LI Power: The political hot potato – By George J. Marlin

The following appears in the March 1-7, 2013 issue of the Long Island Business News:

For close to half a century, the generation, distribution and maintenance of electrical power on Long Island has been a hot potato tossed around by governors, county executives and local pols fearful of being held accountable for outlandishly high electric rates and blackouts.

The political posturing over the years has been nothing if not confusing. For instance, when Gov. Mario Cuomo pushed for a Long Island Power Authority takeover of the Long Island Lighting Co. in 1994, he argued that state control would mean “a new accountability” for the utility.

Eighteen years later, Gov. Andrew Cuomo, pushing for the re-privatization of LIPA’s power grid, denied he bore any responsibility for LIPA’s dismal response after Hurricane Sandy.

So much, in other words, for accountability.

The truth of the matter is that since the 1960s, cowardly public officials have been responsible for Long Island’s power woes. To fully understand this phenomenon, a walk down memory lane is essential.

In the post World War II era, federal housing programs fueled a residential construction boom on Long Island, pushing the population of Nassau and Suffolk counties from 948,000 in 1950 to more than 2.6 million a short 20 years later.

During this boom period, oil was plentiful at $10 per barrel and LILCO was able to maintain cheap rates while meeting the increased demand for electrical power.

But politicians panicked in the early 1970s when the Middle East embargo pushed the price per barrel to over $60, causing significantly higher local electrical charges.

Fearful of voter backlash, they supported LILCO’s plans to build a nuclear plant that they were certain would provide an unlimited supply of cheap power.

Construction of LILCO’s Shoreham nuclear facility began in 1973 and was nearing completion by 1984. In May 1988, however, with changes in the political climate – and with memories of gas lines fading – federal and state government officials blocked Shoreham from opening. The environmental lobby was appeased, but LILCO was destroyed financially, its ability to fiscally recover severely impeded.

Mario Cuomo assured Long island that LILCO’s customer base would not be stuck with the costs of mothballing Shoreham. When a deal was finally struck in February 1989, however, the opposite occurred.

When the newly created Long Island Power Authority took title to Shoreham in March 1992, LILCO had to eat the costs of the debacle, and its 1 million customers were told to expect rate increases of at least 5 percent annually for a minimum of 10 years. This policy brought LILCO residential rates to 17.3 cents per kilowatt an hour – the highest in the nation and triple the cost of some areas.

The state had also promised to create for LILCO a network that would provide cheaper hydro-electric power to help bring down costs. However, a Long Island Sound cable link, which would have transported hydro power from Canada to a New York Power Authority substation in Westchester and then on to LILCO, was abandoned when the governor pulled out of a Hydro-Quebec power deal.

He officially claimed that New York’s successful conservation program and the drop in oil costs made the deal unnecessary. Albany insiders agreed the real reason was that Cuomo didn’t want to upset environmentalists, who were protesting that the lives of Canadian Cree and Inuit Indians would be disrupted by the alteration of river flows needed to generate the electricity.

Additional pressure was put on LILCO’s residential base when local governments announced they would purchase cheaper electricity elsewhere under provisions of the 1992 Federal Energy Policy Act, which encouraged independent power producers.

Increased utilization of independent power producers by local governments and corporate users only added to the bills of homeowners, because LILCO’s expenses had to be spread over a small customer base.

In 1994, three weeks before an election in which he trailed badly on Long Island, Mario Cuomo announced a surprise $9 billion proposal for a government takeover of LILCO and for the then-ailing NYPA to run the critically ill local electrical grid.

While NYPA would oversee daily operations under the plan, LILCO was to be officially purchased by LIPA, a government shell created in July 1986 and headed by Cuomo crony Richie Kessel. To calm the political waters, the plan included a clause that mandated LIPA to pay local municipalities over $300 million annually in lieu of property taxes formerly paid by LILCO.

There were other disturbing aspects of the proposed LILCO takeover. Cuomo announced the plan without providing a feasibility study by a recognized firm specializing in utilities. Although the 1983 $2.5 billion default on Washington Public Power bonds proved that feasibility studies do not ensure successful projects, some sort of data was vital here before the boards of LILCO and NYPA could bless the deal and Wall Street could contemplate underwriting $9 billion in bonds.

