By now, we’re all aware that the theme of our annual meeting is “Listen and Lead.” This seems fairly simple and straightforward. Regarding leadership, there is and will continue to be the ongoing discussion as to whether or not true leaders are born with the skillset needed to lead or if those skills can be garnered through education and training.
With regard to listen, have you ever realized that listen and silent both consist of six letters — in fact they consist of the same six letters. Oftentimes, we may think our value comes from interjecting our thoughts or defending our position when in fact our true value may come from remaining silent, listening, and then leading. Through our democratic cooperative business model, I think we do that extremely well. That is part of what has led Basin Electric to become and remain the financially strong entity that it is.
As in years past, we retained Deloitte to conduct the independent audit of Basin Electric’s and its subsidiaries’ 2019 financial statements. The process typically begins with an onsite visit each September where members of the Deloitte team present their audit plan to the board and staff. That is then followed by interim field work in December and a full boots-on-the-ground effort beginning after the first of the year. But this year will be different. The planning meeting was, and for certain the interim work, will be done remotely. One can also start to surmise that much of the actual audit of the 2020 financials will be done remotely, as well. Truly a different world and mode of operation than what we’re used to.
Once again, I’m happy to report that for 2019, as in years past, Deloitte issued clean or unqualified opinions on the financials for Dakota Coal Company and Dakota Gasification Company each on a consolidated basis and ultimately Basin Electric on a consolidated basis as well.
The complete results of the audit were published in the 2019 annual report, which was published in May. While a bit outdated now, if you haven’t seen it, it’s available on the Basin Electric website. You’ll also find a link on the website to Basin Electric’s more current 2020 quarterly consolidated financials if you wish to review those.
Summary of 2019 financial results
Let’s spend a moment reviewing the 2019 consolidated financial statements that Deloitte audited.
Basin Electric’s assets on a consolidated basis as of the end of 2019 stood at nearly $7.5 billion, up from $7.4 billion at the end of 2018.
Our consolidated net margins and earnings were $76.6 million, up from $64.5 million in 2018. The 2019 results include the early amortization of $11.2 million of the Loss on Investment in Dakota Gas expense deferral as well as the deferral of an additional $80 million of surplus sales revenue, bringing the deferred revenue balance to $155 million as of Dec. 31, 2019.
In 2019, Basin Electric recorded $1.7 billion of member sales and $48.5 million of non-member sales.
Dakota Gas recorded a net loss of $70.5 million. This compares to a net loss of $397.8 million in 2018, which included the $298.8 million write-down of the coal gasification assets at the Great Plains Synfuels Plant.
Finally, Dakota Coal had a net profit of nearly $15.5 million. The large profit was due primarily to a new accounting pronouncement that requires that changes in unrealized gains and losses on certain investments now be reflected in the income statement. With the robust returns in the markets in 2019, Dakota Coal recognized a significant increase in unrealized gains on investments in its Mine Closing Fund.
COVID-19’s impact on the economy
As I’m sure you all expected, we can’t go without talking about the elephant in the room, this year’s biggest story — the COVID-19 global pandemic. In addition to impacting almost every part of our daily lives, it has had an enormous impact on the national and global economy.
Before COVID-19 hit, the United States had recently come through the longest economic recovery in history — and then came the pandemic. While a recession followed across the country and around the world, it is expected to be the shortest in history, lasting a mere two months.
Closer to home, one big impact of the pandemic was the immediate and significant decrease of ethanol load, as well as the demand for electricity in the Bakken. When COVID-19 shut down businesses and schools in March, many people, essential workers excluded, started putting on fewer road miles and business and leisure air travel came to a virtual standstill. This new behavior had an intense effect on oil prices, and therefore ethanol and oil production — a major load for many members throughout our service territory. Some members even had more than one oil-related end-use member, which caused their load, and thus their revenue, to drop dramatically. Fortunately, we’ve seen a fair amount of this load come back.
Knowing how significantly some of our members were being impacted by the pandemic, at their April board meeting, directors authorized the retirement of nearly $18.6 million of patronage capital credits to help mitigate the financial effects members were facing. This is a bit more than half of the credits we would expect to distribute this year. Earlier this week, the board approved the retirement of an additional $14 million of patronage, bringing our total retirement for the year to $32.6 million. We have retired margins allocated through 2003 and are currently retiring margins allocated in 2004. Each year, Basin Electric strives to retire about 1/30 of the cooperative’s total undistributed margins.
