Deregulations issues challenge local governments
In 1992, Congress, through the National Energy Act, eliminated the monopoly that energy generators had always had on electricity provision. Six years later, that action is about to have a profound effect on the nation’s 2,015 municipal utilities and 937 rural electric cooperatives.
Optimists assured cities and counties that deregulation would mean serious cost savings because of the resulting competition between providers. Now, however, local governments are finding themselves forced to deal with issues like stranded costs, tax assessments and appeals, and the continued viability of the plants serving them. Consequently, many are finding more questions than answers.
In Haddam, Conn., for example, the Connecticut Yankee Nuclear Power Station, which represents 25 percent of Haddam, Conn.’s tax base, faced many weighty issues. Like many nuclear power plants, it was inefficient and costly to operate. Additionally, much of its operating cost was “stranded,” meaning the plant could not recover that money from customers via rate hikes.
According to Haddam’s First Selectman Keith Ainsworth, stranded costs could have driven the plant to bankruptcy. In fact, two years ago, one report predicted that stranded costs might prompt the closing of at least 10 nuclear plants nationwide; several have since shut down, and others are expected to close shortly. Stranded costs caused concern for Haddam regarding a recent deregulation bill but ultimately the town will benefit from restructuring its utility operations.
“Stranded costs played a central role in the passing of the deregulation bill,” Ainsworth says. “If the stranded costs are not taken care of and the decommissioning funds are not sufficient, we have a half-decommissioned plant.”
Because of that, the idea of utility deregulation was frightening for Haddam, and for other local governments dependent on inefficient (often, nuclear) plants for major chunks of their taxes. In Haddam, the Connecticut Yankee plant had provided more than 500 jobs as well as a built-in tax base. (A recent disagreement over the plant’s tax assessment resulted in a court decision requiring the town to refund $13.9 million in overcharges.)
Decommissioning the plant, which closed in December 1996, was necessary to re-fit the facility as a gas-fired plant and enable it to play a significant role in the newly deregulated market. By 1999, the town expects to be able to choose from among several service providers, thus reaping the benefits of a deregulated market.
Utility deregulation will present numerous local governments with increased credit-quality challenges as competition heats up in towns like Haddam. Municipalities that depend on tax money from investor-owned utilities for much of their operating revenue will be affected first. It is also likely that state and local finance issues related to deregulation will affect about 2,000 municipalities, counties and school districts, as well as nearly 30 states, as electric utility deregulation becomes a nationwide reality in the coming years.
Plant closings The severity of credit-quality problems for individual issuers of tax-exempt debt will depend on the local utility’s dominance as a taxpayer, the pace of deregulation and local government’s adeptness at successfully managing the transition to lower revenues. Because deregulation will require cost-cutting by investor-owned utilities, particularly those with high fixed costs and poor performance records, the utilities will close inefficient power plants. Plants that close will file property tax appeals, threatening local tax revenue.
As in Haddam, nuclear plants nationwide face an uncertain future. According to the Department of Energy, nuclear plants account for nearly 50 percent of total U.S. generation assets but only 22 percent of the power actually consumed. That means significant stranded costs that potentially affect millions of ratepayers. (Estimates of stranded assets run as high as $135 billion.)
In Waterford, Conn., the Millstone Nuclear Power Plant has been placed on the Nuclear Regulatory Commission (NRC) Watch List for poor operating procedures. No final announcement has been made about the future of the plant, whose tax payments account for almost 80 percent of Waterford’s tax revenue. (The units have been out of service for a year and a half, although property taxes have been paid.)
The city’s governing board maintains minimal debt and has financed Waterford’s capital improvements on a pay-as-you-go basis. The city also has maintained substantial operating reserves as a hedge against possibly adverse tax decisions regarding the Millstone facility. Although the city will evidently face challenges over the long term if the plant can no longer operate, its planning strengths may keep it from suffering.
The NRC also has focused attention on the Dresden Nuclear Plant in Grundy County, Ill., which has been on its Watch List since 1996. Dresden’s physical condition, maintenance backlog and radiation protection abilities concern the commission, according to Jim Lutz, director of emergency management for Grundy County, but no decision has been made to close the plant. Commonwealth Edison, which owns the plant and a nearby fossil-fuel-fired plant, represents more than 30 percent of the county’s tax base.
Its property taxes account for almost 50 percent of the county’s revenues, and about 10 percent of the county’s labor force is employed at the two plants. Because of the county’s dependence on Dresden, it “is not positioned well to be competitive,” Lutz says. “They’re working on it, but they have quite a distance to go.”
The county could suffer serious economic repercussions if deregulation prompts the plant’s closing. Offsetting that concern is the county’s direct debt burden of less than .2 percent, most of which is slated for retirement in the next 10 years.
