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Electric rates in 9 towns called hidden tax

Gov. Markell, other critics say high rates may hinder business growth

Written by MELISSA NANN BURKE, The News Journal
Feb. 12, 2012

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The University of Delaware says it pays $108 per megawatt to Newark -- far above the $65 to $75 a megawatt it would pay to Delmarva Power in a suburban location. Its electric bill is about $9 million a year and growing for its facilities (this photo show DuPont Hall). / THE NEWS JOURNAL/ROBERT CRAIG

When Smyrna residents pump up the thermostat, they also fuel snowplows.

Folks in Clayton who flip on lights also put cops on the beat.

In Milford, people running their vacuums keep city parks clean, as well.

For decades, local governments in Delaware have kept tax rates low while subsidizing their operations with profits from selling electricity.

Through a consortium, the Delaware Municipal Electric Corp., nine Delaware cities buy power at wholesale prices and resell it -- reaping margins of up to 34 percent last year -- to a combined population of 114,000. Those surpluses are used to fund personnel costs and services such as street lighting, libraries and trash collection.

Entity: Delaware Municipal Electric Corp.
Established: 1979
Members: Clayton, Dover, Lewes, Middletown, Milton, Newark, New Castle, Seaford and Smyrna
Serves: 64,000 end-use meters and a population of 114,000
Peak demand (combined): 435.4 megawatts (2010)
Largest distribution system: Dover
Smallest: Clayton
Revenues: 43 percent derived from industrial users; 35 percent from residential; and 22 percent commercial (2010)

Critics say the municipalities are levying a hidden tax. For residential customers in those municipalities, the average retail price was an average 9 percent higher in 2010 than pricing by investor-owned Delmarva Power, according to the federal Energy Information Administration.

For some residents, it's a matter of government transparency that state officials say could be hurting the state's economy.

Smyrna raised electric rates for its 4,100 customers last July because the town needed to plug a budget shortfall of more than $300,000. "We were scrambling for funds," Councilman Anthony DeFeo said at recent town meeting.

Raising property taxes is never popular politically, so city leaders have an incentive to keep electric rates high. Balancing town budgets can fall on the backs of the systems' largest users, who consume many megawatts but wield low-voltage voting power.

The issue has attracted the governor's scrutiny. In his State of the State address last month, Gov. Jack Markell said he often hears complaints from businesses about high electric rates in the towns. The average retail price paid by industrial users of municipal power in the First State was 83 percent higher than Delmarva pricing in 2010 and, for commercial customers, 14 percent higher.

At a meeting in Dover last month, Markell challenged municipal leaders to reduce their industrial rates to compete with lower-priced Delmarva or the lowest-priced Delaware Electric Cooperative. If they don't, they risk losing businesses looking to expand in or bring jobs to Delaware, he said.

"The fundamental issue the governor is getting at is we all use our electric utility as the cash cow to carry all those expenses on the general-fund side that we can't raise revenues for -- or don't want to raise revenues for," Smyrna City Manager Dave Hugg told his utilities committee.

"He used the term 'fat.' There's too much 'fat' in our rates."

Alan Levin of the Delaware Economic Development Office said of the towns, "I don't want to be in their shoes, but it's our objective to build up these markets. We'll meet with DEMEC until we get results. Our hope is we don't have to go to the Legislature."

Markell has not threatened the towns with legislation, but Hugg described the meeting as "uncomfortable" and "tense," with DEMEC board members on the defensive. Local officials fear a bill that would eliminate their monopoly on supply within town limits or place municipal utilities under the purview of the state Public Service Commission.

"I'm sensitive to the revenue needs of the towns," Markell said. "But what would hurt these municipalities more than losing electric customers is losing these businesses. Any empty factory uses no power."

Who's complaining?

"I'd rather pay more property taxes and deduct them, than pay outlandish and unreasonable electric rates," said Jon Patz, a retiree in Dover. "The thing to do would be to cut out the fat, or allow people to choose their supplier."

Supporting the municipalities is DEMEC, which negotiates wholesale power purchases for the nine municipal utilities.

In most cases, local officials have not heard the complaints the governor mentioned, DEMEC CEO Patrick E. McCullar said.

Leaders point to Johnson Controls' new factory, the Amazon warehouse coming to Middletown and Bloom Energy's plans in Newark -- all developments occurring in DEMEC territories.

"We have a hard time understanding how, if we're the problem, why are these sophisticated companies who have done a total cost analysis -- deciding Middletown and Newark, Del., are a better location than 20 other sites on the East Coast," he said.

McCullar acknowledged DEMEC members' rates are higher than average but said they have not hindered development. Electric rates are among a slate of factors companies consider when evaluating sites.