Rating agency visits
One factor in maintaining a stable financial position is our relationship with the rating agencies. We communicate regularly with Fitch Ratings, Standard & Poor’s, and Moody’s Investors Service. The meetings with the agencies in July were conducted virtually, again, visits that had always been face-to-face in the past. And it is certain that the follow-up meetings to be held later this year will be done virtually as well for safety reasons.
During the meetings, our solid financial performance through the pandemic was noted. They acknowledged the actions we have taken to protect Basin Electric, looked at the deferred revenue pool and associated designated cash we have built, noted our robust liquidity, and finally the strength of the financial metrics of not only Basin Electric but also those of you, our members.
Not surprisingly, from a credit weakness standpoint, the agencies looked at the operations of Dakota Gas and also our concentration of industrial and commercial load in light of what was and continues to some degree to be going on in the Bakken and with some of the ethanol plants as a result of the pandemic. In short though, the agencies noted Basin Electric is doing quite well financially.
In June, S&P Global affirmed Basin Electric’s senior secured long-term “A” rating and its short-term rating of “A-1.” In July, Moody’s affirmed its senior secured long-term rating of “A3,” and short-term rating of “P-2.” The ratings from both entities came with a stable outlook. They pointed to the continued achievement of targeted financial goals, strong member relations, the revenue deferral program along with the strong liquidity I mentioned a moment ago, strict cost controls, and the management of capital spending as factors for the reaffirmation.
Along with the ratings from S&P and Moody’s, Basin Electric carries a long-term senior secured “A” rating and a short-term rating of “F1+” from Fitch Ratings. Again, with a stable outlook. We fully expect Fitch will conduct a more thorough and in-depth review of the Basin Electric credit after our meeting with them later this year.
As we expected, the agencies continue to watch the effect of continuing low commodity prices on Dakota Gas, the ongoing COVID-19 pandemic, and its potential financial impacts, as well as the possibility of future environmental regulations due to our relatively large carbon footprint.
Year-to-date financial results
Let’s now take a look at the cooperative’s 2020 year-to-date unaudited financial results for a couple minutes before we move to a high-level review of the 2021-2030 financial forecast.
Electricity sales for the first nine months of 2020 to Basin Electric’s Class A and D members were 19.6 million megawatt hours (MWhs) generating $1.2 billion of revenue. This represents a slight decrease in MWh sales and a 2.4 percent decrease in revenue from the same period last year. Member sales revenue decreased largely due the one mill decrease in the average member rate which took effect on Jan. 1, while non-member revenue decreased primarily due to lower prices.
Operations and maintenance expenses decreased $96.6 million during the first nine months of 2020 compared to the same period in 2019, largely due to lower maintenance, transmission wheeling, purchased power, and fuel expenses. A portion of the decrease in maintenance expenses was due to moving some plant outages from this year to next because of the risk of bringing contractors on-site due to COVID-19.
I think it’s also important to note that as of the end of September, our general and administrative expenses were $11.4 million or 10% under budget, due in a large part to many employees working from home. And, we expect that number to grow through the end of the year and into next as we continue to strictly control costs, including our continued hiring freeze.
The net loss for Dakota Gas for the first nine months of 2020 was $89.5 million. Synthetic Natural Gas, or SNG, and co-product revenue was under budget by $26.7 million and $79.8 million, respectively. The average sales price for SNG, excluding market price adjustments on hedges, was $1.92 per dekatherm or $.70/dekatherm less than the budgeted price. Once again, we need to reference the continuing impact of the pandemic as that has been a major driver in the lower prices of many commodities —including SNG.
While prices for fertilizer products and Diesel Exhaust Fluid were lower for the first nine months of 2020 compared to the same period in 2019, on a positive note, volumes sold actually increased during the first nine months of 2020 compared to the same period in 2019.
Moving to the one thing Dakota Gas can control — expenses — the subsidiary continues to be diligent in managing costs as total operating costs for the first nine months of 2020 were $29.2 million under budget.
For Dakota Coal, even though coal sales were 1 million tons under budget for the first nine months of 2020, net income was $1.5 million over budget.
On a consolidated basis, the net margins and earnings of Basin Electric and its subsidiaries were $116.9 million compared to a budget of $94 million. Our end-of-year projection is for consolidated net margins and earnings of $89.2 million. This is, however, after the deferral of an additional $53 million of surplus sales revenue and the strategic management of $9.5 million of excess margins.
We’ve looked back at our 2019 audited financial results and have taken a look at the unaudited financial results of our first nine months of 2020 operations. So, it only seems appropriate that we spend a few minutes looking look forward.
