Dear Reader,

This briefing paper is the first in a series of papers on the move to competition in the electric industry in New York state and the nation.

This industry has significant and pervasive effects on the health and safety of our residents. It has an enormous impact on the viability of New York to compete in the retention and creation of jobs. Bringing competition to the electric industry involves far reaching policy decisions that require serious public input and debate. Comprehensive solutions are required.

These policy decisions involve tens of billions of dollars and thousands of jobs and will have consequences for decades. These decisions will determine whether New Yorkers can count on reliable service. Our actions will determine whether New Yorkers can achieve large reductions in the excessive electric rates charged New York residents and businesses. Our rates are 50 percent above the national average and 100 percent above the national average on Long Island. These unacceptable rates place a heavy burden on customers and cost this state thousands of jobs.

We have already released two documents, "The Electric Industry in New York" in December 1995 and "Competition Plus/Energy 2000" in March 1996. The first is a general primer on the industry, and the second represents the only comprehensive governmental proposal to address the move to competition. Please contact the Assembly Press Office if you would like copies of either document. The phone number is (518) 455-3888, and the address is State Capitol, Room 347M, Albany, New York 12248.

We are pleased to present this information and look forward to your comments.

Shedding Light on Securitization

In June of 1996, Governor Pataki and Chairman O`Mara of the Public Service Commission (PSC) proposed legislation which has become known as the "securitization" bill. This unprecedented bonding proposal provides utilities with a guaranteed return of stranded investments, through charges on residential and business customers. By definition, these investments would be valueless in competitive markets.

A careful analysis of the bill indicates a number of significant problems.

• The Governor's securitization bill would perpetuate high rates.
  
• The securitization bill would allow utilities to earn full recovery on investments that have no economic value in a competitive market.
  
• Businesses and families could be charged an average of $3000 per customer. This is essentially an irrevocable and burdensome tax on consumers collected by utilities.
  
• The securitization bill would shelter utilities from both regulation and competition, by providing guaranteed recovery from customers.
  
• While sheltering utilities from forces that lower rates, securitization would offer refinancing savings that may reduce rates by less than one percent.
  
• The securitization bill would authorize what amounts to new public borrowing of $15-25 billion.
  
• The securitization bill would delay the introduction of genuine competition and the cost reductions that competition will yield.
  
• Any benefits of securitization could be eliminated by federal taxation.
  
• The securitization bill would place utility workers and reliability at risk.
  
• The securitization bill may negatively affect existing utility bondholders.
  
• No other New York State industry has ever been accorded such privileged treatment, where the cost of investments become the complete obligation of the citizens of New York.

Summary of the Securitization Bill

The Governor's bill allows utilities to convert their "intangible expenditures" into "intangible property," and then to borrow money on the strength of a State guarantee that the utilities' customers will pay for the "intangible property." "Intangible expenditures" can include utility "stranded investments" and independent power producer (IPP) contracts, that are above market prices, guaranteeing returns not only to utilities but also to IPPs and their creditors. Once the borrowing is accomplished, neither the PSC nor the Legislature would be able to intervene to protect customers even if circumstances change.

The bill would be implemented by the PSC, which is the agency that establishes the rates that utilities charge their customers. Under the bill, the PSC would enter into agreements with utilities, known as "qualified rate orders." A qualified rate order would "provide for the recovery, through rates ... of qualified intangible expenditures." Once the PSC issued a qualified rate order, the utility, or the utility's creditor, or any successor in interest, would have a guaranteed right to recover the "intangible expenditures" from electric ratepayers. The "intangible expenditures" would become "intangible property" and the utility would be able to borrow money using the intangible property as security -- thus "securitizing" the utility's expenditures.

The PSC's order would be irrevocable and would be accompanied by a legal promise that "the state will not limit, or alter" the right of a utility or a creditor to charge ratepayers the amount specified in the order.

There is no limit to the amount of utility expenditures that could be made subject to a qualified rate order. Although the definition of "qualified intangible expenditures" purports to exclude costs associated with power plants and other forms of property, the definition would apply to any refinancing. In other words, the PSC could allow any form of utility expenditure, including the costs of nuclear power plants, to be deemed "intangible."

The bill would require the PSC, as a condition for entering into an agreement with a utility, to find that the issuance of the qualified rate order would "result in significant rate savings to the customers" of the utility. The bill does not define "significant rate savings" or specify which customers would benefit from the savings.

This proposal must be analyzed in the context of the movement toward competition in the electric industry, and the urgent need to reduce the cost of electricity in the state. In a competitive electric industry, customers would be able to choose their electricity suppliers. The generation and marketing of power would be performed in an open competitive market by unregulated power producers and other energy service providers. The actual delivery of electricity along transmission and distribution lines would remain a monopoly function performed by utilities subject to PSC regulation. Under the securitization bill, the cost of repaying "securitized" debt would be added to the cost of providing transmission and distribution services, so that all users of electricity would be required to pay for the securitized debt. This will have the effect of delaying the benefits of competition in New York for the 10-15 year lifetime of the debt.

