TODAY’S STUDY: PUBLIC UTILITY OWNERSHIP RECOMMENDED FOR MAUI
Analysis of Alternative Forms of Ownership and Alternative Business Models for Maui County's Electric Utility Company
December 23, 2015 (Guernsey for County of Maui)
The principal goal for an electric utility is to provide safe, reliable, and affordable electricity; in addition, the State of Hawaii and the County of Maui recognize the need to eliminate reliance upon fossil fuels for both economic and environmental reasons. Three main inter-related objectives are desired for future electric service in Maui County:
1. Energy Security and Resiliency
2. Electricity Cost
3. Renewable Energy Integration
Guernsey was tasked by the County of Maui (the County) to complete an options analysis for electrical utility service within the County. The County desires to move to 100% renewable and sustainable energy as quickly as practicable and has concerns about the prospects of such progress under the status quo.
Guernsey believes the ideal path forward to meet the County’s objectives is to organize, develop and enable a private entity akin to an Independent System Operator (ISO) or Regional Transmission Operator (RTO) to oversee the electric grid and energy market while ensuring a reliable power supply, adequate transmission infrastructure, competitive wholesale prices and fair access for renewable power. This approach has several notable advantages:
• There would be little physical infrastructure that would need to change hands, and as such the capital costs for this approach are relatively low. The ISO/RTO would need to acquire existing dispatch, monitoring and control equipment in order to manage the transmission/distribution system; however, the great majority of existing MECO generation assets along with MECO transmission and distributions wires would remain with MECO.
• This approach has the potential for quickest implementation, although a timeline is highly uncertain. The County would need to organize political capital to introduce, negotiate and enact enabling legislation at the State level which would take an unknown amount of time. However, given enough political willpower this route could be completed much more quickly than a negotiated sale or condemnation of the MECO assets, which could take five to seven years or longer.
• This approach can be implemented regardless of the outcome of the HEI/NextEra merger; whatever the regulated electric utility provider for Maui County might be, the utility would be subject to the jurisdiction of the ISO/RTO.
• This approach promotes competition by providing clear price signals and market transparency so that power producers of all types can make rational economic decisions; this approach also optimizes transmission planning such that all power producers are incorporated into planning and infrastructure improvement efforts.
Should the ISO/RTO approach be unacceptable or not capable of being accomplished, Guernsey believes that the most technically advantageous route to enhanced renewables integration must include a change of ownership of some or all of MECO’s existing assets. At a minimum, MECO’s transmission and distribution assets (including its dispatch control center) would need to be acquired by a third party, with such third party being empowered to function substantially similar to an ISO/RTO. If such empowerment could not be obtained, then MECO’s generation assets would also need to be acquired to achieve the desired results.
Of the two primary alternatives for third-party ownership – cooperative or municipal – Guernsey believes the most practical choice to be a cooperative business model. Legal issues aside, there are practical considerations such as public procurement laws, collective bargaining and bond ratings that make the municipal route more problematic than following a cooperative path. Either approach would still face significant hurdles including concern about utility rates.
In order to purchase MECO’s assets, a third party could expect to pay from a low of $525 million (book value) to a high of $867 million (replacement cost new less depreciation) depending on negotiations or the result of a condemnation / eminent domain action. In either a municipal or cooperative business model, it is expected that most if not all of the purchase price would need to be debt financed. The debt financings of either business model would include requirements for a debt service coverage ratio, or a multiple placed upon revenue requirements of the third-party utility; in the case of a cooperative, Guernsey expects this coverage ratio could be 1.25 or greater. Based upon our analysis, we find the debt service coverage ratio to erase the benefits of overall lower cost of capital and exemption from income taxes, such that utility rates would likely initially increase after a third-party acquisition…
HEI/NextEra Merger Discussion
There are numerous advantages and disadvantages associated with the proposed NextEra merger with Hawaiian Electric Industries (HEI).
• NextEra is a well-established mainland firm (45,000 MW under management) with extensive experience in the development and implementation of utility-scale renewable energy
• The company has a successful history from the shareholder perspective (over 300% total return over the past decade), and can provide ample personnel resources (nearly 14,000 employees) to address the issues facing Hawaii, and Maui County in particular
• NextEra has strong financial resources to enable major capital investments necessary to achieve the renewable energy goals, including transmission and distribution upgrades
• NextEra has demonstrated the incorporation of new perspectives and technical expertise in the development and deployment of micro-grids
• Access to capital resources may be improved with the merger as the revised entity will have a market capitalization approaching $50B (current capitalization of >$44B)
• As pointed out recently by Governor Ige, NextEra also has a history of discouraging customer sources of generation which is popular in Maui County, especially at the residential level
• Management control from outside the State of Hawaii further accentuates the gap between shareholder and ratepayer interests
• A merger reduces the potential for conversion of MECO to either a cooperative or to a municipalowned structure (lost opportunity for conversion); condemnation is still an option for municipal ownership, but window for cooperative alternative is practically eliminated
BENEFITS AND DISADVANTAGES OF COOPERATIVE AND/OR PUBLIC POWER
Due to their different ownership structures and no requirement to produce income, municipal and cooperative electric utilities exhibit several notable advantages and some disadvantages when compared to large investor-owned utilities. Significant positives and negatives applicable to the County’s tasking are described below.
