Sneak PEAK into Kentucky Public Energy Authority’s US$536m Gas Supply Revenue Bond

The U.S. municipal bond market continues to shield itself from volatility, as global uncertainties over cross-border trade and monetary policy have recently intensified.

While market participants generally fear trade-related discord between China and the U.S. could lead to a potential global recession, many investors have been diving into safe-haven assets such as U.S. Treasuries and gold.

The yield on the 10-year U.S. Treasury note was last bid at about 1.527% intraday Monday— an inversion of roughly 1.2 basis points with the 2-year note, which was trading at around 1.539%. Furthermore, the yield on the 3-month bill remained around 46 bps higher than the 10-year note – while both inversions spurred continued jitters and debates about a near-term recession.

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The current gold futures contract was also up around 0.15% intraday to US$1,539.65.

While the U.S. Federal Reserve’s Open Market Committee (FOMC) at its monetary policy meeting in July had cut interest rates by 25 bps – largely to insure against downside risks from weak global growth and trade policy uncertainty – Fed chair Jerome Powell apparently disappointed the Street with his views on the FOMC’s path forward.

Chair Powell had essentially referred to the cut – the first in about a decade – as a mid-cycle adjustment and not “the beginning of a lengthy cutting cycle,” which had stirred some unease in those market participants expecting multiple near-term rate cuts.

Still, market participants – bolstered by Powell’s recent remarks at the Federal Reserve Bank of Kansas City’s symposium on “Challenges for Monetary Policy” in Jackson Hole, Wyoming – widely expect another 25 bp rate reduction by the FOMC at its meeting in September.

Against this backdrop, analysts at Janney Montgomery observed that Friday’s bout of risk aversion reverberated in the taxable fixed income market, especially with “the end of the summer near and Street absences high.” They said that when investors add in negative headline risk, “the reaction becomes more severe.”

High yield credit spreads widened around 15 bps Friday, erasing most of the narrowing seen the prior two days, while investment-grade credit spreads widened 1 bp, and mortgage-backed securities widened 2 bps.

However, bond investors have generally retained their interest in munis, with Janney having noted that maturities across the muni yield curve were little changed on Friday.

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Janney Montgomery added, citing Municipal Market Data (MMD), that maturities in 2020-2025 were unchanged, with bumps of 1 bp and 2 bps in 2026 and 2027-2049, respectively. The 30-year Muni/U.S. Treasury (M/T) ratio also hovered around 100%, with the new issue calendar at roughly US$6bn to close out the last week in August.

Demand among investors has also been reflected in Thomson Reuters/Lipper U.S. Fund Flows, which, for the week ended August 21, reported net inflows of more than US$1.35bn, albeit somewhat lower than the inflows of the past two previous weeks of about US$1.5bn and US$2.07bn, respectively.

Although these flows do not include ETFs such as the iShares National Muni Bond fund (NYSEARCA: MUB) and the Vanguard Tax-Exempt Bond fund (NYSEARCA: VTEB), those ETFs remain at lofty heights as prices tick higher on U.S. government debt. MUB and VTEB have soared more than 10.1% and nearly 8.4%, respectively, since their most recent 52-week lows in early November 2018.

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PEAK Bond Supply

Among the deals on the near-term radar, the Public Energy Authority of Kentucky (PEAK) is set to sell a little more than US$536m worth of gas supply revenue bonds, Series 2019 B, to finance the prepayment of a 30-year supply of natural gas from BP Energy Co. (NYSE: BP).

Under the terms of the official statement, PEAK will sell all of the natural gas to be delivered during the initial period under its Gas Purchase Agreement with BP to four municipal utilities: City of Bountiful, Utah; Middle Tennessee Natural Gas Utility District; Citizens Gas; and Philadelphia Gas Works. The deliveries will be made in accordance with long- and short-term gas supply contracts with the project participants.

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PEAK further stated that the bonds are special and limited obligations, payable and secured solely from and by the Trust Estate pledged under the indenture, which includes the issuer’s revenues received under its gas supply contracts, as well as other revenues and funds.

Also, from the issue date of the Series 2019 B bonds to, and including, November 30, 2025, the notes will bear interest at a fixed-rate mode. The bonds maturing December 1, 2049, will be required to be tendered for purchase on December 1, 2025.

Moody’s Investors Service assigned an ‘A1’ investment-grade rating on the issuance, mainly on the back of BP’s credit quality as guarantor for the payments due under the Prepaid Natural Gas Purchase and Sale Agreement. Moody’s also accounted for the overall structure of the deal, including a Receivables Purchase Agreement (RPA), a back-end commodity swap, and the mechanics of debt service payments.

As part of the transaction, BP Energy and the Royal Bank of Canada, acting as the commodity swap counterparty, will enter into a commodity swap arrangement, where the payment obligations of BP Energy are guaranteed by BP plc.

NatGas Prices Lose Steam

According to the U.S. Energy Information Administration, Kentucky holds less than 1% of U.S. proved natural gas reserves, but “organic-rich shales that underlie eastern Kentucky may hold substantial additional natural gas resources.” 

The state also accounts for less than 1% of the nation’s natural gas production Most of the state’s natural gas is produced from wells located in eastern Kentucky. The EIA noted that the state’s annual natural gas production rose in the early 2000s, peaking in 2010, but has declined by about one-third since then as natural gas prices decreased.

Indeed, prices of natural gas have been on a downward slope.

Bespoke Weather Services recently highlighted that natural gas prices had moved lower this past week, closing about a nickel under last Friday’s close, “though we did see some of our usual volatility, as prices tested the 2.25 level in the September contract earlier in the week before sellers stepped in. The contract finished the week just over the 2.15 level.”

The current contract was last bid up at around US$2.21 intraday Monday.

Meanwhile, Kentucky’s residential sector, where almost four out of 10 households use natural gas for home heating, received about one-sixth of the natural gas delivered to end-users in the state. In part because of the state’s relatively mild winters, residential natural gas use per capita in Kentucky is lower than in about two-thirds of the states.

PEAK’s Series 2019 B bond offering is being lead-managed by J.P. Morgan, with pricing slated for September 4.