Skip to main content

Testimony of Tom Sanzillo before the United States District Court for the District of Puerto Rico

May 01, 2023
Tom Sanzillo
Download Full Version View Press Release

Key Findings

An oversight board plan to resolve the Puerto Rico Electric Power Authority’s debt crisis is not feasible, according to IEEFA testimony

The plan to repay $5.68 billion of $9 billion in debt would result in double-digit rate increases for ratepayers on the island


Puerto Rico electrical rates are already twice the U.S. average, even though its median income is less than half of the poorest state in the nation

A transition to renewable sources of energy is desperately needed. The island is hostage to rising costs of fossil fuels, which provide 97% of its power supply

Introductory Questions

Q. State your name.

Tom Sanzillo.

Q. State your business mailing address.

Redacted for privacy.

Q. State your educational background.

Bachelor of Arts from University of California, Santa Cruz.

Q. Describe your professional experience and qualifications.

I am Director of Finance for the Institute for Energy Economics and Financial Analysis (IEEFA). IEEFA provides financial and energy information, and analysis on alternatives to fossil fuels. Since 2007, I have written reports individually and jointly on a host of energy and financial topics related to coal, oil, and gas finance and markets, including individual power plants, coal mining, fossil fuel ports, coal producing companies, rural cooperatives, public power authorities, independently owned utilities, renewable energy financing, institutional investments, public and private financing, energy subsidies, oil and gas price and corporate trends, individual mining and drilling projects, and the Puerto Rico Electric Power Authority (PREPA).

Moreover, I have prepared reports, testimony and blogs on topics related to Puerto Rico’s energy situation since 2015. Those publications have focused on the energy and financial condition of PREPA, specifically pre- and post-hurricane energy planning and priorities, debt management, consultant hiring and fee structure, renewable energy opportunities, management challenges, political interference, budget and fiscal plan, federal oversight, and fuel oil contract and other procurement issues and irregularities. Additionally, I have presented testimony in depositions and to public service commissions, state and local governments and federal court, including the Puerto Rico Energy Bureau (PREB) (CEPR-AP-2015-0001).

Prior to my tenure at IEEFA, I spent 17 years at senior management levels at the New York City and New York State Comptroller’s Offices. I left state service in 2007 as the First Deputy Comptroller of New York State (and served for a short period as the State Comptroller due to an early resignation). In those positions, I had responsibility for the oversight of a: $150 billion pension fund; 1 million-member retirement system; $250 billion state and local bond portfolio; $85 billion in annual contracts and 40,000 contract workflow; audit program of all public authorities, state and local governments; monitoring program of the state budget and expenditures (including payrolls), and review of finances of 1,400 units of local government. My writing on state government finances has appeared in the New York State Oxford Handbook on Politics and Government.

Part of my responsibilities concerned the problem of local government fiscal distress. The New York City Comptroller is a member of the New York State Financial Control Board and monitors the City government budget. The New York State Comptroller, during my tenure, had statutory obligations for existing control boards in New York City and Yonkers (including the Yonkers exit from oversight). The office initiated new control boards in Troy, Nassau, Erie County and Buffalo. As part of the Comptroller’s executive leadership team, I had responsibilities involving these initiatives. Each Comptroller prepares and issues the respective Comprehensive Annual Financial Report for the city or state. Shortly after I left state service, I was asked to serve as a private citizen on the Long Island Power Authority Advisory Board.

Q. State whether you have previously testified or presented before the Title III Court and list the occasions.

I was retained by Unión de Trabajadores de la Industria Eléctrica y Riego Inc. (UTIER) to prepare an expert report in the action styled Unión de Trabajadores de la Industria Eléctrica y Riego, Inc. (UTIER) v. Puerto Rico Electric Power Authority (PREPA), et al., No. 17-00229-LTS, before Hon. Judge Laura Taylor Swain in the United States District Court for the District of Puerto Rico.

Q. State on whose behalf you are testifying before the Title III Court.

I am testifying on behalf of UTIER.

