Gimme Some Money* – The PSNH Divestiture Settlement Deal - Part 2

In my last post, I covered some of the details regarding the PSNH/Eversouce divestiture deal that rolls the three big outstanding PSNH matters – the scrubber costs and recovery investigation, the sell-off of PSNH generating assets, and the impact  of PSNH’s ownership of generating assets on its default service customers – into a single settlement. Legislation related to the deal, in the form of Senate Bill 221, made its way through the NH General Court.  This Bill is not an approval of the deal but does permit the securitization of stranded costs to take place once the PSNH electricity-generating assets have been sold. The details of the settlement have been outlined in the agreement between the State negotiating team and PSNH but it will be up to the NH Public Utilities Commission to finalize all the details and to figure out who will pay what and when.

In Last Fair Deal Gone Down, I laid out my general understanding of the big issues at stake in this complex deal. However, I have a particular interest in the numbers and where the various piles of money will end up once this particular money tree gets shaken. As is usual with utility rate cases, when the numbers are spread out over billions of units of electricity, kilowatt hours (kWh), they don’t seem so bad but, when the absolute dollar amounts are calculated, they can be staggering. In utility cases there are two sets of numbers that need to be tracked: the total dollar amount and then that amount divided by the number of kWh. Both are important and both are relevant.

Let’s start with some of the big kWh numbers.

According to the  PSNH customer migration reports, there were approximately 390,000 customers getting their electricity supplied through PSNH’s default electricity supply service in 2014. The total amount of electricity supplied through this service in 2014 was ~3.8 billion kWh. This means that the average amount of electricity consumed by each customer was 9800 kWh/year or 810 kWh/month. These so-called default-service (DS) customers are largely residential in nature along with a few smaller industrial and commercial customers.

However, PSNH also has another set of customers. These customers purchase their electricity from competitive suppliers but that electricity still has be delivered over PSNH’s transmission and distribution lines. This pool of transmission and distribution customers is larger because it includes the DS customers. There are some 504,000 transmission and distribution (T&D) service customers and, in 2014, the total amount of electricity transmitted through the PSNH lines was ~7.9 billion kWh. This means that 52% of the electricity transmitted by PSNH was supplied by their competitors. These non-DS customers are largely the big commercial and industrial users of electricity, however it is notable that ~20% of residential customers buy their electricity from competitive suppliers. Graphically, the two sets of customers appear as follows:

Now that we have a sense of PSNH’s two customer pools, let’s turn to the big piles of money that are involved in this deal.  Bear in mind that these numbers are approximate only and they will change as the calculations are refined. They are also very dependent on the exact timing of the approval and completion of the deal, the final sales price for PSNH’s generating assets, as well as when the sale of the generating assets actually takes place.

These are the big piles of money:

1.  Lower DS Rates: Let’s start with the good news. The whole point of deregulation is to provide utility customers with access to lower cost electricity that should result from a competitive market. Generally speaking, default service rates from utilities that access electricity supply from the competitive wholesale markets in NE have been lower, as shown in the chart below.
   