There were also concerns that such a large underwriting of bonds could endanger the overall ability of the state and its municipalities to borrow, and that it could increase borrowing costs for everyone. Then State Comptroller H. Carl McCall, a Democrat and Mario Cuomo running mate, had “serious concerns” about the proposal saying: “If this proposal were to go forward and LIPA were to try to go to market and raise some $9.7 billion in debt, I think that might have a very serious impact on other municipal debt.”

McCall also questioned the qualifications of the two agencies that would be charged with managing Long Island’s electrical grid.

“The two agencies that the governor proposes to run this program, LIPA and NYPA, have never had any experience in terms of providing utility services to residential customers,” he said.

Mario Cuomo’s takeover plan, which a New York Times editorial labeled as “clearly an election year ploy,” was savagely attacked by Republican gubernatorial candidate George Pataki, who called it “corporate welfare” and “political opportunism at its worst.”

In a TV ad, Pataki said, “It shows a blatant disregard for taxpayers and the fiscal stability of our state. This cynical deal rips off upstate taxpayers who get nothing but the bill. And it’s not even good for the taxpayers on Long Island. It’s government welfare for a giant corporation that is failing.”

Pataki condemned the deal as an attempt to “buy votes on Long Island by putting our children $9 billion dollars further in debt.”

Two days after his victory in the ’94 gubernatorial election, Pataki confirmed his opposition to the Cuomo plan for the state to purchase LILCO. Pataki’s own transition team recommended against the takeover.

In late 1995, however, Pataki suddenly dropped his opposition to a LILCO takeover. He endorsed a dismantling proposal that further extended the arm of government into people’s daily lives.

“To return a tiny rebate to Long Island voters, Pataki used a new state authority to take over the Long Island Lighting Co.,” said Tom Carroll, chief of the anti-tax think tank Change-NY. “The move required a jaw-dropping municipal debt offering – the largest in U.S. history. Moreover, as other states move toward efficient market-based provision of energy – low energy costs being a key consideration of business when they decide where to locate – Pataki has extended inefficient government control over energy.”

As a New York state “public benefit” corporation, LIPA, unlike LILCO, does not have to pay federal income taxes or dividends, and its interest costs on tax-exempt bonds are lower than LILCO taxable corporate bonds, so there were savings that permitted electrical rates to drop temporarily about 12 percent.

LIPA was intended to be nothing more than a holding company with no more than 25 staffers to oversee financing and debt management. The actual maintenance, generation, transmission, and distribution work was to be handled by KeySpan and, later, by National Grid.

Instead, LIPA’s staff ballooned to over 100 employees as the authority became a dumping ground for the relatives of the politically connected seeking high-paying employment.

According to the State Authority Budget Office’s Annual Report for 2007, LIPA had 49 employees making over $100,000, or fully 49 percent of its workforce. The percentage of six-figure workers at other state authorities at that time was just 7 percent. And the average salary of the 49 percent at LIPA was $154,000.

In a January 2009 article, Newsday also questioned LAPA’s energy contracts, noting that the authority had “inked more than $6 billion in new long-term energy and capacity contracts over the past half decade without disclosing a cent of the costs to ratepayers.”

Most of the contracts were for availability to various power plants “and not for day-to-day costs to buy the actual energy.”

As L.I. Energy Surveillance founder Fred Gorman put it: “That’s a lot of money for an extension cord we don’t need.”

These questionable actions may help explain why LIPA customers pay $460 more for electrical power each year than they did 10 years ago. The average cost per customer from 2002-2012 increased 42 percent, versus 33 percent in the rest of the state, and 27 percent nationally.

When Eliot Spitzer became governor, he made it clear that he was eyeing big changes at LIPA. One member of Spitzer’s inner circle said the goals included “making LIPA more business focused and less political and public-relations driven.

“LIPA needs to move away from the gimmicking – rebate checks and small rate reductions.”

However, the only change Spitzer made in his short tenure as New York’s chief executive was to fire Kessel.

Because LIPA squandered hundreds of millions of new debt on consultants, on failed fuel cells, electric buses, solar panels and costly research and development programs that yielded little, investments in nuts and bolts infrastructure suffered. The effects of this neglect became evident during 2011’s Hurricane Irene and last year’s Hurricane Sandy.

