NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms the 'AA-' rating on implied senior lien gas utility revenue obligations for Long Beach Gas and Oil (LBGO), an enterprise fund of the city of Long Beach, CA.
The rating is assigned to implied obligations as no LBGO senior (first) lien debt is outstanding.
The Rating Outlook is Stable.
KEY RATING DRIVERS
STABLE LONG-TERM GAS SUPPLY: LBGO is a retail gas distributor for the cities of Long Beach and Signal Hill, CA. The majority of LBGO's gas is supplied through a prepay transaction with Merrill Lynch & Co. (prepay rated 'A' with a Negative Outlook by Fitch). The long-term contract, which expires in 2037, eliminates supply uncertainty and provides a cost saving margin.
ADVANTAGEOUS RATE STRUCTURE: Retail rates include an automatic adjustment surcharge that passes through any changes in the market price of gas. The adjustor mitigates volatility in financial metrics that could arise from fuel price fluctuations.
NEGLIGIBLE LONG-TERM OBLIGATIONS: LBGO has minimal outstanding debt, after fully repaying its gas utility revenue bonds on Aug. 1, 2013. Remaining long-term obligations include capital leases and commercial paper. Additional debt is anticipated in 2015, to fund a portion of the capital plan, but should be manageable.
VERY STRONG FINANCIAL METRICS: LBGO's metrics are extremely strong and well above similarly rated retail electric utilities, given the utility's marginal outstanding obligations and cash flow generation that can cover operating expenses and obligations numerous times over.
BELOW AVERAGE SERVICE TERRITORY: Economic indicators for the service area lag both state and national averages. Customer gas consumption continues to decline as well.
LARGE GENERAL FUND TRANSFERS: Transfers to the city, at 13.6% of fiscal 2014 revenues, are well above the 5.8% median for comparably rated retail municipal electric systems. The lack of a formal transfer policy, especially given the size of and the city's reliance on the transfer, remains a credit concern.
INCREASED TRANSFERS: An increase in LBGO's transfer to the city general fund, especially without a transfer cap in place, could put pressure on the rating. Alternatively, implementation of formal financial policies, inclusive of general fund transfer guidelines, would be viewed favorably.
LBGO is an enterprise fund of the city of Long Beach (the city; implied GO rating of 'AA'; Stable Outlook) that distributes gas and oil to 147,000 customers primarily in the city and Signal Hill, CA. The gas and oil systems are financed and accounted for separately.
The city is located in southern California, approximately a half hour south of Los Angeles. Fitch views LBGO's service area demographics as below average, given that city economic indicators currently and historically lag both the state and the nation. The local economy is diverse, benefiting from the Port of Long Beach, the Long Beach Airport and the proximity to the LA metro area, and has seen consistent employment gains. However, the imminent closing of Boeing's manufacturing facility may pressure local employment.
GAS SUPPLY & OPERATIONS
LBGO purchases the majority of its gas supply via a prepay gas agreement with Merrill Lynch (rated 'A'; Negative Outlook). Roughly 83% of LBGO's gas needs are procured through the prepay agreement, which expires in 2037. The prepay agreement provides LBGO with cost savings, as gas purchases are at a discount to market prices. Marginal net revenues derived from the prepay agreement are used to fund LBGO's long-term capital plan and improvements to infrastructure.
The remaining gas is purchased from local suppliers or on the open market and delivered directly into LBGO's distribution system. Market purchases are executed through ISDAs, which LBGO holds with Merrill Lynch Commodities, Shell Energy North America, J Aron & Company, BP Energy, ConocoPhillips, J.P. Morgan Ventures Energy and Freepoint Commodities.
The city has full rate-setting authority and is not subject to regulatory oversight. LBGO's gas rate structure consists of a base rate and a gas cost adjustor that automatically passes through changes in the market price of gas. Fitch views the cost adjustor as a credit strength, in that it protects LBGO from spikes in fuel costs.
Rate-setting strategy is market-based, as opposed to a cost-based strategy. The city charter requires LBGO's gas rates to be in line with other Southern California gas utilities and, as such, LBGO's rates are tied to the rates of Southern California Gas Company and move in tandem.
LBGO's financial metrics are extremely strong, with Fitch-calculated debt service coverage of 50.6x in fiscal 2014 due to the repayment of all of LBGO's gas revenue bonds, leaving only capital lease and commercial paper (CP) obligations. Factoring in LBGO's large transfer to the general fund and gas purchases, DSC decreases to a still strong 2.2x. Transfers to the general fund have ranged from 9.5% of revenues in fiscal 2008 to a high of 15.6% in fiscal 2012. A lack of formal transfer policy is a significant credit weakness, given the city's reliance on gas utility funds to balance its budget.
Liquidity has fluctuated significantly, from a low of nine days cash on hand (DCOH) at fiscal year-end 2009 to a high of 92 DCOH a year later. Cash is held in a pooled fund at the city level and allocated per fund accordingly. LBGO's liquidity position is augmented by a CP program. The utility is authorized to issue up to $35 million in CP. However, the current letter of credit provided by the Bank of NY Mellon (facility rated 'F1+') is sized at $16.35 million, allowing only $15 million of CP to be issued. At year-end 2014 unrestricted funds totaled an acceptable $7.5 million, or 47 DCOH (139 days liquidity on hand, inclusive of available CP).
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'U.S. Public Power Peer Study -- June 2014' (June 13, 2014);
--'U.S. Public Power Peer Study Addendum - February 2015' (Feb. 9, 2015);
--'Revenue Supported Rating Criteria' (June 16, 2014);
--'U.S. Public Power Rating Criteria' (March 18, 2014);
--'2015 Outlook: U.S. Public Power and Electric Cooperative Sector' (Dec. 10, 2014).
Applicable Criteria and Related Research:
U.S. Public Power Peer Study -- June 2014
U.S. Public Power Peer Study Addendum -- February 2015
Revenue-Supported Rating Criteria
U.S. Public Power Rating Criteria
2015 Outlook: U.S. Public Power and Electric Cooperative Sector (Steady as She Goes)