   The other NH utilities—Liberty, New Hampshire Electricity Cooperative, and Unitil—completed their deregulation activities a while ago and sold off their generating assets. As can be noted from the chart above, their rates, in general, have been about 20% or 2 cents/kWh lower than the PSNH rates. This has not always been the case because competitive markets are subject to supply constraints and growing demand. As a consequence, prices can increase and sometimes quite sharply. We saw this just this past winter when the rates for these three deregulated utilities shot up above the PSNH rate. Going back to the historical savings of 2 cents/kWh, the hope is that, going forward, PSNH DS customers will benefit from these savings. If this is indeed the case, then this 2 cents/kWh savings multiplied by the 3.8 billion kWh of electricity sold to DS customers every year would result in annual savings of $76 million. This would end up in the pockets of DS service customers only. A nice chunk of change—but not at all guaranteed because this is very much subject to the constraints of the New England wholesale electricity market which, in turn, is held in check by natural gas supply and pricing. As mutual fund and investment gurus continually remind us, “Past performance is not an indicator of future results.”
2. Stranded costs: This is the difference between the book value of PSNH assets and their eventual sale price. This is estimated to be of the order of ~$400 million. PSNH will get a check for this amount which will be funded by the issuance of rate reduction bonds (see Walking on the Wild Side) – which is the purpose of Senate Bill 221. In other words, PSNH customers—including those buying from competitive suppliers—will end up borrowing money at market rates, hopefully at about 4%, to pay PSNH for these stranded costs. PSNH customers will be on the hook for these costs for the next 15 years. The $400 million borrowed at 4% over 15 years will result in an annual cost of $35 million. Spread over the 7.9 billion kWh of electricity delivered to all PSNH customers annually, this will result in an increased cost to both DS and non-DS customers of about 0.44 cents/kWh.                                                                          
3.  Deferred payments on the scrubber returns: The scrubber went into service in 2011. It was estimated then that the payments to PSNH to cover their operations and maintenance (O&M) costs as well as their return on the scrubber should have been ~$65 million per year. This cost would typically have been recovered through DS rates. However, as I have noted in previous posts, the scrubber costs have been controversial and a prudency review was initiated to investigate the cause of the cost overruns. In the meantime, an agreement was negotiated that allowed PSNH to recover 2/3 of the scrubber-related costs. These were built into the DS rates. PSNH has therefore not been collecting their full costs and return on the scrubber and that unpaid amount has been accumulating. By the end of this year, it will have grown to about $140 million. Per the proposed PSNH deal, these costs will be recovered from all PSNH customers over seven years. The annual cost is $20 million ($140 million/7 years) which, spread over the 7.9 billion kWh of electricity delivered to all PSNH customers, will result in an additional  0.25 cents/kWh for all PSNH customers. This amount will likely change as starting in January 2016, all scrubber costs, including the deferred amounts will go into the DS rates, until such time divestiture is complete.
4. Power purchase agreements:  PSNH has long-term power purchase agreements (PPAs) for renewable energy with the Lempster wind project, owned by Iberdrola, and the converted Berlin paper mill that was turned into a large wood-burning electricity generator, Burgess Biopower, that need to be honored as part of the deal. The costs will be picked up PSNH customers. The consultant report commissioned by the PUC estimated that the Lempster PPA is contracted at close to market prices and there $5 million gain to PSNH if it were sold. The Burgess Biopower PPA, however, is an entirely different matter. The consultants have estimated that, if this agreement were sold, PSSH would have to pay the acquirer ~$125 million to compensate for the above-market prices. The costs for these PPAs are likely to be paid by all PSNH customers. These costs are estimated to be of the order of $10 million per year, which, when divided by the 7.9 billion kWh supplied to DS customers, results in a further cost of 0.13 cents/kWh. The annual costs will vary depending to market prices for electricity and renewable energy credits and could be higher.                                                      
5. Two-year moratorium on T&D Rate Increases. As part of the deal  PSNH agreed to hold off on annual increases in their T&D rates for two years (except for reliability enhancement projects). This should result in an annual savings of $35 million, which is equivalent to 0.44 cents/kWh for all PSNH customers but just for two years.

All these savings and costs are summarized in the table below. The grey columns show the total savings or costs and how they will be spread between DS and non-DS customers. The green-highlighted columns show the costs in cents per kWh after dividing by the annual kWh in each customer pool.

It should be noted that my numbers differ somewhat from those that have been published in press releases. In the original press release, a savings of $300 million over five years was touted for DS customers. My calculations shows a savings to DS customers of  $273 million over five years – most likely because I used a higher interest rate for securitization. My estimate is that over the 15-year life of securitization, the savings to DS customers could be over $800 million dollars, but—and this is important—this is based on, as I noted earlier, a very squishy DS savings of $80 million per year.

This might all seem well and good for DS customers, however, it needs to be appreciated that these savings are occurring on the backs of the PSNH customers that are presently getting their electricity supply from competitive suppliers. These non-DS customers will not realize any savings – they will only pick up costs, as shown in the table above.  I have calculated that this will cost them about $128 million over the first five years and $373 million over the 15 years of the securitization. When you look at these numbers, it is clear why the large industrial electricity users who migrated to competitive suppliers many years ago are not at all impressed with this deal.

So there you have my understanding of where and how the big piles of money will end up in this deal. A lot of details need to be worked out and there is still much discussion and negotiation underway to determine how the various costs will be allocated between DS and non-DS customers. One of the proposals under consideration is that the DS customers will pick up a larger portion of the securitization costs.

This deal is a complicated matter but it seems to provide more certainty than the alternative which is not proceeding with divestiture. However, the time aspect of this deal cannot be overstated. The longer this is dragged out, the more expensive and more complicated it will become: interest rates will go up, the accumulation in the deferred scrubber cost account will increase, and costs will generally increase. Timely resolution would seem to be the prudent course of action.