The county also has adequate taxing margins and conservative financial management. In addition, the Illinois legislature recently approved a three-year freeze on depreciation of nuclear power plants to protect school and other taxing districts from reductions in the property tax assessment base.
As nuclear facilities have aged and marketplace economics have changed, many utilities have been forced to decide what role nuclear power will play in their futures. As utilities assess cost structures, inefficient or poorly operating non-nuclear structures may also close. Changes in the Clean Air Act, for example, are expected to affect the economics of smaller, coal-fired power plants, particularly in the Midwest, and could cause plant closings.
Tax assessments and appeals As deregulation evolves, competition will cause the value of utilities’ assets, including that of unprofitable generating plants, to decline. It also will reduce property taxes in communities that assess utility property for taxation purposes.
The tax appeal threat affects a broad group of communities since it affects all utility property, including non-generation utility assets. Whether the tax assessment is based on the income approach to property tax appraisal or cost or book value, a new, lower tax assessment will result.
Most states face hard choices regarding deregulation’s effect on various sources of tax revenue. Almost two-thirds of the states rely on utility taxes as important components of their revenue budgets; nationwide, investor-based utilities alone produce $15 billion in annual tax revenue. Most states have initiated extensive examinations to determine how utility deregulation will affect state and local government finances. Overall, deregulation will necessitate revised tax policies.
Utility managers will pressure local governments to reduce tax assessments since, nationwide, property taxes represent more than 40 percent of utilities’ tax burdens. Although sales of generation assets by investor-owned utilities have resulted in above-book value prices, future sales may fall below book value as the utilities divest their older generation assets.
In 1996, Lake County, Ohio’s delinquent taxes soared when First Energy contested the personal property tax assessment on the Perry Nuclear Power Plant. (The utility’s assets represented more than 10 percent of the county’s assessed valuation that year.) The county’s stable credit record remains threatened by the resulting tax appeal litigation currently before the state appeals court. As electric industry restructuring proceeds in Ohio, pressure on taxable values is expected to increase.
Tax-assessment appeals threaten Oswego, N.Y.’s credit rating as well. Oswego is home to a Niagara Mohawk oil- and gas-fired generating facility, which represents 71 percent of the town’s tax base. The facility’s property taxes fund 66 percent of the city’s operating budget, but there is concern that Niagara Mohawk may sell the plant to divest itself of generation assets. Whether the sale would be below book value and affect its taxable value remains uncertain.
In Suffolk County, N.Y., an over-assessment of the Shoreham Nuclear Plant on Long Island resulted in litigation that has returned a $1.1 billion settlement, the terms of which are still in discussion. The Shoreham plant, owned by the Long Island Lighting Co. (LILCO), opened several years ago but closed quickly because of environmental concerns.
During the plant’s brief history, the county had over-assessed the plant, resulting in higher taxes, which the plant contested. Additionally, LILCO was the only provider in Suffolk County and many customers had complained about high costs.
New York state legislation created the Long Island Power Authority (LIPA) with the authority to acquire LILCO, and it since has assisted with the litigation and settlement of the matter. LIPA also disallowed operation of any nuclear plant on Long Island.
LIPA took control of the LILCO plant, which was decommissioned and dismantled; the parts were sold and distributed elsewhere. LIPA also is acting on behalf of the county’s taxing jurisdictions, including Brookhaven, N.Y., and the Shoreham-Wading River Central School District, to establish a method for paying for the Shoreham plant tax settlement.
The LILCO acquisition is expected to be completed in 1998, though the settlement agreement is still in the works. LIPA is scheduled to begin service to the county this month.
As demonstrated by LIPA, legislation may become necessary to assist cities and utilities with deregulation. Additionally, law-makers can assist utilities with stranded cost recovery and help them build cash reserves if stranded investments cannot be returned, or if their overall customer base diminishes.
Collecting stranded costs In California, the passage of Assembly Bill 1890 has provided a transition period in which utilities have the opportunity to collect their stranded investments. According to Pam Bass, vice president of customer solutions for Southern California Edison in Rosemead, Calif., the competitive transition charge (CTC) has always been part of customers’ bills and will continue to serve as the stranded cost recovery mechanism. A rate freeze enacted with AB 1890, however, prohibits utilities from increasing the CTC charge to further collection of stranded costs.
“Most companies have recognized that this bill gives us a fair opportunity,” Bass says. The transition period will conclude in 2002, at which time companies that have not collected all stranded investments will be responsible for the outstanding funds.
Companies that have secured their investments will be able to offer customers lower rates. The rate freeze, however, means that discounts may not be offered until after the transition period, Bass says. It is safe to assume that utilities operating in an open electricity market will be unable to recover the currently high, above-market, electric power prices from customers choosing another power supplier. Investor-owned utilities represent about $136 billion in stranded costs, so to help them prepare for deregulation, regulators are letting them accelerate depreciation of their generation assets. That also translates into lower book values.
