MUD gas supplier wants out of 30-year contract; replacement fuel would cost more, utility says -
Published Wednesday, February 12, 2014 at 1:00 am / Updated at 12:14 pm
MUD gas supplier wants out of 30-year contract; replacement fuel would cost more, utility says

A Metropolitan Utilities District natural gas vendor that accounts for 15 percent of the utility's low-cost supplies wants out of the 30-year contract it signed in 2009, leaving the utility with the prospect of buying replacement fuel at much higher prices.

A lawsuit filed in late January in U.S. District Court in Omaha asks a federal judge to allow Royal Bank of Canada, which operates a commodities trading division that deals in natural gas, to terminate in October an agreement to supply the gas.

MUD officials plan to fight termination of the agreement.

“Royal Bank of Canada is trying to hurt MUD and the citizens of Omaha by backing out of a deal for stated reasons that can most politely be described as nonsense,” said Jim Knight, vice president of gas operations for MUD. “Clearly, RBC has had second thoughts about its earlier business decision and is manufacturing legal arguments to try to back out.”

The suit was filed against Central Plains Energy Project, an Omaha-based cooperative formed in 2006 by MUD and the municipal natural gas utilities in Hastings, Neb., and Cedar Falls, Iowa. It is an administrative organization formed to sell bonds and pay the proceeds to gas suppliers such as Royal Bank. CPEP then sells the natural gas purchased from the suppliers to MUD and the two other members, which take possession at pipeline delivery points and send it off to homes and businesses.

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As for Royal Bank of Canada's role in the deal it is now trying to exit, Canada's largest financial institution has been paid $719 million of CPEP bond proceeds for 30 years' worth of heating fuel.

Knight, who also is project manager for CPEP, said Omahans would have paid significantly higher rates for gas without CPEP and its paid-in-advance supply agreement for discounted gas with Royal Bank.

And higher rates “is exactly what will happen if RBC were to prevail,” Knight said

The bank's attempt to terminate the supply obligations comes as natural gas prices are on the rise. Since the 30-year supply agreement with CPEP was signed in August 2009, wholesale natural gas dropped to as low as $3.81 per million British thermal units but have risen since, this month reaching a four-year high of $5.58 per million British thermal units.

Royal Bank of Canada's lawsuit cites changes to bank regulations as the reason for seeking termination. The bank said in the suit that series of international bank regulatory reforms known as Basel III constitute a “triggering event” under the supply agreement that allow for the deal to be canceled. Royal Bank's suit says CPEP was informed of the intent to terminate the agreement on multiple occasions last year.

Because of Basel III, Royal Bank says in the lawsuit, it is forced to reserve more capital to ensure against prospective losses related to the CPEP deal than it was before. Sweeping changes in bank regulation such as Basel III, the suit says, trigger automatic termination clauses in the supply agreement.

MUD board member Thomas Dowd said getting enough gas won't be the problem if Royal Bank is released from its obligation.

“Gas is plentiful,” he said. “If this arrangement would no longer be viable, it's not going to affect our ability to get gas — it's going to affect our ability to price it.”

The Basel III regulations cited by Royal Bank are part of a 27-nation bank-regulation accord slated to take full effect in the United States by 2017; Canada's banking regulator, the Royal Bank suit says, has already required banks to alter capital requirements under the accord.

Knight said Royal Bank is in error in asserting the gas-supply agreement can be terminated. He said he is not worried that the other CPEP vendor, a unit of New York-based Goldman Sachs, also will seek to terminate its contract to supply natural gas to the cooperative by citing the same reasons.

“CPEP does not agree with the right to terminate,” Knight said.

Royal Bank did not respond to requests for more information left by email and voice mail, nor did the Hastings and Cedar Falls municipal utilities.

The CPEP cooperative is not an obligation of taxpayers or utility ratepayers, according to its bond-offering documents. If the whole cooperative fails, according to bond official statements, the only harm to the member utilities would be replacing gas supplies relied on by the member utilities from other sources.

In the case of bondholders owning securities tied to the 2009 gas-supply agreement, Royal Bank would be responsible for repaying them, if it is allowed to terminate the contract.

Outgoing MUD board Chairman Tim Cavanaugh said it's premature to discuss how the district would cover the supply shortfall if Royal Bank of Canada prevails.

Cavanaugh described CPEP as “a very valuable benefit to us.”

An examination of CPEP's annual financial statements shows it has engaged in a series of complex, long-range financial maneuvers to achieve its mission.

First, $1.8 billion of bonds were sold to investors starting in 2007. The money was then paid to partners who pledged to supply natural gas for as long as 30 years, at a discount, in exchange for the upfront cash.

The first deal was with J. Aron & Co., the commodities trading unit of Goldman Sachs. J. Aron collected $529 million in bond proceeds and promised to supply natural gas at a discount to the prevailing rate for 20 years.

Then, in 2009, came the Royal Bank deal. That was 30 years of discounted gas in exchange of $719 million of upfront cash from bonds sold to investors.

In 2012, J. Aron received $609 million of bond proceeds in return for discounted gas over 30 years.

The deals are supported by financial transactions known as derivatives, or assets that derive their value from the value of another underlying asset.

In an attempt to lessen the risk from such long-term supply deals — risks that include swinging natural gas prices and spikes in the interest rates CPEP would have to pay its bondholders — the cooperative agreed to a series of transactions known as swaps. While swaps are not insurance, they have insurance-like aspects that are designed to protect buyers and sellers from changes in the commodity prices and interest rates they are subject to.

In the course of the three gas supply deals, CPEP agreed to swap the floating interest rates it owes to its bondholders for fixed payments provided by the gas suppliers. Such transactions are seen as protection against rising interest rates on the cooperative's variable-rate bonds, increases that would make them more costly to repay.

CPEP also agreed to commodity-price swaps with its gas suppliers. The commodity swaps convert the variable revenues CPEP receives to a fixed figure. That move was designed to guarantee enough revenue to cover the bond payments of CPEP, which does not pay a fixed rate for natural gas supplied by J. Aron and Royal Bank but rather one tied to a monthly industry index that can rise or fall.

As for the savings the CPEP deals provide to member utilities, it amounted to $7 million for MUD ratepayers last year, according to cooperative director Knight. That works out to $12 of savings that year for each of the utility's 600,000 customers.

Said another way, CPEP borrowed $1.8 billion starting in 2007, gave it to its gas suppliers as payment for annual deliveries extending out as far as 30 years, and engaged in highly complex financial engineering to decrease the risks — all to save MUD customers each $1 a month in 2013.

Knight disagrees with any criticism of CPEP, saying it provides long-run savings and protection from unpredictable energy costs.

“I think the savings are significant and that it has been worth it,” he said.

Contact the writer: Russell Hubbard    |   402-444-3133

Russell Hubbard covers banking, financial services, corporate finance, TD Ameritrade, business lawsuits, bankruptcies and other economic and financial topics.

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