Until next time, remember to turn off the lights when you leave the room.

Mike Mooiman
Franklin Pierce University

mooimanm@franklinpierce.edu
6/8/2015

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(*Gimme Some Money – A tune from one of my favorite rock movies “This is Spinal Tap”, the mockumentary of the fictional Spinal Tap rock group. Some great tunes in this movie and the famous Stonehenge scene still makes me chuckle. Gimme Some Money features The Thamesmen appearing on British TV, a la early Beatles and Stones. Enjoy and Go Nigel Go!) 

Last Fair Deal Gone Down* – The PSNH Divestiture Settlement Deal

It has been some time since my last blog but I have been out and about, immersing myself in the solar energy field and working on combined heat and power consulting projects. There is an awful lot happening in the NH energy field – there are natural gas pipeline routing issues, there are grabs for renewable energy fund money to balance budgets, and there is the recently announced PSNH divestiture deal. In this blog, I am going to focus on the PSNH deal as I have written quite a bit about this topic in the past. (I know that PSNH and its parent company have been rebranded under the new name “Eversource” but I will continue to use the “PSNH” terminology as it is still useful.)

Overall, this is a big deal—and in more ways than one. The three big outstanding PSNH matters – the scrubber costs and recovery investigation, the sell-off of PSNH generating assets, and the investigation of PSNH ownership of generating assets on its default service customers are lumped together in a single settlement. It involves a lot of money, is complicated, and is likely to have an impact on all PSNH customers for a long, long time. A big deal indeed!

I have been trying to understand this settlement and learn more. For a deal of this complexity, I will remark that there is surprisingly little documentation: there is only the term sheet posted on the PUC website and a single press release. I have chatted to several people trying to understand more. For a deal so important to NH, PSNH electricity rate payers, and the New England electricity market, it certainly—at the moment—lacks transparency.  I hope that this will improve over time.

So this is what I know:

• The deal bundles the scrubber settlement, divestiture of generating assets, stranded cost recovery, and a bunch of other odds and ends into one agreement. In so doing, it completes the deregulation process that started in 1996.  

• PSNH will take a $25 million haircut on the cost of the scrubber. To recap: the original deal was supposed to cost $250 million but, by the time it was done, it cost $422 million and PSNH was looking to electricity ratepayers to pick up the entire tab and  to pay their ~10% return on the investment. PSNH had been partially successful in this regard and had negotiated to get ratepayers to start paying two-thirds of the costs. The $25 million in this deal is a discount of 15% on the cost overrun.

• From Jan 2016, PSNH’s default electricity customers will be paying the full amount of the scrubber (minus that $25 million) over 7 years, while allowing PSNH to earn their 9.67% regulated rate of return. This will continue until the generating assets are sold.

• However, since PSNH ratepayers have only been paying for 2/3 of the scrubber costs so far, the obligations and returns on the remaining one-third have been accumulating. The total in this account is now of the order of $105 million. Someone is going to have to pay for this in one way or another.

• The deal requires PSNH to sell their generating assets but the new owners will be obligated to keep the plants in service for at least 18 months. PSNH has several generating assets (shown in the table below) and some of the new owners will want to keep them running. Some of the hydro-generating plants have been running for close to 100 years and probably could do so for another 100. The coal-fired power plants are, however, another issue. In a low-priced natural gas market, their value is marginal: requiring the new owners to keep them running for 18 months after purchase when they may have only salvage value could further depress the  price. Consider the table below, which presents data on the utilization of the PSNH plants. One has to question who would buy those plants and keep them running until they can be scrapped, redeveloped, or re-engineered to burn natural gas. They might have some value on the electrical-capacity market, but only time will tell. I don’t believe these old plants will be sold very easily or quickly – PSNH may even have to pay someone to take on those assets.

• According to a consultant report commissioned by the PUC, the differences in book value and the estimated market value for the various generating assets are as follows.

• The difference between the book value and actual market value is termed “stranded costs”, because this is the amount that PSNH invested in generating assets that they are now obligated, due to deregulation, to sell at loss. PSNH will also not earn a return on the stranded costs.  By law, PSNH is eligible to recover these stranded costs from its ratepayers. In other words, PSNH is entitled to get a check for this amount that they can invest elsewhere to earn a return.