In a regional transmission organization (RTO), described in further detail below, member companies, market participants, and other stakeholders vote in and create an organization where all parties are treated the same under an open access or pro forma tariff. Any potential advantages or disadvantages are generally offset for each participant.
A regional transmission organization (RTO) oversees the electric grid and wholesale power market while ensuring a reliable power supply, adequate transmission infrastructure, and competitive wholesale prices. A properly functioning RTO would facilitate the alignment of the utility business models, customer interests, and public policy goals. Absent a functioning RTO there will be limited or no integration of participants because there is no market transparency or transmission tariff under which nondiscriminatory services could otherwise be provided.
As identified by the American Public Power Association (based upon United States Energy Information Administration Form EIA-861 for 2010) indicates that, on average, cooperatives and public power utilities have lower retail rates than investor-owned utilities (IOUs):
Lower rates are generally possible due to one or more of the following:
• The utility governing body is more accessible, and therefore accountable, to its customers;
• The utility is not-for-profit and does not pay dividends to stockholders;
• Rates are set locally, either by citizen-appointed boards, elected officials, or the utility board of member-owners;
• The utility is not subject to income tax;
• The utility may be able to issue revenue bonds that are exempt from federal income tax for capital expense, and
• The utility may have access to low-interest financing from a variety of cooperative banks and federal electric programs.
ASSET OWNERSHIP & LOCAL CONTROL
Cooperatives and public power utilities are often found to provide better, more reliable service because they are owned and managed locally. IOUs are often conglomerates that do not have significant local management resources, leaving important or strategic decisions up to people away from the system.
General benefits accruing to public power and/or electric cooperative utilities include the following:
• Local management control over decisions involving investments, operations, maintenance, power supply choices, customer programs
• Increased community control over management decisions, including how many dollars remain within the local economy and are invested in the local community as opposed to leaving in the form of dividends to distant stockholders
• Citizen-owners or customer-members with direct say in policies through elected or appointed officials/management
• Greater local customer participation in meetings and access to information on planning alternatives, cost estimates, performance and other types of reporting
• Higher responsiveness to customers’ needs and concerns
• Dedication to power reliability, power quality, safety and efficiency that come from being singly focused on local operations
• Increased emphasis on long-term community goals
• Greater influence over electric distribution system aesthetics and design
• Economic development and jobs from lower rates that attracts or retains businesses
• Local employment with a larger portion of revenue retained in the community
• Utility management focused on local goals such as innovation, community technology development, and environmental stewardship
• For public power utilities, improved local government efficiency through integrated utility operations with other municipal utilities
RESPONSIVENESS AND ADAPTATION
Because electric cooperatives and municipal electric utilities are local they are typically more responsive to consumer needs and demands. Cooperatives and public power utilities are often quicker to adopt new technologies and methods of supplying electricity because their smaller size and local management structures allow them to be nimble and adapt to, or often lead, change in the electric utility industry.
For instance, the National Rural Electric Cooperative Association (NRECA) noted from a 2012 Federal Energy Regulatory Commission (FERC) survey that the cooperative industry leads electric utilities in advanced metering:
• Cooperatives’ advanced metering penetration has surpassed 31 percent compared with 23 percent for the country as a whole
• Approximately half of cooperatives have installed at least some Advance Metering Infrastructure (AMI) on their systems
• 30 percent of cooperatives with AMI/AMR have begun to integrate their metering systems with other systems such as outage management systems, customer information systems and geographic information systems.
RENEWABLES, DISTRIBUTED GENERATION AND MICROGRIDS
Cooperative and public power systems are often leaders in adapting renewable power goals and integrating renewable energy into their systems.
Cooperatives and public power entities are heavily involved in renewable energy. According to the NRECA, more than 90% of the cooperatives in the United States use renewable sources of electricity.
According to recent NRECA data and the Solar Electric Power Association’s “2012 SEPA Utility Solar Rankings,” cooperatives located in eighteen states have more than 4,000 solar-powered consumer-owned residential DG projects, representing more than 23 megawatts (MW) of capacity. The addition of 700-plus commercial and industrial (C&I) projects brings cooperatives’ solar-powered DG capacity to almost 53 MW.
