hospitals to employ various strategies to attract and retain clinical talent. Higher salaries and signing incentives, paying more overtime and/or using contract labor at hourly rates that are at all time highs will all contribute to spending pressures at a time when the consumer is looking for every way to reduce their outlays for healthcare.

The insurers will continue to encourage additional procedures to be performed outside the hospital as ambulatory surgery centers (ASCs), urgent care facilities, and the home become the preferred venues for patients to receive care. Even when these service modalities are provided through hospital owned facilities, they are not as profitable as reimbursements are lower for services outside of the acute care setting.

Policy changes and an aging population could increase governmental insurance coverage at the expense of hospitals’ commercial insurance coverage. As retirees migrate to Medicare from commercial insurance, hospitals will receive lower rates of reimbursement for services. Elevated unemployment will also lead to lower patient volumes, as consumers who lose employer provided insurance defer non-urgent care. The same factors driving seniors to Medicare (cost) will also exist should a public option be legislated and that will create the same pressure on revenues that the shift to Medicare does.

If anything, already existing hospital credit trends will continue. Large hospital systems will be better positioned to deal with changes than will stand alone facilities from a financial standpoint. Rural hospitals will continue to be under pressure and more vulnerable to changes in payer mix towards public rather than commercial insurers. The pandemic has not changed that.

MOODY’S UPDATES SCHOOL DISTRICT RATING CRITERIA

Moody’s has published updated methodologies for how it rates US public school districts that provide public education directly to students, typically from pre-kindergarten or kindergarten through 12th grade (K-12) or a subset of grades within this range. School districts rated under this methodology are operationally independent from a city or county government and have the power to issue debt on their own behalf or through a dedicated financing vehicle.

The methodology is used to create a “scorecard” for each rating.  The factors it uses and weights are the school district’s underlying economy (30%), financial performance (30%), its institutional framework (10%), and leverage (30%). Institutional framework refers to at what level of government funding mechanisms are established. Some states rely on a local basis for funding topping off shortfalls from local sources to meet state requirements versus districts where the state sets the basis.

The change has put some 637 school district rating under review. 304 US K-12 public school districts are now on review for possible upgrade, 236 on review for possible downgrade, and 97 on review direction uncertain . The general obligation unlimited tax (GOULT) ratings of 85 US K-12 public school districts were upgraded.  These actions affect issuers with approximately $65 billion in debt . Final reviews under the new methodologies will occur over a course of several months.

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.