• We have the book value, $660 million, of PSNH assets. From this, we subtract the value that PSNH may realize from the sale of the assets, ~$225 million, as well as the $25 discount on the scrubber. This leaves us with approximately $410 million of stranded costs.

• The check for $410 million in stranded costs that must be paid to PSNH will be funded through a 15-year stranded costs securitization deal at a lower interest rate, which hopefully will be of the order of 3 to 4%.  This is exactly like refinancing a mortgage on a home – instead of continuing to pay PSNH their 9.67% on the depreciating book value of their generating assets, PSNH ratepayers are going to pay someone else 4%. My post Walking on the Wild Side discusses securitization of stranded costs in more detail. 

• My stranded costs calculations do not take into account the fact that PSNH had entered into some pretty sweet long-term deals with the Lempster wind-power plant and with the wood-burning operation at the converted Burgess paper mill in Berlin. According to a consultant report commissioned by the PUC, the market value of these deals is a negative $120 million (!). These costs could be bundled into the stranded costs calculation and increase the amount that will need to be funded.

• The odds and ends in this deal involve the setup of a $5 million renewable energy fund, another fund that will be used to compensate municipalities for the decline in property taxes that are sure to result from the decreased property valuations that will occur after the sale of the generating assets and some as-yet unquantified protections for union workers at the affected properties.

As I noted earlier, this is a complicated, messy, and expensive deal, with long-term obligations for PSNH ratepayers—but here is the rub. Ratepayers could get angry and annoyed and royally ticked off. NH legislators could fight it and try to renegotiate it and drag it out for the next few years, and then it will be taken through the courts which will take a few more years. In the meantime,  PSNH, as a regulated utility responsible for supplying default electricity to their customers, will charge their customers for the scrubber and those aging assets and coal plants. PSNH will be making money all the time while legislators try to renegotiate the deal. 

In meantime, it is highly likely that interest rates will rise and the very low interest rates that are currently available for refinancing will increase. Ratepayers will then have to pay more for the deal and—even though it might be viewed as unfair— the very pragmatic approach is to pay PSNH a big chunk of change as soon as possible so that NH can move along with deregulation. Some might view it as being in the utility’s best interest to drag along this process as long as possible but this is what happens when a process is not completed –someone ends up paying. 

There is another concern to consider if this deal drags out. PSNH’s default electric service rates this summer will most likely be above market rates, which could promote migration to competitive suppliers. Such a process has the potential to accelerate rapidly, leaving fewer and fewer PSNH customers on the hook for all of PSNH’s costs associated with those generation plants. This will increase prices for the remaining customers, which will promote more migration and eventually the one remaining PSNH customer is going to be responsible for all the PSNH costs. This so-called “death spiral” would create a crisis both for PSNH and for NH because someone is going to have to pick up the tab. I am not clear as to what the end game would be in this situation, but I do know that some nasty legal battles will ensue and a lot of money would be wasted in the process. There is clearly a price to be paid for dragging out this deal.

So what do PSNH default electricity rate payers get out of the deal if it closes soon? Well, they will have to pay PSNH for the stranded costs and enable PSNH to get their full return on the scrubber until the Merrimack plant is sold.  Over time, this deal should result in savings for PSNH default electricity ratepayers because they will benefit from the lower mortgage on those assets. They should also benefit from lower default service rates going forward because all of PSNH electricity supply will be sourced from the New England wholesale market. Various amounts have been touted for these savings. The PSNH press release indicated savings of $300 million over the first five years of the deal. I plan to dig deeper into these savings figures in a future blog.

However—and this is a big However—this refinancing deal will only work if all PSNH customers pick up the tab, i.e., all residential, commercial, and industrial customers in the PSNH service areas, even if they buy their electricity from a competitor. The deal will not work if just default electrical service customers have to pay, because they can leave. Every time a default customer leaves, the remaining customers must carry a larger piece of the remaining costs. It is important that these charges cannot be bypassed. This means all PSNH customers, and especially the industrial and commercial customers who buy their electricity from other competitive suppliers, will be caught up in the payment net and will see their rates increase. The essence of the settlement is that to complete deregulation and to get the remaining PSNH default electricity service customers off the hook, all customers in the PSNH service areas are going to have to pay for the stranded cost recovery charges.

Here are some of the questions I have been asked about the deal.

