Electric industry overview: Restructure or reorganize

Vermont's power companies, especially Central Vermont Public Service and Green Mountain Power, have learned this year the meaning of the old Chinese curse, "May you live in interesting times."

Headlines in 1998 have trumpeted: The refusal of the last Legislature to deregulate the industry and allow for competition until more information about the consequences of such a move is available; the possibility of GMP and CVPS going bankrupt; requests to state regulatory agencies for rate increases that have been denied or granted at much lower levels; appeals of these denials to the Supreme Court; reductions in staff; and most recently, a governor's commission headed by business lobbyist William Gilbert and Ben & Jerry's Homemade executive Elizabeth Bankowski, to study the underlying cause of all this -- the Hydro-Quebec contract signed by the power companies and the state that has left Vermont paying double the going market rate for power.

The commission's report was released December 18 and included a recommendation that CVPS, GMP and Citizens Utilities Company merge in an effort to cut administrative costs.

Before the report was made public, and despite reports to the contrary, both CVPS and GMP deny that merger talks have already started. Both acknowledge, however, that their companies are open to almost any idea to cut the high cost of power in the state.

"We will look at any proposal they make to lower costs in Vermont, and we're committed to doing that," said Steve Costello, CVPS's manager of media affairs.

Added to this complicated situation is the question of what a utility bankruptcy would do to the state's bond rating, the looming and expensive decommissioning of Vermont Yankee, the possibility of an end-run around the Legislature by the regulators, and the threatening disruption of Vermont's property tax base by deregulation in neighboring states (see sidebar), and you have what William Porter, director of GMP's corporate relations, characterizes as a "stressful" year, and one Costello calls "interesting" and "at times confusing."

MERGERS

The idea of merging the state's utilities is not a new one.

"Mergers and consolidations are a topic people have talked about for years," said Richard Sedano, the state's Public Service Commissioner. "People have looked at the 22 electric companies in Vermont and said 'Why?' Part of the reason is that 17 are publicly owned, and there are reasons that define them -- municipalities wanting control of their power industry. However, we do have private sector companies, and, increasingly, pressures in the electric industry to be more efficient to cut costs in a way that is consistent with providing good service. So around the country, you see utilities merging."

The bottom line on mergers, however, is the bottom line for electric consumers, said Speaker of the House Michael Obuchowski.

"My reaction to consolidation and merger is that any change in the electric industry needs to be measured against a yardstick, and my yardstick would be, do the rates go down for all customers, and is reliability of service enhanced or retained Obuchowski said. "How do you judge it."

Vermont has to ask if bigger is better, Obuchowski said.

"My answer is: only if the people, and by that I mean the customers, stay in control," Obuchowski said. "We don't want in Vermont these mega-corporations over which Vermonters and Vermont's leaders and citizens have no control."

HYDRO-QUEBEC CONTRACT

How did Vermont get into this situation? According to a widely published essay on the state's power industry called "Vermont's Electricity: A Citizen's Primer," written in 1997 by Rep. Steven Darrow (D-Putney), it was a rash move in the late 1980s on the part of the utilities to cut the state out of the power business.

"Nuclear cost overruns, the energy crisis, higher fuel prices and a new environmental awareness led to a renewed interest in Canadian hydro power," Darrow wrote. "The Department of Public Service, acting for the state, bought modest amounts of... (the) power and wholesaled it to Vermont utilities."

The Legislature in 1987 gave the DPS authority to sell retail power to Vermont consumers. "The utilities saw the state as a competitor and began negotiations to contract directly with Hydro-Quebec in order to fill the transmission capacity and thus exclude the state," Darrow wrote.

With the permission of the state, the utilities signed a contract with Hydro-Quebec in 1991, locking in a rate that looked good at the time to the utilities, the state and the regulators, but which has since become a major albatross. At the same time, and without the state's permission, it signed away the possibility of the state's "opting out" of the contract.

If the costs were reasonable, given current rates available, the state wouldn't want to "opt out." It's the high cot of the Hydro Quebec power that has led to this situation.

"Everyone knew what the rates were going to be." Porter said. "What everyone missed is what the rates were going to be from other sources. The contract was negotiated in 1987. Other utilities were investing in nuclear and coal plants. Vermont decided to buy the power from Hydro-Quebec instead of investing in power plants. At that time, the projected costs for New England and the Northeast from the plants were quite high, and the Hydro-Quebec contract looked like a 30 percent cheaper option. Well, as it turns out, mostly because of advancing technology and natural gas, prices of new power sources have been much cheaper than they were expected to be. So the Hydro-Quebec costs have been a little less than they were projected to be under the original contract, but they are higher than the other sources." So, even if the utilities merge and cut costs dramatically, the basic problem remains.

"The core problem in our industry today is high power costs," Sedano said. "And while some sort of consolidation may, in fact, serve the consumers, the core problem still relates to the costs. If we resolve those issues, the consolidation may enhance the improvements we get from our power cost reductions. It's important for power suppliers to appreciate that the significantly above-market cost contracts are very difficult. The Hydro-Quebec contract has put tremendous amount of risk on companies involved with that contract."