Q. List the documents you considered for your testimony.

Among other secondary resources and relevant news articles, as cited herein, I reviewed:

  1. Plan of Adjustment and all associated schedules.
  2. Disclosure Statement and all associated exhibits.
  3. 2023 Commonwealth Certified Fiscal Plan.
  4. 2022 PREPA Certified Fiscal Plan and all prior PREPA Certified Fiscal Plans.
  5. PREPA Monthly Reports to the Governing Board.
  6. LUMA’s budgeted and actual operating expenditures as reported to PEB.
  7. PREPA’s Grid Modernization Plan.
  8. PREPA’s approved Integrated Resource Plan.
  9. PREB’s docket in CEPR-AP-2015-0001 on PREPA rates.
  10. Puerto Rico Department of Housing’s Action Plan for the Use of CDBG-DR Funds for Electrical Power System Enhancements and Improvements. 

Q. Describe the purpose of your direct testimony.

The purpose of my testimony is to show that the proposed Plan of Adjustment is not feasible, because it (a) is based on faulty and unreasonable financial projections, (b) is not consistent with the provision of future electrical service adequate to support the Commonwealth’s economy, and (c) is structured in a way to result in a long-term credit risk that could impede future market access.

The Plan of Adjustment is not supported by reasonable projections.

Q. Is the Plan of Adjustment supported by reasonable financial projections?

No, the Plan is not supported by reasonable projections, neither in the most recent PREPA 2022 Certified Fiscal Plan (Fiscal Plan) nor in the supporting documentation (specifically Exhibit P, “Legacy Charge Derivation”) of the Disclosure Statement. As will be discussed later, it is not clear on which of these two documents the Financial Oversight and Management Board for Puerto Rico (Oversight Board) is basing its claim as to the viability of the level of new debt in the Plan of Adjustment.

The Disclosure Statement partially bases the feasibility of the Plan of Adjustment on the Debt Sustainability Analysis of the Fiscal Plan: “the feasibility of the Title III Plan of Adjustment is at least partially determinable by whether the plan provides for an amount of ongoing debt within the range of the debt sustainability analysis in the Fiscal Plan.” In principle the Plan of Adjustment must not provide for a level of debt that the Certified Fiscal Plan cannot cover with the resources of the utility. As shown below the Plan of Adjustment does just that. The debt levels projected by the Plan of Adjustment exceed that identified by the Certified Fiscal Plan and its projections about the capital needs of the utility are low.

In the rest of this section, I explain why both of these documents —the Debt Sustainability Analysis of the Fiscal Plan, and Exhibit P of the Disclosure Statement—are based on faulty projections and how these faulty projections result in a false impression of the feasibility of the Plan of Adjustment.

Q. What is the purpose of the Debt Sustainability Analysis, and what is this analysis based on?

The Fiscal Plan clarifies the purposes of the Debt Sustainability Analysis as PREPA works to exit bankruptcy:

The debt sustainability analysis (DS) included here provides a framework for assessing PREPA long-term capacity to pay debt service. PREPA’s debt levels need to align with the objective of recovering market access to fund ongoing and future infrastructure capital investment and/or refunding savings and ensuring a sustainable electric system with affordable energy prices for the Commonwealth and its residents. The follow debt sustainability analysis describes PREPA’s capacity to pay current and projected debt.

Thus, the Debt Sustainability Analysis relies on the projections of future electrical system expenses and hence rates presented in the Fiscal Plan to align the debt levels with the needs for a sustainable and affordable electrical system.

Q. Are the projections of future electrical system expenses in the Fiscal Plan reasonable?

No, they are not, for the following reasons:

  1. The Fiscal Plan projects all expenses, excluding debt service, through 2038. This projection contains no capital expenditures over the plan period, beyond investments made by federal funds or by private developers (whose costs enter the Fiscal Plan as purchased power costs). The lack of capital expenditure allocations throughout the plan period is noted in Exhibit P of the Disclosure Statement, which states the necessity of adding $2.425 billion in capital expenditures over the plan period. Thus, to provide PREPA with the resources necessary to become viable, an adjustment to the Fiscal Plan would need to be made. This would, according to Exhibit P, necessarily reduce the amount available for any Legacy Charge. The lack of a capital expenditure item in the Fiscal Plan is unreasonable.
  2. The Fiscal Plan assumes that 3.75 GW of new renewable energy capacity will come online by Fiscal Year 2027 (i.e., by July 1, 2026). This follows the August 2020 approved Integrated Resource Plan, which calls for six tranches of renewable energy procurement, totaling 3.75 GW, with Requests For Proposals (RFPs) to be released between December 2020 and June 2023. As of April 2023, only two of these six RFPs have been released, and PREPA has signed contracts for less than 1 GW of solar capacity. Thus, it is all but impossible for PREPA to have 3.75 GW of projects constructed and operational by July 1, 2026, given the delay between signing a contract and having a constructed and operational project. This delay means that PREPA will be purchasing more oil and natural gas than forecast in the Fiscal Plan, resulting in higher fuel and purchased power costs than projected. This additional cost will reduce any estimated surplus that could be used to pay the Legacy Charge.
  3. The Fiscal Plan also assumes that no new natural gas plant capacity will be built in Puerto Rico over the Plan of Adjustment period. The government of Puerto Rico has recently taken action counter to this assumption, issuing a Request for Qualifications (“RFQ”) for a 300-MW new natural gas power plant, which would continue to tie the island to imported and price-volatile natural gas for the next several decades. This additional cost will reduce any estimated surplus that could be used to pay the Legacy Charge
  4. The Fiscal Plan’s projection of significant fuel savings starting in FY 2024 are unrealistic. The Fiscal Plan projects a fuel budget of $2.9 billion for FY 2023 and only $1.4 billion for FY 2024. Even acknowledging that PREPA is currently underspending the FY 2023 fuel budget (as of February 2023, it was on track to be 20% below its FY 2023 fuel budget), projected declines in fuel prices from FY 2023 to FY 2024 would not be sufficient to reach the Fiscal Plan’s projected FY 2024 fuel budget. Specifically, Henry Hub natural gas prices are expected to decline 27% and West Texas Intermediate oil prices by 5% from FY 2023 to FY 2024; given that PREPA spends about 75% of its fuel budget on oil, this represents a weighted average decline in fuel prices to PREPA of about 10%. We therefore estimate fuel expenditures for FY 2024 at approximately $2 billion, several hundred million more than projected in the Fiscal Plan. This additional cost will reduce any estimated surplus that could be used to pay the Legacy Charge

Q. What is the consequence of including these unrealistic assumptions in the Fiscal Plan?

All of these assumptions combine to produce an expense forecast and therefore a forecasted rate that is unreasonably low, presenting a more optimistic picture than is warranted of rate affordability, even in the absence of any debt service.

Q. Even given these unrealistic assumptions, do the Legacy Debt levels in the Plan of Adjustment comport with the Debt Sustainability Analysis contained in the Fiscal Plan?

No. The Disclosure Statement states that “[t]o be consistent with the applicable certified fiscal plan, the Plan [of Adjustment] cannot provide for more debt than the applicable certified fiscal plan’s debt sustainability analysis determines should be sustained by Reorganized PREPA.” Yet, this is not the case. The Plan of Adjustment does the exact opposite; it assumes substantially more resources are available to pay debt than the Fiscal Plan.

Notwithstanding all of the faulty assumptions identified above that improperly depress expenses, the Debt Sustainability Analysis in the Fiscal Plan establishes a range of debt levels from $2.44 billion to $5.61 billion. The actual debt level identified in the Plan of Adjustment is $5.68 billion for Legacy Debt and $2.425 billion for capital expenditures not included in the Fiscal Plan, for a total of $8.11 billion in new debt that would be emitted over the Plan of Adjustment period. This is significantly higher than the range presented in the Debt Sustainability Analysis.

Q. Does the Debt Sustainability Analysis recommend that the cash resources identified be reserved exclusively for the purposes of the repayment of the Legacy Debt obligation?

No. It is a tool that simply identifies the presumed cash that is technically available if the revenue and expense assumptions actually materialize. The decision on how those resources are used is not assumed by this revenue/expense model. In addition, the qualitative discussion contained in the one-page Debt Sustainability Analysis is silent on this question. Nowhere is it stated that the total surplus (if any materializes) be put toward the payment of Legacy Debt. Indeed, the analysis of the Fiscal Plan presented above suggests that there are operational and capital needs that are insufficiently funded by the current revenue and expense projections in the Fiscal Plan.

