New York State Assembly
Shedding Light on the Estimated Savings from the LIPA/LILCO Proposal
The Long Island Power Authority (LIPA) has estimated that its proposed purchase of much of the Long Island Lighting Company (LILCO) will result in reductions in electric rates of roughly 18 percent in Suffolk county and 20 percent in Nassau county and the Rockaway-Queens part of the LILCO electric service territory over a 10 year period. This paper primarily addresses two questions:
To answer briefly,
BASIS FOR LIPA'S ESTIMATES
The heart of LIPA's estimates can be found on pages 8 and 11 of LIPA's March, 1997 presentation booklet, "Summary of Agreement in Principle." The LIPA savings projections are in comparison to projections prepared by LILCO, expanding on estimates made for a rate proceeding before the Public Service Commission (PSC). LIPA credits the deal with savings from a variety of factors including tax free financing, exemption from federal income tax, "synergy" savings from the proposed merger of Brooklyn Union Gas and LILCO, return of the Shoreham tax settlement to ratepayers, use of a rate stabilization fund and more growth in electricity sales on Long Island because of the lower rates.
ANALYSIS OF SAVINGS FACTORS
Our analysis led us to attempt to replicate LIPA's calculations, analyze the components of LIPA's savings estimates, and then project the savings beyond the 10 years of LIPA's estimates. Doing this required a nearly complete reliance on LIPA for information. LIPA and its consultants have literally supplied reams of data for which we are grateful, although, in performing the analysis, we continued to find gaps in both our requests and their responses that have led to additional requests and the need to make simplifying assumptions to bring our analysis to this point.
Based upon our analysis, we conclude that some of the cost factors that LIPA attributes to the deal would have simply occurred in any event. Additionally some of the savings in the initial 10-year period appear to occur because some costs are shifted beyond that period into later years.
The difference between our and LIPA's estimate comes from various sources:
Critics can argue over our interpretation of these various factors versus the interpretation given by LIPA. They can also point out that LIPA has claimed to be conservative in its estimates. So have we. For example, we could have argued for comparing LIPA's projected rates to current rates levels which would have cut the average savings to only 7.15 percent. While some might doubt that a 10-year LILCO rate freeze is a reasonable assumption, it can be pointed out that most of the utilities in the state are engaged in proceedings that would require at least some modest rate reductions over the next few years and that the PSC would be loath to increase the highest electric rates in the nation any higher.
The results of our analysis of the components of LIPA's rate savings estimates are summarized graphically in Exhibit A. The exhibit shows the magnitude of each of the major elements that make up LIPA's savings estimate as well as our projections of LILCO rates against which LIPA's rates and costs should be compared.
In summary, the LIPA deal does appear to provide some real rate savings through year 10 resulting from the differences in fixed costs (interest on debt, stockholder dividends, federal income tax) between LIPA and LILCO. The effect of the fixed cost savings with an adjustment for the projected increase in sales (resulting from LIPA's fixed cost reductions) yields an overall average savings estimate of 8.9 percent for LIPA. Allowing for some differences in determining the overall applicability of factors, one can reasonably argue that the savings could approach double digits--or half of what LIPA projects. On the other hand, comparing the LIPA saving to a PSC imposed rate freeze would lower the savings estimate to 7.15 percent.
BEYOND YEAR 10
Our analysis of information provided by LIPA indicates that rates could rise substantially after year 10. To a great extent, this is because a number of the financing mechanisms employed by LIPA tend to lower costs in the first 5 or 10 years and raise them subsequently. A detailed look at LIPA's bond issuance is the subject of a separate paper.
Performing the post 10-year savings analysis is complicated by LIPA not having projected rates past the first 10 years. By itself, this is not surprising; projections made for such a long period are notoriously poor. Unfortunately, the LIPA deal involves a commitment over a time span of 35 years. To get some sense of the impacts after year 10, we looked at a comparison of projected fixed costs incurred by LIPA and LILCO as well as some of the mechanisms that affect the timing of savings and costs.
