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Massachusetts Municipalization Lexington Leads Utility 'Revolution'

by Michael Scarchilli Posted 03/27/06

While many state and local governments are mulling the use of public-private partnerships to finance infrastructure, Massachusetts is, in one sense, considering a move in the opposite direction.

Rising fuel costs and electricity rates have prompted communities in the state to join a number of nationwide towns and cities looking into acquiring, or reacquiring, power systems. The commonwealth is weighing legislation that would simplify the process for local governments to acquire and operate existing power systems.

Lexington, a town of 30,000s about 14 miles southeast of Boston, is helping to push and frame debate on an issue that could have implications for the municipal bond market. Local governments would likely sell debt — either taxable or tax-exempt private-activity bonds — to finance the purchase of investor-owned utilities.

“The legislation is key because the option to form new munis creates competition to the IOUs,” said Patrick Mehr, a Lexington businessman and volunteer coordinator of the Massachusetts Alliance for Municipal Electric Choice, which supports the legislation. “New muni [utilities] in Massachusetts could provide lower rates, more reliable electrical service, and better responsiveness to local needs.”

Existing Massachussetts law makes it impractical for municipalities to purchase the IOUs that serve them and that’s got state lawmakers contemplating change on Beacon Hill, the site of the General Court, the Commonwealth’s legislature.

Efforts by local governments to purchase investor-owned utilities are foiled by some laws, written a century ago, that effectively provide IOUs a veto over any proposed sale. The town of Webster, for example, was the last Massachussetts municipality to form its own electric utility, and that was in 80 years ago.

A pair of bills emerged this year with the potential to help the number of municipal utilities expand from its current 41. One bill would eliminate the IOU veto provision; the other would provide the mechanism for municipalities to acquire existing systems — advocates of public power contend that it would be too costly to start a system from scratch. Last week, however, the joint committee on Telecommunications, Electricity, and Utility assigned those bills to “study,” a place committee chairman Sen. Michael Morrissey described as “legislative Neverland.”

Rep. Jay Kaufman, the Democrat from Lexington who sponsored the two bills, said assignment to study means one of two things: it could either be an active study, where the committee simply needs a little more time to deliberate, or it could be a study in which the bill “is going nowhere fast.”

When asked for his sense on the destiny of these bills, Kaufman said he is concerned, saying he “knows the committee chairs haven’t seen the obvious wisdom in the bills” and have reflected unease about them because of the huge gap in time since the formation of the last one. “We’re proposing to enter into if not unknown territory, very unfamiliar territory,” he said.

Morrisey said he appreciates concerns that the current law is too cumbersome, but is unconvinced that the legislation appropriately addresses how to determine the value of power assets in a possible sale.

“The hard part is how to agree on value of the assets … how to assure a proper return on the investment,” he said. He said that if, for example, the business is worth X, and is expected to net Y each year in the future, there’s an issue of how many years of anticipated revenue the IOU should be paid for. As for the legislation, he said “it’s not dead, but it’s certainly not on the fast track. There are a lot of issues that still need to be ironed out.”

Kaufman said that even if his legislation fails this year, it will play a role in stimulating important discussion on the matter, and giving it a stronger starting point in next year’s legislative session. The issue was first raised in 2002, and is not likely to go away anytime soon, he said.

Bob Ferdon, of counsel in Fulbright & Jaworski LLP’s New York office, said federal tax law can complicate transactions involving municipal acquisition of IOU assets, and limit the use of tax-exempt debt. Ferdon said that IOUs typically “write down,” or depreciate the value of their assets over time, which reduces the cost-basis of the assets. Such depreciation effectively lowers the value of the assets, which increases the gain upon sale, generating a higher tax bill for the IOU.

Additionally, federal tax law, with a few exceptions, limits the use of private-activity bonds for such municipal acquisitions, he said. And when tax-exempt private-activity bonds may be used, it’s difficult to obtain sufficient allocations from the pertinent state, he said.
“The volume cap that would be allocated would probably not be sufficient to cover much of the purchase price, unless you somehow strung it out over a period of years,” Ferdon said.
Beyond that, the idea is not without its critics.