• Is this a good deal or a bad deal? – It all depends on your perspective and your level of pragmatism. Some may say “Hey, it's a deal”—which is better than no deal. Customers who migrated to competitive suppliers on the understanding that they would not be held responsible for the scrubber costs will now be gathered up in the net of payers. For large industrial and commercial customers, who feel the sting of high electricity prices acutely, this is going to be particularly painful. Their costs will rise and it will put them at a competitive disadvantage: some may even consider relocating to states with lower energy costs.

• What is the alternative? – We take the deal off the table and continue with the scrubber cost prudency review. If the outcome is that PSNH overspent on the scrubber and are entitled to a smaller recovery, you can be assured that a long-winded legal battle will ensue. Perhaps in this process, PSNH will take a larger haircut on the scrubber than the $25 million that they have presently agreed to. In the meantime, default service rate payers will continue to pick up the tab, their rates will rise, and more will leave PSNH for competitive suppliers, pushing PSNH closer to that death spiral. Some larger users of electricity might see some benefits from this, because it pushes the obligations and costs of having to contribute to stranded cost recovery out into the future but it could end up being a lot messier and expensive in the process.

• Does PSNH make out? – To a degree, but less than they were entitled to, as per the regulatory compact that we have with utilities and that they are entitled to by law. Monopolistic and regulated utilities are a necessary part of our energy infrastructure: this is the price we have to pay if we want the lights to turn on at a flick of a switch.

• Do PSNH default customers save money? – Yeah. They will be paying a lower interest rate on the assets and there will now be a larger group of PSNH customers helping to pick up the tab. Default electricity customers, mainly residential customers, should eventually see some rate relief.

• Will all PSNH customers and distribution and electricity supply customers pick up the tab? – Most probably.

• Is there a better deal out there? – I’m not sure, but I do know that it will take years to negotiate and that, in the meantime, PSNH will continue to earn a return on the book value of their generating assets. Default electricity service customers pay above market rates and increasing migration could cause a crisis. Bear in mind that there are some looming environmental mandates out there, such as the EPA requirement for cooling towers at the Merrimack plant, which will further burden rate payers.

Some have characterized this deal as “suck it up, pay up and move on”. This might be a harsh characterization and, even though I do not have horse in this race, it might well be time for some well-considered pragmatism. This situation is a mess due to the stop/start approach to deregulation, poorly crafted legislation, lack of oversight and transparency on the scrubber costs, and some bruising utility related legal battles in the past in which the State of NH has not come out well. Indeed, there is plenty of blame to go around but, at this stage, I am not sure what is gained from digging up old graves and beating on the remains. Perhaps it is time to buy the expensive headstone, agree to pay for fresh flowers every month for the next 15 years, and put this matter to rest.  

When thinking about this deal, the words of the late great Robert Johnson, the blues guitarist, in his song “Last Fair Deal Gone Down”*, come to mind:

Ida Belle, don't cry this time
Ida Belle, don't cry this time
If you cry about a nickel, you'll die about a dime
She wouldn't cry, but your money won't mine

Until next time,  remember to turn off the lights when you leave the room. 

Mike Mooiman
Franklin Pierce University

mooimanm@franklinpierce.edu
4/26/2015

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(*Last Fair Deal Gone Down: A tune by the great blues guitarist Robert Johnson covered here by Eric Clapton on his 2004 Me and Mr. Johnson album.)

Walking on the Wild Side* - Stranded Costs and Picking up the Tab for the PSNH Power Plants

In my recent blog post, Options, I discussed the four options that will be considered as regulators and legislators deliberate over the fate of the PSNH power plants. One of these options is to compel PSNH to sell their generating assets and to complete the process of electricity deregulation in NH that was started in 1996. This would make the electricity supply market in NH a fully competitive one. In this post, I examine how this might be done, what the consequences will be for the PSNH customers, and how they will end up picking up the tab for the PSNH power plants. 

As laid out in the discussion of the public utility regulatory compact in an earlier post, a State provides an electrical utility with a monopoly to provide service in a specific area so that it can make the large-scale investments it needs to provide us with safe, reliable and reasonably priced power. Once they do so, they are entitled to recover the cost of the investment and earn a guaranteed return on those investments over the life of the projects - which can some range from 20 to 30 years, and even longer in the case of nuclear power plants.