Based on limited research, it appears that the position of NRECA regarding renewable energy is more advanced than APPA’s position; public power relies heavily on more traditional power sources and is therefore more closely linked to fossil fuels. NRECA, being a collection of more rural systems, has the advantage of being closer to many forms of renewable energy, and is therefore more invested in renewable energy research and adaptation.
Distributed Generation Cooperatives are invested in adopting and advancing distributed generation (DG). A 2013 NRECA report notes:
• Two-thirds of cooperatives interconnect with member-owned generation
• 75% have interconnection policies, up from 45% in 2009
• 45% purchase excess power from member-owned generation, up from 20% in 2009
• 47% offer net metering, up from 28% in 2009
The Department of Energy (DOE) definition of a microgrid is:
“A microgrid is a group of interconnected loads and Distributed Energy Resources (DER) with clearly defined electrical boundaries that acts as a single controllable entity with respect to the grid and can connect and disconnect from the grid to enable microgrid operation in grid-connected or islanded mode.”
Any small-scale localized station with definable boundaries and its own power resources, generation and loads qualifies as a microgrid. Microgrids can be intended as back-up power or to support the main power grid during periods of heavy demand. Often, microgrids involve multiple energy sources as a way of incorporating highly desirable renewable energy resources. Other purposes include reducing costs and enhancing reliability.
As shown in the following figure microgrids can be broadly classified as: 1. Distributed microgrid, or 2. Facility microgrid
A more detailed classification of microgrids includes:
• Off-grid microgrids: Off-grid microgrids includes generators for remote locations and other microgrid systems not connected to a local utility network.
• Campus microgrids: Campus microgrids are fully interconnected with a local utility grid, but can also maintain some level of service in isolation from the grid, such as during a utility outage. Typical examples serve university and corporate campuses, prisons, and military bases.
• Community microgrids: Community microgrids are integrated into utility networks. Such microgrids serve multiple customers or services within a community, generally to provide resilient power for vital community assets.
• Nanogrids: Nanogrids are the smallest discrete network units with the capability to operate independently. A nanogrid can be defined as a single building or a single energy domain.
Fully grid-tied systems that can't operate in islanded mode cannot be classified as microgrids, but instead are defined as grid-tied DER. Also, backup systems that serve very specific, limited loads and are not capable of feeding power back to the grid are generally classified as uninterruptible power supply or backup systems and not microgrids.
The practice of using microgrids is also known as distributed, dispersed, decentralized, district or embedded energy generation. DERs on distributed microgrids are generally owned by the utility company or Independent Power Producers (IPPs) and are solely dispatched by the utility company or Independent System Operators (ISOs) for the safe, reliable and efficient operation of the grid. Facility microgrids are typically owned and operated by the customer and are dispatched by the customers based on their requirements.
With the more stringent environmental regulations, growing concerns for cybersecurity, and more frequent severe weather events utilities are increasingly exploring microgrid options to supply reliable power to their customers.
DERs connected on a microgrid are typically interconnected via control logic to allow for:
• Optimization of economic dispatch
• Integration of renewable energy
• Emergency islanding
• Managing critical/non-critical loads to available generation
• Optimized island operation for fuel cost leveraging
• Energy resiliency and cybersecurity
The modular nature of microgrids could make the main grid less susceptible to localized disaster. Modularity also means that microgrids can be developed, step by step, to incrementally modernize the existing grid by strategically establishing microgrids in various locations across the grid during the process of modernization.
It is recommended that the following steps be performed for any microgrid project:
• Technical feasibility study
• Load flow analysis
• Dynamic simulation of the system
• Power protection and power quality studies, especially for island operation
• Relay coordination study
• Pre-deployment validation
Some of the technical challenges encountered while developing a microgrid project includes:
• Intermittent power availability from renewable energy (wind, PV etc.)
• Low system inertia (mostly from renewable energy sources) resulting in higher frequency and voltage fluctuations
Advantages of microgrids:
• Higher system efficiency due to reduced distribution losses
• Increased reliability of electric service
• Enhanced ability to integrate renewable energy
• Provides competitive environment as independent power producers can sell power to the grid
Disadvantages of microgrids:
• Can be expensive to construct, operate and maintain compared to similar size centralized system
• Legacy policies and regulations can create financing risks and challenges for microgrid projects
• Lack of technically knowledgeable personnel in remote locations
• Technical challenges associated with island operation and intermittent energy sources
The fundamental structure of an (IOU) is predicated upon earning the regulated return on invested capital; hence it is not conducive to the consumer self-generation vision currently being touted. Municipal ownership, assuming administrative and budgetary autonomy, is pro-customer (voter) and is a business model more supportive of self-generation. All of the business models would discourage grid defections, as it would increase the cost to the remaining customers. The anticipated improvements in battery technology and resulting cost reduction will undoubtedly increase grid defections; however, the vast majority of electricity consumers prefer the security and safety of grid-connected electric service. In theory the business model most supportive of consumer self-generation is the cooperative model wherein the system savings are ultimately refunded to the customer-owners.