Q. Earlier in your testimony, you referenced that Exhibit P of the Disclosure Statement also attempts to provide justification for the debt levels proposed in the Plan of Adjustment. Do the projections and formulations in Exhibit P create a reasonable basis for the Plan of Adjustment?

No. Exhibit P attempts to balance the rate affordability issue, Legacy Debt and the capital needs of the electric system going forward. Instead, it only serves to more fully highlight the case that PREPA cannot sustain the Legacy Charge.

Exhibit P is based on an analysis of household-level rate affordability and “share of wallet” (the share of household income that goes to paying electricity bills). The Exhibit P analysis purports to find the rate that is affordable at the household level (without regard for affordability to commercial and industrial customers that will also pay a comparable rate) and converts this into hypothetically available revenue for the system. The exercise then subtracts projected electrical system operational expenses to determine the amount of headroom available for servicing Legacy Debt and new capital expenditures over the Plan of Adjustment period. (New capital expenditures do not include federally funded capital expenditures or privately-funded generation costs that are already incorporated into the Fiscal Plan as part of projected purchased power costs).

Exhibit P’s estimate of new capital expenditures over the Plan of Adjustment period is $2.425 billion. From this, Exhibit P derives the $5.68 billion that the Plan of Adjustment proposes to emit to cover Legacy Debt. This implies that $2.425 billion plus $5.68 billion (or $8.11 billion) is the amount available for Legacy Debt and new capital expenditures over the Plan of Adjustment period. It is the upper limit.

Therefore, under Exhibit P’s methodology, if the capital expenditure needs are going to be higher than $2.425 billion, the amount of Legacy Debt repayment would need to be reduced accordingly. Similarly, if the resources necessary to support future debt fail to materialize and therefore are less than $8.11 billion, the amount of Legacy Debt repayment would need to be reduced accordingly.

Q. Is $2.425 billion a reasonable estimate of future capital needs not covered by federal funds or private investment?

No. The Oversight Board provides no justification for its estimate of $2.425 billion, which as a measure of the system’s unmet capital need, is almost certainly too low. In December 2022, the Puerto Rico Department of Housing published an “Unmet Needs Assessment” summarizing the capital needs of the electrical and water systems beyond the federal funds available. Subtracting out the water system numbers and the $1.9 billion that the Department of Housing has available for the electrical system, the resulting electrical system unmet need is $6.4 billion.

Q. Do other formal plans and funding commitments concur that $2.425 billion is too low?

Yes. In October 2019, PREPA produced a transformation plan with a total price tag of $20.3 billion over the next 10 years. According to the Financial Plan, there are $14 billion set aside by the federal government. Very similar to the HUD estimate, there is a funding gap of approximately $6 billion. This $6 billion is necessary to complete the rebuilding of the grid. Currently, this is a substantial unfunded need for a necessary and known expense to ensure the viability of the system to provide reliable electricity, and for assets built properly to generate the revenue needed to cover expenses.

The Plan of Adjustment dramatically understates the need for at least $6 billion in capital expenses. This is unreasonable. 

Using the Oversight Board’s own methodology in Exhibit P, and assuming that the headroom for future debt is $8.11 billion, the need for at least $6 billion in capital expenses would reduce the headroom available for Legacy Debt to $2 billion or less.  And if the amount available for future debt is actually less than $8.11 billion, the amount available for Legacy Debt would need to be further reduced accordingly.

Q. Is $8.11 billion a reasonable estimate of the headroom available for new capital expenditures and legacy debt?

No. As stated above, the $8.11 billion was derived from subtracting projected system expenses from projected revenues derived from rates that the Oversight Board calculated to be theoretically affordable at the household level. Exhibit P does not specify what this hypothetical rate is, but it is clearly above the rate projections of the Fiscal Plan (which include no Legacy Debt repayment or capital expenditures).

We find $8.11 billion of surplus resources to be unreasonably high because (a) as noted above, the projected electrical system expenses in the Fiscal Plan are unreasonably low; and (b) as discussed in the next section, we find that the rates projected in the Fiscal Plan (and therefore the higher, unspecified rate used to derive the system revenues in Exhibit P) are unaffordable for the economy as a whole. The Oversight Board’s analysis in Exhibit P has not considered the impact of the Plan of Adjustment on the system’s ability to provide electrical service that is adequate to support Puerto Rico’s future economic growth.