In states in which book value represents the basis for property tax assessment, accelerated depreciation means reduced tax assessments and lower tax revenues. As utilities reduce their potential stranded costs by writing off the value of inefficient generation or by divesting their generation assets to reduce their market power, their generation-related property tax assessments are expected to be lower. That will shift the property tax required for local government operations to other classes of property owners.
Local governments also may need to cut spending to compensate for the lower tax revenues. Deregulation also threatens to affect states that levy gross receipts taxes. Tax bases have been reduced as new players have entered the market, and, when they sell power out of state, they are not governed by the tax laws of the purchaser’s state.
Other ideas Cities and counties can – and are – taking steps to prepare themselves for deregulation. Some, like Dover, N.C., are striking long-term bargains with providers by offering them what are, in effect, new monopolies in return for guaranteed rates. Dover’s long-term deal with Duke-Louis
Dreyfuss is expected to save the city almost $80 million over the next 10 years. In Philadelphia, officials threatened to take their power needs elsewhere, prompting the Pennsylvania Electric Company to offer decreases in the city’s electric rates. Similarly, Brook Park, Ohio, used threats of municipalization to prompt its provider to cut rates. Additionally, in California and a number of other areas across the country, regional partnerships are resulting in lower rates.
Local governments must take pre-emptive measures to avoid being derailed by deregulation. They must plan to mitigate lower taxes, recognize the importance of utility taxes to the municipality’s budget, maintain reserves and accurately gauge the political environment.
Overall, deregulation pressures will intensify, and, as some local governments experience a drop in taxes from investor-owned utilities, their financial positions will likely face stress. Protecting facilities from stranded-cost closings, providing necessary legislation and maintaining consistent tax revenue will allow deregulation to create a flourishing competitive environment.
Dan Aschenbach is senior vice president for Moody’s Investors Service, New York, N.Y.
When electricity first illuminated streets in the late 1800s, private companies began spinning webs of power lines in the nation’s nascent cities. At the time, there was virtually no government supervision of the rapidly developing electric industry, and there was little to prevent the duplication of overhead wires from city centers outward.
To mitigate the confusion as potential dangers and unattractive cityscapes began to emerge, local authorities and states decided to take control. They determined that a regulated geographic monopoly was the best way to allow the competing electric companies to grow and serve citizens. In return, regulatory bodies would oversee electric company operations and determine the rates of return the companies could earn.
Electric utilities and their investors have long enjoyed that monopolistic structure with steady growth and price increases. Today, however, high electric rates in parts of the United States, combined with global competitive pressures on U.S. manufacturers (typically the largest users of electricity) have resulted in calls for drastic change. Industrial electric customers won their argument, and they now enjoy a choice between wholesale electric suppliers nationwide. Retail consumers of electricity have yet to benefit from a choice of providers.
The next round of electric industry restructuring includes retail access to competitive electricity, which will allow residential, commercial and municipal customers to purchase electricity from any supplier they choose. That raises the question of how local governments will be affected by the move toward full retail competition in the electric industry.
Careful planning will ensure that local governments are able to maximize the benefits associated with deregulation. To do that, cities and counties will need to become smarter consumers. Additionally, cities and counties may have to:
* act as brokers or aggregators for their residential or business consumers to ensure that they, too, benefit from the changes with lower rates;
* examine the existing financial relationships with their local electric companies in terms of fees and taxes received to ensure that those important revenues continue to flow under the different market structure; and
* for those that operate municipal electric utilities, examine their own competitive position in terms of the prices they offer, their customer service operations, and the competitiveness of their distribution systems.
The entire picture is changing with regard to the buying and selling of electricity, and the old relationships between local governments and their current electricity providers will change as well. Counties or cities with electric power plants may see changes in ownership; in fact, restructuring provides an opportunity for local governments either to sell some or all of their utility operations or to buy some or all of the operations of their current providers.
Local governments with high energy needs, large blocks of potentially vulnerable citizens or high portions of revenues tied to electric industry operations will also be dramatically affected by deregulation. Most of those municipal systems have had to develop wheeling rates for transporting the power of other suppliers through their system or to end users within their system service territories, thus creating a new source of revenue from large customers.
Other local government entities, such as those with few facilities, no legal relationship and minimal receipts from the electric industry (no franchise rights, no right-of-way fees), may see less of an impact from retail competition on their costs of operations or on their constituents. Additionally, the 1996 deregulation of wholesale electric markets may eventually have a silver lining for local governments because manufacturers and other large customers no longer have to move their operations to obtain more favorable electric rates.
Planning ahead and providing appropriate education about the issues will determine how the coming changes will affect cities and counties. Local governments need to take the upper hand in deregulation and ensure that the changes taking place will benefit both local government’s operations and its citizens.
