[BETA] Fortnightly

Nowhere are the failings of traditional utility regulation more evident than on Long Island. The New York Public Service Commission (PSC) has raised rates for the Long Island Lighting Co. (LILCO) 31 percent since 1989. Rates are now over twice the national average (em the highest in the continental United States. Meanwhile, Long Island's economy has been ravaged by defense cutbacks that have erased 100,000 jobs (em a 10-percent drop in employment. The high electric rates have kept new industry from moving in, and a grocery chain is now Long Island's largest employer.

The normal order has been turned upside down. While pressures for competition are sweeping the industry, New York State has floated three proposals for a public takeover of LILCO in the last 15 months. Instead of facing the ominous prospect of absorbing huge stranded costs, LILCO's investors hope to be bailed out by the state. While utilities fight public power, LILCO is quietly trying to sell itself by orchestrating a public takeover. And Gov. George Pataki, a Republican, is advocating government intervention instead of championing competition.

The Shoreham Settlement

Long Island's current electric rate problem is an outgrowth of the closing of the Shoreham nuclear plant in the late 1980s, which left LILCO in dire financial straits. At the end of 1988, LILCO had $4 billion invested in the plant and an equity ratio of 33 percent. Its cash flow from operations was only $235 million, and it needed $575 million in capital to finance debt maturities and capital spending in 1989. Without major rate relief, LILCO faced bankruptcy.

Disaster was averted by a settlement negotiated between LILCO and Gov. Mario Cuomo to return LILCO "to investment grade financial condition." The $4-billion investment in Shoreham was put into rate base as a regulatory asset, to be recovered in rates over 40 years, with a return on the unamortized balance.

The immediate impact on rates was to be mitigated by a phase-in plan involving 11 rate increases, two in 1989 followed by nine annual increases. The first three increases were provided by the settlement: 5.4 percent in February 1989, 5 percent in December 1989, and 5 percent in December 1990. None of the remaining eight annual increases was guaranteed; the settlement only provided nonbinding targets for each rate hike of 4.5 to 5 percent per year. The PSC was to administer these increases through normal ratemaking procedures. The settlement also required that "the PSC shall ensure that the future impacts on rates are to be minimized to the maximum extent practicable."

The agreement did not place any restrictions on how LILCO used the rate increases. LILCO did not have to cut costs, and it did not have to use the rate increases to strengthen its balance sheet. The job of framing specific policy to constrain LILCO and minimize the impact on rates was left to the PSC.

The settlement gave LILCO immediate credibility with the financial community. Rating agencies upgraded LILCO's bonds, and deferrals under the phase-in plan enabled LILCO to report healthy earnings. Although cash flow remained weak, LILCO