Grays Harbor Energy

Fitch Bond Rating

"The additional debt adds to an increasingly high debt load for the utility, with debt to funds available for debt service at 10.3x in fiscal 2007, which is above the median of 4.8x for similar utilities" - despite that Fitch rated the PUD bonds as an investment grade 'A' rating. The following is the exchange of emails between Richard Bassett, Managing Partner of Charlestown Investments, and Fitch.

 

Thank you for providing me with your full rating for the Grays Harbor PUD.

In my own career I have provided corporate credit analysis and financial valuation consulting, systems, and education to more than 65 banks operating in more than 120 countries including Citibank, Deutsche Bank, ABN-Amro, UBS, JPMorgan, Bank of America, HSBC, Lloyds-TSB, Barclays, Credit Suisse and others.

Based on my own experience and a reading of this rating I believe that all of the points that I raised in my e-mail to you of May 13th remain valid and that Fitch has earned an “F” grade for this rating.

While this is a comparatively trivial fund-raising, Fitch has not served investor interests well as the information that would have challenged the PUD’s misrepresentations of material facts was easily available and brought to your attention more than a week before the securities were priced.

This rating proves my earlier point that “the issuer gets the rating they pay for, not the rating the investor deserves”.

Regards,
Richard Bassett

Mr. Bassett-

I wanted to send our full report on Grays Harbor County Public Utility District for your review.

Best regards,
Cindy Stoller

The local opponents to the Grays Harbor PUD’s pending deal have now asked the Governor’s office to intervene and they cite your rating as an issue of concern. Their appeal to the Governor is at : www.graysharborenergy.com .

Regards,
Richard Bassett

 

 

The Aberdeen Daily World served the Grays Harbor PUD with a Freedom of Information demand last week and secured the material for a major story in today’s local paper.

http://www.thedailyworld.com/articles/2008/05/13/local_news/02news.txt

If the figures that the PUD has provided the newspaper are correct and the deal is as it is described in the documents provided than the Grays Harbor PUD will lose at least $4.5 million a year on this contract for every year of the contract.

In 2005/6 the State of Washington paid for a study by a local firm, Paneltech and if you use the published figures from their report and simply update the fuel costs for oil and hog fuel but leave all of the other numbers as they had them then the annual loss is $7.7 million. Interestingly this report’s two authors include one of the three local PUD commissioners, Truman Seely, and Roy Nott who served as a consultant to the PUD and is now the COO of Evergreen Cosmopolis – no conflicts here, of course.

If you take our numbers, which frankly are more accurate then either of the above, the annual operating loss in cash terms to the PUD is minus $9.5 million.

If this is a 15 or 20 year contract then the cumulative effect is staggering.
The full details illustrating this will be on www.graysharborenergy.com  by tomorrow morning.

If your rating stands as issued yesterday and these bonds are priced on the 22nd on that basis, I think that you have a liability problem.

Regards,  

Richard Bassett

 

After having read your release on the Fitch Rating for Grays Harbor PUD I can see why there is a widespread view that “the issuer gets the rating they pay for, not the rating the investor deserves”.

Your rating has a clear disconnect between the commentary and the numbers. As you know, most people only look at the rating and the subsequent pricing, particularly for this size of issue. However, the disconnect between the text and the “analysis” makes it clear that the text is designed to provide Fitch with “cover” in case something goes wrong.

How else could you explain the following quotes from your rating:

“The additional debt adds to an increasingly high debt load for the utility, with debt to fund available for debt service at 10.3x in fiscal 2007, which is above the median of 4.8x for similar utilities in the “A” rating category”.

As the Grays Harbor debt load is poised to rise significantly with this issuance and there is a high probability of ongoing operating losses, and you have already noted that their debt level is high, why would they maintain this rating?

Further, you clearly accepted the material provided by the Grays Harbor PUD without questioning or investigating it. Even the most cursory examination would have shown that this undertaking includes significant counterparty risk, concentration risk market risk and the risk of significant cost overruns, all of which combine to create a significant contingent liability in the form of environmental remediation risk.

The counterparty risk arises from the mill’s dependence on the ongoing successful operation of the mill by the PUD’s partner, a newly formed company, Evergreen Pulp. Evergreen has no experience anywhere in the world in the production or marketing of dissolving sulphite pulp. This is a very volatile market space where prices can rise by 100% in a year, as they did in 2007 or fall by 50% or more in a year as they are now doing in 2008.  Evergreen appears to be undercapitalized and as this is a mill that Weyerhaeuser deemed not to be viable and it has been idle for two years the risk of the mill never re-starting or having a very short future is considerable but apparently played no part in your rating.

Concentration risk is identified in your own report where you state “the reopening of the Cosmopolis pulp mill as expected would result in that mill becoming the largest customer and accounting for over 10% of the district revenues.” Did you stress test this to see what the impact would be on the Grays Harbor PUD’s overall position if after the PUD has expended all of these funds the mill doesn’t re-open?

It is not apparent that you have a sense of the cost of power production at this mill, which is certainly not less than $95 per MWh in a market where industrial users purchase power at less than $45 per MWh. Further, the blandishments of the Grays Harbor PUD that this power can be produced even if the mill isn’t running ignores the simple fact that 75% of the fuel used to generate power is from a pulp by-product, red liquor. If the mill isn’t running, there’s no fuel and the cost to convert the existing boilers to run on wood waste is well in excess of $40 million. Of course, you could run on oil instead of doing the conversion but at $125 a barrel the cost per MWh is approaching $300.

The PUD’s anticipated $10 million requirement to refurbish and restart the mill is not supported by the facts. On May 6th, 2008 the following was published in the Aberdeen Daily World http://www.thedailyworld.com/articles/2008/05/08/opinion/letters_to_the_editor/03opinion.txt . As you can see the PUD’s estimated capex requirement is wholly inadequate.

You also reference the state’s mandated renewable targets in the context that is presumably an acceptance of the PUD’s proposition that they have no choice and regardless of the outcome of the Cosmopolis deal local rate payers will simply be forced to cover any cost overruns or other problems through higher utility rates. However, if you had read the state legislation and compared the existing position of the PUD with that legislation you would have found that there are two criteria to avoid fines in 2020 and the PUD already meet one of them. I have provided the citation, explanation and supporting analysis as an attachment to this note.

Further, you appear to have accepted the false representations of the PUD that they have a judgment that this will qualify as “green power”. I attach a copy of the sole document that the PUD has on this subject which is, as you can see, equivocal.

If the pulp mill fails then the power generation assets have no value and that’s why there were no energy entrepreneurs competing to acquire these assets. Further, if you look at the closure costs of another dissolving sulphite mill in Washington State, Rayonier’s Port Angeles mill, you will see that this process has consumed more than 5 years and more than $100 million and is not yet complete. As the PUD’s counterparty is a newly formed company with no other US assets, what happens if the pulp mill fails and the PUD’s partner company disappears?

These issues and other supporting information have been publicly available on the website www.graysharborenergy.com  for more than a month so there is no excuse for not having an awareness of these issues nor for the clear analytic failures underpinning this “rating”.

I think that the Grays Harbor PUD rating reveals material shortcomings in Fitch’s rating methodology and oversight. When your own report identifies an issuer is well outside the norms for others in the “A” rating you undermine the ratings of comparable utilities which stay within the bounds of the scoring system. While this report may be the work of a “junior analyst” it seems implausible that any rating would be issued without some more senior oversight of the work and in this case the oversight was non-existent or at best, cursory.

As you are well aware, investor opinion of the rating agencies has never been lower than it is today, this type of work will do nothing to repair investor confidence in the rating process.

Regards,
Richard Bassett