The group is urging the governor to help bring down power costs around the state by encouraging investments in infrastructure to improve capacity, transmission and generation -- the lack of which contributes to costs and drives up prices.

"Just look at the price of electricity in this state -- we're ranked 48th or 49th in cost of power, which means it's high," said economist Edward C. Ratledge, who teaches at the University of Delaware and sits on the Delaware Economic and Financial Advisory Council.

"Don't get too concerned about the 'muni' thing. The governor has to talk to Delmarva, too."

Electricity runs the town

Cities would have to significantly raise taxes, cut services or lay off staff to shrink their electric-fund margins, officials say.

"That has an effect on people and businesses, as well," Ratledge said. "To do an analysis, you'd have to find out whether a substantial increase in property taxes would force people or businesses out that way instead. It's always a trade-off."

The municipalities say their money has to come from somewhere, and they've always done it this way.

In other states, publicly owned utilities also contribute financially to local or state government, often in lieu of taxes, or as in Delaware, as a transfer to general funds.

In Middletown, the formula for a low tax rate and profitable electric utility is written into the town charter, which allows Middletown to transfer 100 percent of its electric-fund surplus to the general operating fund each year.

Between 2006 and 2010, Middletown transferred between $3.2 million and $5.1 million from the electric fund to the general fund annually. Last year, it transferred $5.09 million, compared with $1.64 million collected in property taxes.

As of 2010, roughly $84 million of assessed property in Middletown was exempt from taxation either by state law or as a result of town-imposed tax breaks, according to auditors.

"From an equity standpoint, the towns have felt it's better to raise the electric rate and get all the constituents to pay into the full municipal operating costs," said state Rep. Danny Short, a former mayor of Seaford who identifies with both the municipalities' and governor's views.

"When you raise property taxes, you miss the nonprofits, state office buildings, schools, courts, et cetera. They enjoy the services of the city, but don't pay for them on the same level."

Leaders at the nonprofit Nanticoke Memorial Hospital understand this and are grateful for Seaford's services, even though they'd like to save more on electricity, CEO Steven Rose said.

"It would be just as beneficial to the hospital if they brought in new businesses to the community," Rose said. "It's not just about us."

DEMEC and others highlight extreme cases like Newark and Dover, where as much as 50 percent of the property is tax-exempt. Shifting such a revenue burden onto taxpayers there would be wholly unfair, officials say.

"For us to make up that $3 million in annual income from the university alone, we'd have to double the property tax," Newark Mayor Vance A. Funk III said. "I don't know if I want to be in office if that happens."

UD says it's not about to leave Newark. But it's mindful that three miles down the road it would pay $65 to $75 a megawatt under Delmarva's tariff, rather than $108 a megawatt under the city's. UD's electric bill is about $9 million a year and growing, said David Singleton, vice president for UD facilities.

"We're not the only tax-exempt entity in Newark," Singleton said. "When the state created that category, they meant we don't have to pay taxes. To make up for that in some other way seems to circumvent the reason for the exception."

(Having UD as a customer does have its costs: Newark pays more than $250,000 a year in merchant fees so the university may pay its bill by credit card.)

Some politicians are concerned municipalities would seek to shift the revenue burden from the commercial and industrial classes onto residential customers.

"That's where I would see a problem," said state Rep. John Kowalko, D-Newark South, chair of the house Energy Committee, who sees the regulation of municipal utilities as "the nuclear option."

"This is an issue that's going to need a lot more discussion," he said. "Ultimately, the only way to have a reduction overall for all rate payers is to have some other revenue mechanism for these tax-free parcels and tax-free businesses."

Local control

Things work slightly differently in New Castle, where a body separate from the City Council decides how much to transfer to the city's general fund each year. New Castle's Municipal Services Commission has historically had rates ranking among the lowest of DEMEC members.

"The commissioners take into consideration what the city is asking for, and whether it's appropriate, but they have no obligation to honor that request," said commission Secretary Chip Patterson. "It's very clear the revenues we raise are for the operation of municipal services of water and electric."

Advocates of publicly owned utilities emphasize the benefits of local control -- such as access to those setting the rates.

"Your dividends from the electric utility go back into the city, and your 'public service commission' in the city is your council," Newark Councilman Stuart Markham said. "You have a direct way to reach them, unlike the [state] Public Service Commission."

Another business model exists downstate, where the unregulated Delaware Electric Cooperative is owned by its 84,000 mostly residential members in Kent and Sussex counties enjoying rates roughly 30 percent below average prices in Delaware -- and with the choice to purchase from other suppliers. The Co-op also returned $4.1 million last year to members, CEO Bill Andrew said.