LIPA communications with customers was awful and the authority failed to implement simple prescriptions that could have helped prevent outages all over Long Island, including updating ground workers’ technology and equipment and improving customer communications systems.

The agency failed to implement 2006 recommendations to replace its obsolete 25-year old outage management system. When Sandy hit, field workers were using memo pads, not iPads or smartphones to track and repair outages.

After Hurricane Irene, Gov. Andrew Cuomo made it clear that LIPA needed to be dramatically reformed. “End it, don’t mend it,” he declared.

A spokesman for the governor said: “The bottom line is that LIPA has become bloated and expanded far beyond the job it’s supposed to do. The governor believes that LIPA should be returned to its core mission in order to reduce costs for ratepayers. This means drastically reforming the current way it does business.” While the governor did order NY’s inspector general to investigate LIPA rate practices and billing system, there was little other action.

In fact, the current governor failed to appoint a suitable person to LIPA’s CEO position, which has been vacant since he took office in 2011. Cuomo, who appoints nine of LIPA’s 15 trustees, also failed to fill board vacancies. When Sandy hit Long Island, there were four governor-appointed vacancies as well as five holdovers whose terms had expired.

In the wake of the Sandy debacle, the governor went looking for a culprit.

A New York Post editorial put it this way: “Now Cuomo’s searching out the guilty party – but he would do well to look in the mirror before he travels too far down that road. Cuomo can point all the fingers he wants. But some of them are pointing right back.”

A Nov. 19, 2012 editorial in The New York Times agreed: “Mr. Cuomo was right to call for an investigation. But if the investigators are diligent, they will find that one of the problems – and also one of the answers for a more reliable system – lies right in the governor’s office.”

The investigation the Times mentioned is a Moreland Commission on utility storm preparation and response the governor appointed late last year. With the exception of former NYPA Chairman John Dyson, the other nine members were mostly politicos with no utility experience.

To no one’s surprise, a hastily prepared 16-page preliminary report, released in January, concluded that LIPA had a dysfunctional management structure and the least risky restructuring option was an investor-owned utility in which a “qualified private utility purchases LIPA’s assets and serves as a sole utility manager.”

Less attractive alternatives, according to the commission report, include having LIPA assume full authority to manage the system and operations, or having LIPA turn over all management responsibilities to the New York Power Authority.

So, what about privatization? Is selling LIPA to a private utility the right decision, or is it just the governor’s way of tossing the hot potato to a third party?

In 2010, following the advice of its financial adviser – Lazard Ltd.’s Power, Energy and Infrastructure division – LIPA hired the Brattle Group to conduct a strategic organizational study to determine if, among other alternatives, a sale of its assets and businesses to a private utility would benefit ratepayers.

Under the privatization option, the Brattle Group concluded the financial structure and the cost of capital dollars would have to change. Fifty percent of the purchase price of LIPA would have to come from an equity investment and the other half would have to come from the proceeds of newly issued taxable debt.

Brattle concluded that under this scenario the cost of running a new, private entity “would go up roughly $438 million per year due to financing costs alone.”

More troubling: Because LIPA’s outstanding debt of almost $7 billion includes non-callable bonds that cannot be immediately redeemed, the authority cannot pay off all its debt when title is transferred to a buyer. LIPA would have to continue paying interest on the debt until all its bonds can be redeemed at future call dates or upon maturity.

“As a result,” Brattle reported, “LIPA would need to raise approximately $961 million more than its current debt obligations. This increases the cost of privatization.”

The Brattle Group concluded that any savings in operating costs that might be realized under a privatization scenario would be “overwhelmed by the increase in new financing costs.” By Brattle’s estimate, a rate hike of as much as 20 percent would be necessary.

And that conclusion does not factor in that an investor-owner, unlike LIPA, would have to pay federal and state taxes on net earnings, would have to give a return to investors and would not be eligible for the FEMA reimbursements enjoyed by government.

In the case of Hurricane Sandy, the private entity would have had to pass on more than $1 billion of recovery costs to ratepayers.

The privatization scenario also doesn’t include the costs of infrastructure improvements that would have to be funded with higher-cost, taxable corporate bonds.

So what has changed since the Brattle report was released in 2010? Answer: The political climate. In the wake of Hurricane Sandy, state and local politicians are in a panic trying to cover their butts.