Based on the information provided by LIPA, year 11 of the deal appears to be critical. If one accepts everything underlying the average 19 percent savings that LIPA estimated for the service territory, some of those underpinnings disappear in year 11. The savings from the merger of LILCO and BUG appear to apply only for the first 10 years. Additionally, LIPA's Rate Stabilization Fund which hold rates below the level required to fully cover LIPA's costs is depleted by year 11. In year 11, then, LIPA's rates should increase to reflect the loss of savings contributed by these factors in year 10, approximately 2 percent for the merger and 7 percent for the Rate Stabilization Fund.2 Additionally, the savings attributed to the Shoreham tax settlement are not available after year 5. In other words, if one disagrees with our assessment that some of these factors LIPA claims as contributing to rate savings should be ignored, by year 11, the question is moot. These savings disappear.
At this point we turn to the primary source of actual savings from the LIPA proposal: the reduction in fixed costs that LIPA would pay compared to those projected for LILCO. We have attempted to project fixed costs which largely consist of payment of interest and principal on debt, stockholder dividends, and federal income taxes for both LIPA and LILCO.3 Because most other changes in variable costs should affect both LIPA and LILCO in similar fashions, projected fixed costs provide some indication of the rate levels that could be expected in the future. Exhibit B depicts LIPA's projected fixed costs (mostly, interest and principal payments on bonds) compared to LILCO's projected fixed costs (return on equity, interest on debt, depreciation, and federal income taxes). As can be seen, late in the period analyzed, LIPA's fixed costs rise above those of LILCO, although LIPA's fixed cost should fall dramatically once the initial bonds that finance the deal are repaid. In between, LILCO's rate level could actually fall below LIPA's
WHAT IS THE COST TO LONG ISLANDERS OF THE LIPA DEAL?
This appears to be a deceptively simple question to answer. The primary cost to Long Islanders of the rate savings logically is comprised of the financial costs associated with the bonds LIPA will issue to finance the deal. What no analysis has truly attempted to address are the costs associated with the 35 year commitment that Long Islanders will enter into with LIPA, until the bonds are paid off. That 35 year commitment, combined with other aspects of the deal, may effectively cost Long Islanders the ability to reap future savings from technological innovations in electric power supply and increased competition among electric power producers. This is further compounded by LILCO's holding an 8 year contract to operate LIPA's transmission and distribution system and a 15 year contract for the supply of power to LIPA. Even with LIPA's presence, LILCO will effectively continue as a monopoly on Long Island while the rest of state moves toward competition in electric energy supply.
There is a tendency to dismiss the potential for competition and the impact of new technologies on Long Island. However, looking back over the past 35 years demonstrates that this industry is susceptible to enormous and unpredictable change. During that time, nuclear energy technology appeared first as a savior and then as a millstone for the industry with horrendous consequences for Long Island. In the past several years, technological changes coupled with abundant supplies of natural gas have made competition possible in this industry which had been viewed as a natural monopoly. The problem is weighing these costs against the savings promised by the LIPA deal.
Our analysis shows:
1LIPA assumes an inflation rate of 2.8 percent which we use instead of LILCO's 2.5 percent inflation rate.
2The merger savings would presumably disappear from LILCOs rates as well although LIPA did not include these savings in LILCO's rates in its comparison.
3LIPA provided projections of fixed costs for both LIPA and LILCO through the year 2017. We projected fixed costs from 2018 to 2035 by using the average 10 year (2007-2017) annual percentage increase contained in LIPA's estimates of total fixed costs for itself and LILCO. Specific adjustments to these projections were then made for these known changes: the full depreciation of Nine Mile 2 (LILCO) in 2027, the full amortization of the Shoreham regulatory asset (LILCO) in 2030, and the full repayment of the initial debt issuance (LIPA) in 2034.
