Fortnightly
LILCO\(emThe Politics of High Electric Rates
September 01, 1995By Charles M. Studness
Traditional utility regulation has been unable to prevent the electric rates of some utilities from rising far above those of neighboring companies. Two factors are responsible for this failure. First, regulators lack the means to keep seemingly reasonable but unnecessary costs from creeping into rates. Second, ratemaking considers a utility's costs in isolation and does not use peer benchmarks to true up rates.
Political pressure helped limit rate increases for nuclear plants during the 1980s. Yet, in the case of the Long Island Lighting Co. (LILCO), with the highest electric rates in the country, political pressure has proved ineffectual.
The 3.5 million people on Long Island who are served by LILCO paid an average electric rate of 15.3 cents per kilowatt-hour (›/Kwh) in 1994 \(em 16.8 cents for residential customers and 14.3 cents for commercial and industrial customers. These rates were roughly 50 percent above those in the New Jersey and Connecticut suburbs of New York, and twice the national average. If these rates were cut to the national average, residents would stand to save $1.2 billion annually \(em about $700 per residence and $6,000 for each of Long Island's 102,000 businesses.
The most significant factor driving rates is the 1989 settlement that allowed LILCO to recover and earn a return on its $4-billion investment in the Shoreham nuclear plant. Over the 40-year life of the settlement, LILCO will collect $14 billion for Shoreham \(em $4 billion in recovery, and $10 billion as a return. LILCO's electric rates have risen 31 percent since 1989.
At the same time, employment has declined by 10 percent (100,000 jobs). Moreover, the replacement of jobs lost from declining defense spending has been compromised by high electric rates.
Neutralizing the Opposition
Discontent is obvious, but has not been mobilized effectively. Consider how the New York Public Service Commission (PSC) publicized its March decision approving LILCO's request to freeze base rates for 1995. All five commissioners came down to New York City from Albany to announce the decision to the financial community. They promised to honor the financial obligations of the Shoreham settlement, emphasizing the importance of LILCO's bond ratings and its "access to reasonably-priced capital."
But in the political equation, the ratepayers did not count. The elements that should have created political pressure in favor of lower rates had been silent or absent: the press, large customers, and coordinated interest groups.
First, the press on Long Island is almost monopolized by Newsday, a loyal supporter of LILCO. Newsday has attacked rate plans proposed by Nassau and Suffolk counties, the two counties LILCO serves. Nassau has petitioned the PSC to allow retail wheeling; Suffolk is asking the Federal Energy Regulatory Commission to permit a county agency to buy wholesale power for residential customers as a "muni-lite." The strained logic of Newsday's attack on these plans suggests that the paper is deeply committed to LILCO's cause at the expense of the community. Wisely or not, Newsday has abrogated the normal role of the press as a catalyst for change.
Second, cuts in defense spending have left Long Island bereft of large industrial companies that could spearhead a drive for lower rates. Grumman has all but disappeared, and the Island's largest employer is now a grocery chain,
Waldbaum's. There simply are no large customers that can exert pressure for lower rates the way Raytheon has in Massachusetts.
Third, individual proposals to cut rates have lacked the clout of a concerted effort between interest groups. A state agency, the Long Island Power Authority (LIPA), has proposed a $9-billion takeover that values LILCO's common stock at $17.50 per share. LIPA would finance the buyout by selling tax-exempt bonds. Servicing the $9-billion debt, however, would limit the rate cut LIPA could achieve to about 10 percent, which would leave Long Island rates 70 percent above the national average, and second-highest among major utilities. LIPA would simply be paying too much for LILCO's assets. For $9 billion, LIPA would get only $3.5 billion of operating plant, and pay $5 billion for Shoreham intangibles \(em that is, "good will." Besides LIPA and the counties, high rates have spawned municipalization studies and attempts by school and water districts to access the wholesale power market.
For its part, LILCO has skillfully held the opposition at bay. The utility has wielded its alliance with Newsday to cast doubt on the viability of competition for Long Island, effectively precluding the opposition from using competition as a unifying theme. Keeping the opposition unorganized, LILCO has been able to isolate and disarm individual initiatives to cut rates.
LILCO's financial policy also makes it difficult for the PSC to reduce rates. The Shoreham settlement placed no restrictions on LILCO's use of funds produced by rate increases. LILCO has used these funds to pay dividends at the expense of its financial strength. LILCO's equity ratio (29 percent) and interest leverage (1.99) remain dangerously low. Meanwhile, its dividend payout ratio has averaged 80 percent for the last four years. This continuing financial weakness has bedeviled the PSC, which has backed away from cutting rates for fear of jeopardizing LILCO's precarious financial position.
While LILCO's financial policy has served investors well thus far, it is not without long-term risks. Management has opposed competition, refused to prepare for it, and kept the company in a vulnerable financial position. Any attempt to reduce rates will likely be disastrous for investors. Moreover, as pressures continue to grow, the likelihood that policymakers will eventually cut rates will also increase. t
Charles M. Studness is a contributing editor of PUBLIC UTILITIES FORTNIGHTLY. Dr. Studness has a PhD in economics from Columbia University, and specializes in economics and financial research on electric utilities.
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