THE "STEP-UP" CLAUSE

What makes the Hydro-Quebec contract even more complicated and dangerous is the "step up" provision, which requires Vermont's other electric companies, including the small municipal ones, to shoulder the financial responsibilities and obligations of the contract if one or more of the players, especially one of the major ones like CVPS or GMP, go bankrupt.

This puts the municipal power companies and Citizens Utilities in what Obuchowski and others are cling "a bankruptcy chain."

"The step-up provision requires that if one of the companies defaults on its contract, the other companies are required to step up and take over that responsibility." Porter said. "The burden of taking on Green Mountain Power's burden would be too great for any of the other utilities to carry. They wouldn't have the money. They would have to have rather large rate increases, or they would go bankrupt themselves. So bankruptcy is a threat to all the other utilities."

INTERNAL COST CUTTING

CVPS and GMP have embarked on a dramatic series of cost-cutting measures, including reductions in staff, decreases in dividends to shareholders, and in the case of GMP, putting its building up for sale:

STOCKS:

Two years ago, GMP cut its stockholders' dividends; it cut them again during the fourth quarter of 1998, from an annual rate of $1.10 a share to .55 cents a share.

"Utilities stock has always been in a separate category, because there's little opportunity for growth in value because profit is limited by regulators," Porter said. "Other companies earn as much money as they can for their shareholders. Utilities can only earn as much as the regulators allow them to earn. Therefore, they have traditionally paid pretty good dividends, and that's why people have traditionally bought them. Utility stock is widely used as a 'widows and orphans' stock: good income, not a lot of growth."

The company told its 8,000 disappointed stockholders -- about 80 percent of whom are individuals and about 2,000 of whom live in Vermont -- that its "earnings potential wouldn't support the higher dividend because our rates have been too low to provide the dividends," Porter said.

CVPS cut its dividends four years ago, Costello said.

"We were well ahead of the curve," Costello said. "Going back to November of 1994, CV saw the emerging cost issues in Vermont and acted to reduce its dividend. At the time, we issued a statement that said 'emerging competition in the electric industry requires the company to retain a larger share of its earnings to provide the financial flexibility necessary to operate in this environment." We cut our dividend and we continue to review it."

STAFF REDUCTIONS:

GMP has reduced its staff by about 25 percent since 1992, and is currently undergoing a large-scale reduction; many people, including top managers like Porter, are leaving under early retirement and buyout package offers.

"We have had some changes in top management," Porter said. "The company has reduced its executives by 20 percent. Christopher L Dutton remains president and CEO. Edwin Norse, the chief financial officer, is leaving at the end of the year, December 31, under early retirement for people over 50. He and I accepted it. In all, GMP will see a 20 percent reduction. Plus, 17 employees left under early retirement and voluntary severance packages this fall. By the end of this year, the company expects to be below 300 employees and have the smallest workforce since 1976. There have been no cuts in the line force."

CVPS has been cutting people since 1994, Costello said.

"We've had two separate shrinkages of the work force." Costello said. "One is still on-going. Starting this past year, we began reducing our staff by roughly 100 people through voluntary retirements or buyouts. By the end of the year 2000, we will have reduced our staff by 31 percent -- compared to 1994 levels."

To find areas for cost-cutting and efficiency, CVPS created employee teams to study every task performed by the company and make recommendations for procedures that could be eliminated or streamlined.

"Those are being phased in," Costello said. "About half of those people have left now, and the rest will be leaving over the next 11 or 12 months. It's been across the board, officers as well as rank-and-file employees. And we did it while still retaining a reliability rate of 99.96, which is about as good as you can find anywhere in the world."

OTHERS:

GMP's corporate headquarters are up for sale or lease.

"We're in a building that was built in 1983," Porter said. "It was controversial at the time, and it still is. I have to tell you, it's a very nice building. But the cost of it is high, and I think we could get equivalent office space elsewhere. Also, we have reduced the workforce, so we have more space than we need. We don't have a deal yet, but there is some interest."

BANKRUPTCY

The most certain thing in a bankruptcy is uncertainty, Porter said.

"It's new territory and I don't think anybody knows what would happen if all the utilities go bankrupt," Porter said. "What that would do to the credit rating of the state? Nobody knows the answer, but there is a concern."

Both CVPS and GMP are in financial double, but GMP's situation appears to be more critical.

"The reason Green Mountain Power is in a more precarious position than CVPS is that we have less of our Hydro-Quebec contract costs in our rates," Porter said. "Over the last four years or so, we have worked very hard to avoid putting those higher costs in the rates, and in the process we've saved ratepayers $40 million. Other companies have put more of those costs in the rates. One result is that we have the lowest rate in New England, about 25 percent below the statewide average. Now we have to pay the costs. If we could just have average rates, GMP would have no financial crisis."

According to Porter, if GMP goes under, Vermont will be in even more double than it is now.