Taking into consideration that Exhibit P ignores billions of dollars of future capital needs, underestimates future system expenses, and proposes a rate that is unaffordable for the economy, we find that there is, in fact, no headroom for Legacy Debt.

Q. Aside from underestimating the need for future capital expenditures, does the Plan of Adjustment provide sufficient detail to provide reasonable assurance that PREPA will have market access to meet those capital needs?

No. Future debt is presumably enabled by the Additional Bond provisions that will be spelled out in the New Master Trust Agreement. Leaving critical questions regarding any future debt issuances to a document that does not exist is unreasonable. Moreover, it appears that existing creditors could have veto power over the Additional Bonds; the Disclosure Statement states that “[t]he Additional Bonds shall be subject to an additional bonds test, which shall be reasonably acceptable to the Oversight Board and, the Required Fuel Line Lenders, and National, and documented in the New Master Indenture.”

In its attempt to clarify the critical question of the priority status of Additional Bonds, the Disclosure Statement is contradictory.

The New Bonds shall be secured by Reorganized PREPA’s Net Revenues up to an amount equal to the Legacy Charge Revenues and the right to receive such Net Revenues up to an amount equal to the Legacy Charge Revenues, as more particularly described in the New Master Indenture. For the avoidance of doubt, (i) the New Bonds shall not have a priority of payment senior to that of the Additional Bonds, provided, however, that the Revenues securing any Additional Bonds exclude during the applicable periods an amount up to the Legacy Charge Revenues and Remaining Legacy Charge Revenues, as applicable.

The statement that New Bonds and Additional Bonds will be treated equally is contradicted by the statement that of the two instruments the Legacy Debt is paid first, out of the Legacy Charge revenues. In essence, this would appear that the Legacy Debt has priority status, notwithstanding the statement to the contrary. This logical inconsistency which appears to subordinate any Additional Bonds to the Legacy Debt, if left unaddressed, is likely to be uncovered by any future diligence and weaken (if not preclude) future market access. The non-default provisions of the Legacy Debt, as discussed in Section IV of my testimony below, further reduce the probability of future market access for additional capital expenditures.

The Plan of Adjustment will not allow PREPA to provide future electrical service at the level necessary to support the Commonwealth’s viability.

Q. Will the Plan of Adjustment allow PREPA to provide future public services at the level necessary to the Commonwealth’s viability?

No. Electricity is an essential public service. It needs to be provided reliably and affordably for the Commonwealth’s economic viability. Currently, Puerto Rico’s electrical system is neither affordable nor reliable, and continues to lack the operational resources that are needed to transform it. As will be explained in the rest of this section, imposing an additional rate increase via the Legacy Charge will make this necessary transformation even more difficult to achieve, resulting instead in a continued unreliable and expensive system that is incapable of producing a steady revenue stream for bondholders.

Q. Have there been improvements in the reliability and affordability in the system that suggest it can achieve reasonable viability?

No. The current electrical system’s lack of basic reliability has life threatening implications. The largest most recent example is Hurricane Fiona, which was a category 1 storm that clipped the southwest coast of Puerto Rico—yet knocked out electrical service to the entire island. Restoration of 60% of power took eight days.

The lack of reliability of Puerto Rico’s grid is well-documented. Distribution system reliability is typically measured by the SAIDI and SAIFI indices (System Average Interruption Duration Index and System Average Interruption Frequency Index, respectively). In the United States, these indices in 2021 were 121.5 minutes (SAIDI) and 1.03 events (SAIFI). The most recent annual distribution system SAIDI and SAIFI numbers for Puerto Rico were 1,022 minutes and 4.7 events, respectively.

Puerto Rico continues to pay an exorbitant amount for this unreliable service. Current electric rates are above 26 cents per kilowatt-hour (kWh), more than twice the average electric rate in the United States; meanwhile, Puerto Rico’s median household income is less than half of that of the poorest U.S. state. The Oversight Board’s own economic advisor, Dr. Andrew Wolfe, argued that a rate above 21.4 cents/kWh would harm the island’s economic competitiveness, and “would eventually contribute to a downward economic spiral that would result in Puerto Rico returning to a path of declining economic activity, which would in turn adversely impact the demand for electricity and in the end lead to another debt service payments crisis for PREPA.”

