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 notes that the new rules for retail sales of power from generation output facilities financed with tax-exempt debt are complicated and will be subject to further interpretation. For example, a contract available to the public may have a maximum term of 180 days without jeopardizing the tax-exempt status of the bonds; a non-public-use contract offered at uniform rates may run for 90 days; and a negotiated contract for 30 days.

Dick Johnson, general manager of Snohomish Public Utility District, said the new rules are "perhaps even worse with regard to the existing and new retail customers, the regulations force public power utilities to try to shoehorn customers into limited contracts of the terms of only a few months. And I'm referring specifically to the 90-day limitation."

Stranded Costs and Existing Customers

The rules also state that when a public power entity is left with excess generating capacity due to customer losses, a contract to sell excess power is not treated as a private business use if: (1) the contract's term (including all renewal options) is less than three years, (2) the issuer does not issue tax-exempt bonds to increase the capacity of its generation system during the contract's term, (3) open access transmission is offered under FERC rules, (4) all output is excess capacity due to open access, (5) the contract mitigates stranded costs of the owner attributable to entry into the open access system, and (6) stranded costs recovered under the contract by that owner are used to redeem tax-exempt bonds as quickly as possible.

But according to Dick Johnson, while the rules provide helpful mechanisms for selling excess generation, one problem remains: Flexibility only results after customers move their energy purchasers to another supplier.

Jerry Jordan, of the California Municipal Association, voiced concern with the three-year term limit. He said that if a customer leaves the system and the public power entity has to sell excess generation, it might not prove beneficial to be limited to a three-year term.

Not The Final Fix

The private-use regulations have been promulgated by the Treasury both as temporary rules that will expire in three years and a venue for soliciting comments and proposing changes.

Senate Energy and Natural Resources Committee Chairman Frank Murkowski (R-Alaska) has introduced S.1483, which proposes public power entities willing to forego future use of tax-exempt financing would have no change in the tax status of their outstanding debt if they enter competitive markets. Outstanding bonds subject to private-use restrictions could be retired over an extended period, rather than face retroactive taxation. APPA opposes the bill.

More interpretation is needed. Moody's noted that while the rules allow for additional flexibility, they continue to constrain municipal electric utilities from fully participating in retail choice programs because in certain instances the bonds will become taxable. Moody's pointed out that how Treasury interprets the rules in individual cases will become important.

The Edison Electric Institute plans to join the fray by offering written comments to Treasury, and plans to participate in April hearings. "We are up to the challenge of competition with public power," said Thomas R. Kuhn, EEI president. "But tax exemptions and other subsidies to public power utilities give those suppliers significant financing advantages in a competitive marketplace."

Lori A. Burkhart is contributing legal editor to Public Utilities Fortnightly.

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