Public power gains popularity as sector sustains its financial strength

Pam Boschee, Managing Editor

Electricity consumers across the country are awakening to a new way of doing business with an electricity provider. Particularly in the West, they are exploring the concept of public power systems. The prospect of shielding from rate spikes and inadequate supply is appealing to consumers who smarted from costly bills and blackouts.

For example, in November 2002, San Francisco voters rejected a measure that would have allowed for a city takeover of PG&E Corp. The vote was 53 percent to 47 percent. In November 2001, a similar vote came within 520 votes of passing.

In Clark County, Nev., which includes Las Vegas, 57 percent of voters voted “yes” in November 2002 on a non-binding measure that enabled establishment of a public power system.

In September 2003, an initiative in Winter Park, Fla., passed 69 percent to 31 percent to give the city permission to take over Progress Energy’s facilities.

According to the American Public Power Association (APPA), about 100 communities have indicated their interest in exploring the creation of a public power system in the last two years. APPA knows of about 50 that are moving forward.

Advantages of traditional strengths

The traditional strengths of public power have served them well over the rocky period of financial meltdown experienced by merchant power and many investor-owned utilities (IOUs). The public power systems sustained their collective solid credit foundation via their focus on the mission of providing low rates to customers and the general lack of direct competition for retail customers. These utilities are able to quickly enact and implement rate increases or rate cuts because of the absence of state or federal rate regulation. This flexibility allows them to respond to changing costs or competitive structures in ways not possible for IOUs.

However, public power utilities are also under pressure to preserve existing rate structures, either due to political reasons or because the rate base may not be able to bear further rate boosts.

This sector includes municipally owned electric utilities, combined utilities that provide retail water, sewer or gas service along with electric service, as well as joint action agencies consisting of two or more participating utilities that have joined together to achieve economies of scale in developing capital resources and other mutually beneficial services. Most public power utilities operate as vertically integrated utilities and either own or have secured, through long-term contracts, sufficient generation to meet native-load demand.

Public power ratings remain strong

Accoring to Standard & Poor’s (S&P), which has about 240 ratings in the public power sector, the overwhelming majority of the sector carry investment-grade ratings, with only five ratings below investment-grade. The overall credit strength of public power is further demonstrated by the rating distribution, with about 80 percent rated at least “A-” and 21 percent of ratings reaching the “AA” category. A healthy 89 percent of the rated public power entities have stable outlooks. At the high end of the spectrum, Palo Alto, Calif. and San Antonio, Texas’ City Public Service are rated “AA+”. These two utilities share the characteristics of vast and diverse service territories, experienced and proactive management, and consistently strong financial performance.

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In contrast, U.S. IOUs in 2003 the average rating for this sector slipped out of the high “BBB” category into the mid-“BBB” range. The number of companies rated “BBB” and below has continued to rise while the number of firms rated “A” and above declined. About 35 percent of the IOU sector now carries rating of “A-” and above, compared with nearly 40 percent just one year ago. About 47 percent of the sector falls into the “BBB” category rating, and 18 percent are rated speculative grade, including six companies that are rated “D.” Last year also brought numerous outlook changes from stable to negative, according to S&P.

The future looks bright

S&P reported that with limited, exceptions, U.S. public power utilities have shown a willingness to adjust rates as needed and to implement pass-through mechanisms that recover costs. The credit rating impacts of federal energy legislation, a new transmission structure, the continued deterioration in creditworthy counterparties in the industry as a whole, volatile natural gas and energy prices, new environmental compliance standards, a mandated renewable portfolio and variable weather patterns, for example, should be limited. S&P expects that public power’s generally conservative approach and limited appetite for risk should result in maintenance of the strong credit quality of the sector as a whole.

Fitch Ratings reported it expects credit quality of municipal electric systems (and rural electric cooperatives) to remain failty stable. Rating changes would continue to most likely reflect individual credit issues.

Fitch noted that renewed emphasis on the building of new coal-fired power plants appears to be taking place. Although this reflects coal’s greater price stability, it will also require a greater refocusing on underlying assumptions related to this type of generation, including environmental issues, technology, fuel availability and pricing, and construction costs.

View from the top

EL&P had the opportunity to learn more about these issues and others in an exclusive interview with Joe Nipper, senior vice president, government relations, American Public Power Association. At the time of the interview, a rally of about 800 APPA members had concluded in Washington, D.C.

EL&P: What are the top priority issues for public power?
Nipper: The issues that we were focusing on during the rally were threefold: the pending energy bill and what may happen to it. If it’s enacted, what will the next steps be which essentially leads to rulemaking; Clean Air Act changes or air quality issues more in general, looking at the Clean Air Act proposals pending in Congress as well as the continuing development of the administration’s climate position program, the updated, enhanced voluntary greenhouse gas reduction program. We’re actually participating in that development with the administration. We continue to support a voluntary approach vs. mandatory caps. We also identify the area of telecommunications, which is a burgeoning service area for our members. We’re increasingly aware and under the impression that Congress is beginning to set the stage for next to begin the process of a comprehensive overhaul of telecommunications law, so we will want to be involved in that.