The Governor's bill would apply to the utilities' "intangible expenditures," which would include (but not be limited to) their strandable costs. Strandable costs are costs which utilities have already incurred but would not be able to recover because of the
lower prices anticipated in a competitive market. The excessive costs of nuclear plants or long-term power purchase contracts are examples. Estimates of utilities' strandable costs in New York range from $15-25 billion, or approximately $3000 per customer.

Under existing law, utilities are not guaranteed full recovery of these costs. The PSC is charged with the duty of protecting the public by setting rates which balance the interests and expectations of all parties. The utilities face a risk that some of their costs will not be recoverable -- a risk that is borne by their stockholders and reflected in the capital markets. The PSC has determined, in its pronouncement on competition in the electric industry, that "while ... rates must reflect a reasonable balancing of ratepayer and shareholder interests, they may or may not include stranded investment."

Under the Governor's securitization bill, utilities would be guaranteed the right to charge ratepayers for the full amount of any sum fixed by the PSC. This guaranteed recovery for utilities would replace the balancing of interests normally performed by the Commission. Once the securities were sold, neither the Commission nor the Legislature would have the legal authority to intervene on behalf of ratepayers during the lifetime of the bonds.

Such an abdication of regulatory responsibility would be unprecedented. Under the securitization bill, utilities would have large portions of their assets placed beyond the reach of regulation, yet would have these same assets sheltered from competition.

It cannot be credibly argued that the costs recoverable under the securitization bill would necessarily have been recovered by utilities in any event. Since the utilities currently have no entitlement to such recovery, and the PSC has the duty to adjust rates to protect the public interest, there is no guarantee, or even likelihood, that cost recoveries guaranteed by the PSC under the securitization bill would equal recoveries that would occur under competition or under regulation.

The securitization bill would deprive ratepayers of the ongoing protections and savings afforded from flexible regulatory scrutiny and from the pressures of competition.

The bill has no standards to protect customers.

The only precondition for this windfall to utilities would be a finding by the Commission that "significant savings" for customers would result. No definition of "significant savings" exists in the bill. The Governor's bill would not require the PSC to measure these savings against the savings that would result if utilities were exposed to competition; nor would it require them to be measured against the savings that would result from more assertive regulatory treatment. Rather, the bill allows the
Commission to measure "savings" against a hypothetical full recovery by utilities of all of their strandable costs and against projected rate increases that would result from a full recovery.

The "savings" achievable through securitization are trivial at best.

Assuming that utilities' full strandable costs equal $20 billion, and assuming that securitizing would result in utility borrowing costs that were lower by an average of one percent, securitizing all of the utilities' strandable costs for a period of ten years would result in estimated reduced borrowing costs of approximately $134 million per year over the ten-year period. Viewed in the perspective of overall rate impacts, these "savings" would be less than one percent.

In fact, one impact of securitization over the next ten years could be to raise rates for some utilities. Many of the utilities' costs are currently being paid for over periods of 30 years or longer. Securitization may compress the repayment schedule into a much shorter period of 10 to 15 years. This would require customers to pay more cash up front so that utilities could enjoy early repayment of their debt.

Even if securitization were able to achieve "savings" of one percent, this would accomplish little for New York, where utility costs are more than 50 percent higher than the national average, and where high electricity bills have become a serious burden on businesses and families. In reality, a securitization deal covering all of the utilities's strandable costs would simply ensure that New Yorkers would continue paying unacceptably high rates well into the future.

Securitization is a poor substitute for assertive regulatory action.

The PSC has already determined that utilities are not legally entitled to full recovery of their strandable costs. The Governor's bill, however, ignores this fact. The Governor's bill does not require any concessions from utilities in exchange for the guarantees they would receive. The bill does not require that there be any relation between the savings achieved and the amount of utility recoveries that are guaranteed. And most importantly, the bill does not require that there be any comparison between "savings" under a proposed securitization deal and real savings that could be accomplished through assertive regulation or through competition.

The bill has no standards for public participation.

Under the securitization bill, the PSC would be permitted to negotiate with utilities to obtain concessions and increase the savings available under a securitization deal. The bill, however, lacks any standard to govern such a process. The bill would allow the PSC to base a finding of "savings" on cost reductions entirely unrelated to the expenditures being securitized. In other words, the utility could promise rate reductions based on worker layoffs and relaxation of customer service and reliability standards. There is no clear requirement of evidentiary hearings or other opportunities for public comment. The standards are so broad that any deal struck between the utilities and the Commission would be virtually immune from legal challenge by aggrieved ratepayers or other parties.

The bill could cause utility customers to pay higher federal taxes on behalf of the utility.