In 2018, the Oversight Board adopted an affordability target of 20 cents/kWh in the August 2018 Fiscal Plan, which was to be achieved within five years, mainly through significant reductions in fuel and purchased power costs. Five years later (when rates are now higher than in 2018), the marked failure to implement the capital and operational investments that would have allowed for achieving this goal strongly caution against raising rates further and diverting electrical system resources to pay Legacy Debt.

Q. Aside from these rate thresholds, has any other standard been developed to evaluate the affordability of adding the Legacy Charge to rates?

Yes. David Brownstein, Citigroup’s advisor to the Oversight Board, established a clear standard for any debt restructuring agreement in his declaration in support of the 2019 RSA. He stated “any recovery by PREPA’s creditors had to be secondary to the Commonwealth’s overall economic recovery, for which the recovery of PREPA plays an important role. That meant any agreed repayment of legacy debt could not outpace revitalization of the island’s overall economy, and in particular the ability of PREPA’s customers to pay any increased rates or additional charges required to service restructured PREPA debt.”

According to the most recent fiscal plan of the Commonwealth, real GNP is negative to flat through 2025. Through FY 2029, the GNP is marginally positive, driven almost entirely by federal funding. The 2023 Commonwealth Fiscal Plan projects a negative real GDP growth of 0.5% annually from FY 2029 through FY 2051 and a precarious fiscal situation with no clear pathway to any period of sustained surpluses. Throughout the Plan of Adjustment period and subsequent years, there is a consistent decline in population expected.

Although the proposed Legacy Charge is a mixture of fixed and volumetric rates, one can derive the equivalent per kWh charge from Exhibit A to the Disclosure Statement (“Load Forecast and Illustrative Cash Flow for New Bonds”) by dividing the projected cash flow from the Legacy Charge by projected sales. (It is important to emphasize that, because low-income customers will be exempt from the Legacy Charge, this equivalent average per-kWh charge is lower than the actual rate increase that will be imposed on non-exempt customers). This average rate starts at 2.8 cents/kWh in FY 2024 and increases to 4.3 cents/kWh in FY 2051, imposing double-digit rate increases throughout a period in which Puerto Rico’s economy is projected to be shrinking almost every year.

Q. Does the Plan of Adjustment include any analysis of the economy’s ability to support the proposed rate, including the Legacy Charge?

No. The Plan of Adjustment lacks any analysis of the Plan of Adjustment’s affordability from a macroeconomic perspective, effectively abandoning the Oversight Board’s previous 20 cents/kWh target. Instead, the derivation of the Legacy Charge is based only on an analysis of rate affordability at the household level, as described in the previous section. Why does this matter? If the economy cannot support the rate, the electrical system will not be able to meet its capital investment and operational needs. This point has been well-proven in the history of PREPA, whose rates have historically been consistently above the Oversight Board’s previous affordability threshold of 20 cents per kWh.

Prior to the onset of PREPA’s bankruptcy, PREPA would borrow or use its reserves to pay operating expenses rather than raise rates to the levels needed to cover operational expenses, as shown in the following Figure from the 2017 Fiscal Plan:

When this strategy proved to be ineffective, PREPA began cutting operational expenses, compromising the integrity of the electrical system. As the following table demonstrates, expenditures on the generation system (not including fuel and purchased power), transmission & distribution, customer accounts and maintenance all fell by 14% to 22% after FY 2013.

From 2008 to 2013, PREPA lost 10% of its workforce; from 2013 through 2020 (well before the transition to LUMA), PREPA lost an additional 35% of its workforce.

These dramatic cuts to workforce and to operating budgets had already had a noticeable impact on the reliability of the system by 2016, when consultants to the Puerto Rico Energy Bureau found, “PREPA’s generating fleet has deteriorated rapidly over the last two fiscal years with a dramatically increased percentage of time in forced outages”; “PREPA’s operational spending has not been consistent with operation of a safe and reliable system since at least FY2014”; and “PREPA’s reduced staffing levels appear to be leading to severe consequences for system safety, reliability, and operability.” These warnings went unheeded.

