Make OPALCO Power Affordable Again.

Revenue Shortfalls in OPALCO's Rural Cooperative

By Alex Conrad

Monday, June 1, 2015

With regard to [OPALCO's] need to meet certain debt covenants, we hear a lot about 'revenue shortfall' [see orcasissues .com/new-opalco-surcharge-to-correct-shortfall] Let's pause for a moment and look at publicly available data, some of which may surprise you.


At the end of 2014, OPALCO's TIER (times interest earned ratio) fell to 1.13. A ratio of 1.25 or greater is required to be in compliance with debt covenants. Specifically, this is required by OPALCO's RUS lender...essentially the federal government via the USDA.


OPAI,CO's April 2015 board minutes indicated that a CAP (corrective action plan) was being prepared to address the out of compliance 1.13 TIER. Little detail was publicly provided beyond saying the CAP would address the reasons for the 1.13 TIER result and present a plan to correct the ratio. One can reasonably presume that recent rate surcharge discussions are one result of the CAP.


What is TIER anyway? Specifically, it is a company's EBIT (earnings before interest and taxes) divided by interest expense. This is a simple math exercise, but what does it mean? TIER is a measurement of an entity's ability to service the debt it has taken on. As such, the minimum RUS ratio reflects a reasonable endeavor by OPALCO's lender (the federal government) to ensure that future debt payments will be made and a potential default avoided. (n.b. defaulting on a minimum ratio requirement and defaulting on the debt itself are NOT the same thing)


So OPALCO's 1.13 TIER is telling us, and telling OPALCO's lender, that the future ability to service debt is in jeopardy. For reference, OPALCO's 2010 through 2013 year ending TIER numbers were: 3.21, 5.27, 2.07 and 2.24.


Again, TIER is a measurement derived from earnings (revenue minus expenses, excluding taxes and interest) and interest expense, i.e. how much the debt service is costing the entity. OPALCO is repeatedly telling us that revenue shortfalls are driving the current crisis...let's pause to look at actual data.


While it is true that 2014 revenue failed to meet the 2014 budget, 2014 revenue INCREASED from 2013. (In fact, revenues increased year-over-year for all three sub-groups: residential, commercial and other) The actual numbers: 2014 $22,029,025 vs 2013 $21,431,278. So the first takeaway here is to realize that when OPALCO talks about revenue shortfalls vis-à-vis the need to submit a CAP, they are talking about shortfalls against their budget, NOT against actual results. 2014 revenues saw an actual 2.2% increase year-over-year. Calling a 2.2% increase a shortfall is sophistry worthy of the 'other' Washington. Perhaps there are K Street jobs waiting for some people here, but I digress...


So 2014 saw a 2.2% increase in revenue. What about expenses? 2014 operating expenses increased significantly: 2014 $20,901,493 vs 2013 $19,906,881. That's an increase of $994,612, or 4.9%.


In fairness, the biggest 'miss' on the expense side on 2014 appears to be cost of power, largely out of OPALCO's direct control...and this brings us to an important point. It is TRUE that OPALCO and other utilities face unprecedented challenges going forward. Centralized power-gen and grid maintenance costs are poised to increase over time while the capital costs of renewables and energy efficiency will trend downward...very soon, the traditional maths of utilities will no longer work, yet the need for centralized power-gen is not going away any time soon. It's a complicated and expensive problem for any utility to navigate through to the future. Add in the unique costs we have here directly related to our Salish Sea island infrastructure, and the path forward becomes even more difficult.


More than a few utilities around the US will wind up as wards of the state as a result of these challenges. There's no reason yet to believe that will happen here. But while it's reasonable for OPALCO to expect open minds to these challenges from members, it's also reasonable to expect more sophisticated transparency from OPALCO beyond the ubiquitous cry of climate-driven revenue shortfalls. The current idea on deck, a revenue true-up where budgeted revenue = actual revenue is preposterous for a number of reasons, but that is for another forum and another discussion.


OK, back to TIER. We've looked at revenue and expenses for the EBIT side of the equation. What of interest expense, the other major value? Interest expense also rose dramatically in 2014: 2014 $908,934 vs 2013 $786,193. That's an increase of $122,741, or 15.6%. Also consider that interest on long-term debt from 2010 to 2013 came in respectively at: $684,822, $733,675, $759,686 and (2013) $786,193.


It's not hard to find the culprit here. OPALCO's year ending 2014 long-term debt liability was $24,987,266 compared to $17,558,365 for 2013. That's a WHOPPING $7,428,901 increase from 2013, or 42.3%.(!) Consider long-term debt liabilities from 2010 to 2013: $12,096,608, $14,318,323, $15,462,363 and (2013) $17,558,365. This increase appears to be unprecedented, at least in recent history. Note that more debt is certainly ahead as sub-marine cable replacement capital projects commence. Continued misses on things like TIFR floors will undoubtedly raise OPALCO's cost of capital for these already expensive future projects - plainly spoken, this could mean significant and unexpected additional costs for the members.


What could be driving such a non-trivial increase in debt? Could it he the warming weather? Could it be a shortfall? No, it's almost certainly related to a capital project. So, could it be broadband? This seems like a leading candidate as an expensive capital project that is both new and in range of a $7 million loan. It's difficult to discern for certain with available information.


As an illustrative exercise though, let's assume for the moment that the dramatic increase in debt is indeed related to broadband; broadband which OPALCO regularly tells us its paying its own way. (but while not delivering, even minimally, to their own forecasts...but that is yet another topic for another forum/time) With this assumption in play, let's further assume that 2014 interest expense did not increase by 40%+, but instead by 4.7%, basis recent historical data. First we need 2014 EB1T...we know interest expense and TIER, so math tells us EBIT is $1,027,095. So let's calculate TIER again with EBIT (conservatively, keeping it constant) and an interest expense of 2013 + 4.7%. We have 1,027,095 / 823,144 = 1.25. It's close, but there is now NO TIER covenant default in this scenario, even with disappointing revenue and operating expense results. Does this mean that broadband related debt is pushing TIER below minimum requirements? And if so, is by extension driving the need for the upcoming surcharge? Maybe, only OPALCO has the granular data to know for sure.


A few suggestions for good faith transparency:

— Publish the CAP report submitted as a result of TIER falling below its minimum threshold.

— Solicit the opinion of an independent auditor to weigh in on the impact of broadband on utility finances, specifically with regard to rates and future cost of capital for expensive projects like sub-marine cable replacement.

— Expand the discussion on rates to examine the utility's structure. Is a non-regulated utility the best structure going forward? Broaden the stakeholder groups currently involved in this dialogue.




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