On a consolidated basis, our 2021-2030 financial forecast shows net margins and earnings of approximately $90 million per year, all while holding rates constant. In other words, maintaining our current average member mill rate. I should also note that we build our revenue deferral pool to $300 million through 2023 as approved by the members at the 2018 annual meeting. But the good news doesn’t stop there. We also show significant — if I dare use that term — excess margins. We would look to use those excess margins to get our balance sheet in order as requested by the membership. This, among others, includes the possible acceleration of the deferred regulatory asset associated with the impairment of Dakota Gas’ gas assets at the end of 2018 and the acceleration of the depreciation of not only the Leland Olds Station, but also of our other coal-based generating stations. However, now that we’re FERC [Federal Energy Regulatory Commission] jurisdictional, we’ll need to work with the commission to get its approval of the regulatory plan.
For many of you, we’ll have more on this at the members-only session this afternoon. For those in the listening audience that are representatives of the many banks, investors, and rating agencies we deal with, we’ll share more with you at meetings we’re in the process of scheduling.
Member Investment Program
One of the great things about cooperatives is our willingness to work together and pool resources. A shining example of this in the Basin Electric family continues to be the Member Investment Program — something we’ve talked about numerous times in the past.
Approximately one-third of the cooperative’s membership participates in the Member Investment Program by investing any excess money they have in a larger pool of funds managed by Basin Electric.
We have been seeing more investments on average, likely because we can offer members a higher rate of return, while still being a cheaper source of capital for us than issuing commercial paper, for example.
Basin Electric’s Member Investment Program has seen several records this year. In March, a new record high of $362.3 million was set. Then in May, that was surpassed, reaching $367.7 million. An even higher milestone was reached in July, when investment levels surpassed $400 million for the first time in history. The success of this program is a testament to the financial strength of the membership.
Basin Electric is continuing to diversify its generation portfolio, this year adding solar to our already diverse mix of coal, natural gas, wind, and other sources. This is important from a financial perspective because the insurance companies, investors, and banks we deal with — as well as the rating agencies — are putting an increased focus on both the qualitative and quantitative aspects of the environmental, social, and governmental factors that are becoming increasingly prevalent.
Pressure on coal
Given that, I’d be remiss if I didn’t bring you up to speed on the continued pressure on coal-based generation. If you recall, last year as part of my presentation I showed a portion of a video highlighting the efforts of a group known as Unfriend Coal. The message was an attempt to convince insurers to stop providing insurance coverage to entities that have coal as part of their portfolio. Without insurance, those entities would simply not be able to operate.
Frankly, the group has been relatively successful and has become even more aggressive in its campaign. Unfriend Coal has changed its name to Insure Our Future and has expanded its scope to urge all insurers and reinsurers to end all support for new oil and gas projects. Without going into detail, I can state that Basin Electric has been impacted by these efforts.
In conjunction with that, a couple weeks ago 60 businesses called upon the U.S. insurance industry to halt insuring and investing in fossil fuel projects. “Coal, oil, and gas infrastructure can’t operate without insurance” the group said in a statement. Note that in this statement, oil and gas were added to the list.
But, the pressure on our industry doesn’t stop there. Early last month, Morgan Stanley became the first major U.S. investment bank to pledge it would achieve a net-zero emission goal in its lending portfolio by 2050, in line with the goals of the Paris Agreement on climate change.
Then, one day later, JPMorgan Chase released a press statement noting that it was adopting a financing commitment that is aligned to the goals of the Paris Agreement. To quote from JPMorgan’s press release, “Climate change is a critical issue of our time. The goals set in the Paris Agreement are commendable and ambitious, but the world is not on track to meet them. While the world has a long way to go, we at JPMorgan Chase want to do more. That means working with clients, policymakers, and advocates to transition our economy and turn the goals of Paris into a reality.”
This is definitely an issue we’ll continue to monitor.
On a lighter note, we’ve covered a lot of numbers and have talked about assets. A few weeks ago, an employee — or that group many of us refer to as “our most valuable asset” — made the following comments to her manager. “I’m very fortunate to work for Basin Electric. It’s not often one can say they truly love their job. There are always going to be ups and downs, but the cooperative spirit is contagious. We need to remind ourselves sometimes just how lucky we are. And being able to work through this COVID pandemic experience should be an eye-opener to employees as to how very fortunate we are. Sometimes there are frustrations that get me down, but through this experience, we need to ask what more can we give of ourselves to our jobs because Basin has given us, especially in this situation, more than most employers.”
In light of everything going on around us and affecting our daily lives, this may just be the opportune time to be silent — to listen and lead.