This article was written by Luisa Freeman, a Vienna, Va.-based freelance writer.
The Clinton Administration’s electric utility deregulation plan addresses a number of issues that will affect local government. The Comprehensive Electricity Competition Plan lists specifications for state governments attempting to regulate retail competition between electric providers and for federal interaction with and among those local governments.
The plan lists five main objectives to aid with quality control:
* Encouraging states to implement retail competition. The plan includes a “flexible mandate” requiring utilities to allow customers to choose their suppliers by Jan. 1, 2003; however, states can opt out of competition if they determine, through a public proceeding, that consumers would be better served by an alternate policy or continued service under the current monopoly.
The plan directs state public utility commissions to regulate and provide for recovery of stranded costs, adding that the Federal Energy Regulatory Commission (FERC) should provide a backup plan for the states;
* Protecting consumers by fostering competitive markets. All electric suppliers will be required to disclose information on the prices, terms and conditions of their services, as well as on their generation source and emissions. Similar to FDA food label requirements, utility disclosure presumably will educate customers to help them make better decisions about their suppliers. Companies also will be required to provide federal and state access to their books and records. FERC also will regulate market power by overseeing any mergers or consolidations of companies, which may occur more frequently in a competitive market;
* Ensuring access to and reliability of the transmission system. FERC will institute and oversee a private organization that will set and enforce standards to ensure reliable service for customers. To prevent operators from favoring certain customers, all utilities will be required to participate in an independent system operator structure that gives FERC the authority to release control of a company to an independent operator. A regional transmission planning agency will be created to govern the regional market;
* Promoting and preserving public benefits. The plan calls for a Renewable Portfolio Standard which requires companies to obtain a percentage of their sales from renewable sources such as wind, solar power, biomass or geothermal generation, thus saving customers money.
By 2010, 5.5 percent of sales must be generated from renewables. In addition, the plan calls for a $3 billion-per-year fund to be established. It will provide matching funds to states for low-income assistance, energy efficiency programs, consumer education, and development and demonstration of emerging technologies, such as renewables; and
* Amending existing federal statutes to clarify federal and state authority. FERC will have jurisdiction over rates, terms and conditions of retail transmissions and the authority to order retail transmission in certain areas. Statutes will be amended to ensure that suppliers have comparable access to all necessary transmission facilities and to ensure overall compliance with the new retail competition.
The plan also calls for an amendment to the Internal Revenue Code to ensure that private-use limitations do not apply to outstanding bonds for public utilities and to provide for taxation of bonds for new facilities.
The Administration’s plan supports retail utility competition with federal legislation. Its architects claim that the specifications will result in lower prices, a cleaner environment, new services, innovations in technology and more reliable service for all participants. The full text of the plan can be accessed online at www.hr.doe/electric/plan.htm. -Christina Couret
As utility companies face deregulation, customers are, for the first time, permitted to choose their service providers. But deregulation also means that customers must educate themselves about their different options instead of blindly accepting the company that served them previously.
Deregulation has already affected the Northeast and California, and other states are beginning to establish competitive utility marketplaces. For example, Pennsylvania has initiated deregulation in phases, starting with a 13-month pilot program for 5 percent of the state’s residential, industrial and commercial electric customers. Roughly two-thirds of the state will be eligible to enroll in the program before the end of the year, and the remainder of the state’s customers will have a choice of providers by January 2000.
Although some customers may opt to stay with their original service providers, many in Pennsylvania are learning about deregulation through state-sponsored educational broadcast and print ads. Some companies have educated customers through mailed notices, media campaigns, workshops or web sites.
PECO Energy Horizon Group, a Wayne, Penn.-based participant in the state’s pilot program, suggests customers ask the following questions when choosing a supplier: * Is the supplier a licensed company?
* Is the supplier local or out-of-state?
* What are the payment options? (Some suppliers accept payment in a variety of forms, such as check, electronic funds transfer or credit cards.)
* Is a signed, long-term contract necessary to get the rate or discount quoted?
* Does the price or discount include all fees and taxes?
* Is there a fee or penalty to switch suppliers?
* Is a special meter required? If so, will there be a charge for installation?
In addition to asking questions, businesses should:
* Define the company’s needs;
* Consider choosing a supplier with additional services, such as energy management, fuel procurement or telecommunications support;
* Know the difference between real savings and token gifts;
* Look at the experience and expertise of the supplier; and
* Determine the company’s decision-maker.
Although customers may initially be confused by the different service options available through deregulation, all customers will profit from flexibility in choosing their suppliers. Competition will force the companies to create more benefits, such as 24-hour customer service and multiple payment options, for their customers. Pilot programs enable companies and customers to sort out any problems with deregulated service, establish a model for statewide service and educate the customers about their choices.