Consider the following highly simplified example by way of illustration. If an electrical utility agrees to invest $1 billion in a new power plant and receives approval from the Public Utilities Commission (PUC), they would go out and borrow the $1 billion, perhaps at a cost of 5%. Then, once the plant is built, the utility would, over time, recover the $1 billion through a depreciation charge and they would assess a return on their investment. This return would, of course, be higher than the 5% which is their cost of borrowing. Let's assume the plant has a 25-year life, so the depreciation amount would be $40 million per year ($1 billion divided by 25), which would be passed on to the ratepayers as part of the price for electricity supply. Moreover, the utility would also be entitled to earn a return on its investment. Assuming the public utility regulators agree to a 11% return (which is close to what PSNH presently earns), that first year the utility would earn $110 million (11% of $1 billion) which they would recover as a rate base charge that is a component of the all-in costs for electricity paid by their customers.

In Year 2, the depreciation from the first year is subtracted, leaving $960 million ($1000 million - $40 million) of undepreciated value which then becomes the basis for the 11% return on the rate base in the second year. In this year the return would be $960 million x 11% or $106 million. With this approach, the utility recovers its initial outlay via a depreciation charge over the life of the power plant, and it earns a return on its investment via the rate base charge.

It is important to realize that the utility's return on the rate base is not all gravy and it doesn't all go to its shareholders. The utility borrowed that $1 billion and it needs to pay its lenders their annual interest rate, which we assumed to be 5%, so the utility's net return on the invested capital will be 6%.

On top of these depreciation and rate base returns, the utility charges their customer for the cost of fuel – natural gas, coal or oil – as well as the operating and maintenance costs, the salaries for the workers, the property taxes and all other small charges associated with running an operation generating electricity. All these charges are summed and then divided by the number of kilowatt hours (kWh) of electricity produced. This yields a price per kWh for electricity which, after review and approval by the PUC, becomes the rate that the utility charges its customer for electricity supply.

In my last post, I shared a chart which showed the various costs components, including depreciation charges and rate base returns, for the 2012 electricity supply from PSNH. Electricity rate setting is an intriguing topic and it is perhaps something we could cover in a future post.

But, let's now return to the topic at hand: what will happen should PSNH be compelled to sell off their generating assets? The key numbers in this case are shown in the figure below, which breaks out the various values that will be considered in this matter. The top number, $674 million, is the total book or undepreciated value of PSNH assets as of 2012. The original value before the depreciation charges was $1.1 billion according to the Northeast Utilities 2012 balance sheet. My assessment of the book value is that it consists of $422 million associated with the mercury scrubber installed on the Merrimack power plant a few years ago and the remainder, $252 million, is the undepreciated value for the rest of the generating assets A list of these generating assets, which include coal-fired, oil-fired and hydro operations, was provided in my last post.

From the book value of $674 million, I have subtracted the value that PSNH might realize from the sale of their various power plants. I have optimistically assumed a value of $200 million - which leaves us with approximately $474 million of what are termed "stranded costs".

These costs are termed "stranded" as they represent the value of the assets on which PSNH can no longer earn a return nor can they recover their investment via depreciation charges due to utility regulation changes. Nevertheless, PSNH is still responsible for interest payments and paying down the debt they incurred when they purchased and installed the assets many years ago.

I had also noted previously that there is presently a prudency review underway that will determine if PSNH should have spent $422 million on the mercury scrubber at the Merrimack plant when the original budget was $250 million. If it is determined that PSNH was unwise in spending that amount of money, the New Hampshire PUC will make a determination that only part of those costs should be part of the book value for PSNH generating assets and the stranded costs will decrease commensurately.

It is unlikely that PSNH would agree with such a decision. We should not forget that PSNH, through its parent, Northeast Utilities, is a for-profit publically traded company that has an obligation to its shareholders to ensure steady dividend returns and an increasing share value and it is only to be expected that they will mount a legal challenge to the NHPUC scrubber value determinations as any write-off of assets would have a significant effect on their profits and lead to a bunch of unhappy shareholders. In the legal battle will that will ensue, the NH Courts may end up determining the final value of the Merrimack scrubber project. In the process, millions will be spent on lawyers, consultants and expert witnesses, time will drag on, rates for PSNH energy supply customers will continue to be high and the value of the coal-fired power plants will continue to diminish. From my perspective, this seems rather inefficient compared to getting everybody involved around a table for a few days to hammer out a compromise: things might get done faster, a great deal of money would be saved and the PSNH ratepayers would be better served.

Let's assume, for the sake of illustration, that a determination is made that the scrubber project is only worth the original $250 million. PSNH would have to take a haircut of $172 million and write down the value of the assets. In this case, the numbers would be those shown in the diagram below.