As a result, the state has hired Lazard Ltd. to take a new look at privatization, while also glancing over the range of other options. Gov. Cuomo has also dispatched his secretary, Larry Schwartz, “to engage elected officers and business and community leaders to form a consensus around the best option for LIPA.”

So far, Schwartz has been telling anyone who will listen that the governor has not yet made up his mind.

Although Lazard has not yet released its findings, privatization clearly remains a preferred option. Details leaking out of the consulting firm’s recent meeting with Long Island Association executives suggest a scenario in which the $3.8 billion Shoreham debt would be guaranteed by the state and re-bonded at lower interest rates for 20 years.

A private entity would be found to buy LIPA’s assets for the remaining $4 billion of debt and financing costs – more if they can get it – finally getting LIPA off Long Island’s back.

Again, details are wanting, but the plan appears similar to stranded asset financings that were done for private utilities in numerous states, including California, Connecticut, Massachusetts and New Jersey.

Proponents may claim that ratepayers’ monthly payments on the new Shoreham debt would be smaller – and they would – but only because the debt would be paid off by the children and grandchildren of current customers.

It’s like refinancing one’s 10-year home mortgage with a 30-year mortgage. Monthly payments may go down a bit, but the total interest payments over the extended 20 years will be significantly higher than the total interest paid on the 10-year mortgage.

Other issues that could muck up a privatization deal: The new owner would have to successfully terminate or renegotiate LIPA’s existing power service agreements with various providers, and retool, or get out from under, the new management service agreement with PSE&G. The acquirer would also have to deal with LIPA’s ownership interest in the Nine Mile Island nuclear facility.

Then there is the governor’s condition that there must be a rate freeze for three to five years after LIPA is acquired. Similarly, the governor wants guarantees that local communities would not immediately suffer the loss of the hundreds of millions of dollars LIPA pays in lieu of taxes to support local governments and schools.

Why would a private utility with an obligation to its shareholders to make a profit buy this political hornet’s nest knowing it would be expected to improve services and to rebuild a decrepit infrastructure without raising rates?

What happens if the costs exceed the allowed revenue during the rate freeze? And what happens immediately thereafter? A rate freeze might give cover to politicians to get through the next election, but rates would eventually go through the roof.

In my judgment, no company would touch such a deal unless it is forced into it.

Privatization of LIPA would not benefit its customers. It would only benefit elected officials who want to be off the hook when disaster strikes.

So what is a feasible plan? The first step, I believe, was implemented when Gov. Cuomo ordered National Grid to take command of the response to winter storm Nemo in February.

That’s the way it was supposed to be from the moment LILCO was bought out. KeySpan, and then National Grid, were supposed to be the responsible manager and public face during a crisis, not LIPA. They have the expertise and better response plans and communication systems.

Next, the governor should downsize the LIPA board and appoint smart people who are not political hacks, who are willing to make capital improvements and who will not be intimidated by extremist environmental bullies.

The reconstituted board should then eliminate at least 75 percent of LIPA staff, leaving only green-shaded number crunchers. Costly renewable-energy projects should be shelved.

Finally, the management company should be instructed to implement short-term, achievable improvements that can limit outages the next time disaster strikes. This should include trimming trees, replacing damaged poles and providing workers on the ground with the latest communication technology. The savings from LIPA’s downsizing and the sunset of no-return “green energy” projects should easily cover the costs.

As for major capital improvements, such as burying power lines in new developments and areas where it is economically feasible, they will have to be funded with proceeds from long-term bonded debt. Unlike a private utility, the reformed LIPA would still be able to raise the capital at cheaper interest rates via the tax-exempt market.

The best approach will be a gradual one. As existing bonds mature, new debt could be issued that is specifically dedicated to hardcore projects, not pie in the sky experiments.

If, over time, rates must go up to achieve further progress, the cost will be much more palatable to customers seeing genuine service improvements.

The sine qua non to achieve the ends I have described is a leader who has the vision to see beyond the next election. Long Island’s long-suffering citizenry deserves no less.

Marlin, a former bond trader, has been an investment banker for more than 35 years. He is the co-author of “The Guidebook to Municipal Bonds: The History, The Industry, The Mechanics.”

 

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