Thursday, October 24, 2013

Should I Stay or Should I Go?* - PSNH and Electricity Deregulation in New Hampshire

Over the past few blogs, I have taken a look at electrical utilities in NH and at the State's largest electrical utility, PSNH, in particular. I have also highlighted the regulatory compact that exists between a state and its public utilities. That compact can change through policy changes, so in this post, we take a look at the start-and-stop process of electricity deregulation in New Hampshire and how it has impacted PSNH. 

Until 1996, PSNH's business model was pretty simple, as shown in the figure below. It was a regional monopoly, solely responsible for generating, transmitting and distributing electricity to consumers within its franchise area. It totaled all the costs associated with its services (generation + transmission + distribution), built in its regulated return on assets, divided it by the number of kilowatt hours of electricity sold and came up with a price for supplied electricity. This price then had to be reviewed and approved by the New Hampshire Public Utilities Commission (NHPUC). PSNH was the classical, vertically integrated, regulated utility company.  

In 1996, however, in response to high electricity rates and the electricity deregulation wave that was sweeping the country at that time, NH deregulated the electricity business and introduced competition into the generation (or electricity supply) part of the business. The logic behind deregulation was that competition would remove the monopolistic position of the electrical utilities, it would increase competition, and the outcome would be lower prices for electricity and more services for consumers.

At the same time, it was recognized that, while the electricity generation side of the business could be opened up to competition, the other two parts of the electricity business—transmission and distribution— should remain as monopolies. In the primer on public utilities, I pointed out that one of the reasons for allowing monopolies in the provision of public services, such as electricity, is that it avoids the congestion problem: if we allowed competition in the transmission and distribution of electricity, our state would be crisscrossed with transmission towers and power lines from different companies and our streets would be cluttered and festooned with wires and poles from different distribution enterprises - perhaps like the picture below.

An essential aspect of deregulation was that the public utilities should get out of the generating business altogether and sell off their generating assets as it was determined that true competition could only arise if the monopoly controlling the wires did not run their own product (electricity) through their wires. The concern was that the entity that owned the transmission and distribution network would naturally favor their own generated electricity and would put up overt, as well as subtle, barriers to competition. That was the initial deregulation plan for New Hampshire and so electricity restructuring in NH required the utilities to sell their generating plants.

But then in 2000, there was a major bump in the road to deregulation.

California was one of the first states to deregulate electricity supply in 1996. The California utilities had to sell off their generation assets and they were also prevented from setting up long-term power supply agreements with generators. Moreover, retail rates for many consumers were capped but wholesale rates were allowed to float. It soon became apparent that this system was very fragile and ripe for being gamed. Electricity suppliers rapidly figured out that closing down of in-state plants, for maintenance or other reasons, would increase wholesale power prices and increase their profits. This, combined with dry weather, which created a shortage of imported hydro power, led to electricity supply shortages in California, blackouts and sky-high wholesale prices in 2000 and 2001. With a cap on retail sales in some areas, utilities soon found themselves selling retail electricity at lower costs than they were purchasing at wholesale. Clearly this could only last so long: it ended up crippling some of the larger California electricity utilities and driving one of the largest, Pacific Gas and Electric, into bankruptcy.

The State of California declared a State of Emergency and had to scramble to set up long-term power purchase agreements to ensure electricity supply — at an enormous cost to California rate payers. Much of the blame was subsequently leveled at Enron, who were accused of market manipulation. Careful reading of the California electricity crisis, however, indicates that market manipulation was only one of many causes of the problem. Poorly constructed deregulation policy seems to have been the more important aspect. Regardless of the reasons, electricity deregulation in California was viewed as little short of a disaster.

NH legislators had the benefit of observing California's travails from afar and quickly took their foot off the deregulation pedal and in 2001 the State delayed the divestiture of PSNH's non-nuclear generating assets. This left NH with the hybrid system, or partial deregulation, that we have today, with competition in the supply of electricity but with PSNH also supplying electricity from its own generating assets. The structure of the electricity business in the PSNH franchise area now looks like the figure below.


