San Francisco Local Agency Formation Commission (SFLAFCo) Public Hearing on the Final Report on the Electric Financial Feasibility Study (Continued from December 12, 2003).
Ken Mellor, R. W. Beck gave a presentation on the Final Electric Financial Feasibility Study. Topics discussed were the September 23, 2003 Draft Report, public input, key changes in the final report from the draft report, and findings and conclusions. Recommendations were made to (1) proceed with a detailed appraisal; (2) evaluate costs and benefits of acquiring various parts of the system; (3) consider implementation of AB117 as the first step; and (4) develop a sound Management Implementation Plan. A presentation was made and is available at the Clerk of the Board’s Office, Room 244, City Hall.
Questions and Answers
Vice-Chairperson Commissioner McGoldrick asked Mr. Mellor to explain why the issues around the transmission system are not favorable.
Mr. Mellor stated that the transmission system that they considered was the one that moves from the Martin substation north into San Francisco. There are 230,000 volt lines and 115,000 volt lines. Generally, those can be separated from a line point of view because at that high of voltage you do not get under-billed distribution lines and transmission lines on the same towers. But, you do have them going into the substations. There are approximately seven or eight substations that they did assume would be acquired and those transmission lines go into each substation. When you try to sever that substation and if you leave the lines under the ownership of PG&E, then you have this issue of where to make this severance. Where do you do the metering? From being involved in these types of activities in the past, that has always been a significant bone of contention. The investor-owned utility would typically say that you can’t acquire a part of the substation and not another part of the substation, so you better go out and build a new substation. To eliminate those issues, it is assumed that you would acquire the transmission system.
Vice-Chairperson Commissioner McGoldrick asked for Mr. Mellor’s opinion of the best and worst-case scenario regarding PG&E’s cooperation.
Mr. Mellor stated that in the worst case, the severance is about $43 million. In the medium case, it is about $4 million, and in the best case it is about $2 million. There is a substantial difference in the three cases.
Commissioner Ammiano discussed community aggregation. The California Public Utilities Commission (CPUC) was being followed, and there was a resolution introduced that could have undermined the whole process of community aggregation. After conversations with his office and Commissioner Brown in addition to public testimony and advocacy, they were able to achieve a vote yesterday that was a win-win. It does show that they need to continually monitor the situation because the political winds operate separately from the procedural winds that are here.
Commissioner Schmeltzer asked for a more detailed description of the components of the detailed study that was recommended in the final report.
Mike Bell, R. W. Beck stated that at one of the earlier LAFCo meetings, the question was raised as to the next logical step in this process. What they have discussed in the report is a valuation of a full appraisal of the system to determine the cost of acquisition between those wide ranges that are identified in the report. Based on the other work that had been in other areas, it is estimated that full appraisal would take about six months to complete, and the appraisal of the system would cost between $500,000 and $600,000. At that point, you would have a much more precise idea of the value of those facilities. That doesn’t necessarily mean that that is the price that you could purchase them at because undoubtedly, if PG&E was an unwilling seller, they would attempt to either stop the process or obtain the highest price possible. But, it would give a much more precise number that the range of values that were identified by basically spending some time looking at the substations, the condition of the system here in the City, and spending a few days with engineering personnel looking at the system.
The step moving forward would be an appraisal to identify what that range would be and then at that point in time having those numbers, the decision would be made whether it would make sense to proceed. Given the condition of the system, it is suspected that there might be pieces you wouldn't want to purchase. At the same time, you could deal with the transmission and generation questions.
Alternate Commissioner Fellman stated that the report indicated that there would be instances where there are parts of the PG&E system that would have to be replaced. How could the City and County become involved at that point if there was a replacement required? Is that something that we could step in and build the replacement? Would PG&E have an automatic right to replace it?
Mr. Mellor asked for clarification of the question.
Alternate Commissioner Fellman clarified if for example, tomorrow we learn that PG&E needs to replace a section of its distribution system, could the City replace it and own that section of the distribution section rather than have PG&E do that replacement? Could we do it on a piece by piece basis?
Mr. Mellor stated that they had looked at a lot of cases for spot municipalization where somebody was going to add a whole new area in a currently unimproved area. So they are putting in a large new industrial tract or new residential subdivisions, and cities have decided that they can go in and just municipalize just that portion of the City and then own that part of the system and interconnect with whatever utility. Typically, it doesn’t make sense. Part of it is the difficulty in serving a little spot is who has responsibility to maintain reliability and metering issues. Even though it looks marginal in some cases, and in some cases if you were to look out twenty or thirty years, it looks very good. But, in the short term, it usually isn’t. The same thing would be in San Francisco where if you have a specific line segment to sever that from PG&E and just own that one would be technically difficult.
Alternate Commissioner Fellman stated that Mr. Mellor raised another question as to what authority the City and County would have if it does not own the transmission and distribution system as community aggregation is brought in and loads are brought into the City that the City and County controls rather than PG&E. If upgrades on the system need to be made or service needs to be improved, what rights does the City have to have PG&E meet the community aggregation needs of the City and County?