Now the total book or accounting value would be $502 million, which would consist of $250 million for the value of the scrubber and $252 million of undepreciated value for the rest of the generating assets. From this, we subtract the $200 million that PSNH might realize from the sale of the assets which leaves us with approximately $302 million. This will be the amount due to PSNH for their stranded costs. The question now becomes: Who writes that check? As it turns out, the unpleasant answer is that all PSNH customers will end up paying for the stranded costs, as will become clear in the explanation that follows.

PSNH has approximately 500,000 customers and, for the purposes of simplification and illustration, let's assume they are all equal. That means each rate payer would have to send PSNH a check for $604 to cover their portion of the stranded costs. PSNH will want that money as soon as possible so that they can invest the $302 million into another project to start earning a return or return the money to its shareholders. It is unlikely that PSNH customers are going to be rushing for their check books to write a $604 check payable to PSNH. One alternative would be for PSNH customers to pay down this amount over time through their electricity charges and also pay PSNH their expected 11% interest. Essentially PSNH would be lending the $604 to each of their rate payers, and they would expect to earn a return on that loan. If we assume the payments are spread over 10 years, this means that each rate payer would be paying an extra $8.32 per month to PSNH for the next 10 years to cover the stranded costs. In kilowatt hour terms, and taking into account that PSNH distributed 7821 Gigawatt hours of electricity in 2012, this would equate to surcharge of ~0.6 cents for every kWh of electricity distributed by PSNH.

In these days of low, single-figure interest rates, 11% is a very high interest rate to pay on a loan. Many of you might be asking whether is it not possible to refinance this amount at a lower interest rate, just as we would do on our home mortgages?

Well, this is exactly what would happen should the regulators and legislators steer PSNH ratepayers down this road. There are many financial institutions that would be willing to lend PSNH customers the $302 million at a lower interest rate, especially if they can be assured, by law, that PSNH ratepayers are obligated to pay down the debt over a fixed time period and that there is no way to avoid the obligation.
 

This refinancing of the stranded costs is done through a process called securitization, which is a series of financial deals in which debt obligations, such as mortgages, are sold to another party and are pooled with similar obligations. This pool of obligations is then sliced and diced and sold to a new set of investors who pay for the pieces in order to earn a return on their investment that would, in this example, come from principle and interest payments that each homeowner with a mortgage makes every month.

The key aspects of securitization are

• The transference of risk from the original party that held the obligation to a new group of investors.
• The original party gets their money back right away so they can invest it in new projects.

The way that securitization would work with stranded costs is via the following steps:

Step 1: The regulators, with legislative approval, would establish a financing order which will give PSNH the right to impose, bill and collect stranded costs from its ratepayers. The stranded costs become an asset on the PSNH balance sheet which replaces the $674 million for the generating assets.

Step 2: A new financial company, called a special purpose enterprise (SPE), is set up.

Step 3: PSNH sells its right to collect stranded costs from PSNH ratepayers to the SPE.

Step 4: The SPE funds the purchase of stranded cost obligations from PSNH by selling bonds to investors such as banks, insurance companies and other financial institutions. For those not financially inclined, a bond is essentially an IOU agreement that is set up between two parties. One party lends an agreed amount of money and the other commits to pay back the borrowed amount at some time in the future but also to pay a fixed interest rate every year. In this case, the security for the IOU would be the stranded costs obligations that PSNH can, by law, collect from its ratepayers.

Step 5: Using the revenue from selling these bonds, the SPE will pay PSNH for the stranded costs so PSNH gets a cash payment, it no longer has the asset on its books and it can take the money and return it to its investors.

Step 6: Every month the stranded costs payments from the individual rate payers will be passed through PSNH to the SPE, which will use these payments to pay the interest on the bonds and eventually the principal amount back to the bond holders.

This securitization process accomplishes two objectives: PSNH gets its money right away and it can return the funds it to its shareholders or use it for new projects, and the risk associated with the stranded costs is passed onto a new group – the bondholders in the SPE.

The risk issue is an important one and, quite frankly, this is not a very risky investment for the bond holders. PSNH customers will be mandated by law to pay for the stranded costs so the risk of 500,000 ratepayers not paying up is low. (There is, however, the possibility that future lawmakers in NH would not feel constrained by these obligations and could choose to overturn them, but this is little different from the risks that lenders to public utilities are presently exposed to.)