We now have 18 competitive electric power supply companies and 92(!) aggregators who have the opportunity to offer competitive prices to their customers. Their prices are based on market rates and whatever supply agreements these companies can establish. We also have PSNH supplying electricity to its customers, but this price is regulated and is calculated on the basis of the costs required to run their generation facilities and guaranteed return on their generation plants divided by the amount of electricity supplied. As a regulated supplier of electricity with high fixed costs due to their generating facilities, the cost basis for PSNH's electricity is therefore higher.  As a result many PSNH customers have migrated to lower cost competitive suppliers, leaving PSNH with less customers over which to spread these costs — which then drives their costs for electricity even higher.

In the table below, I have provided a sampling of the residential electricity supply rates in New Hampshire which include those from other NH electrical utilities as well as competitive suppliers in the PSNH franchise area.

As can be noted from data in this table, PSNH's standard rate for electricity supply (referred to as their default rate) is higher for their customers than that of competitive suppliers as well as other NH electrical utilities. This has now become cause for concern for legislators and regulators alike. Earlier this year, NHPUC commissioned a report to review the situation and their recommendation is that the State needs to complete the process of deregulation and compel PSNH to divest their generation assets. PSNH strongly disagrees with this position, as shown by Gary Long, the previous long-term CEO of PSNH, in his recent testimony and in a PSNH report. Completing deregulation and getting PSNH to divest their assets is a perennial issue in NH politics, but the argument has become far more intense during the past two years due to the flood of customers leaving PSNH for cheaper electricity supply rates and the increasing burden the remaining customers face via increased energy service rates.

There are good reasons for and against divestiture on both sides. I have attempted to summarize below the main points for and against compelling PSNH to sell of its generating assets.

Arguments for Holding onto Generating Assets 
  1. Deregulation in California was a disaster for the state and for some utilities that went bankrupt as energy supply companies were able to game the system. This would not have occurred if utilities had been allowed to hold onto their generating assets.
  2. Many states have pulled back from deregulation or have not completed their deregulation plans. Only 15 states offer retail choice.
  3. Owning generating assets like hydro and coal-fired power stations allows the diversification of energy supply, which better serves NH customers as energy commodities go through different cycles of high and low prices.
  4. Reliability of electricity supply could suffer because the only motivation for independent power producers is profit. If it is not in their best interest to supply power at market rates, they can simply turn off their generating plants.
  5. PSNH provides a safety net for its customers. If you cannot or do not sign up with any of the other providers, PSNH is obligated to serve you. The generating assets are part of that safety net.
  6. High energy service rates in NH are more a result of policy created by law makers than PSNH's doing.
  7. The region has become heavily dependent on natural gas, for which there is no storage. Any interruption of natural gas supply, such as a pipeline problem, will have an immediate impact on electricity supply. Coal plants have at least some stocks of coal on site.
  8. Divestiture can result in a increased costs to all PSNH customers increase because PSNH would need to be compensated for lost returns on the sale of the assets via stranded cost recovery.
  9. Winter energy prices for New England would be higher if PSNH did not continue to operate their plants especially during the high demand winter months.

Arguments for Divestiture:
  1. The original intent of deregulation was to have all electrical utilities sell their generating assets. PSNH is the only utility not to have done so and, to complete the deregulation process, they must be compelled to divest the generating plants.
  2. If PSNH owns their own generation operations, they will be likely to favor their own generating plants and make it expensive and challenging for competitive suppliers of electricity.
  3. There has been considerable migration of customers away from PSNH, which has led to PSNH distributing the costs associated with its generation operations over a smaller and smaller group of remaining customers, which will continue to increase the costs for electricity supply to these customers. Higher prices will, in turn, prompt further migration away from PSNH, and eventually leave PSNH with no customers. This has been characterized as the PSNH "death spiral".
  4. PSNH energy customers are paying higher than market rates due to the generating assets. This is taking money out of NH consumer pockets and passing it onto PSNH,  their parent company, Northeast Utilities and their shareholders.
  5. PSNH coal-generating plants are polluting, expensive to run and sit idle for a great deal of the time, but they still earn a continuous and assured return for their shareholders which is extracted from their energy customers.
  6. NH ratepayers are the only New England rate payers that are on the hook for paying the costs of utility-owned electricity generation plants.
  7. Reliability and resource adequacy of electricity supply is not the responsibility of one utility. We have a regional electrical grid shared by the New England states and as such is the responsibility of the regional grid authority, the Independent System Operator – New England, also know as ISO-NE, to maintain reliability and supply adequacy.

