IOU, co-op or muni? Experts debate the creation of public utilities
A merger debate in Hawaii has sparked a campaign for a public utility, but is that model best for ratepayers?
It seems that not a month goes by without another installment in "Utility 2.0" news. Most recently, it was New Hampshire, which announced last month that it would join growing group of states in opening a regulatory docket to collect comments on grid modernization and changing utility business models.
How utilities can make money in the 21st century is among the most pressing questions for utility officials across the country, with most executives telling Utility Dive in a survey that they don't expect their business models to be the same in 5 years as they are today.
For the most part, conversations about changing business models have centered on market structures, deregulation schemes, and the amount of vertical integration appropriate in the power system. But in Hawaii, a different question on utility business models is getting a lot of attention as part of a larger debate over a controversial merger — whether the power company serving the state should be an investor-owned utility, a cooperative, or a municipal power company.
It is a debate that could have ramifications for utilities of all types nationwide.
The Hawaii Issue
In response to the proposed acquisition of Hawaiian Electric Industries (HEI) by Florida-based NextEra Energy, a group of residents in Hawaii took their activism beyond opposition to the deal. They formed the KULOLO (Keep Utilities Locally Owned, Locally Operated) movement, aimed at convincing regulators to explore alternate utility ownership models as they evaluate the merger proposal.
“We believe the Utility 2.0 model might be a publicly owned one," KULOLO Spokesperson Rob Harris told Utility Dive.
But not all stakeholders agree. Concentric Energy Advisors CEO John Reed argued in testimony to the Hawaii's regulators that commissioners must evaluate the proposed $4.3 billion purchase of HEI on its own, but must not concern themselves with the growing clamor in the state for a different kind of utility.
“Several parties have filed comments that question whether alternatives should be considered to establish whether the Proposed Transaction is in the public interest,” Reed testified to the Hawaii Public Utilities Commission (PUC).
Reed said the purchase of HEI's subsidiary electric utilities, and not the consideration of alternative, publicly owned electric utility business models is the decision before the commission. But he also questioned the alternative utility models that started the KULOLO movement.
KULOLO would have the commission reject the NextEra/HEI investor-owned utility (IOU) business model in favor of a municipal or a cooperative utility.
Reed argued that the electric sector nationwide is moving further away from co-op and muni models. Eight of ten privitization efforts since 2000 have been approved, he said, while “municipalization has generally been unsuccessful since 2000."
"It is reasonable to conclude that the more recent trend has been privatization," he said.
Of the more than 900 cooperatives and 2,200 municipal electric systems in the U.S., few have been formed in recent decades and “rarely through an acquisition approach,” Reed argued. “The economics of forming a new utility are very challenging.”
Time also works against municipalization or establishing a cooperative that would acquire IOU assets, according to Reed (in docket 2015-0022).
“The timeline to achieve municipalization of IOU assets could be as long as 5 years to 10 years, and often is not successful," he said. "Furthermore, when the financial analysis has been conducted, and all the costs have been identified, municipalization efforts are most often abandoned.”
Struggles to create a public option
Not surprisingly, electric co-op veterans take exception to Reed's perspective.
“The reality is the U.S. is 99.9% electrified and divided into monopoly-defined service territories,” countered Solar Electric Power Association (SEPA) VP Bob Gibson, a former National Rural Electric Cooperative Association executive. “The idea that cooperatives are unworkable because there haven’t been new ones formed is misleading. It is usually just as hard for an IOU to buy a co-op or a muni. There have been relatively few new utilities.”
Only two of 22 municipalization attempts since 2000 were completed, Reed testified. He described 6 attempts in Iowa over a 6 year period that all failed. He described three recent efforts in more detail.
Jefferson County Public Utility District
After a 2008 vote to proceed, it took five years for the Jefferson County Public Utility District (PUD) in Washington State to form an 18,000-customer electric utility in 2013. The $110 million cost was double the original estimate and almost 2.5 times the book value of the Puget Sound Energy assets.
“Despite getting access to hydro power they continue to struggle to match the prior IOU’s rates,” according to Reed.
“Jefferson County is probably the worst example of a takeover to pick,” said Regulatory Assistance Project (RAP) Senior Advisor Jim Lazar. The PUD paid a high price because they were able to take advantage of very low interest rates available through the Rural Utilities Service (RUS).
“It is true they are having trouble maintaining the same rates as Puget but Puget was losing money there,” Lazar said. “Puget was willing to sell because it was a sparsely populated area that created relatively higher operating costs than the rest of their system.”
One of the reasons rates haven’t gone down is that the Jefferson County PUD has made substantial investments in system reliability that Puget wasn’t making, he added.
Winter Park, Florida
Reed also described the four to six year process through which the City of Winter Park, Florida, municipalized with assets acquired from Progress Energy. A bond issuance that promised an $8 million per year profit lost an estimated $11 million over the first four years of operation, the debt service ratio dropped off, and the muni’s credit rating went negative. Only a subsequent rate increase has alleviated the emergency.
“The cost to acquire a utility often overshadows the new utility for decades,” Reed testified. "In addition to the high acquisition costs involved that are often multiples of book value, there is no inherent advantage of a coop or muni on the largest component of a customer’s bill – fuel mix.”
“Most public power takeovers are in the vicinity of 140% of book value and they usually take time to produce significant net benefits,” Lazar said. But non-profits with access to tax exempt bonds and a responsibility to consumer-owners rather than shareholders tend to keep costs low.
