Letters to the Editor
September 2004
To the Editor:
"Co-ops are beginning to look like ripe fruit" for IOU acquisition, Michael T. Burr wrote in his story on cooperatives ("Consolidating Co-ops," June, p. 71). In many cases, just the opposite is true.
Across the country, cooperatives are making acquisitions, cherry-picking service territory from investor-owned utilities. They may not make the big industry headlines, but rural electric cooperatives have become players in utility mergers and acquisitions.
During 2002 and 2003, five cooperatives acquired service territories, power plants, and distribution/transmission lines from IOUs, including Westar Energy, Citizens Communications, and Dominion Resources. (In contrast, no IOU has acquired all or part of a cooperative since 2000, according to Burr's article.) When Citizens Communications put three of its electricity divisions up for sale, cooperatives acquired two of them.
This trend is likely to continue. Over the past 20 years, cooperatives have built significant equity; they now have the financial resources for these transactions. According to the National Rural Electric Cooperative Association (NRECA), distribution cooperatives enjoy an average equity-to-asset ratio of 43 percent, much stronger than many IOUs; U.S.-traded IOUs have an average equity-to-asset ratio of about 33 percent, according to Multex.
Selling off rural territory makes sense for IOUs, many of which have suffered from rate caps, rating agency downgrades, and profit pressures from Wall Street. Within the distribution system of IOUs, there frequently are rural pockets, remote areas that are inconvenient and expensive to serve. Tax-exempt cooperatives often are operating in the same rural areas as IOUs, and as experts at serving the rural market, they can supply these customers better, faster, and cheaper.
Selling these territories to a cooperative can allow an IOU to pay down its debt; such was the case when Midwest Energy, a cooperative in Hays, Kan., acquired a contiguous rural service territory from Westar in 2003. Westar applied the proceeds, $33 million, toward its debt load.
Density also is an issue. Because utilities often use a postage-stamp rate for their customers within a given state, an IOU's high-density urban customers, whom it costs less to serve, can end up subsidizing the more expensive rural customers. Cooperatives have an average of 6.6 consumers per mile, according to NRECA, compared with 34.5 for IOUs. If a cooperative acquires IOU territory, it has the economic benefit of adding density; if an IOU buys an average cooperative, it suffers a decrease in density.
Burr's article also suggested that co-op customers could be better served if their cooperatives were acquired by IOUs. Again, the opposite is often true. Many co-op members benefit when their utility makes an acquisition of IOU territory.
Earlier this year, Vermont Electric Cooperative closed on its purchase of Vermont Electric Division from Citizens Communications, an $18 million transaction that more than doubled the size of the cooperative. It also sparked an 8.3 percent rate reduction, with the guarantee of no general increase for the combined system for the next five years.
In 2002, Kaua`i Island Utility Cooperative purchased Kaua`i Electric from Citizens. The $215 million transaction is expected to deliver more than $26 million in rate relief to co-op members over the next decade.
Because IOU rates must cover return on equity, cost for income taxes, and generally higher borrowing costs, acquiring a cooperative would likely mean either a bad return for the IOU or higher rates for the former co-op customers.
Acquisitions aside, co-ops continue to consistently outperform IOUs in customer satisfaction surveys. In the third and fourth quarters of 2003, Touchstone Energy cooperatives earned a score of 80 in the American Customer Satisfaction Index, managed by the University of Michigan Business School. The electric industry average was 77, and only one IOU, Southern Co., scored as high as the cooperatives.
Meanwhile, cooperatives' retail electric rates are far more competitive than portrayed in last month's article. According to 2002 data from the U.S. Department of Energy, cooperative rates are lower than investor-owned utilities in all three sectors:
o Residential: Cooperative customers paid 7.8 cents/kWh, while IOU customers paid 8.6 cents;
o Commercial: Cooperative customers paid 7.1 cents/kWh, while IOU customers paid 7.8 cents;
o Industrial: Cooperative customers paid 4.2 cents/kWh, while IOU customers paid 4.9 cents.
From M&A transaction activity to customer satisfaction to lower rates, it is clear the cooperative movement
is just as vibrant in 2004 as it was when the lights were going on in the 1930s.
Bill Conway
Investment Banker, Christenberry Collet
bconway@cccoibank.com
To the Editor:
Having been through a couple of electric cooperative mergers, I read with interest the June 2004 article "Consolidating Co-ops." However, I found it to be incomplete. The article mostly focuses on rates, as if customers care only about the cost of electricity and have minimal concerns about customer service, reliability, or power quality. Every customer survey I have ever seen, as well as informal feedback from customers, indicates just the opposite: Customers care first about reliability and service, and rates second-as long as rates are within a fairly competitive ballpark. It has been my experience in two different states that cooperatives provide superior service and reliability compared to IOUs, and often the smaller cooperatives provide equal or better service than the larger cooperatives.
The article also implies that by consolidating, cooperatives would be able to dramatically reduce their rates. The article neglects to mention that for most cooperatives, wholesale power costs represent 60 to 70 percent of their retail cost structure. Depending on your wholesale billing, consolidating might have very little if any impact on wholesale power costs; so it might only affect the smaller piece of the pie, distribution costs.
Not all electric cooperative mergers or consolidations are a bad idea. But more consideration should be given to how it affects service issues.
Matt Berry
Customer Service, Midwest Electric
mberry@midwestrec.com
The Author Responds
Mssrs. Conway and Berry both make good points-points that illustrate how co-ops' world is changing.
The more progressive electric cooperatives are seeking greater economies of scale (through acquisitions and consolidation) and are striving to distinguish themselves as quality service providers. Such co-ops recognize that a federally sanctioned, not-for-profit ownership structure will not insulate them from the economic pressures driving the utility industry today-especially when investor-owned utilities are on the hunt for growth opportunities that fit into the "back-to-basics" strategy mandated by Wall Street.
Furthermore, the debate and interest that this topic has sparked-both publicly and behind the scenes-signals that the winds may be shifting for co-ops.-Michael T. Burr
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