Q. What does the Fiscal Plan project for future electrical rates?

Even without the Legacy Charge, and with the unreasonably optimistic financial assumptions described in the first section of my testimony, the Fiscal Plan does not produce rates below 22 cents/kWh in any year through 2038 (see figure below). In other words, the Fiscal Plan does not achieve rates that are economically affordable. Adding the average Legacy Charge on top of this situation, as also shown in the figure, will only exacerbate the problem.

Q. What transformation would be required for Puerto Rico to achieve stable and affordable rates?

It is well understood that a rapid transition to renewable energy is instrumental to achieving fiscal balance and stability by reducing annual fuel costs, which recently have risen to more than 60% of operating costs. PREPA’s dependence on imported fossil fuels for 97% of centralized power generation is the dominant cause of volatile and high electric rates; recently signed contracts for solar show that renewable energy can generate power at a lower, stable cost. Yet this large-scale transition to renewable energy has yet to be implemented. Puerto Rico has never met its legislatively established renewable energy targets. The only renewable energy added to Puerto Rico’s electrical system since Hurricane Maria has been due to the investments of private citizens in installing rooftop solar and storage.

Q. What impact does raising rates above what is economically sustainable, as proposed in the Fiscal Plan and the Plan of Adjustment, have on PREPA’s ability to achieve this transformation?

The more that rates are raised above what is economically sustainable, the more this will replicate all of the same dynamics described above that have encouraged the system to cut operating needs and reduce capital investment. Indeed, many of these same historical patterns are already continuing, with the introduction of LUMA Energy as a private operator. LUMA already has a serious problem of being unable to hire the workforce that it needs; it was recently reported that the company is short approximately 600 employees, particularly linemen. LUMA is also substantially behind on the operational spending and investment that was supposed to lead to a 30% improvement in SAIFI and a 40% improvement in SAIDI over the three years from FY 2022 to FY 2024. In the 1 ½ years of this period (through December 2022), LUMA has spent only 42% of the amount budgeted for its “Improvement Portfolio.”

In addition, LUMA recently suspended all work on vegetation management on high-voltage transmission lines through the end of Fiscal Year 2023 due to “budget problems.” LUMA has warned the Public-Private Partnership Authority that the projected budget for Fiscal Year 2024 is insufficient for “prudent” operation of the system and that the lack of sufficient budget for grid operations will result in “a significant reduction in the reliability of the transmission and distribution systems, delays in the execution of system remediation programs and LUMA’s ability to respond to outages.” [emphasis added]

In short, despite the Fiscal Plan’s projections of sufficient operational and capital spending to significantly improve reliability and transition the system rapidly to renewable energy, these outcomes are not happening, at least not at the speed embedded in the Fiscal Plan’s projections. (In addition to the recent actions and statements of LUMA, see page 6 of this testimony for a description of the delays in renewable energy procurement relative to that projected by the Fiscal Plan). The transformation actually needed to reduce and stabilize rates and to create a functional grid continues to be postponed.

Q. What will be the result of continuing to postpone the transformation to a reliable and affordable system?

Excessive dependence on fossil fuels will continue to make rates volatile and expensive, above what is projected in the Fiscal Plan and at times above 30 cents/kWh. Puerto Rico will continue to suffer from unacceptably poor, life-threatening electricity service.

A poorly managed, expensive and unreliable grid stands no chance of producing a stable revenue stream for bondholders and attempting to impose a Legacy Charge on this system will only exacerbate the dysfunction.

In short, imposing the Plan of Adjustment will impede PREPA’s recovery and impair PREPA’s ability to provide electrical service in a manner that supports Commonwealth economic growth.

The unusual default provisions of the Plan of Adjustment technically allow PREPA to meet its legacy debt obligations, but at the expense of creating a long-term credit risk and potentially impeding market access.

Q. Is it likely the Plan will enable PREPA to meet its obligations to legacy bondholders without the significant probability of default?

The Plan of Adjustment contains unusual provisions about the nature of “default.” Typically the failure to pay debt service when it is due is an event of default. In theory, upon an event of default the full outstanding balance may be due immediately. An event of default usually can trigger a period of reorganization to give the debtor time to realign its organization and assets. This cleansing period can then presumably be remedied in a corrective plan and the company moves forward as a going concern once again.