“We feel that there is already a mechanism in place that allows every city and town in Massachusetts to purchase the electric infrastructure that serves that town,” said Caroline Allen, a spokeswomen for major Massachusetts utility NStar. “The mechanism in place for cities and towns pursuing a takeover is a deliberate, careful process put there for a reason. It’s not something to be taken lightly. Our biggest concern with the pending legislation is that our equipment might not get fair market value in a sale and so our remaining customers would end up subsidizing those who choose to leave the system.”

Allen said that IOUs are mindful of high energy costs, but that “even [municipal power utilities] are feeling the pinch of high global energy prices.”

According to data from the Massachusetts Municipal Wholesale Electric Co., the average monthly municipal power bill per household has gone up from $52 in 2004 to $63 in January 2006. NStar’s average monthly household bills increased from $66 to $107 over the same period, and National Grid, another large IOU, increased from $60 to $82 over that period.

The American Public Power Association conducted a study using 2004 data — the most recent data available — which found that residential customers of IOUs paid average rates that were 10% above those paid by customers of publicly owned utilities in 2004. Public power customers paid an average of 8.2 cents per kilowatt-hour for residential electric service, compared to 9.0 cents per kilowatt-hour paid by residential customers of IOUs.

The Massachusetts Alliance for Municipal Electric Choice’s Web site cites a report from the American Public Power Association, which found that average muni residential rates in Massachusetts were 9.9 cents per kilowatt-hour in 2003, 16% less than rates of 11.8 cents per kilowatt-hour for IOUs such as NStar and National Grid — which serve 85% of the state.

MAMEC’s Mehr also said that outages are “far more frequent with IOUs,” citing the APPA reliability survey for the period 1991-2000, which reported 40% fewer outage minutes for the average customer than NStar for participating munis. Additionally, he said, whether munis are formed are not, the “single most important result will be to create for the first time a real need for NStar to improve on these areas. What’s needed is competition.”

Allen, on behalf of NStar, acknowledged that munis have lower rates, but said “that’s due to the fact that they don’t have property taxes, low-income discounts or energy efficiency programs to pay into.” In response, Mehr said that munis pay “payments in lieu of taxes” equal to IOU property taxes, and that Lexington has already budgeted that into its estimates.

He then said that a Lexington muni would also provide low-income discounts, and foot the bill for energy efficiency programs, which run the typical customer $1.50 per month currently. However, Allen said that Mehr’s statements on PILOTs are “all speculative.” She said that while munis can pay PILOTs, they are not required by state law to do so, whereas IOUs like NStar are bound by state law to pay.

Ursula Schryver, director of customer programs for the APPA, said that rising interest rate and fuel costs have inspired communities to “look at their options.”

There were 2,011 publicly owned utilities in the United States as of 2004, as compared to 220 investor-owned utilities, according to Energy Information Administration data.

However, IOUs represent 68.9% of all customers, compared to 14.4% with munis. The balance of customers have cooperatives (12.2%) and power marketers (4.4%), while just under 40,000 customers nationwide get their power from federal power agencies, 98% of which are in Texas.

Schryver said that at any given time, about 50 to 100 communities nationwide are at some stage of looking into municipalization. During the past decade, 22 towns and cities throughout the U.S. have municipalized their power systems, with the last one being Winter Park, Fla., last year.

Schryver said that municipalizing is a “long, somewhat challenging process, and the cities have to be committed to doing it.”

Additionally, not all Massachusetts towns are lining up for the chance to form a muni.
The city of Cambridge recently conducted a study with consulting firm Camp Dresser & McKee Inc. into acquiring NStar and municipalizing, and found it to be “cost prohibitive.”

City manager Bob Healy said in an e-mail that he felt municipalizing would “jeopardize the city’s triple-A bond rating,” and said that the negative prognosis on setting up a muni is “primarily caused by NStar’s liability for $49 million dollars in nuclear plant decommissioning costs which is over and above the acquisition costs, and the reinvestment in infrastructure that I believe NStar has been ignoring.”

Calls to CDM for comment were not returned by press time.

Fitch Ratings analyst Karl Pfeil said that an impact on a municipality’s bond rating after establishing a muni would depend on whether or not it issued general obligation or revenue debt to fund the acquisition. He said that while the legislation itself has no rating implication in and of itself, the impact creating a muni would have on a GO rating is unclear.

However, he said, if a town or city were to issue revenue bonds backed by proceeds from the electric company, it would be rated as a new entity and assigned an initial rating. In that case, he said, there would be multiple factors the agency would look at, including community support, to evaluate the credit.