A new law could help New York utilities reduce electric rates

and improve their balance sheets.

Legislation recommended by Gov. Pataki on June 1, 1996, seeks to provide the New York Public Service Commission (PSC) with a new financial tool to address possible stranded costs as the state moves toward a competitive retail electric market.

The proposed legislation, the Electric Ratepayers Relief Act of 1996, would allow electric utilities to obtain highly secure, lower-cost financing for intangible expenditures using a statutory credit mechanism similar to that used by Puget Sound Power and Light Co. (Puget Power) in June 1995 (see sidebar). After successfully lobbying for specific legislation in Washington State, Puget Power was able to "securitize" over $200 million in expenditures for demand-side management (DSM) at a triple-A rating (as compared to an underlying utility rating of A-A3).

While the New York bill has gained approval from a broad range of constituents (see sidebar) and has passed the state Senate by an overwhelming margin, the state Assembly did not act on it before summer recess. The Governor hopes the Assembly will pass the bill when it returns later this year, as many expect it will. As a transition tool, the Act would "sunset" by December 31, 2000.

Policy Issues for the PSC

Over the past 24 months, the PSC has pursued its Competitive Opportunities Proceeding as a collaborative forum for industry participants to discuss and shape the roadmap for the deregulation of New York State's electric markets. It issued its major policy decision in May 1996.1 In that order, the PSC laid out a timetable for the state's utilities to file plans, which must include details on:

s Setting protocols for a statewide independent system operator

s Separating generation from transmission and distribution

s Mitigating and resolving strandable costs.

As the PSC reviews these issues with each utility on a case-by-case basis, the negotiations on measuring, mitigating, and allocating the burden of strandable costs will prove thorny at best. The financing and recovery of intangible expenditures are particularly sensitive in the transition to a competitive market, because they are not backed by free-standing productive tangible assets.

The Act has been crafted as a policy tool that effectively "enlarges the pie" of an otherwise zero-sum stranded-cost game, and could be used by the PSC as part of the broader negotiations that will ensue in this area. Specifically, by giving the PSC the ability to confer "irrevocability" on a portion of a utility's intangible expenditures recovery (which may otherwise prove uncertain, and financeable only at higher cost), the PSC gains a basis for exchanging utility (and, potentially, third-party) adjustments or concessions (e.g., write-downs, cash settlements, and multiyear rate reductions) for the benefits made available by the financing.

Statutory Details

The Act creates a number of new technical features:

s Qualified Expenses. A new category of expenditures ("qualified intangibles expenditures"), defined by statute, representing costs incurred by an electric utility, for which it does not acquire any physical property (em i.e., buy-outs of independent power producer (IPP) contracts, DSM expenditures, environmental remediation expenditures, and expenditures made in connection with regulatory assets.

s Rate Orders. By creating "qualified rate orders" (QROs), to be issued at the discretion of the PSC, the act would enable the commission to provide for the recovery of all or a portion of qualified intangibles expenditures through special irrevocable service rates. The rates thereby become a state law property right (special intangibles property) that can be sold or pledged as a basis for financing. By elevating the utility's recovery expectation to the status of a state property right, the bill creates a credit enhancement that facilitates lower-cost financing by the utility.

s Flexible Financing. Special financing would include a mortgage-type financing (secured by the special intangibles property), or a "true sale" of the special intangibles property to a third party or special-purpose subsidiary.

s Bankruptcy; Bypass. The Act would include provisions dealing with bankruptcy and customer bypass, require successors in interest to collect and remit revenues sufficient to service the financing, and set up assignee rights in special intangibles property under New York law. A concurrent state agreement would preserve the law so as to not to impair outstanding transactions.

Key Policy Aspects

s Ratepayer Savings. A QRO cannot be issued unless the PSC determines that "significant" ratepayer savings would occur.

s PSC Control. Issuance of a QRO is discretionary; the PSC may require appropriate utility or third-party adjustments or concessions as a condition to issuance of a QRO.

s Voluntary Filings. A QRO requires a voluntary filing by the utility; and, before the QRO can be effective, the utility must agree in writing to all terms and conditions.

s Quantification. In requesting a QRO, the utility will be expected to propose its comprehensive plan for the use of this legislation. The proposal must include a quantification of the expected ratepayer savings.

s Cooperation. The Act anticipates that the PSC and the utility will work together to develop the details of the QRO, taking into account (a) the effects on ratepayers; (b) the needs of the financing parties; and (c) the effects on other interested parties, who will have the opportunity to fully participate in the process that results in the final terms of the QRO.

Financial Benefits

Standard & Poor's has indicated that the Act could make a significant and important contribution to the financing capability of New York utilities. The Act requires a sharing of the resulting benefits.

