The town of Hermann, Missouri has taken legal action to ease a financial crisis brought on by its deal with the Prairie State Energy Campus.

Bunny & Norm Lenburg / Creative Commons

The town of Hermann, Missouri has taken legal action to ease a financial crisis brought on by its deal with the Prairie State Energy Campus.

Exit strategy from Prairie State: How towns could get out of a bad deal

The Prairie State Energy Campus has by many accounts been disastrous for many of the Midwestern towns that signed on to buy power at rates that turned out to be well above market prices.

A number of municipalities are facing serious financial crises because of the deals, forcing them to raise electricity rates, raise taxes and even contemplate bankruptcy.

State power agencies entered into power agreements  with the coal-fired plant with the idea that the electricity would be a good deal – that they could get electricity for their citizens at affordable prices and also make money by buying more than they needed and selling it into the market.

As part of the deal, the municipalities contracted with the state power agencies to finance the plant, and agreed to pay for a certain amount of electricity even if they don’t receive it.

As is now well known, things haven’t worked out according to plan.

The plant’s cost more than doubled to over $5 billion. A key premise of the plant is that it uses coal from a nearby mine, but that coal has turned out to be of poor quality and uneconomical to burn. In part because of the coal quality, the plant has been plagued with problems, reducing its production and raising its operating costs. And market electricity prices have been much lower than the project backers predicted, meaning that unneeded electricity from the contracts cannot be resold except at a loss.

So a number of municipalities would like to get out of their deals.

But that is not so easy. The agreements they signed explicitly say that if municipalities want out, they have to sell their share to another entity. And if partners in the deal default, the electricity and the financial burden must be picked up by the remaining partners.

The municipal contracts and the money that flows from ratepayers secure the bonds that were sold by state power agencies like American Municipal Power and NIMPA in order to pay for the plant’s construction. Those bonds are held by major financial firms like Invesco, PIMCO and Franklin Templeton.

Options on the table

However, there appear to be a few different options for municipalities to break free, or ways that – advocates say – they could be relieved of crushing debt.

Municipalities could convince their state power agency or other municipalities to take up their obligation, like the small town of Marceline, Missouri did. This is probably an easier option for municipalities getting relatively small amounts of power from the plant than for those with bigger obligations. If a partner with a large share of electricity defaulted and there was no party willing to purchase the power, then the power agency – the issuer of the bonds – could be at risk of default.

Cities could also file lawsuits alleging the deals violated state or federal laws, including limits on how much debt – as a portion of their overall budget – they are legally allowed to accrue. Lawsuits are pending in Batavia, Illinois and Hermann, Missouri. Among other things, Batavia residents allege that advisers gave them bad advice and misrepresented information in persuading local leaders to enter the contracts.

Another option would be to declare bankruptcy, which would free municipalities from paying back the bonds. This is a rarely used option, though, as municipal leaders fear how it will affect their access to credit in the future.

Tom Sanzillo is the director of finance for the Institute for Energy Economics and Financial Analysis, which has focused on the problems with Prairie State. Sanzillo is also the former first deputy comptroller of New York state and an expert on municipal finance. He noted that municipalities including New York City and Detroit have adopted formal advisory boards to work out problems.

“Smaller communities, like Troy, New York, have also used these tools to manage financial distress,” said Sanzillo. “In every state where the plant sells electricity, fiscal oversight structures exist that could assist with a remedy, but they are largely absent [from the Prairie State situation].”

Such an advisory board could likely oversee a whole municipality or the municipal utility specifically, he noted.

While it does not appear there is an immediate way that those who have profited from the plant could be forced to help municipalities deal with the debt, the IEEFA has proposed that the developers of the plant do just that.

Specifically, Sanzillo says Peabody Energy, the coal company which owns the mine supplying coal to the plant, or Bechtel, which constructed the plant, could chip in.