Mr. Mellor stated essentially none. The whole concept of community aggregation is that you are using PG&E’s system to deliver the power and the City would only be responsible for the energy supply. The customer would get two bills even though they may show up on the same piece of paper, one for energy supply for the City and then the cost of delivering that energy from PG&E. Under the rules of AB117, the City would have no authority over the quality of the distribution system.
Alternate Commissioner Fellman asked if PG&E has an obligation to maintain the system to provide reliable delivery for the City’s loads under those circumstances.
Mr. Mellor stated yes, PG&E being regulated by the CPUC has standards that they are required to meet in terms of system reliability. In some cases, those are not as specific as you would like to see. If they were not to provide an acceptable level of reliability, that would become a CPUC issue.
Commissioner Schmeltzer stated that $500,000 to $600,000 is a substantial amount of money. However, the information obtained through that study would be substantial and important information. What are the components that we are looking at? Is there a way to break that down so the Commissioners could look at what the pieces of that study are and perhaps select parts of it?
Mr. Mellor stated that the $500,000 to $600,000 is the cost of an appraisal. That is going out and actually cataloging facilities, looking at their value, looking at the level of depreciation and coming up with something that would be sufficient to be able to take to court in a forced acquisition. PG&E is likely to force that to happen. You would have to go in and condemn the facilities. In order to condemn them, you would have to have that level of appraisal. What has been done so far is not at the level that would be sufficient for that kind of action. That is one of the pieces that you would have to do in order to go through a condemnation process. That does not include any of the legal fees or any of the other costs that would be associated with attempting to acquire the system.
Gloria L. Young, Executive Officer asked if the $500,000 to $600,000 for the estimated valuation of the system includes the Sound Management Plan?
Mr. Mellor stated that a Sound Management Plan is needed to move ahead and is a separate recommendation.
Ms. Young asked for the cost of the Sound Management Plan since it is separate from the appraisal cost.
Mr. Mellor stated there is no reference to who is going to be the acquiring entity. It was assumed all along it would be the PUC. The process of looking at a management system is being looked at. You would want to put together a project plan for this kind of activity. An estimate would be $200,000.
Ms. Young asked if the cost of the Management Plan could be amended into the Plan to give the Commission an average of costs for future discussion.
Mr. Mellor stated that they added $60 million dollars from their draft report to the final report for acquisition costs. That $60 million was intended to include costs like the appraisal, the management plan, legal fees, and other items. The costs are in the report, but not on a line-item basis.
Ms. Young asked for the information on a line-item basis.
Chairperson Commissioner Gonzalez asked if there was information requested from PG&E that was not provided.
Mr. Mellor stated that they went through a long and involved process. What happened is they got trapped into asking for more information than they should have because of the kind of questions that were coming and in some cases from PG&E. They were getting into more and more detail and reached a point where PG&E was not willing to provide it, and didn’t have the budget to analyze it if they got it. At that point, it was decided not to ask for any more information. PG&E provided 90 to 95% of load information for customer classes. They also at the December 12, 2003 LAFCo meeting stated if more was needed, to call them. They were still offering to be more precise if needed. It was decided that with a level of 95% of information that was wanted, it was okay for the report. He would not criticize PG&E for not providing the requested data.
Mr. Bell stated the initial data request from R. W. Beck was quite detailed and asked for a good deal of information, much of which PG&E refused to deliver. That information would have made this process much easier in terms of the value and the economic analyses. PG&E was quite clear that was proprietary information and not much of it was available. As Mr. Mellor stated, a very good response was received about the load resource data and certain areas, and that had been incorporated into the final report.
Alternate Commissioner Fellman stated that she was confused as to where we stand with this study and the appraisal. It was indicated in the beginning of R. W. Beck’s presentation that this would be a "fatal flaw analysis." The recommendation is it’s worth looking into further to see if acquisition is appropriate. But, the way the appraisal is characterized, it was said that it is something you could take to court. It seems you have this document that says it is worth it to look at it and go forward. But is a middle step needed that says here is what we have analyzed, and it is really worth it to go forward before you take on the $40 million dollar battle of acquisition?
Mr. Mellor stated that he does not think you are going to be able to get much better certainty as to the outcome without going the full step. A wide range boundary was provided that allows you to make the decision as to whether or not the economics are worth enough to take on the battle. It was clear as to what they thought the risks were. The risks have been outlined in the report and they think that is a policy decision that needs to be made as to whether the benefits outweigh the risks or not. In almost all cases, the benefits were almost all positive enough to make moving forward look attractive.
Alternative Commissioner Fellman asked Mr. Mellor if it was his recommendation that the next step after doing an appraisal would be to acquire the system. Or are we taking the step to determine then at the end of the appraisal whether we should go to the next step?