“And there is more,” Lazar added. “Satisfaction is much higher both for consumers and for employees whose only jobs are to minimize costs and maximize the quality of service.”
In the case of Winter Park, a long-postponed undergrounding of infrastructure obtained from Progress in the system separation has kept costs high, explained EnergyShouldBe.Org Founder Ken Regelson, a municipalization advocate in the struggle between Xcel Energy and the City of Boulder, Colorado. But, he said, residents have supported the effort with voluntary rate increases.
Reliability has improved dramatically with the number of yearly outages in 2014 falling from 22 to 0.5 and the average outage time cut by 67.5%, Winter Park recently reported. Rates are between 2% and 12% below surround IOU rates. And the utility has paid off all debt incurred in the takeover.
The contentious Boulder municipalization that began in 2011 remains incomplete, and multiple federal and state legal proceedings are ahead, Reed said.
“It has cost millions of dollars,” he reported to Hawaii’s PUC, and “it is reasonable to expect that this case will take years more to resolve at a significant cost to the city.”
“For a co-op or a muni to do a hostile takeover means undoing an incumbent utility. That is extremely difficult and extremely expensive if the incumbent utility is in opposition,” Gibson acknowledged, pointing to Boulder as an example of an IOU unwilling to let go of an affluent service territory.
“But 12 co-ops just bought out the southern Minnesota service territory of Alliant Energy,” Gibson added. “Alliant no longer wanted to operate in those rural and semi-rural areas and they worked out a deal. That has happened often in recent years.”
Where a public option has worked
A takeover is very expensive if it is hostile, Gibson said. “But if there is an opening, there is no reason it can’t work.”
Both Reed and Lazar said the system separation, in which the new utility takes over the involved part of the incumbent’s distribution system, is usually the most expensive and difficult part of the process.
“Most communities already are built out, and large distribution systems are in place,” Reed testified. To purchase or build a distribution system at today’s market prices, “large amounts of capital would have to be raised and spent all at once, and other local government priorities for capital investment likely would be threatened by such a massive outlay.”
As a result, he argued, customers of recently-formed public power companies have not had the low average retail electric rates once obtainable from a takeover.”
“Lots of efforts did not come to fruition,” Lazar said, “but the takeovers that have happened have worked fine.” He highlighted four thriving Pacific Northwest public power providers:
- The City of Hermiston, Oregon, successfully municipalized, despite resistance from Pacific Power and Light (PP&L) in the early 2000s that forced it through the lengthy legal efforts Boulder now faces. An independent 2014 study found its customers to have the region’s lowest utility cost burden.
- The $45.5 million, 1988 buyout of CP National assets by the Oregon Trail Electric Cooperative was, like the recent Alliant deal in Minnesota, relatively pain-free because the IOU wanted out of the utility business and was looking for a buyer.
- The Columbia River PUD takeover of Portland General Electric assets in the mid-1980s began as a hostile proceeding, but a public vote led to a system separation appraisal by regulators that satisfied both sides.
- After the $23.5 million Emerald PUD takeover from PP&L in the early 1980s, the power provider struggled to keep its rates competitive. A $36 million bond offering retired the initial debt but took time to work through needed system upgrades.
“I remember being at a public meeting as a consultant some years after Emerald was formed,” Lazar recalled. “A woman brought a box of candles to the board, saying that reliability had improved so much she didn’t need them anymore.”
Back to Hawaii
Many observers in Hawaii say the sentiment for a public option is so strong that the only thing keeping NextEra from pulling its offer for Hawaii’s electric utilities is a $90 million penalty for withdrawal before next spring. If it backs out at that time or if regulators reject the deal, “Hawaii will go after public options aggressively,” Lazar said.
The most important testimony so far filed is from the State Office of Planning because it represents the Governor’s position, he explained.
“That is the inside game testimony," Lazar said, "and it is visceral about what a bad move it was to bring in an outside corporation.”
But the KULOLO sentiment is no guarantee of success, Reed argued. The 2002 takeover of Citizens Electric by the Kauai Island Utility Cooperative (KIUC) led to rapidly rising rates, despite the unequivocal cooperation of the seller.
“When KIUC started operations in 2002, it had the highest rates of any island," Reed said. "The difference between Kauai and O‘ahu was 69%, and the difference between Kauai and Maui was 35%."
KIUC communications manager Jim Kelly said that's not the whole story.
“There were early issues with the generation mix that caused bills to go up, but the Board started turning things around in 2009 when it set a 50% by 2023 renewables goal,” he said. “Some of the first PPAs for renewables fell through during the financial crisis, but Recovery Act money and the investment tax credit helped propel the utility forward."
We should be at 38% renewables by the end of 2015, and we should get to the 50% goal within about three years," Kelly said.
And, as Reed’s testimony noted, “After 13 years, KIUC’s rates are now in line with other Hawaii islands.”
The cooperative model’s greatest strength, Kelly said, is that “the owner-members democratically determine the direction of the business.” But that means a “huge component” of the utility leadership’s obligation is educating members about issues and costs, because the weakness of the cooperative model is how challenging it is to manage the owner-members’ expectations about rates.
“Being a co-op does not mean your rates are automatically lower any more than being an IOU means rates are automatically higher,” Kelly said.
Decisions about buying and being bought are made by the member-owners of municipal utilities and cooperatives, but both are rare, Gibson said. “Utilities are stable businesses. Unless it is a deal in the interest of both parties, it is going to be hard to make because IOUs, co-ops, and munis will fight to keep their territories.”