Charts of the Month: SPACs, ERCOT, Medicare Advantage Reform, and CA Clean Energy

April 2021

Capstone’s Charts of the Month highlight regulatory, legislative, and policy-driven developments that investors should be paying attention to. All graphics were recently published in Capstone research.

For more information on any issue, contact sales@capstonedc.com.

In this edition:

1. SPACs: SEC Scrutiny Unlikely to Undermine Market; No Momentum for Impactful Legislation
2. California’s Vision for 100% Clean Energy Will Offer Investors Opportunities Across Value Chain
3. Medicare Advantage Reforms in Dem. Crosshairs as a Pay-for Amid Looming Insolvency; Medicare Buy-in Would Clear Path
4. ERCOT: NRUC CDS Attractive as a Hedge Against Further Disruptions in ERCOT Market & Other Risks

1. SPACs: SEC Scrutiny Unlikely to Undermine Market; No Momentum for Impactful Legislation

The size of the average SPAC has increased, which, combined with private investment in public entity transactions, has allowed for the acquisition of larger operating companies in the de-SPAC transaction. We believe this increased popularity has led to inevitable scrutiny by the SEC.

Number of SPAC IPOs and Average Size, 2005–2021 YTD

Source: SPAC Analytics, Capstone analysis; accessed 4/1/2021

Our Take: Capstone believes that despite increased scrutiny of Special Purpose Acquisition Companies (SPACs), the SEC is unlikely to undermine the market and eliminate the opportunity for companies to go public through a SPAC. SPAC offerings have faced two primary criticisms: 1) the companies provide financial projections that prove overly optimistic, and 2) compensation structures incentivize SPAC sponsors to complete an acquisition, even at unfavorable terms. While we expect the SEC to closely review SPAC filings, provide more comments and guidance for greater compliance, and potentially pursue enforcement against companies that do not comply with regulations, we do not think the commission can independently prohibit financial projections or limit compensation models. Legislative action is required to increase the liability for de-SPAC transactions and to effectively prohibit financial projections, and there is currently no momentum for legislation.

2. California’s Vision for 100% Clean Energy Will Offer Investors Opportunities Across Value Chain

Utility-scale solar and solar + storage systems will likely continue to dominate California’s interconnection queue in the coming years. However, recent grid reliability concerns have elevated the importance of a diverse resource mix and are likely to ensure continued opportunities for other generation resources, including onshore wind and distributed generation.

Projected New Generation Capacity, 2030 and 2045

Source: California Energy Commission

Our Take: California’s three key energy policy regulators—the California Energy Commission (CEC), California Public Utilities Commission (CPUC), and California Air Resources Board (CARB)—released the SB 100 Joint Agency Report: Charting a path to a 100% Clean Energy Future, outlining the state’s strategies for achieving its target of 100% clean electricity by 2045. While not necessarily predictive or prescriptive, the March 15th report highlights the enormity of the challenge that California and other states face pursuing rapid decarbonization. Addressing these challenges will define policy in California in the coming decade and, in our view, will provide significant opportunities for investors across the energy value chain.

3. Medicare Advantage Reforms in Dem. Crosshairs as a Pay-for Amid Looming Insolvency; Medicare Buy-in Would Clear Path

Medicare Advantage (MA) reform would likely take shape in the form of reduced quality bonus payments, changes to the benchmarking system, or increased attention on coding intensity, detailed below:

Likely Avenues for Democrats’ Medicare Advantage Reform Efforts

Source: Capstone analysis, MedPAC, Brookings Institution, CBO

Our Take: Capstone believes investors should pay attention to Congressional action to reform Medicare Advantage (MA) as a central pay-for for Democrats’ lofty healthcare goals. As the Medicare Trust Fund’s 2024 insolvency nears, we believe the likelihood that Congress uses MA reform as a pay-for is increasing, as it would save Medicare at least $10 billion annually. Although it is not our base case, the initial catalyst we believe would increase the likelihood of MA reform the most is Congress passing Medicare buy-in legislation before the 2022 election. We estimate that buy-in legislation could double MA enrollment, a significant tailwind for MA insurers. However, it would exacerbate the Medicare Trust Fund’s nearing insolvency and the need for meaningful pay-fors. We believe that once drug pricing is expended as a pay-for, MA reforms would be a necessary and underappreciated avenue for Democrats to accomplish their ambitious policy goals. We expect legislation to reform MA will be introduced in some form.

4. ERCOT: NRUC CDS Attractive as a Hedge Against Further Disruptions in ERCOT Market & Other Risks

The National Rural Utilities Cooperative Finance Corp.’s (NRUC) credit default spreads have barely budged since Winter Storm Uri, despite its $4.6 billion exposure to rural utility cooperatives in Texas. Many of these cooperatives were very hard hit by Uri, and loans to cooperatives in Texas represent almost 16% of the NRUC’s loan portfolio.

Our Take: Capstone believes investors looking for a hedge against long positions in the Electric Reliability Council of Texas (ERCOT) market should consider credit default swaps of the NRUC, a member-owned lender for US electric cooperatives, due to its exposure to the Texas market. The NRUC has a total of almost $500 million in exposure to Rayburn Electrical Coop. and Brazos Electric Power Coop., two of the hardest-hit transmission and distribution cooperatives in Texas. However, we believe it is likely that the NRUC also has exposure to the distribution cooperatives that are members of either Rayburn or Brazos, so the NRUC’s exposure is likely greater than the $500 million disclosed to investors.

Uri’s financial burden has been a significant source of financial strain on market participants throughout ERCOT—particularly with respect to rural electric utility cooperatives, which tend to be net purchasers of power and have been harder hit by the disruptions in the power market during Uri. We believe the financial strain is not confined to the specific utilities and retailers that incurred substantial operating losses during the February storm. Lenders that have substantial exposure to certain municipal utilities and retailers in Texas—and specifically to electric utility cooperatives—also face increased risks.