Prepay-Energy Bonds: A Muni Segment Poised for Growth

What You Should Know

Prepay energy bonds can help issuers lock in discounted power prices, but many municipal SMA managers aren’t equipped to navigate these securities. AB’s innovative technology and infrastructure puts the opportunity within reach as the AI buildout continues to gain momentum.

Prepay Energy Bonds: Sophisticated Tool for Hedging Energy Costs

Public utilities issue this type of municipal revenue bond to lock in long-term rates from an energy provider. The proceeds pay for energy upfront in a lump sum at a discounted rate over the life of a contract that could last decades. This helps hedge against volatility in energy prices.

The utility also saves by leveraging cheaper financing in the tax-exempt muni market, but this is where things get interesting.  Repayment is effectively guaranteed by a special purpose entity, usually a large bank’s commodity arm. This puts credit risk with the financial institution, not the utility.

The structure of prepay-energy bonds and the transaction itself can be complicated, involving many parties. There’s typically a prepay conduit issuer, energy provider (guarantor), participating municipal utilities, commodity swap provider, and guaranteed investment contract provider.

AB’s Innovation Edge Powers Credit Insight and Early Adoption 

Because the prepay energy market isn’t mainstream, muni SMA managers often avoid its unfamiliar, intricate structure. In our view, the issue isn’t fundamental weakness—it’s a lack of understanding of the sectors complexity which is riddled with mispricing and information gaps, which can create opportunities for those who know where to look.

Innovation has enabled AB to be early adopters of prepay-energy bonds. Our integrated platform features taxable and muni investment teams working together to decode the market. With our proprietary optimization and in-house credit research capabilities we seek to solve the impediments that bar traditional managers from buying into an attractive sector creating a benefit for clients. 

Issuance Looks Set to Climb as Energy Demand Rises

We think factors including demand from AI hyperscalers and energy hungry data centers are likely to boost power prices, making prepay energy bond issuance an even more attractive proposition for municipalities to save costs over the long-run.

Today, the prepay energy segment is approximately 5% of the total tax-exempt market, but issuance is growing much faster (Display). The surge in new entrants in 2025 suggests that wide-ranging energy users—from utilities to data-driven enterprises—are looking to lock up funding costs in an uncertain energy landscape. This seems like more than a financial strategy—it could also be long-term planning.

A Modest Share of the Market, but Growing Rapidly

Comparison of Prepay-Energy Segment to Total Tax-Exempt Bond Market 

As infrastructure expands, cities electrify and the urgency of climate goals intensifies, these structures offer municipalities a proactive way to procure energy. That power is foundational to economic development, public services and sustainability, and prepay bonds provide an avenue to support growth, manage budgets and deliver value to ratepayers.

An Attractive Opportunity—but Trading and Implementation Matter

The prepay energy sector offers attractive spreads versus generic high-grade municipal bonds (Display), but it’s vital to get position sizing, liquidity and diversification right.

The structure of these issues can make trade execution complex. But with AB’s scale and experience, we can manage it effectively—aggregating positions, optimizing lot sizes and integrating exposure to align with client objectives. It’s not just about innovative technology—it’s also about having the infrastructure, credit expertise and portfolio design to deploy these bonds effectively in a broader muni strategy.

Prepay-Energy Bonds Offer a Yield Advantage

Option-Adjusted Spread Comparison: Prepay-Energy vs. Municipal Bonds (Basis Points)

We think prepay energy bonds are poised for a wider role. The fundamental story is strong and the early-adopter aspect seems even stronger. Adoption is still light, so spreads are wider than in more crowded parts of the market. The bond structures offer a built-in yield advantage, and spreads could decline further as adoption rises, boosting returns. That seems to put early investors in a good position.

Takeaway: We think prepay-energy bonds are poised to play a larger role, as issuers seek to hedge energy costs in an era of AI buildouts and electrification. AB’s research platform, optimization technology and scale offer municipal SMA investors an early entry into the opportunity.

There is no assurance that a separately managed account will achieve its investment objective. Separately managed accounts are subject to market risk. The market values of securities owned will fluctuate so that your investment, when redeemed, may be worth more or less than its original cost.