ALASKA ELECTRIC AND ENERGY COOPERATIVE, INC. History and Description A. Introduction. Essential to an understanding of the basis for the existence of Alaska Electric and Energy Cooperative, Inc. (AEEC) is a grasp of an important component of cooperative financing. In order to borrow money at favorable rates a cooperative must be able to assure the lender that the cooperative will earn sufficient revenues to repay the borrowed funds. Typical of every loan agreement is a covenant obligating the cooperative to earn enough revenue to cover expenses and pay its debt service, plus earn a "margin" (analogous to a "profit" when referring to for-profit entities). The amount which must be earned is expressed by one of two different ratios: Times Interest Earned Ratio (TIER) or Debt Service Coverage (DSC). Both earnings ratios have the same essential function: to measure the ability of the cooperative to pay its debts. TIER indicates the extent to which earnings are available to meet interest payments. DSC indicates the extent to which cash is available to meet payments of principal and interest. The relative amount of the earnings ratio required by cooperative lenders is determined by the type of cooperative organization. The business model that has evolved in the lower 48 states and is accepted by the financial markets recognizes two types of electric cooperatives - distribution cooperatives, which purchase electricity at wholesale, and generation and transmission cooperatives (G&Ts), each typically composed of several distribution cooperative members who purchase most or all their power requirements from the G&T. The major lenders to cooperatives, including the Rural Utilities Service (RUS) and the National Rural Utilities Cooperative Finance Corporation (CFC) typically require distribution cooperatives to maintain higher earnings ratios than they require for G&Ts. Because electrical utilities are capital intensive, requiring financing for enormous plant
investments, the annual debt service payments are also generally very large sums. The higher earnings ratio required for a distribution cooperative results in significantly higher payments from the member customers. AEEC was formed as a G&T to take advantage of the more favorable loan covenants afforded G&Ts by the financial markets. B. HEA's Power Supply History. The history of AEEC can be understood only in the context of the history of Homer Electric Association, Inc. (HEA) itself. Beginning with the signing of a contract in May, 1963 HEA became dependent on Chugach Electric Association, Inc, (Chugach) for all its electric power supply requirements. Chugach developed the Bernice Lake Power Plant and supplied power to HEA not only from Bernice Lake, but also from the Cooper Lake hydro plant and via its transmission line to Anchorage, and later from its Beluga facility. Chugach obtained financing from the Rural Electrification Administration (REA), now Rural Utilities Service (RUS), for Bernice Lake as well as other generation, transmission and distribution projects. The REA designated Chugach as the logical entity to develop generation and transmission assets for itself, HEA and Matanuska Electric Association, Inc. (MEA). A series of disputes between Chugach and its wholesale customers culminated in Chugach notifying HEA and MEA, on January 3, 1984, that Chugach would not do more than meet HEA's and MEA's 1982-83 peak demand levels once the 1983-84 winter was over. HEA at that time was anticipating continued growth, and found itself in the position of having to provide for its own power supply above its peak of73 MW. Since MEA was in the same position, both HEA and MEA met to discuss how to best supply their future peak demands. They decided to do so by organizing a G&T to build new generation assets. Their reasoning was 2
that they could charge their members lower rates if the generation assets were owned by a G&T, rather than by the individual distribution cooperatives. This was because under the REA's financing requirements a distribution cooperative had to earn a margin equal to a minimum of 50% its annual interest payments, or 1.5 TIER, while a G&T was not required by REA to earn any additional revenues above the cost to cover expenses and debt payments. In January 1984, HEA and MEA incorporated the Alaska Electric Generation and Transmission Cooperative, Inc. (AEG&T). In August 1984, AEG&T filed a loan application with REA for construction of a generating plant to be located in Soldotna, and known as "Soldotna One." In September 1984, AEG&T awarded the Soldotna One bid to General Electric. In June 1985, the Alaska Public Utilities Commission issued AEG&T a permanent certificate of public convenience and necessity to serve HEA. In July 1985, REA and CFC, who was providing supplemental financing for the project, required the assignment to AEG&T of the Chugach-HEA power sales agreement. The resulting power sales agreement between AEG&T, Chugach and HEA is the one currently in effect. Under that agreement, Chugach agreed to sell and AEG&T agreed to buy 73 MW of power which AEG&T was then to sell to HEA along with power from other facilities built, leased or otherwise committed to by AEG&T to meet HEA's wholesale power requirements. The Commission reviewed and approved the agreement. In the summer of 1986, AEG&T began providing service to HEA using the Soldotna One unit to supplement the power purchased from Chugach. In October 1987, all the Railbelt utilities, including AEG&T, signed up for a share of the Bradley Lake Hydroelectric Project. AEG&T's share was 25.8%, with 12% dedicated to HEA 3