Peabody originally proposed and drove the development of the plant, critics say, as a way to sell low-quality coal from its Lively Grove mine. But Peabody reduced its ownership stake to 5 percent over time; as critics see it, continuing to profit from its mine while leaving the financial burden of the struggling plant on ratepayers and municipalities.

Peabody and Prairie State representatives declined to comment or respond to emailed questions for this story, and Bechtel did not respond to a request for comment.

Sanzillo also proposes that the bondholders – who are largely global financial institutions with billions in assets – could simply forgive or renegotiate the bonds, so that municipalities do not have to pay back the full bonds and the interest which continues to accumulate.

The amounts in question are crippling for the municipalities but would be a drop in the bucket for the bond holders, Sanzillo posits. And if the municipal utilities are likely to default on the bonds, it could be in the bondholders’ interest to negotiate more realistic payment plans.

The legal route

In March 2015 the small town of Hermann, Missouri filed a lawsuit arguing that it is not required to pay the bond issued by the Missouri Joint Municipal Electric Utility Commission (MJMEUC), the electricity supplier, because it was unconstitutional to saddle Hermann with the amount of liability resulting from the bonds. The lawsuit argues that provisions in the bond say the state power agency does not have the authority to unilaterally put a municipality or other government agency into debt.

By the end of 2009, the lawsuit notes, MJMEUC had amassed $1.45 billion in liability because of Prairie State. Hermann’s share is $37.5 million. The town’s annual operating revenue is just $11 million.

Meanwhile Batavia, Illinois signed a contract agreeing to purchase 50 MW, or 3.1 percent, of Prairie State’s power, and to pay $900,000 for construction costs, with the idea they would sell unneeded power on the market. Like other “take-or-pay” contracts with Prairie State, the town was obligated to buy that electricity even if it was never delivered.

In 2014, Batavia residents filed a class action lawsuit alleging that power agencies, advisers, Peabody, Prairie State and others misrepresented the deal and project when pitching it to the city council. Among other things, they did not inform the council how the federal government’s imminent carbon regulations would change the economics of the coal-burning plant, the lawsuit says.

In an ironic twist, in May Prairie State CEO Don Gaston wrote a letter to the EPA asking the plant be exempted from its new carbon limits on power plants, saying the limits would make the plant uneconomical and cause “very difficult economic times” for the municipalities contracted to buy its power. This, despite the fact that part of Prairie State’s original sales pitch was that it would be a low-carbon energy source that would thrive under expected new regulations.

Batavia’s advisers also pressured the town council into signing on, the lawsuit alleges, by claiming a decision had to be made by a certain date.

“These aren’t people who follow what’s happening in the energy world – these are small-town city council members,” said a Batavia resident who has been closely monitoring the Prairie State deal, who asked that her name not be used.

“All the risks were not disclosed when they made the decision to move forward – not disclosed by the consultants, and not disclosed by the developer Peabody,” she continued. “It’s like buying a home and the basement floods but they make it all look nice and don’t tell you the basement floods.”

From 2012 to 2014, Batavia’s share of power from Prairie State cost $52.3 million more than it would have at the promised rate of $46 per MWh, the lawsuit says, and almost $20 million of this cost was passed on to Batavia residents, who make up the plaintiffs.

The city council voted to increase the sales tax half a percent to help pay off the bond, even though the bond order specifically says that the bond is not the obligation of the state of Illinois or any towns, but only of the power agency.

“The use of additional, broader-based taxes to pay for Prairie State should be a blazing red flag that this project is out of control,” Sanzillo said.

Batavia also increased its electricity rates about 6.5 percent in 2014 and 2015, which has hit low- and middle-income people and manufacturers hard.

One outdoor furniture company with 1,200 employees, Suncast, threatened to leave Batavia because of the impending electric rate increases, until the municipality offered incentives to keep them in town including allowing them to pay lower rates for electricity. That, however, meant that other ratepayers would have to pick up the slack.

In June the Batavia council created an incentive program of lower electricity rates to attract a company that manufactures auto parts out of recycled plastic. Without the incentive, the council wrote, the high cost of electricity would have kept the employer away.