Ratepayers, for example, would enjoy rate savings from (a) financial engineering generated from credit-enhanced financing made possible by the Act, and (b) utility and third-party adjustments or concessions, whatever their form, exchanged for financing benefits.

Utilities presumably would gain from a "balance sheet uplift," since they could acquire greater security for otherwise uncertain recovery of expenditures. This uplift, in turn, would improve the outlook for holders of debt or equity.

For their part, third parties, such as IPPs and their financiers, could benefit from buy-outs or buy-downs of controversial and risky contracts, and stronger utility financial condition on other contracts.

The state itself expects to benefit from (a) lower electric rates for residents and business, (b) improved financial health of its investor-owned utilities, (c) economic development benefits that accompany rate reductions, and (d) the availability of a balanced financial tool that can smooth the transition to a competitive retail markets.

A Tool, Not a Bailout

The Act is not intended as a panacea for all stranded-cost problems, nor as a "bailout" for the state's utilities. The Act merely gives the PSC an additional resource to use as it seeks to fashion compromise solutions to the extraordinary problems created by decades of regulatory policy.

The Act will be most advantageous to utilities with relatively weak financial ratings, and/or those whose balance sheets may be significantly affected by intangibles expenditures or regulatory assets. Recognizing that the facts and circumstances of each utility vary, the Act is flexibly designed to accommodate 1) a high level of PSC discretion, and 2) a range of financing plans. It provides the common technical elements needed by financial counsel to opine on the exclusion of competing liens, and to establish a "true sale" securitization or valid first-security interest for the financing.

Because the financial stakes are so extraordinarily high, the Act seeks to balance competing interests. The procedures requiring utility initiation, PSC discretion, utility consent, and demonstrated ratepayer savings (em as well as the participation of all interested parties (em are intended to accommodate the strategic concerns of all relevant parties.

The financing device provided by the Act, and the general problems it may help address, are not specific to New York.2 Indeed, most states will grapple with these issues to varying degrees as the nation moves toward a competitive retail environment. The Act, therefore, may represent a model of interest to consumers, industry participants, legislators, and regulators around the country. t

Anastasia M. Song is assistant secretary to Gov. Pataki of the State of New York. Hugh M. Dougan is a partner at Winthrop, Stimson, Putnam & Roberts of New York City, which assisted the Governor's office in adapting and refining the Electric Ratepayer's Act.

The Puget Power Model What Worked for DSM

In 1992, Puget Sound Power & Light found itself with approximately 7 percent of its assets in demand-side management (DSM) investments. With a competitive environment looming ever closer, the utility could not court on rate-base recovery of its $240 million.

Puget Power's solution began with the Washington State Legislature, which created a statutory right to recovery of conservation investments in June 1994. Under this law, customer rates must be allowed to recovered DSM-related expenditures approved by the state public utility commission--along with the costs of financing. Most important, this secured revenue stream may be sold, pledged, or assigned as the basis for issuing securities.

On June 8, 1995, Puget Power completed its first transaction under the statute. That transaction-structured and underwritten by Salomon Brothers, Inc. and Chemical Securities, Inc.--established the Puget Power Conservation Grantor Trust by a true sale and transfer of $202 million of Puget Power's DSM investment assets. The trust then sold certificates to outside investors, providing Puget Power with cash to repay existing securities.

(See, "Mortgaging Your Conservation: A Way Out for Stranded Investment?, by Andrea L. Kelly and Donald E. Gaines, Pubic Utilities Fortnightly, Oct. 15, 1995, p. 21.)

New York Backers A Range of Endorsements

In addition to prominent environmental and consumer groups, a broad range of industry participants favor New York's Electric Ratepayers Act, including:

s New York Public Service Commission

s New York State Energy Association (a trade group representing the state's investor-owned utilities)

s Niagara Mohawk Power Corp.

s Consolidated Edison Co.

s Brooklyn Union Gas Co.

s Independent Power Producers of New York

s Business Council of New York

s National Lenders Forum (representing 25 lending institutions)

s New York State Consumers Protection Board

1. Re Competitive Opportunities Regarding Elec. Serv., Cases 94-E-0052 et al., Opinion No. 96-12, May 20, 1996, 168 PUR4th 515 (N.Y.P.S.C.).

2. As this article went to press, the California legislature approved a bill (AB 1890) to restructure the state's electric utility industry for retail competition. Like the New York Act, the bill deals with stranded costs by allowing utilities to apply for an irrevocable Commission financing order. The order would allow temporary collection of nonbypassable fixed charges to recover a utility's existing intangible costs (including the nonmarket portion of generating asset costs). The bill creates a device for nonrecourse debt financing through a state agency, based on such financing orders. The technical financing definitions substantially mirror the provisions of the New York Act.

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