and 13.8% dedicated to MEA. In 1995, AEG&T expanded its operations and hired a Manager of Rates as well as two part-time consultants and in 1996, the City of Seward and ML&P joined AEG&T as Joint Action Members. Joint Action Membership allowed Seward and ML&P to participate in the regional planning process and allowed both Seward and ML&P to have two representatives each on the AEG&T Board with limited voting rights. In October 1997, MEA representatives informed HEA and AEG&T that MEA had determined it was no longer in MEA's best interest to continue funding AEG&T at its existing level. When HEA did not acquiesce and the parties deadlocked on the issue, MEA filed suit against AEG&T and HEA. Although the dispute was ultimately resolved by reorganizing AEG&T, the reorganization itself created regulatory concerns and tax questions, and did little to bring HEA and MEA back together as cooperating members of AEG&T. It was around this time that HEA began investigating the feasibility of relocating the Soldotna One turbine to Nikiski for incorporation into a co-generation plant. In early 1999, AEG&T entered into a co-generation agreement with a Unocal subsidiary to relocate the Soldotna One turbine to Unocal's Nikiski facility and incorporate the turbine, along with a heat recovery steam generator ("HRSG"), into the Nikiski Cogeneration Plant. The HRSG was used to capture the waste heat produced by the turbine and utilized that heat to produce steam. This steam was then delivered to Unocal, and later Agrium, for use in producing fertilizer. In exchange for the steam, Unocal agreed to give AEG&T natural gas for use in running the combustion turbine. Commercial acceptance of the project officially occurred in May 2001. Although the reorganization of AEG&T in 1998 was adequate to allow HEA the latitude to independently move forward with the Nikiski Cogeneration Project, it did not eliminate the 4
conflict between HEA and MEA. Partially in order to finally alleviate this conflict, and also to satisfy a suggestion by the Commission that "AEG&T evaluate its functions as a cooperative and reassess whether this organizational form best suits its current function," HEA took steps to withdraw its assets from AEG&T. C. Formation of AEEC. On August 6, 2001, an electric cooperative known as Alaska Electric and Energy Cooperative, Inc. (AEEC) was formed. HEA retained the services of Thomas Strait, CPA, a nationally recognized expert in cooperative tax issues, to guide the reorganization. That same month AEEC filed an application with the RCA for a certificate of public convenience and necessity to serve as the exclusive wholesale power supplier of HEA. The RCA approved the application on June 19, 2002, and the restructuring transaction finally closed on June 30, 2003. Under its certificate of public convenience and necessity from the RCA, AEEC is responsible for providing all the power requirements for HEA. The bulk of the power is still provided to AEEC by Chugach and re-sold to HEA at cost. AEEC holds title to substantially all the substations and all transmission lines used to deliver power to HEA members. In addition AEEC is the purchaser of the Bradley Lake share of power dedicated to HEA and owns the Nikiski generation facility which it is in the process of expanding. D. Governance of AEEC. AEEC is structured as an electric cooperative. It has one member - HEA. Its ninemember board of directors is elected at an annual meeting by the voting delegate appointed by the HEA board. Historically the members of the HEA board have constituted the AEEC board. The HEA general manager is also the general manager for AEEC. 5
E. Operation of AEEC. AEEC has no employees. All AEEC operations are conducted under the terms of a management agreement whereby HEA provides, at cost, all required services for AEEC. F. AEEC Rates. Under the wholesale power agreement between HEA and AEEC, HEA pays the actual costs incurred by AEEC for delivering power to HEA, plus cash roughly equal to 105% of AEEC's annual debt service (principal and interest). The resulting margin is allocated to HEA as patronage capital. For rate-making and other regulatory purposes the RCA treats HEA and AEEC as a single entity. G. Financing. AEEC's primary lender is the CFC. As of May 1, 2010, the amount AEEC owed to CFC was approximately $43,000,000. AEEC has been approved to borrow up to an additional $180,000,000 from CFC's affiliate, the National Cooperative Services Corporation, in order to finance future electric generation plant. The loan agreements require AEEC to maintain a DSC ratio of not less than 1.05 (in other words, to earn cash equal to 105% of its annual debt service). This obligation should be contrasted with the loan covenant of HEA which requires it to maintain a DSC ratio of at least 1.35 (to earn cash equal to 135% of its annual debt service). It is this difference in earning requirements that makes AEEC a valuable financing vehicle. Under the current debt structure of AEEC, HEA is able to avoid having to collect approximately $1,700,000 per year in higher rates. As more money is invested in additional generation the savings to HEA ratepayers will increase significantly. 6