Under the Plan of Adjustment, PREPA is not in default on the New Bonds if it demonstrates that it has done everything within its power to charge, collect and properly deposit the Legacy Charge in the relevant accounts but is unable to pay debt service when it is due. This provision reflects the weak economic outlook described in the 2023 Commonwealth Fiscal Plan, the poor condition of the system, a history of missing implementation deadlines for operational improvements and the high likelihood of non-payment of the Legacy Debt.

Q. What is the consequence of PREPA not meeting its debt service obligations under the Plan of Adjustment?

If PREPA cannot meet its debt service obligations and has done everything in its power to collect and deposit the Legacy Charge, then the amount of any outstanding unpaid debt service remains to be eventually paid. The Series A and B bonds do not accrue interest after their maturity date, but any outstanding principal and previously accrued interest continues to be owed. Presumably the amount of any outstanding unpaid debt service, and any possible charges accruing, is recorded in some manner in PREPA’s financial statements and bond disclosures, although this is not specified in the Disclosure Statement.

We note that the parties to the issuance of the New Bonds may not seek a credit rating from a credit rating agency. The elimination of non-payment of debt service as an event of default and the absence of provisions that allow for the acceleration of payments when nonpayment occurs are likely to weaken PREPA’s market access.

Q. What are the implications of these unusual default provisions?

These provisions forestall any immediate bankruptcy process. However, in the future, carrying delinquent unpaid debt service on the books of the utility would undoubtedly serve as a red flag that could preclude market access. Rather than providing short-term relief these provisions create the perception of a long-term credit risk. This will inhibit PREPA’s ability to finance the additional capital needs discussed previously in my testimony.

In short, while the event of default and commencement of bankruptcy proceedings from non-payment of debt service is technically avoided by how the Plan of Adjustment defines “default,” the charges imposed by the Legacy Charge are unaffordable for all of the reasons described previously in this testimony.

Q. Please summarize the conclusions of your testimony.

My testimony has found that:

  1. The Plan of Adjustment is not supported by reasonable financial projections. The Legacy Debt repayment proposed in the Plan of Adjustment is well outside the range of the Debt Sustainability Analysis contained in the Fiscal Plan, once future capital needs are taken into account. Furthermore, the Legacy Charge is derived from an analysis that does not provide adequately for the future capital needs of the system, underestimates future expenses, and overestimates the electric rate that the economy is able to support. Once these factors are taken into account, there is no headroom to support repayment of the Legacy Debt through rates. Thus, the Plan of Adjustment is not feasible.
  2. The Plan of Adjustment will not allow PREPA to provide electrical service at the level needed to support the Commonwealth’s economic viability. The Plan of Adjustment does not include a macroeconomic analysis of the affordability of the deal, and the rates under the Plan of Adjustment will be significantly above previously established affordability thresholds. Historically and currently, under such conditions, PREPA has been unable to execute the operational reforms and transformation to renewable energy needed to ensure reliable and affordable electrical service. Thus, the Plan of Adjustment is not feasible.
  3. Although the unusual default provisions of the Plan of Adjustment technically appear to allow PREPA to meet its Legacy Debt obligations, this does not compensate for the fact that the Plan of Adjustment is unaffordable and will continue to result in a dysfunctional electric system. The default provisions create a long-term credit risk and potentially impede future market access to obtain resources for necessary capital investments.

The purpose of a bankruptcy proceeding is to provide a fresh start. This Plan of Adjustment is not a fresh start; it is the same old quagmire wrapped in different paper.

I declare under penalty of perjury pursuant to the laws of the United States of America that the foregoing is true and correct to the best of my knowledge and belief.

Dated: April 28, 2023.

Thomas Sanzillo

Tom Sanzillo

Tom Sanzillo is Director of Financial Analysis for IEEFA. He has produced influential studies on the oil, gas, petrochemical and coal sectors in the U.S. and internationally, including company and credit analyses, facility development, oil and gas reserves, stock and commodity market analysis, and public and private financial structures.

Go to Profile

Join our newsletter

Keep up to date with all the latest from IEEFA