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EL&P: Although the energy bill is again stalled, which items are foremost on the minds of public power?
Nipper: The provisions that are most important to us in the bill are hydrolicensing, relicensing reform provisions. About half of the federal licenses on hydro projects that are up for renewal over the near term are held by public power systems. Our members have a strong and probably a disproportionately larger interest in trying to ensure that reforms streamline the process, give it more certainty, avoid or reduce redundancy and duplication. Inside the electricity title itself, there are two or three things important to us. The first is the service obligation or native load protection provisions. These are important in order for our members to ensure that they continue to use their transmission rights, whether they are transmission owners or whether they have firm contractual rights to be able to use those rights to serve their customers and meet their service obligations. Beyond that, the provisions on open access to transmission, or the so-called ‘FERC light’ provisions are important to our members.

EL&P: Will public power increasingly look to building or acquiring its own generation as a means to protect itself from price volatility?
Nipper: Yes, there’s a clear trend in that regard, not only for price volatility, but in mnay cases equally or just as much for constraints on the transmission system. This provides the abiliytto import power at competitive prices. It’s price and reliability of supply.
Fortunately, our members continue to enjoy strong credit ratings and a stable and favorable financial outlook for the rating agencies. They have access to capital and are issuing bonds for construction of new generation and transmission facilities. There’s a wide variety of kinds of generation projects going up—natural gas, renewables, coal-fired projects. Self-reliance and self-determination has been a hallmark of public power since its inception and coupled with local control, it gives us the ability to chart our own destiny (where other factors are favorable) and continue to build facilities and acquire the resources necessary to make sure we can serve our customers.

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EL&P:: Will the new generation capacity be primarily for your members’ use?
Nipper: Yes. It’s primarily and, in some cases, exclusively for their own needs. When you size a plant, you need to size it a little larger so you can grow into it because it’s a facility that is going to last for quite a while. In the front-end years, you may have some surplus capacity that may be available to sell to others, but often those sales occur between public power systems or between public power systems and cooperatives. The facility that is built may be owned by a joint action agency or some other consortium of public power system, so some of that surplus capacity is made available to other members of the consortium. They are not building generation for a merchant function.

EL&P: Has there been more difficulty in gaining or maintaining transmission access in the last year or so?
Nipper: I’m not so sure that there has been an increase in problems of access per se. There continue to be access problems in various parts of the country and in more localized circumstances. I don’t want to minimize this issue—frankly, there’s still some discrimination toward transmission access that occurs. However, a larger problem is generally the lack of adequate transmission capacity and the bottlenecks that occur in various places. So, it’s access, but not because access necessarily is being denied. There’s isn’t enough room for everybody.
Members are also experiencing higher transmission service charges as a result, both in terms of the tariff for service and the congestion charges, locational marginal pricing fees, and that sort of thing has presented a type of double whammy in the sense that in a lot of areas there is less ability to get on the transmission system because of contrain and it costs more when you get on.

EL&P: If the Public Utility Holding Company Act is repealed, what disadvantages or advantages might that bring to public power?
Nipper: It’s difficult to see any advantages. I think it’s all downside for not only public power systems, but for consumers in general, unless there are some offsets provided. That has been our position in the legislation over the last few years. In the first instance, we don’t think repeal of the Holding Company Act is a good idea. If the act is going to be repealed, it needs to be accompanied by other provisions that offset the harm to consumers and shore up the FERC’s ability to review mergers and acquisitions. We are concerned that repeal will result in a new wave of consolidation within the industry. We’ve seen a lot that over the last decade or so. Often times that consolidation has negative effects on our members because it does allow greater concentration of generation and transmission resources in a region under a single entity, which doesn’t always result in market abuse, but it certainly results in the potential for increased market power and that potential for abuse must be mitigated or guarded against by strengthening the criteria and rigor under which FERC reviews mergers. We don’t think that the way the repeal is proposed adequately allows regulators everything they need to monitor those entities and their behavior. The transfer of regulatory authority, for example, in the provisions that are pending in the bill from the FERC to the states doesn’t allow for complete transfer of authority. The provisions talk about access to books and records but only with limiting criteria related to financial issues, as opposed to other operational issues that might be important for regulators to look at. We worry about the sheer ability of state public utility commissions to handle the workload with their limited staff resources. We also worry about their legal ability to follow the money. When there are multi-state holding companies and those regulators have authority in a single state, it becomes more difficult to track transactions across state lines, particularly when a state has a subsidiary, but the corporate offices are elsewhere.

EL&P: There seems to be a growing interest in the municipal power model. Have you noted an increase in such initiatives in the U.S.?
Nipper: There has been a renewed interest in establishing public power systems as a result of the western debacle and the price volatility around the country. Cities have increasingly taken a look at the public power option, and there have been a number of newly created public power systems created in the wake of the volatility that we’ve seen over the last three or four years as well as some new approaches.
For example in California, customers of the investor-owned utilities were looking over at their public power neighbors, wondering why their prices didn’t rise. That has resulted in two or three cities forming new municipals. These are fast-growing communities where they’ve been able to make it work financially by establishing new public power systems that serve only newly developing areas within the city.

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