It is important to note that I am not making judgments on the merit or correctness any of these "Should I Stay, or Should I Go?"* arguments. Indeed, each one of them is worth its own blog posting, hours of legal debate and a thick consultant report. They are simply some of the for and against reasons that have been advanced in this debate. There are, no doubt, some that I have missed, so if you see a big omission in the listing of arguments, please share it with me.  

This knotty situation is further complicated by the fact that the generating assets are listed on the PSNH books at $674 million and, in the present coal-unfriendly and low-priced natural gas environment, it is unlikely that buyers are going to be lined up, like on new iPhone release day, to purchase PSNH's coal-fired assets. Regardless, this is a complicated issue, and it is one that the regulators and legislators in NH are presently wrestling with: one way or another, it is going to impact the wallets of PSNH rate payers.

In a future post, I will look at possible outcomes of this debate. Until next time, remember to turn off the lights when you leave the room—even if you do have cheaper electricity from a competitive supplier.

Mike Mooiman
Franklin Pierce University
(*Should I Stay or Should I Go - A fine 1982 tune from The Clash, my second favorite British punk group off their appropriately titled "Combat Rock" album. Rated at 228 on Rolling Stone's "The 500 Greatest Songs of All Time" list. That's about right, I'd say.)

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Monday, October 7, 2013

Wind in the Wires* - New Hampshire Electrical Utilities and a Closer Look at PSNH

In this post I build on our knowledge of public utilities and take a look at electrical utilities in New Hampshire. I will take a particularly close look at the largest electrical utility in New Hampshire, Public Service of New Hampshire (PSNH), as it has had a rather checkered history and it also provides a useful case study of the challenges faced by electrical utilities in these days of deregulation, low natural gas prices and waning interest in coal-fired electricity generation. 

In my last blog, I discussed the regulatory compact that exists between utilities and the communities they serve. The essence of this compact is that we provide the utility with a monopoly to provide service so they can earn predictable profits and we gain by getting build out of the required service infrastructure, the ability to negotiate reasonable rates as well as safe and reliable service.

We have all benefitted from this monopolistic business model that permitted the rapid electrification of the USA with electrical supply even spreading into rural areas. We have gained enormously from the reliability of our electrical supply – it is there all the time when we need it. (If you have reservations regarding the reliability of the US grid, I encourage you to spend some time in any of the less-developed countries to gain an appreciation for the dependability of US grid.) It makes possible our modern lives, it cooks our food, lights our homes and powers our communications and - increasingly - our transportation. Moreover, as knowing and unknowing investors in utility companies, we have benefitted from the regular profits and dividends produced by utilities that have funded part of our retirement and pension plans.

As noted previously there are three aspects to the electrical utility business as shown in the figure below. There is the generation of power, typically at a large power plant located in a central location. Then there is the transmission of electricity over long distances from the generation point to towns and cities and, finally, there is the distribution of electricity through the community via the sub-stations, wires and transformers to individual homes and businesses. Not all electrical utilities focus on all aspects of the business. Some for example, such as my local electrical company, just focus on the distribution part of the business. Others, such as the merchant wood-fired power plants or the wind farms in NH, just focus on generation, whereas other utilities, such as PSNH ,are fully integrated organizations involved in all three aspects of the business.


 In NH we find several types of electrical utility companies:

  • There are those that are owned by shareholders who are seeking a financial return on their investments. These are referred to as investor-owned utilities (IOUs) which are most commonly public-traded companies. In NH the big three are (1) PSNH, which is wholly owned by Northeast Utilities (NU), (2) Granite State Electrical Company, which is part of the Liberty Utilities group owned by the Canadian company, Algonquin Power and Utilities Corporation, and (3) the NH-based Unitil company. The key to these organizations is that you do not have to purchase electricity from these organizations to be an investor and the more shares you own, the greater say you have in the running of the company. Because these companies are investor owned, they are driven by the need to maintain profitability and regular dividend payouts.
  • Electrical cooperatives are organizations that focus on supplying electrical services to their customers who are the members and owners of the cooperative. New Hampshire Electric Cooperative is a good example. Each member of the cooperative has an equal voice in the organization and profits are used for infrastructure investments, maintaining low electricity rates or are paid out as dividends to members. These types of utilities are very customer focused as they don't have to face the investor pressure that the IOUs are subject to. These organizations are largely in the distribution business as they purchase their power from a number of generators.
  • There are also electrical utilities that are run by local government organizations, such as municipalities. These are called "munis" and they are only responsible for the distribution of electricity within their communities. In NH we have a few of these organizations: Ashland, Littleton and Wolfeboro, among others, have their own municipal electric companies that are responsible for the distribution of electricity within their town limits.
A map of the service areas for the various NH electrical utilities is presented in the figure below. The blue areas belong to PSNH, the yellow to NH Electric Cooperative, the light green to Granite State Electrical Co. and the pink to Unitil. The few cross-hatched areas are the municipal electrical companies. If you want to examine this map in more detail follow this link.

The history of electrical utilities is a fascinating one and it started in 1882 with Thomas Edison's first generating plant in New York City that initially supplied electricity within a single square mile to 59 customers in what is now Manhattan's Financial District. Within a few years, there were over 30 generating plants supplying electricity in that city. However, the key player in the rise of electrical utilities was Samuel Insull, who was sent off to run the Edison electrical company in Chicago in 1892.

When Insull started his career in the electricity business, electrical companies were then limited local enterprises that generated and distributed electricity to customers within the vicinity of the generating facility. But Insull was a superb businessman and very astute, and he soon realized that to cover the enormous cost associated with generating plants, he needed to sell a large volume of electricity. To do so, he needed to increase his customer base to more than the customers in close proximity to the generating plant. To sell more electricity, he set up tiered electrical rates with lower rates available in lower demand periods, he invested in alternating current transmission technology which allowed him to transmit electricity over long distances and he invested in large coal-fired generating plants. He also bought up his competitors and, with his transmission capability and tiered rates, was able to diversify his customer base, sell more electricity over a wider area and increase the utilization of his equipment.
Insull also saw the benefits of a natural monopoly as it eliminated competition and would provide the returns necessary to raise money for the big infrastructure investments. He actively advocated for government regulation of utilities in order to ensure their status as a natural monopoly. As a natural monopoly he could be assured of a large customer base, steady revenue and profits and, with these, he could provide steady returns to investors and he would also be able to borrow money for large infrastructure projects at low interest rates. Insull's model was soon adopted by electrical companies throughout the country.

State regulation of utilities started in 1907 when New York and Wisconsin enacted regulations that required state oversight of utility financial performance and the establishment of electricity rates based on the revenues and costs of a utility. By the start of the World War I in 1914, most states had established regulatory bodies for electrical utilities. In NH, regulation of electrical utilities started in 1911 with the establishment of the Public Service Commission which was given oversight and rule-making authority over railroad and public utilities. In 1951, the Commission became the Public Utilities Commission and, in 1985, regulation of transportation activities and railroad were moved to the Department of Transportation.

Samuel Insull's influence even stretched into New Hampshire. In 1925 the Chicago-based, Insull controlled Middle West Utilities holding company purchased the NH-based Manchester Traction, Light and Power Company which supplied power to the City of Manchester and other companies on the Merrimack River. Middle West Utilities established the New England Public Service Company (NEPSCO) in 1925 to consolidate all of its New England acquisitions under one holding company. One year later, Public Services of New Hampshire was established as a formal company to operate all of the New Hampshire electrical companies that Insull's group had purchased (Source: History of PSNH). In the early years, PSNH operated steam, gas, electrical railway and bus services but, by the 1950s, many of these non-electricity businesses were closed or sold to allow PSNH to focus on supplying electricity. In those early years, a lot of PSNH electricity was generated by hydroelectric plants located on various rivers in NH but, as demand grew, PSNH built the large fossil fuel plants located in Bow and Portsmouth.
In 1972, PSNH started planning for the construction of the Seabrook Nuclear Power plant. The intent was to build two 1.2 GW reactors. Opposition to nuclear power, cost overruns and construction delays led to the commissioning of only one unit - 18 years later in 1990, at a cost of about $7 billion. The second unit was never completed and the huge debt taken on by PSNH lead to its formal bankruptcy in 1988 and its consequent acquisition by Northeast Utilities in that same year. It was the largest US bankruptcy at that time.
Northeast Utilities, the parent company of PSNH, is a publicly traded holding company that owns four electric companies, two natural gas companies and electric transmission business serving NH, MA and CT. Six of these are key companies here in New England: Connecticut Light and Power, NU Transmission, Western Massachusetts Electric Company, Yankee Gas Service Company, the recently acquired NStar Electric and Gas Company and, of course, Public Services of New Hampshire. The bulk of Northeast Utilities' revenue comes from the distribution and transmission of electricity rather than from its generation. Electricity generation only contributes 6% of NU's revenue, largely from the generating plants in NH.
Northeast Utilities is a profitable company with over $7 billion in revenues, a profit margin of about 11% and it pays out about 57% of its earnings as dividends. Return on net property, much of which is regulated, is about 8%. Based on its present stock price of $41/share, it earns its investors a dividend yield of about 3.6% - certainly much better than you and I earn by keeping our money in a savings account at a local bank. A great deal of NU's stock is held by institutional investors, mutual funds, retirement funds, insurance companies, etc., which means that a good number of us with 401K or retirement plans end up indirectly with an interest in NU.
If we take a closer look at the PSNH part of the NU business we learn the following:

In 2012 PSNH delivered 7821 GWh hours of electricity in NH and earned $946 million dollars doing so. This equates to revenue of 12.1 cents per kWh. Remarkably, only about 26% of this electricity came from PSNH's own generating fleet. The rest came from long-term power purchase agreements with other independent generators, such as the Iberdrola wind farm in Lempster, NH, and purchases on the short-term and spot electrical market administered by ISO-New England.
PSNH owns 13 transmission substations, over 100,000 distribution transformers of different sizes and more than 13,000 miles of transmission and distribution lines. PSNH also owns generating assets and, except for some small solar operations in Western Massachusetts, these are the only generating plants in the Northeast Utilities stable of assets.
The generation assets of PSNH include ~1200 MW of generating capability, of which the Merrimack and Newington plants are the largest. The table below provides some more detail on PSNH's generating assets in New Hampshire.

These generating assets are listed at $1.1 billion on the NU balance sheet and, based on the overall depreciated value of all PSNH assets (which include generation, transmission and distribution), the depreciated or remaining value of these generating assets are of the order of $700 million. The bulk of this value seems to be the $421 million spent on the scrubber at the Merrimack plant a few years ago. It is this scrubber, and its associated costs, that feature heavily in the ongoing deregulation and PSNH debate here in NH and which we will take a look at in future posts.

Operating an investor-owned regulated utility like PSNH used to be an easier task. They had a monopoly to serve customers, and every time they made an investment, they could pass on the costs to the rate payers and earn a reliable and quite generous return for their investors. The challenge was that they had to think long term - sometimes thirty years out or more and they had to make large investments in infrastructure and, to make those investments, they had to raise money that then needed to be returned over the long term. Electrical utilities had long depreciation timelines as it was assumed that their monopoly position would continue. All that would be fine if the world did not change - but it has. There is now a wind in the wires* as economic thinking has changed, consumers demand choice and competition, fuel prices have shifted and regulations allowing competition have been introduced.
With these winds of change blowing through the wires, many integrated utilities with generation assets find themselves in competitive, instead of monopoly, generation markets, and with a great deal of non-depreciated capital on their books, as well as the obligation to service the long-term debt they incurred when they originally funded the investments. This, in turn, leads to the issue of stranded cost recovery, in which the utilities, having made their long-term investments, seek compensation for those investments when they cannot realize their anticipated returns due to regulatory changes. This is a very critical part of the present debate about PSNH and its generation assets and we will take a closer look at these issues in future posts.

In my next post, we will take a look at the very different world that the integrated electrical utility companies now face. In the meantime, be sure to turn off the lights when you leave the room - but keep in mind that every time you do, there is an electrical utility investor who will be unhappy that you did.

Mike Mooiman
Franklin Pierce University

(*Wind in the Wires – A dark tune about electricity from Patrick Wolf, a young UK artist who draws a lot of chamber music influences into his arrangements. If you are a Smiths or a The Cure fan, this will appeal to you. Don't forget to apply the black mascara beforehand.)

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