Despite being smaller than IOUs, electric cooperatives and public power utilities hold high financial standards for themselves and overall they are very well-financed.
Moody’s Investors Service, 2009:
“Additionally, public power electric utilities have shown an ability to manage through the recent turmoil in credit and fuel markets and there have been generally sound finances and reliable service to customers. There have been no public power credit rating downgrades related to the impact of the unsettled credit markets. Many utilities also have undertaken strategic efforts to begin to manage expected changes in environmental regulation.”
ACCESS TO CAPITAL
Cooperatives and public power utilities have ready access to federal financing, revenue bonds and industry banking facilities but may have challenges attracting additional capital outside of these resources.
DEPTH OF EXPERTISE
Cooperatives and public power utilities are typically smaller, more locally-based operations and as a result may have trouble attracting talent and may not have as much back-up human capital in the event of emergency. Typically, cooperatives and public power utilities mitigate this weakness by belonging to statewide and national organizations that allow them to leverage the knowledge and resources of other utilities.
CHALLENGES TO IMPLEMENTATION
Lack of electric utility operation knowledge can inhibit the start-up of an electric utility. A typical mitigation of this would be to hire the most capable staff from the existing utility. Additionally, especially with public power, the new entity likely has expertise in other utility operations that can be extended over to the new utility, such as billing, human resources, and other administrative needs.
DISADVANTAGES SPECIFIC TO MAUI COUNTY
Municipalities in the United States operate under a broad variety of state laws, municipal charters and ordinances, case law, and labor/capital markets. Maui County’s particular legal and commercial environment places it at somewhat of a disadvantage as compared to a cooperative electric utility business model.
Public Procurement Laws
• A cooperative would be a non-public entity, and as such would not be subject to public procurement laws.
• Conversely, were the County of Maui to own and operate an electric utility, that municipal utility would be subject to the County’s existing public procurement laws. While such laws are established for good and valuable purposes, they do create inefficiencies when compared to private business entities; such inefficiencies typically result in increased capital and operational costs, and therefore increased utility rates to customers vis-à-vis private sector procurement practices.
Unions / Public Collective Bargaining
• A cooperative would be a non-public entity, and as such would not be subject to public collective bargaining laws. While it is possible that some or all of the workforce of a cooperative could elect to unionize, such action is not typical for the great majority of electric cooperatives in the United States.
• Conversely, were the County of Maui to own and operate an electric utility, that municipal utility would have to address collective bargaining challenges. Guernsey has direct experience with this issue through our consultancy to the City of Oklahoma City, which is seeking to purchase the water and wastewater utility assets of Tinker Air Force Base which the city surrounds. Oklahoma City’s labor workforce is unionized, and in seeking to expand its service area Oklahoma City was highly concerned about the increased cost for the Air Force base, as well as the disruptions that would be caused in its existing workforce as personnel competed for the new positions. This concern was so great for Oklahoma City that it ultimately engaged legal counsel to determine whether an independent trust could be established such that it would be free from unionization challenges.
• The County of Maui currently enjoys strong bond ratings (AA+ from Fitch) which are a testament to prudent financial management and provide economic benefit to the citizens via lower cost of borrowing. Strong bond ratings also position the County well with access to capital markets, enabling relatively higher levels of borrowing should emergency or unplanned capital requirements arise.
• The book value of MECO’s capital assets is estimated at approximately $525 million, which is likely the lowest purchase price for MECO’s assets; in either a negotiated sale or a taking through eminent domain / condemnation it should be expected that the actual cost of acquisition would be higher. Acquisition of these assets would require bonding in excess of the County’s total outstanding bonds and would markedly change the financial data upon which rating agencies form their opinions. This is not a barrier to pursuing a municipal electric utility but does present a significant challenge to County residents beyond mere electric service.
• A compounding complication with bonding is the cash flow necessary to support high bond ratings. Rating agencies look for a debt service coverage ratio (DSCR) that is a multiple of the minimum amount necessary to meet annual debt service; while agencies differ in what they find acceptable, a coverage ratio of 1.25 is a reasonable target. The end result is that unless other financial subsidy is provided, the municipal utility would have to charge its customers a multiple of the actual cost of debt service in order to achieve the highest bond rating possible. In this specific application, Guernsey estimates that an electric utility owned and operated by the County of Maui would actually have to charge higher rates than those currently charged by MECO, with a significant driver being the debt service coverage ratio…