"In a bankruptcy, a company operates under the protection of a bankruptcy court Porter said. "One creditors are held off for some period of time while the company is allowed to keep operating. But it's far less certain that service wouldn't be affected. There are no guarantees, because obviously, in a bankruptcy, a company does what it can to save money."

The company studied utility bankruptcies elsewhere in the country, and found that rates generally go up.

"There have been two in New Hampshire, one in Texas, and the Vermont Electric Co-op went bankrupt a few years ago," Porter said. "There's no case where bankruptcy had produced lower rates for utilities. So people in the state who think the utilities should go bankrupt, and then they'll get some lower rates -- that's never happened. In all the bankruptcies I know about, a rate path has been negotiated, and the regulatory commissions have agreed to it. In the case of the Public Service Company of New Hampshire, the closest to us, the rate out of bankruptcy called for a 5 1/2 percent increase every year for seven years with no review."

One thing Vermonters should know, Porter said, is that power will continue to flow into homes and businesses.

"I don't think there's any threat that the power's going to go off, even in the bad scenario of a bankruptcy," Porter said. "It hasn't in other cases where a utility has gone bankrupt. I don't think the customers should be afraid of that."

RATE INCREASE

GMP has tried several times to get its rates increased, and in mid-December 1998, the Public Service Commission finally agreed to an additional 5.7 percent increase for GMP and a 4.7 percent increase for CVPS CVPS is happy with the increase, Costello said.

"It has removed, for the short term, some of the obstacles, and gives us the opportunity to focus on the long-term picture," Costello said.

However, GMP had asked for a 12.9 percent increase, so it will still not recover all its Hydro-Quebec costs. And even the 5.7 percent raise is considered temporary, Sedano said.

"This case is being put to sleep from now until September 1999," Sedano said. "At that time, unless something has changed, the case will reawaken and be reexamined. The objective for both companies is to allow them time to address their high power costs. They must use every cost-cutting efficiency effort that's available to them that will convince Vermonters that they have done what they can to lower rates as far as they could."

Among possible cost-cutting ideas, Sedano said, are renegotiating, if possible, with Hydro-Quebec, seeking innovative financing, perhaps on Wall Street, and cutting costs.

CUTTING POWER RATES

The obvious first step in cutting rates is getting Hydro-Quebec to the gaining table, a delicate negotiation which has been in process for some time.

"The regulatory decision in the GMP rate case has already significantly impaired the HydroQuebec contract," Sedano said. "So the question is what Hydro-Quebec and the utility parties are going to do about it."

A new bargaining chip might come from an old lawyer's trick, the countersuit. The power companies are currently in arbitration -- not in court -- with Hydro-Quebec over its performance during last January's ice storm.

Vermont believes that a significant system failure during and after the storm shows that the company is inappropriately vulnerable and should be held liable. Hydro-Quebec is arguing that the storm constitutes an "Act of God."

If Hydro-Quebec would be willing to renegotiate the long-term power contract, however, it has been suggested that Vermont might withdraw its complaint.

One thing all the players agree upon is that regulated or deregulated, Hydro-Quebec or no Hydro-Quebec, the cost of power is not likely to go down, at least in the short run.

"Nobody has ever claimed power costs will go down," Porter said. "Savings under competition will be less than they will be if we don't have competition."

The market price for energy -- the price power producers get for the energy they sell on the market -- is at a rock-bottom level now, Sedano said, adding, "the market is out of balance because of the excess power supply we've had for some years."

Right now, the fixed costs of producing power are being covered.

"But if we come up against a shortage, nobody's going to want to build a new power supply unless they have some reasonable expectation of getting their costs back," Sedano said. "Utilities are built by entrepreneurs taking risks. That cost is higher than electricity costs today. So market prices are going to go up. But rates, which are driven by politics, are coming down."

It's all going to end up some place in the middle.

"There's some economic place where it's going to end up, once the markets are allowed to work." Sedano said. "No one really knows where that is. But there's a transition period where the costs are going to be divided among consumers and shareholders, and that's the tough part. How to share costs is what we're concerned about."

DE FACTO DEREGULATION

One way for the companies to reduce power bills is to create value, which GMP and CVPS can do by selling generation facilities like Vermont Yankee and by voluntarily "conceding" their monopoly positions in the state, Sedano said.

"If they concede that there should be retail competition, that might be an enticing offer," Sedano said.

But if the power companies raise money by selling away some of their physical assets and their monopoly positions, that might be also be construed as de facto deregulation an end run around the Legislature, which has put competition and divestiture on hold for further study.

"You might think of it that way." Sedano said. "Or the Legislature might think the regulators are solving this problem. And of course, the Legislature is always free to step in and do whatever it thinks is necessary. There are serious regulatory issues. Because of the high-risk problems, regulators have to act. If the Legislature wants to provide more guidance, it will help drive a positive outcome to all this."

Copyright Boutin-McQuiston, Inc. Jan 01, 1999
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