Even the modest "savings" that would be obtained through reduced interest rates could evaporate due to increased federal income taxes, depending on whether a securitization deal is treated as a sale or as the production of debt. It is not clear what tax treatment the Internal Revenue Service will afford the creation of "intangible property" from "qualified intangible expenditures."

The bill does not require that all customer classes be treated fairly.

The bill also lacks any standard governing the allocation of "securitized" costs among different classes of ratepayers. Creditors loaning money to utilities would most likely insist that the most "secure" method of cost recovery be adopted. The most secure cost recovery method would most likely be a fixed charge per customer, often referred to as a "line charge," rather than a charge based on the volume of energy actually used by each customer. If a fixed customer charge is used as a recovery mechanism, low-volume users such as small businesses and families would pay a disproportionately high share of the costs.

Securitization will cost customers even more money if energy price estimates are not accurate.

Securitization represents a gamble that the price of wholesale electricity will not rise over the long run. A securitization deal would attach a fixed dollar figure to a currently unknown future stream of utility revenues and would allow the utilities a guaranteed recovery of those dollars. In this sense, a securitization deal is a ratepayer buy-out of the utilities' strandable costs. If prices rise beyond current PSC forecasts, less cost will be stranded and the ratepayers will have paid too much in the buy-out. Because the PSC will have permanently waived its regulatory authority, the ratepayers will have no opportunity to recover their excessive payments to the utilities.

Holders of existing utility bonds may experience downgrading as a result of a securitization deal. Securitization would have the effect of creating a new class of bondholders with rights that are superior to those of existing utility bondholders. Securitization may also encourage utilities to revise their capital structure by reducing the percentage of common equity. This could expose existing bondholders to greater risk. Moreover, since there will be continued pressure to reduce rates after the securitization deals have been transacted, all investors who do not hold the privileged "securitized" debt will bear the increased risk that results from the ongoing need to reduce rates.

The Governor's bill describes securitization as "a transition vehicle which provides ratepayer relief as the state moves towards competitive electric markets." As noted, however, the potential "ratepayer relief" afforded by securitization is trivial when compared to the size of the guarantees that would be enjoyed by utilities. The practical effect of securitization would be to deprive ratepayers of the savings and benefits of competition by sheltering huge portions of utility assets from the pressures of competition.

Moreover, securitization could undermine the competitive process by providing the utilities with an unfair advantage over their competitors. By carving out their uncompetitive costs and insulating those costs from competition, the utilities would establish themselves in a unique competitive position: they would earn a market return on their competitive assets and a guaranteed return of their uncompetitive assets.

Utilities would have a strong incentive to include as many fixed costs as possible for recovery through securitization. To be profitable, any business must recover its fixed costs. A utility that recovers its fixed costs through a line charge not subject to competition can sell electricity in the competitive part of the market at prices that exclude recovery of the fixed costs covered by the line charge. In contrast, new entrants into the competitive market must recover all their costs in the market. There is a real risk that securitization might in fact cover more than stranded costs, because the utilities' incentive to securitize as many fixed costs as possible would coincide with the PSC's incentive to maximize the "savings" resulting from securitization. As noted, however, these savings, taken by themselves, are not real but only serve to perpetuate high rates. The customers will pay both the high securitized line charge and the "competitive price." A higher line charge, accompanied by an artificially low "competitive price," would have the result of discouraging entry into the competitive market, thus reducing the ability of competition to produce lower prices for consumers.

The Governor's bill does not take into consideration the potential impacts on competition of securitization. The bill simply provides for guaranteed recovery of "qualified intangible expenditures" as long as they result in undefined and unquantified "significant ratepayer savings."

A securitization deal would be accompanied by a state promise never to interfere with the utilities' right to collect the money from ratepayers. This would provide the utilities, or the holders of securities sold by utilities, with constitutional protections even stronger than those enjoyed by people who hold State-issued debt.

For all practical purposes, the Governor's bill authorizes the creation of $15-25 billion in new public debt. The only significant difference between the borrowing contemplated under the Governor's bill and public borrowing, is that one is repaid by all of the utilities' residential and business customers and the other is repaid by taxpayers. In either case, it is the people of New York that pay.

If the utilities receive permanent guarantees for recovery of their fixed costs, it will be impossible to achieve the rate reduction that New Yorkers need without sharply reducing other utility costs. Utilities facing pressure to reduce rates will attempt to reduce their workforce in order to reduce costs. Although labor has already undergone widespread reductions, pressure for further reductions will result from securitization.

Furthermore, the PSC may negotiate "concessions" from the utilities as a precondition for a securitization deal. These concessions might or might not involve reduced recovery of strandable costs by utilities. More likely, the concessions would involve promises of rate reductions that would come from unspecified sources. This would leave utilities free to cut labor costs as the "price" for obtaining a securitization deal.

Efforts to reduce rates through workforce reductions create the risk that the reliability of the electric system may be weakened. Budget cuts in maintenance and customer service may undermine the ability of utilities to respond to outages and other customer needs.