With a steady stream of monthly payments from a large group of customers that are mandated by law to pay for the stranded costs through their electricity rates, this is indeed a low risk investment and, as a result, the bond investors would be willing to accept a much lower interest rate than the 11% PSNH would expect. In our present low-interest environment, I believe investors in these bonds would be willing to accept interests rates of 5% or perhaps even lower. Costs for funding would also be significantly reduced by the fact that interest on debt is tax deductible, exactly like your mortgage, which further reduces the cost of borrowing.

What we would then have done through securitization is refinanced that $302 million obligation to PSNH, which carried an interest rate of 11%, to one with a 5% interest rate. In the process, the monthly payments for PSNH ratepayers will drop from $8.37/month to $6.41, or from 0.6 to 0.5 cents per kWh, which is a 23% reduction in the monthly stranded cost obligation for all PSNH ratepayers. So by issuing lower interest rate bonds through the SPE, stranded cost recovery amounts charged to PSNH ratepayers will have decreased – hence the name: rate reduction bonds. In reality, these rate reduction bonds will actually result in additional tariffs on all PSNH ratepayers, but the amount is lower due to refinancing. It is important to note that the numbers I have calculated are presented for illustration of these concepts only and that the final numbers could be quite different depending on the outcome of the prudency review, the final stranded costs tally and the market for securitization of these costs in a year or two.

Now some readers might be thinking that this is pretty wild and crazy financial stuff and that we are clearly walking on the wild side*, financially speaking. Well, that would not be correct. Securitization is a long standing tool that is used extensively in the mortgage industry, and it is, in fact, one of the reasons we have such a robust home lending market in the US. It very likely that after receiving your mortgage for your home, your obligation was sold to another party who pooled your mortgage together with several thousand similar mortgages via a SPE. Bonds in the SPE were sold and bond holders were promised regular interest payments based on the monthly payments from that pool of mortgages. As my Financial Management students in the Energy and Sustainability MBA program at Franklin Pierce University learn, securitization and the unchecked transference of risk played a large role in the 2008/2009 housing crisis and recession. Moreover, securitization for stranded costs payments has been done before here in New Hampshire: PSNH ratepayers are presently assessed a stranded cost recovery charges associated with the Seabrook power plant as part of their monthly electricity rates.

One of the questions we should be asking ourselves with respect to stranded cost recovery is - which customers of PSNH will be obligated to pay these charges? The answer  – I believe – is that all PSNH distribution customers will be assessed these charges, including those getting their electricity provided by competitive suppliers. The key to stranded costs recovery is the establishment of the financing order by the NH PUC that will give PSNH the right to impose and collect stranded costs from its customers. However one of the most critical aspects of this financing order will be that these charges are non-bypassable. In other words, PSNH customers will not be able to avoid them by going to other electricity suppliers. Without this provision, the issuance of rate reduction bonds is unlikely to happen as bond investors would view it a particularly risky investment if ratepayers could escape their obligations.

Now, if you live in the PSNH franchise area and are buying your electricity from a competitive supplier, you are likely whipping yourself up into a froth of indignation at the unfairness that you should be assessed charges related to PSNH's generating operations. However, do take into account that many of these obligations were likely incurred when you were a PSNH electricity supply customer and present PSNH customers might consider it unfair that you could walk away from your obligations. A greater unfairness probably occurs when someone new moves from out of state into the PSNH franchise area and is assessed stranded costs recovery charges they had absolutely nothing to do with.

There is, of course, the possibility that things will play out differently in the legislative and legal deliberations that will occur over the next year or two, but this is where I am placing my bet. If you are angry with stranded cost recovery charges that might be assessed, the very best way for you to show your indignation and to challenge PSNH is remarkably simple - use less electricity. Show PSNH that you mean business by investing in energy savings projects. Put in more insulation, upgrade your windows and heating systems and install low-energy lighting and solar heating systems.

And, of course, remember to turn off the lights when you leave the room.

Mike Mooiman
Franklin Pierce University

mooimanm@franklinpierce.edu
11/17/13

(*Walk on the Wild Side – Probably the best known song by the late and very great Lou Reed who just passed away last month at the age of 71. I remember listening to this song as a young teenager and having very little idea at that time what I was singing about as I accompanied Lou Reed on vocals. Fortunately, neither did my mom. Even if I didn't understand the lyrics, the arrangement, the "Doo, doo, doo" chorus and the very prominent bass line appealed to me.)


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