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Puerto Rico keeps the lights on, but debt crisis far from over

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[August 15, 2014]  By Luciana Lopez

NEW YORK (Reuters) - Puerto Rico managed to keep its electricity flowing this week – but creditors made it clear that the crisis enveloping the island's power utility is far from over.

Banks, led by Citibank and Canada's Scotiabank, on Thursday agreed to a seven-and-a-half month extension of $671 million in credit lines the Puerto Rico Electric Power Authority (Prepa) needs to buy oil that is essential to keep it operating.But they also got Prepa to commit to appointing a chief restructuring officer next month, and to produce a full restructuring plan in March next year, in an attempt to get the power company's finances onto a more stable footing.

Prepa's troubles are perhaps the starkest symbol of the huge debt burden threatening to overwhelm the U.S. territory. Investors, including some major U.S. funds, have already lost billions of dollars on bonds issued by the island's government and the entities it owns, such as Prepa.

The financial morass has got so bad at Prepa that it has been borrowing to pay for operating expenses, according to credit rating agency Moody's Investors Service. Auditors Ernst and Young said in 2012 that Prepa - with borrowings of $9 billion - has more liabilities than assets since 2011.

Prepa declined repeated requests for comment for this story.

"It's not viable. It's not sustainable anymore," said Sergio Marxuach, policy development director at the San Juan-based Center for a New Economy, and a longtime analyst of Prepa's troubles. "They are essentially at the mercy of their creditors right now and the oil companies. And the vultures," Marxuach said with reference to so-called "vulture investors" who may be seeking to profit out of the island's troubles.

The company will eventually either have to go through a jarring restructuring, or it will have to turn the power off on a rolling basis, he warned.

Prepa's considerable list of problems includes an over-reliance on expensive oil, its aging infrastructure – some dating to the 1960s – a bloated workforce, and a billing system that is regarded as arbitrary and difficult to understand.

And all this while the island's population is declining and its manufacturing base shrinking, reducing demand for electricity. Puerto Rico has lost around 200,000 people since 2000 and is now estimated to have a population of only 3.62 million.

Many analysts say that an overhaul of the agency would need to include a massive haircut for investors in Prepa's debt, big job losses, the closure of some facilities, and an attainable plan to reduce its reliance on oil.


A June report from Prepa said the utility had $137 million in cash and cash equivalents. That same report said that Prepa spent $196 million on fuel alone that month.

Puerto Rico itself faces $72.6 billion of public debt, including the Prepa money. That's about $20,000 for every man, woman and child on a Caribbean island where the median household income was just $19,429 in 2012. Its pension funds for government workers are severely underfunded, adding to the stresses.

Many of those closest to the situation see any Prepa negotiations with creditors as a precursor to a much wider restructuring of Puerto Rico's debt, including the government and its water and highway agencies.

The government hastily introduced and passed a law in late June that gives some of the island's public corporations a legal framework for a bankruptcy-like procedure. Before that there was no such mechanism for entities like Prepa.

The so-called Recovery Act shocked investors, who abruptly sold off the island's public debt, including not just Prepa bonds but even general obligation bonds and debt linked to sales tax receipts.

Prepa is a monopoly in Puerto Rico. There are two private generating companies in the south of the island – but they also sell electricity to Prepa. It is the only electricity distributor, as well as generating most of the island's power.

Some companies have decided not to rely on Prepa. Rum maker Bacardi, one of Puerto Rico's marquee companies, began using biogas for some needs around 2007 and added windmills in 2010. Those two sources account for about half the company's energy needs on the island.

In a normal year, this gives the company protection in case Puerto Rico suffers a big hit in hurricane season, but this year the company is also preparing contingency plans in case it can't get the rest of its power from Prepa. It may even have to switch the production of distillates away from the island in a worst-case scenario.

The company wants to avoid that, said Eduardo Vallado, director of supply chain and manufacturing for the Americas for Bacardi. "We need the Puerto Rico claim on our label," he said. "In the end we need Prepa's energy to operate."


Some other companies and wealthier individuals do have their own generators – and a few do produce power through alternative means. Food distributors have been reducing their reliance on Prepa for years, using solar panels and other sources. "With such a stressed system, any emergency could put it to the test," said Manuel Reyes, a executive vice president for MIDA, a food industry group in Puerto Rico, in reference to Prepa and other economic problems on the island.

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At the root of Prepa's problems is a long history of inaction that left the utility so reliant on oil imports. For various reasons, proposals over many years to build pipelines to bring imported natural gas from the south of the island to its power plants in the north – closer to the capital of San Juan - have been nixed. Renewable energy projects have been so mired in red tape that many investors have lost interest. Prepa also doesn't hedge, leaving it exposed to oil price spikes.

Prepa's San Juan, Palo Seco and other plants were built in the 1960s and 1970s, when running on oil was normal. But, while many utilities elsewhere have shifted to other fuels, such as coal and natural gas, Puerto Rico has done little, even as oil prices have tripled in the past 10 years.

Prepa said earlier this year that about 55 percent of the island's electricity comes from oil. For the United States the figure is well below 1 percent.

"The only way to solve this is take away the crack, oil, from Prepa," said Luis Fortuno, who was governor of Puerto Rico from 2009-2013 and is now an attorney with Steptoe & Johnson in Washington, D.C.


Power bills across Puerto Rico have been elevated for years. Rates on the island have reached above 30 cents per kilowatt hour in recent years, about double the prices charged in much of the U.S.

The company has other high costs, as well: A confidential report by consultants Alvarez & Marsal in October 2012 for Puerto Rico's Government Development Bank (GDB) said Prepa had a large fleet of unnecessary vehicles, obsolete and excessive inventory and sloppy cost controls, noting a "low sense of urgency for cost management throughout the organization." The report also recommended slimming Prepa's workforce, which totaled 8,465 in the middle of last year.


But when Senate President Eduardo Bhatia pushed for an energy reform bill earlier this year, he faced push back from within his own party partly because some legislators had relatives or friends employed by Prepa, according to Senate aides.

Another problem is that Prepa does not charge the authorities who run the island's 78 municipalities for their power, and there are many other exceptions that hurt its ability to generate revenue.


While just about everyone seems to agree Prepa can't go on the way it has been, there's little agreement on the way forward. Prepa reforms have an unsuccessful track record in Puerto Rico, underscoring the difficulty in overhauling an agency that many say has become a political football with entrenched interests. The labor unions, who represent about two thirds of the Prepa workers, are powerful, with loud voices that have swayed legislators in the past.

The revolving door for governors and their administrations has also contributed to the crisis. None of the island's last four governors has served more than one term. It means that energy projects proposed by one administration have often been abandoned or watered down by the next.

New projects will take a long time to get off the ground - at least a year for renewable energy projects, and two-to-three years for natural gas plants. The permitting process is bureaucratic and costly. The biggest hope is that a Prepa restructuring would keep it away from the political machinations that have helped hobble it for years. A critical test will be how much leeway the chief restructuring officer gets to come up with a bold reorganization plan.

Some lawmakers acknowledge that it can't be like business as usual anymore. "You have to take out the politicians, and the only way you take out the politicians is bankruptcy," said Rep. Rafael "Tatito" Hernández Montañez.

(Reporting by Luciana Lopez; Editing by Martin Howell)

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