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S&P, Moody's React on Four Public Sector Gas Deals

Wall Street's shake-up this month was felt in four western public sector utility natural gas financing deals where muni electric operations have tried to protect themselves against volatile and higher wholesale gas prices with long-term, prepaid supplies.

Standard & Poor's Ratings Services (S&P) Sept. 15 put three of the deals on CreditWatch with "developing implications," and Moody's Investors Service last Tuesday downgraded to "A2" from "A1" more than $500 million in revenue bonds used for pre-paid long-term natural gas supplies for a group of Southern California public power providers.

Moody's said the rating action comes following its recent downgrade of global insurance giant American International Group (AIG) to "A2" (on watch for downgrade) from "Aa3." Goldman Sachs & Co. "Aa3" is the gas purchase contract guarantor, and AIG is the commodity swap guarantor in the SCPPA deal financing long-term gas purchases for five of its muni members (the cities of Anaheim, Burbank, Colton, Glendale and Pasadena).

Global credit woes have continued to seep into the public-sector utility space where the electrics made bold natural gas hedging plays in recent years, and major ratings agencies, such as Moody's, last July downgraded several of the utilities in California and elsewhere around the nation. At that time, the hedges were bad enough that one municipal said it was closing its hedging program.

In each case for S&P, its CreditWatch placement of Merrill Lynch & Co. Inc., a key player in the public sector gas deals, was the main driver in taking action regarding Roseville (CA) Natural Gas Financing Authority, Long Beach (CA) Bond Finance Authority and the Public Authority for Colorado Energy (PACE). Bank of America Corp.'s deal to acquire Merrill Lynch in a $50 billion acquisition prompted all the rating agency actions (see related story).

The Roseville authority, a state-chartered joint powers financing unit, funded the prepayment on a 20-year, 46 Bcf gas deal with Merrill Lynch Commodities Inc. as a means of helping supply the City of Roseville's electric utility generation. The gas authority has a supply contract with the city for all of the gas supplied by Merrill under the prepaid contract, with supplies priced at first-of-month index for Pacific Gas and Electric Co.'s citygate delivery point, minus a specified discount.

"S&P will resolve the CreditWatch after holding discussions with management to address capital planning, earnings projections, and strategic direction," said S&P analyst Kenneth Farer. "If the [merger] transaction is completed, the ratings on Merrill Lynch will likely be upgraded."

For Long Beach's municipal utility, the city's finance arm secured revenue bonds for $887.4 million for a prepaid natural gas supply deal involving Merrill Lynch that was announced 11 months ago with much fanfare. Long Beach's municipal gas utility has a 30-year pre-pay supply deal satisfying 80-90% of its 12-13 Bcf annual gas demand with terms that were supposed to keep its retail rates below the surrounding Sempra Energy utilities for the next three decades (see NGI, Oct. 22, 2007).

The deal with Merrill Lynch Commodities Inc. also was billed as unique in that it was not priced just to the California-Arizona border natural gas prices. Instead, the municipal gas utility's 30-year, $900 million deal carries a discount of 94.2 cents/MMBtu that is applied to half the annual volumes using the Southern California Gas Co. weighted average cost of gas and the other half to the California border price index.

In Colorado, for the $653.2 million PACE gas project revenue bonds, S&P imposed the same CreditWatch with developing implications as Merrill Lynch guarantees the gas supplier's obligations. Besides Merrill, the counterparties to the transaction are Colorado Springs Utilities Co., the muni involved; Royal Bank of Canada as the commodity swap provider; and Calyon and Americanized Occidental Life Insurance Co. as the guaranteed investment contract providers for the debt service fund, S&P said.

As with Roseville, S&P said it will resolve the CreditWatch situation in this case after holding discussions with management to "address capital planning, earnings projections and strategic direction." Similarly, if the merger transaction is completed, Merrill likely will be upgraded, S&P said.

In contrast, if Merrill's merger was not completed, the investment firm would be likely downgraded, said S&P, noting that would reflect what the rating agency called "negative market sentiment with respect to the broker dealers in the wake of the collapse of Lehman Brothers Holdings Inc."

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