1. What is a recovery obligation?
It is a type of bond that is sold by a power or utility company to “recover” the costs of a large one-time expense, most commonly storm damage or the retirement of a coal plant, or to pay for other equipment costs the power plant. Here’s how recovery bonds differ from typical debt offerings: Utilities can seek regulatory approval to set up a special financial subsidiary to sell the recovery bonds, and are then authorized to add a small ongoing fee to customers’ monthly electricity bills . These fees, which can continue for decades in some cases, are transferred to the financial subsidiary, and the financial subsidiary then distributes this money to bondholders in the form of regular coupon plus principal payments. If some customers do not pay their fee, then the shortfall is made up by increasing the fee for all other customers. The state undertakes never to interfere with this collection mechanism.
2. Can you give me an example?
You probably remember the headlines from the winter storm named Uri that paralyzed Texas in February 2021. The same storm caused billions in economic costs for power utilities in Oklahoma, Louisiana and Kansas. Utilities in all four states chose to issue recovery bonds rather than add a massive one-time surcharge to customers’ bills. In Oklahoma, after getting permission from the state legislature, four utilities sold about $2.8 billion in recovery bonds to investors, including BlackRock, Citadel and a collection of insurance companies.
3. Why are so many of them sold recently?
Fire and ice. Much of the recent growth has come from bonds sold to deal with damage from the massive 2017-19 California wildfires, as well as the Uri. In Texas, a planned $3.4 billion in taxable municipal debt issued by a state agency to help utilities will be the state’s largest long-term muni offering ever. Wildfires and ice storms have been linked to climate change, making extreme weather more likely worldwide, leading to greater damage to power grids from hurricanes or blizzards. Climate change is also leading to greater pressure to retire coal plants early. Utilities in some states, including Indiana, are looking to sell reclamation bonds to help cover the costs of early coal plant shutdowns.
4. What is the advantage of a recovery bond?
From an investor’s point of view, recovery bonds are unusually safe: They are backed by state laws that guarantee payments will continue even if utilities go bankrupt. Recovery bonds also offered higher yields than comparable corporate bonds. Securities offered in August by the Oklahoma Development Finance Authority included debt with a weighted average duration of about 22 years, which yielded about 4.7 percent, or 135 basis points above Treasuries, data compiled by Bloomberg showed. This difference was greater than for other debt with top credit ratings. For example, a comparable Microsoft Corp. bond that matures in 2045 was trading at the end of August at about 76 basis points above Treasuries, according to Trace price data.
5. How can bonds be safe and offer such high returns?
In Oklahoma and other states where utilities have sold recovery bonds, some critics have argued that the bonds are being sold at higher interest rates than necessary. They argue that’s because the utilities don’t pay the interest — their customers — which means the utilities have little incentive to push for a better deal. If true, households and business customers face an unnecessarily high surcharge on their monthly electricity bills for decades — even if that’s still better than the alternative of a huge one-time increase in their utility bills.
• A Bloomberg article on the rise of recovery bonds.
• An article about PG&E’s fire recovery bond.
• A paper by the Natural Resources Research Institute on Non-Traditional Approaches to Utility Capital Expenditure Lending.
More stories like this are available on bloomberg.com