Why rural electric cooperatives should test the equity markets.

 

I know, I know ... asking a rural electric cooperative to consider issuing stock is like asking a leopard to change its spots. But with competition and all the turmoil in the utility industry—unbundling, retail access, regional transmission organizations, convergence mergers, global mergers—it is a question cooperative executives are starting to ask. Cooperative conversion (to continue the animal metaphor) is the elephant in the middle of the room. Everyone is aware of it—even thinking about what it means—but no one really wants to talk about it.

Lest you think I am some wild-eyed advocate of investor-owned utilities, let me give you some background about myself. I have represented rural electric cooperatives since 1985. I have worked for distribution and generation and transmission (G&T) cooperatives at both the state and federal levels. Cooperatives have been invaluable in electrifying rural America and developing an economically strong heartland. I believe in the creed that cooperatives operate for the benefit of their members. Period.

Then why do I think it is healthy to talk about cooperative conversion? There are two reasons, really. First, I am afraid of what competition from mega-utilities will do to cooperatives. Second, in this risky business, co-op members may be better off as shareholders than as owners.

Can Co-ops Compete With IOUs?

There is no question that retail access is taking hold across the country. State by state, so-called customer choice is arriving. And what customers do the marketers and the large IOUs want to access at retail? High load-factor, large-load industrial and commercial customers. If those customers are cherry-picked, a G&T cooperative's costs will have to be spread among fewer and fewer small rural members. Cooperative rates inevitably will increase, tempting the remaining cooperative members to choose a competing electricity supplier. Rates will increase further, causing more members to leave and creating what some in the industry foresee as a death spiral for G&T cooperatives.

For distribution cooperatives on the generation side, competition is likely to put pressure on all-requirement contracts and strain the long-standing, strong ties between distribution cooperatives and G&Ts. On the retail side, competitive pressures may lead to bypass options either by contiguous distribution systems or new wire construction to serve poached distribution load. In either instance, distribution costs will have to be spread among fewer customers, raising rates and potentially creating the same downward spiral for distribution cooperatives that some predict G&Ts will face.

But beyond these gloomy financial prospects, I am afraid that competition will change the helping-hand culture that has been a hallmark of the entire utility industry for decades. If there is a natural disaster in Texas, will utilities in the Midwest still be willing to send linemen to help? Will utilities that are now pure generators or pure marketers be able to help at all? Competition that reduces rates is good. Competition that stifles cooperation is not. This cultural change may well fall hardest on cooperatives, which often have limited means and resources with which to deal with catastrophes and may only be able to look to other limited-resource cooperatives for assistance.

But Members Don't Have to Bear Risk Alone

The second reason I think it is healthy to talk about cooperative conversion concerns the cooperative creed: operating for the benefit of members. Not only will members potentially be hurt by competition, but members actually may be better off as stockholders of a cooperative than as passive owners.

Typically, a member's financial interest in a cooperative—that is, the member's patronage capital—is held in the cooperative until it is allocated by the cooperative's board of directors. Even when the board allocates patronage capital, it often is not paid out to members, but remains with the cooperative. Conversion would unlock patronage capital and allow members to exchange their patronage capital, dollar for dollar, for stock.

Members also would get subscription rights in the converted cooperative: the right to buy additional stock at the initial public offering price. To the extent that the value of their stock increased, members would participate in the financial growth of the converted cooperative. Members would have an immediate, tangible interest in their utility plus the potential for additional appreciation. Members also would have a choice that they now lack: If they did not want to undertake the risk of ownership, they could sell their shares for cash.

Risk is not something that traditionally has been associated with electric utility ownership. But with retail access and national power marketers, risk of utility ownership can only increase. That brings up another benefit of cooperative conversion for members: a sharing of risk. Some of the stock of the converted cooperative will be owned by the public. If the converted cooperative is successful, the members will benefit. On the other hand, if the converted cooperative cannot succeed even as a stock company, members will not be the only ones bearing the risk, as they are now.

We can wish that the elephant in the middle of the room would simply disappear. But that is not likely to happen. Competition is here to stay and, sooner or later, it will profoundly affect rural electric cooperatives. We can wait for competition to come to us. Or we can start talking.

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