How the bank-run bond market could make clean energy cheaper

Solar Power Station over urban skyline at night.

Georgia utilities are getting a discount on gas — but paying full price for renewables.

By Meg Duff, Capital & Main

This story is produced by the award-winning journalism nonprofit Capital & Main and co-published here with permission.

For decades, some towns and cities have been getting a discount on their natural gas supply by locking in long-term contracts with big banks. These prepaid municipal bonds first emerged in the 1990s and are especially popular across the Southeast. They represent more than $80 billion in prepaid natural gas supply and billions of dollars in savings, according to financial analysis commissioned by MCE.

Recently, towns and cities in California have started locking in similar discounts for renewable energy, lowering electricity bills as they work toward state targets for renewable energy. Since 2021, the California Community Choice Financing Authority has issued prepaid renewable bonds totaling nearly $10 billion, according to the authority. Like prepaid gas bonds, they help municipalities save 10% or more on long-term energy contracts.

Communities in Michigan, Minnesota and Vermont have all reached out to learn more, said Garth Salisbury, a board member of the Financing Authority and its treasurer and controller. “I think deals are going to get done,” he told Capital & Main.

Still, it may be a long time before renewable prepays make their way back to Georgia, which pioneered such transactions. To take off, municipal agencies would need to invest aggressively in solar instead of seeing it as a competitive threat to power sources they already own. In California, cities that have already moved to prioritize renewable energy see additional unexpected savings thanks to prepays. The Southeast could benefit as well. To do so, however, cities would first have to make solar power a priority.

How Prepays Benefit Towns — and Banks

The Municipal Gas Authority of Georgia occupies a long low building in the Atlanta suburb of Kennesaw; the windows reflect spring-green trees. The Gas Authority serves similarly leafy communities across the Southeast: suburbs and small towns that were not historically a priority for large investor-owned utilities.

The Gas Authority was created in 1987 by the Georgia Legislature to help smaller cities manage their gas supply. It now serves 82 municipalities across Georgia, Alabama, Florida, Pennsylvania and Tennessee. In part, it supplies gas directly. The Gas Authority owns coalbed methane gas reserves in Alabama and in Kansas. It also co-owns additional Alabama reserves with similar agencies in other Southeastern states through a nonprofit it manages called Public Gas Partners.

But the Gas Authority also issues bonds to buy gas from banks’ commodities trading arms. “These deals initially started with Goldman [Sachs] and Morgan Stanley — and the other investment banks that have come out with these trading arms — being the gas supplier as well as the underwriter,” said Arthur Miller, a retired investment banker with experience designing complex tax-exempt bond transactions.

Prepaying for gas from banks lets towns and cities save by leveraging their tax-exempt status. “It’s a legal arbitrage,” Salisbury said, in the sense that municipalities benefit from differences between the municipal and commercial bond markets.

Municipalities borrow at their tax-exempt rate, in contrast to the higher taxable interest rates paid by corporations; they pay banks in advance for energy, essentially giving the banks cheap loans. “The taxable entity is going, ‘Wow, if I were to borrow this money myself, I’d be paying a taxable rate!” Salisbury said. “I’ll take it!”

The bank then passes savings back to cities as a discount on the market price of energy. Over the past two decades, the Gas Authority has become a national leader in these prepaid bonds. Many prepays have discounts between 10% and 20%, but Tim Morilla, a director at Fitch Ratings who rates Gas Authority bonds, has seen prepays with discounts of up to 40%.

Sometimes, these bonds can align municipalities’ interests with those of investment banks. Buying gas on the commodities market means the Gas Authority must plan around volatile gas prices. They do that by hedging: buying financial products called derivatives that are designed to gain value when their bond values fall.

Both the Dodd-Frank banking reforms after the Great Recession and the more recent Basel III banking reforms attempted to impose stricter rules on derivatives; the goal was to keep banks from taking large risks without enough capital in reserve. The Gas Authority spoke up against higher capital requirements in both cases, arguing that higher capital requirements would make derivatives too expensive for municipalities, rendering gas supply bonds too risky as well.

For prepaid gas bonds to make sense, other market factors also have to align. These bonds dried up, for example, after the 2008 financial collapse. “We didn’t see a transaction for eight years,” said Dennis Pidherny, a managing director on the municipal bond team at Fitch Ratings. “No one wanted to take the credit of the big investment banks, right? And then you had interest rates, taxes and taxable rates all over the place.”

When market conditions improved, the Gas Authority again started issuing prepaid gas bonds, facilitated by banks such as JPMorgan Chase & Co., Goldman Sachs and Royal Bank of Canada. Since 2018, the Gas Authority has issued 12 prepays worth around $9 billion through a subsidiary called Main Street Natural Gas, Inc.

The main benefit for investment banks, Salisbury said, is that tax-exempt bonds appeal to a different group of buyers than do commercial bonds. These deals help them reach new customers — often bond buyers in higher tax brackets. Banks can also use these bonds to reach investors who don’t want to buy from them directly, Salisbury said. Some prepays are structured such that the investment bank collects a fee but another bank or hedge fund gets the tax-exempt financing; that party’s credit rating goes on the bond.

