[BETA] Fortnightly

THE U.S. TREASURY DEPARTMENT HAS ISSUED RULES that will allow all public power systems to participate in independent system operators without risk of losing the tax-exempt status of their bonds.

Investor-owned utilities are not happy. According to the Edison Electric Institute, the regulations significantly expand the ability of large government-owned electric utilities to use federal subsidies to compete against private utilities.

Meanwhile, the American Public Power Association is pleased that the rules passed Jan. 21 will allow public power systems to participate in ISOs and offer open access without jeopardizing the tax-exempt status of bonds. But APPA does not believe the rules go far enough to allow public power systems to fully participate in the emerging competitive markets (em a view that several other public power entities share.

Tax-Exempt Facility Financing

Public power systems are allowed to use tax-exempt bonds to finance utility facilities because they are owned and controlled by state and local governments. But the U.S. Constitution limits the issuance of tax-exempt debt to ensure that public credit is not used for private purposes. The limit on government bonds came from the Tax Reform Act of 1986, which was further tightened by Congress, so that private use may not exceed the lesser of either 10 percent or $15 million for a single project. Violations of private-use regulations can result in loss of tax exemption for bondholders and force recall of the bonds.

Private-use limitations are intended to ensure that only state and local governments and the public benefit from facilities financed with tax-exempt bonds, hence the term "public use." In a regulated, monopoly environment, few problems arose. But as competition increases, the problem for public power systems is that applying the rules to existing facilities with outstanding bonds creates impediments to competition.

According to Large Public Power Council Chairman Mark Crisson, it wasn't clear whether private-use restrictions were violated if a public power entity were to join an independent system operator. For example, if a California municipal utility had joined the ISO, would its tax-exempt debt that financed transmission assets have become taxable? Not now. The new regulations allow public power companies to join an ISO without violating the restrictions.

But it might prove a bit more complicated. S. David Freeman, general manager of the Los Angeles Department of Water and Power, speaking at the APPA's 1998 Legislative Workshop on Jan. 26 in Washington, D.C., said that while he appreciates the Treasury's "initial efforts," their actions alone do not allow the city of Los Angeles to join the California ISO. He noted that the city owns more than 25 percent of the state's transmission capacity, but uses only 10 percent. He said the proposed access charge would be too expensive (em $37 million per year. Los Angeles has a lot of generating capacity, he said, and "by no means" has the Treasury cleared up "our ability to use our power plants in the traditional manner." This regulation might even be a "step backwards on the wholesale side."

The new rules also apply to generation facilities financed by bonds. But Moody's