SUMMARY OF THE LIPA PROPOSAL
LIPA has negotiated an agreement for a partial purchase of LILCO. Under the agreement:
• take over LILCO's transmission and distribution (T&D) system;
• take over LILCO's 18% share of an upstate nuclear plant (Nine Mile 2);
• take on LILCO's "regulatory assets" representing the promise that LILCO would be able to collect certain (mostly Shoreham-related) costs;
• assume and refinance $3.2 billion in LILCO's long term debt and assume payments on another $476 million of LILCO debt;
• pay LILCO $2.5 billion for assets being purchased;
• settle LILCO's litigation concerning overpayment of taxes on Shoreham; and
• issue approximately $7.6 billion in tax exempt bonds to finance the deal.
• keep its fossil fuel electric generating plants;
• keep its natural gas business;
• keep its administrative offices and service facilities;
• get an 8 year contract from LIPA to operate LIPA's T&D system and provide billing and customer services;
• get a 15 year contract to sell electric power to LIPA;
• retain rights to certain future business opportunities associated with use of LIPA's T&D system;
• retain $882 million in long term debt; and
• receive $2.5 billion in cash for the value of its assets.
With the $7.6 billion in bonds to be issued by LIPA and the $476 million in LILCO debt that LIPA will assume, the total deal is worth more than $8 billion.
ASSESSING LIPA'S ASSUMPTIONS
A thorough analysis of LIPA's savings estimates requires making explicit the implicit assumptions on which the LIPA estimates are based. The assumptions on which LIPA's estimates rest include the following:
ASSUMPTION: Savings resulting from the merger between LILCO and Brooklyn Union Gas will be available to reduce LIPA's rates, but not LILCO's.
VALIDITY: The Chairman of the Board of LILCO has testified that these savings are not dependent on the LIPA/LILCO deal, and that they would go to reducing LILCO's rates if the LIPA transaction did not occur.
ASSUMPTION: LILCO's rates would rise steadily over time, with increases in variable costs (fuel, labor, maintenance) outpacing inflation.
VALIDITY: All of New York's other electric utilities are involved in Public Service Commission cases addressing rate levels and increased electric competition. No utility is proposing rate increases, and most are proposing reductions. Higher-than-inflation increases for LILCO are certain to be rejected by regulators.
ASSUMPTION: The Shoreham tax settlement provides a source of savings to be used to lower LIPA rates, but would be unavailable to LILCO.
VALIDITY: LILCO anticipates receiving $1.2 billion in refunds due to tax overcharges for Shoreham, while the LIPA proposal would settle the case for $625 million. LILCO has committed to returning any Shoreham tax refund to customers. In the absence of the LIPA deal, local governments would be directly responsible for the costs of the Shoreham tax refund.
ASSUMPTION: LIPA electricity sales will rise significantly compared to sales expected for LILCO, due to LIPA's lower rates.
VALIDITY: It is reasonable to expect some increased demand for electricity as prices decline. LIPA's estimates appear reasonable although they do not seem to take into account LIPA's promise to aggressively promote energy efficiency.
THE SHOREHAM TAX
AND ONE-TIME PAYMENTS
The one-time cash payment that LIPA proposes to provide to customers is comprised of funds from three sources: the settlement of a lawsuit against LILCO brought by a group of its customers (RICO Settlement); the refunded overpayment of property taxes associated with Shoreham already paid by Suffolk County to LILCO (Shoreham Phase I); and the settlement of a pending tax challenge for additional tax over payments associated with Shoreham (Shoreham Phase II). The settlement of the pending Shoreham tax challenge also is proposed by LIPA to fund rate reductions, during the first 5 years following LIPA's partial purchase of LILCO, in addition to those discussed above. These rate reductions would vary between Nassau and Suffolk counties.
Neither the benefits of the one-time cash payments, nor the Shoreham tax settlement rate reductions, should be attributed to the LIPA deal. The RICO settlement payments are already owed to LILCO customers, and must be paid whether or not LIPA purchases LILCO. The Shoreham Phase I and Phase II payments are also owed to LILCO customers, and would be used to reduce rates whether LIPA or LILCO owns the Long Island electric system. Further, since the cost of the Shoreham Phase II settlement would be charged entirely to Suffolk county ratepayers, through a rate surcharge, no net benefits arise from the settlement of the Shoreham tax settlement for Long Island ratepayers as a whole.