The Batavia lawsuit has been moved to federal court and is pending; the plaintiffs’ attorneys are trying to move it back to state court.

Passing on the obligation

Tom Loucks, an attorney representing Batavia in their lawsuit, said selling the contract or the energy to a different entity is technically feasible but not very likely for most municipalities.

“Unless we see a tremendous boom they’re not going to purchase a participant’s interest at a rate higher than they have to on the open market,” he said.

In late 2013 the town of Marceline announced that it was transferring its obligation to buy 4 MW of power from Prairie State to the Missouri Public Energy Pool, which already had its own deal with Prairie State. Marceline will also have to pay $22,000 a month for 45 months to get out of its obligation, but the move is still projected to save the town about $6 million over the five years covered in the contract.

Sanzillo and others say it would appear Bechtel and Peabody could afford to funnel some of the profit they’ve made on Prairie State back to the struggling municipalities. But it is not clear that there would be any viable way to force them to do this.

Peabody Energy is the world’s largest private sector coal company with billions in assets despite recent financial troubles. Bechtel is one of the world’s largest contractors, well-known for construction projects for the U.S. government in Afghanistan and Iraq, and for water infrastructure projects around the world, among other things. Bechtel was paid $4 billion for construction of the Prairie State plant.

Sanzillo notes that there are also other entities that have benefited from the Prairie State deal, who could be stepping up to help.

“The investment banks, lawyers and financial advisors that underwrote the deal all collected fees,” he said. “All are continuing to collect fees from ongoing bond refinancings. State power agencies and the state political leaders they are formally and informally accountable to benefit as they award lucrative finance, construction and energy contracts.”

Bond relief

There is also no clear way to force the bond holders – the major investment firms – to revoke or reduce the debt owed on the bonds. But it is not unheard of for bond holders to renegotiate, often in the interest of helping a party pay something rather than defaulting.

Carrie Sloane is an expert on municipal finance at the Refund America Project, a think tank focused on alleviating the impact of the financial crisis on communities. She said that in general, forgiving or renegotiating bonds is a possibility and could be the best route for a bond holder.

But the issue is highly complicated, she pointed out, and financial institutions might even have some self-interest in allowing municipal utilities to default. That’s because once an entity defaults or declares bankruptcy, it will cost them much more to borrow in the future – ultimately offering more potential profit for the finance industry.

Sloane’s colleague Saqib Bhatti has noted that cities can sue or even declare a “debt strike” and refuse to pay their debts if they think they’ve been saddled with unreasonable terms.

Four of the major Prairie State bond holders, Invesco, PIMCO, Franklin Templeton and JP Morgan, declined to comment for this story.

Sanzillo points to Paducah, Kentucky, where the utility is now saddled with $555 million in debt because of Prairie State, and where regular ratepayers have seen bills of more than $1,000 to pay for the construction. Paducah’s mayor was quoted calling the debacle the worst thing to happen to the town since the Great Flood of the Ohio River in 1937.

Most of the financial entities are major institutions with large budgets and much expertise in energy and finance. By comparison, towns like Paducah, Batavia, Marceline and others saddled with debt by the plant operate on small budgets and have little in-house energy expertise.

“Financially, these bond holders are worth in the trillions, and you look at Paducah which is worth almost nothing,” said Sanzillo. “If those bonds defaulted and went to zero, those institutions wouldn’t even know it. Would it affect their ratings? No. Does it affect Paducah? Damn right it does.

“This is not how public finance questions should be settled. It is the worst of all possible outcomes.”

One thought on “Exit strategy from Prairie State: How towns could get out of a bad deal

  1. Good article. This part really needs to be emphasized, “make money by buying more than they needed and selling it into the market.” There are a lot of municipal utilities that operate well and jointly own portions of large baseload plants. But these small govt owned utilities should not be trying to make money by selling in to the market. They got greedy and got burnt.