"We do not subsidize other services with our electric revenue," Andrew said.

Looking to expand and diversify its base, the Co-op has offered to buy out Milford, Lewes and Dover's utilities in recent years, but in each case the cities declined or, in Dover's case, has yet to answer.

The Lewes Board of Public Works in November rejected a bid by the Co-op, despite an estimate that Lewes customers would save roughly 25 percent a month on their rates.

In Dover, the Co-op would save customers about $25 million a year through a rate reduction, in exchange for a substantial payment to the city for Dover's distribution system, Andrew said.

"The consensus at the present time is we want to continue to own our own utility. That consensus could change in the future," said Councilman David Bonar, chair of Dover's utilities committee. "We do derive some $6 million to $9 million a year from it."

Andrew said, "We've made it known that we'd be interested in talking to all the municipalities in Delaware."

Eyeing the competition

McCullar expects most municipalities will pass through reductions of up to 15 percent in 2012 because of the falling price of natural gas and additional sources of self-generation DEMEC is poised to fire up this year.

After a study showed Newark had charged large customers 23 percent more than their fair share, or $2.8 million, City Council last year cut rates by 9 percent to 11 percent for those classes, including the University of Delaware and Dow Chemical. In January, the city trimmed rates again by roughly 9.5 percent for all classes.

Smyrna recently announced it also over-collected -- by $375,000 in 2011. Officials will likely return that to ratepayers through a lower rate during the next 12 months, City Manager Hugg said.

Other towns have recently reduced rates, such as Lewes (7.6 percent for residential class and 6.1 percent for commercial) and Milford (18 percent for large users and 2 percent for residential). Others are studying whether their allocations for cost of service are "out of whack" and will make adjustments if necessary, McCullar said.

That's not enough, the governor has replied.

A study of Delaware's economy in 2010 cited high electric rates among the state's challenges in attracting and retaining businesses -- especially those in manufacturing who by their nature use a lot of juice, said Levin of DEDO, who often hears such feedback from companies he visits.

Investor-owned utilities such as Delmarva might have lower industrial rates in part because they serve larger customers -- an economy of volume. Smaller municipal utilities lack the critical mass to spread costs around.

"We're trying to market the entire state, not just one area," Levin said. "We need to have competitive rates with other parts of the country. Especially if a group doesn't have a presence in Delaware today, it can be a non-starter when they see a charge of 12 to 14 cents per kilowatt hour when they could be getting it somewhere else for 6 cents."

Under state law, property owners within city limits must be customers of the municipality.

"We've lost accounts to neighboring states like Maryland which has cheaper rates," said Ron Longhany, plant manager at U.S. Cold Storage, a facility in Milford with electric bills averaging $1.6 million to $1.8 million a year.

US Cold Storage image
U.S. Cold Storage in Milford is working to cut its electricity bill, which averages $1.6. million to $1.8 million annually. LED lights are replacing mostly sodium vapor lights, and the lights automatically brighten when motion is detected. Milford is one of nine Delaware municipalities with municipal electricity rates that Gov. Jack Markell believes are so high that they discourage economic development. / THE NEWS JOURNAL/BOB HERBERT

"At our plants in Bethlehem and Hazelton, Pa., it's 20 to 25 percent lower than here. We're happy to see this reduction that just happened, but it's getting harder and harder to stay here, honestly."

Elsewhere in Milford, Sea Watch International expanded its clam-processing plant last year by adding a second shift -- in part because of a reduction in utility costs extended by the city. City Manager Dick Carmean, who negotiated the deal, said Sea Watch was also considering sites in Massachusetts and Virginia.

"It did enter into our decision as to where we would expand," said CFO Jerry Gordon in Easton, Md., who would not disclose specifics of company costs.

Talks ahead

DEMEC's board has hired a consultant to evaluate where members stand in comparison to other Mid-Atlantic utilities in terms of rates across classes, plus an analysis of how regional pricing is affected by the higher congestion and capacity charges on the peninsula.

Each municipality has different costs and challenges. Markell said he won't "prejudge" a potential solution. He does want the conversation to continue.

Geoffrey Sawyer III, the governor's chief of staff, will meet individually with each municipal staff in the coming weeks. A 20-percent to 30-percent reduction in the rates for industrial users would generally make DEMEC members competitive with Delmarva and the Co-op, but it might dilute the non-electric services that towns provide, Sawyer said.

"As I said to the munis and DEMEC, it is dangerous to paint this issue with a broad brush," Sawyer said. "We are resisting setting a certain target reduction or one-size-fits-all solution."