Many of the Gas Authority’s recent prepays fall into this category. “The investors say, ‘Oh, this is not a Goldman deal, this is a Bank of Montreal deal. I don’t have any Bank of Montreal paper,’” Salisbury said. “So they have opened up the market to a whole other pocket of investor interest.” Renewable energy bonds can help investment banks diversify further.

Renewable Prepays Take Off in California

MCE in San Rafael, California, is a short drive across the Golden Gate Bridge from San Francisco; the parking lot is shaded by solar panels. It exists thanks to a 2002 California law that allows local towns and cities to bypass investor-owned utilities and buy power from other sources. In California, this law came after a state experiment in energy deregulation; deregulation ended, but communities kept local control over their energy choices. Across the country, investor-owned utilities often faced financial disincentives for moving away from fossil fuel infrastructure.  

Salisbury is MCE’s chief financial officer; he is also a former investment banker for JPMorgan and Royal Bank of Canada. When he was hired in 2019, Goldman Sachs reached out immediately. “My second day working at the job, they were pitching the idea of doing prepayments of renewable energy,” Salisbury said.

MCE’s mission is to confront the climate crisis. With California’s other so-called community choice aggregators, it has entered into long-term contracts worth hundreds of billions of dollars to buy from solar and wind developers. Those bonds — and California laws requiring a shift to renewable energy — have given developers the financial security to break ground on vast tracts of land to build renewable power across the state.

The prepay potential is obvious. Municipalities were already promising to buy renewable energy from developers; if they could prepay for that supply, they could get a discount. “It’s a lot more complicated of a thing to prepay, but we figured out a mousetrap that worked,” Salisbury said.

In 2021, community choice aggregators created the California Community Choice Financing Authority to issue prepaid bonds on their behalf. It has since issued 11 prepays together worth nearly $10 billion — about as much as all the prepays Georgia’s Gas Authority has issued since 2018. As of 2023, MCE said, 34% of U.S. prepaid municipal bonds were for renewables, not gas.

Utilities that provide both natural gas and electricity to consumers have another prepay option: If they are planning for their customers to gradually move from gas to electric over time, they can issue bonds that also switch from gas to electric at a later date. A recent prepay from the Sacramento Municipal Utility District in California is designed to switch from gas to electric after 15 years. Another, issued by Alabama-based Southeastern Energy Authority, serves six municipal utilities; two of those — one in the city of Tallahassee, Florida, and one, the Salt River Project, a utility serving Phoenix — built in an option to switch from gas to renewables in the future.

“You’re seeing that flexibility creeping in, because everyone is well aware that we’re under a transition, but no one knows how quickly or how smoothly it’s going to go,” Pidherny said. But those switch bonds make less sense in places where gas and electric utilities are separate. In Georgia, despite the Gas Authority’s success with gas prepays and the state’s strong solar potential, renewable prepays have not yet appeared.

In part that is because tax-exempt bonds can only be issued by municipalities; most Georgians get their electricity from investor-owned utilities. Only a small minority get their power from the Gas Agency’s electric counterpart, the Municipal Electric Agency of Georgia, which owns and purchases energy on behalf of 47 municipalities.

The Electric Agency owns most of its energy, including stakes in one of the nation’s largest nuclear reactors, stakes in four coal plants and full ownership of a gas plant, which it fuels with discounted gas from the Gas Authority. It aims for 90% clean energy by 2045, most of which will come from new nuclear reactors.

But prepays can only be issued for energy that municipalities buy rather than energy they own directly. The Electric Authority could, in theory, issue renewable energy prepays for energy it buys externally, Salisbury said. In fact, it recently completed its first solar power purchase agreement, for an 80 megawatt solar installation scheduled to come online this year.

For prepays to pencil out, though, it would have to buy a lot more. Salisbury said that prepays only make sense for large deals — around half a billion dollars in supply or more. In California, that means hundreds of megawatts of solar or other renewable energy per deal.

California and Texas have leaped ahead of other states in terms of wind and solar production, said Nick Guidi, senior attorney at the Southern Environmental Law Center. “You basically have the top two and then there’s a huge drop-off.” While Georgia ranks seventh in the nation for solar development, it still only has 4,100 megawatts of solar online; California has 10 times that.

The Electric Authority intends to bring more solar online in the future, but it has not shared firm targets in its financial statements. Those statements do, however, flag renewables as a potential risk, a competitive threat to the power generation assets it already owns. The Electric Authority declined to comment.

The Electric Authority shares those concerns with the Southeast’s large utilities, which Guidi said have blocked competition from renewables. When municipal contracts aren’t available, renewables can get built by selling into state or multistate electric markets, where they can compete on price. This is how many wind farms in Texas got off the ground, Guidi said.

The Southeast does not have a comparable market, but its large monopoly utilities recently created a pared-down version called the Southeast Energy Exchange Market. Its participants, however, are not required to buy energy from all other participants — or even to tell renewable developers that they aren’t buying. “You can toggle them off,” Guidi said. Some of the same utilities have also opposed transmission lines that could help renewable energy grow. Capital & Main reached out to the market for comment.

Copyright 2024 Capital & Main.

Correction: This story originally originally misreported the number of prepaid bonds issued by the California Community Choice Financing Authority since 2021 and their worth. It has issued 11 prepays worth nearly $10 billion, not five prepays worth nearly $9 billion. Additional information about Garth Salisbury’s role at CCCFA has been added.

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