Mr. Mellor stated that you wouldn’t do the appraisal unless you had a strong indication that you were going to move ahead and try to acquire the system. This is a policy decision that says it looks good enough to spend that money. If there is a major division at the policy level as to whether this looks good, he would not move ahead with it. He thinks you wouldn’t go out and spend $500,000 or $600,000 unless you have made the decision to move forward.
David Rubin, Director, Service Analysis, PG&E provided comments on the Final Electric Financial Feasibility Study and discussed concerns with the Study. Written comments are available at the Clerk of the Board’s Office, Room 244, City Hall.
Mr. Mellor replied to Mr. Rubin’s comments and concerns as follows:
The criticism that the revenue stream would be lower under PG&E’s assumptions rather than ours raises a number of issues. One is that PG&E’s data was used, but one of the factors in PG&E’s data is an average revenue per kilowatt hour from the large commercial industrial accounts. If you look at their large commercial industrial accounts across their system, you will find that many are served at transmission voltages and interruptible rates. You don’t have those kinds of customers in San Francisco. When you look at their average revenue from that class of customer, were you to apply it to San Francisco, it would be too high or too low. That was taken into account in the analysis and increased the average revenue per kilowatt hour to reflect the fact that there isn’t a lot of those low revenue customers in the system. That makes up the difference between what PG&E is suggesting and what is in the report. It was looked at very carefully.
On power prices, one of the issues is that R. W. Beck used the Energy Commission prices and those same prices were included in the Energy Commission’s projections at PG&E’s rates. If you look at the Final Report, you will find that we moved away from using the Energy Commission’s rates to rates that were more reflective of the concerns that PG&E raised, and the rates that were used in the long-term. Not just the year 2004, but for the long term those rates were below the California Energy Commission’s projections which are based on the energy prices that were used in the report. Their view is that if in fact energy prices are higher than are used in the report, then PG&E rates will go up, and the actual estimates of PG&E’s rates are low or are conservative as used in the report. One of the issues is that PG&E’s critique always looks for the things they can attack, but they never look at the things where the assumptions are conservative. That is the case of the revenue levels long-term. They didn’t attack those estimates because they are very conservative.
2004 seems to be a pivotal year. An assumption is that what has happened in the decisions is that it appears that the 8.2% rate increase or whatever increase it is that will come about in 2004 as a result of coming out of bankruptcy is a negotiated number. The way they did that was that they got a lot of benefit in the first year at the expense of later years. What you are going to have is a levelization of PG&E’s rates, which do not necessarily track the costs that are outside of the cost contained in the decision. For that reason, PG&E’s long-term rates have been understated in the report.
If you look at the analysis, you will find that 2003 has stopped being shown in part not only because that year is gone, but also because that year was a year before the assumed 8.2% rate reduction. The number used for the PG&E rate reduction may have been 6.8% or 7%. You would not go through this and acquire the system in 2004, 2005, or 2006. It would take at least that long. You have to look out when you are looking at what is happening out in those later years.
PG&E was asked what their revenue and rate projections were in the future. Partially because of the uncertainty that they had. During this process, they are going through the bankruptcy proceedings. They probably didn’t have confidence in the data they had to turn over for the report. They didn’t provide any help in estimating what future rates would have to be, so those had to be build up. The numbers are very conservative and the numbers that relate to revenues are probably lower than will actually happen. We do not have concern with that criticism.
PG&E talked about a change in the treatment of the capital additions. That was done. We said we were disadvantaging the acquisition of this utility by requiring them to pay as you go for all future capital additions. PG&E does not do it and other municipal utilities do not do it. For a startup utility, it was assumed that instead of a pay as you go, you would issue debt to pay for new capital additions. Yes, it spreads it out over the life of the facility, but that is what publicly-owned and investor-owned utilities do. They have debt. If you look at how their rate basis is established, you will find that a significant portion of PG&E’s rate basis is depreciation. That is to recover the cost over the life of the facility. They don’t go out and pay as you go for new capital additions. We didn’t think we should put that burden on the publicly owned utility either. That is a general response to PG&E’s concerns.
Ed Smeloff, Public Utilities Commission made the following comments:
He concurred with the last observation that Mr. Mellor made that long-lived utility assets should be capitalized. That is the proper way of distributing the costs across a rate-payer. It is certainly a normal way that a municipal utility would develop and finance new capital additions. He can give the Commission a considered response after review. The issue related to what power purchase commodity is going to be in the future--there is a lot of uncertainty about it. There is increased volatility in markets. A lot of the electricity commodity is tied to the price of natural gas. It will be the same whether the utility is owned municipally or if it is owned by an investor-owned utility. The exception is that a municipal utility decides to further diversify its portfolio and get additional non-natural gas resources as a way of hedging against that future risk of volatility in cost increases.
Public Comment
Tom Roberts made the following comments:
The acquisition cost is a major factor in whether this is financially desirable for the City to do. It looks like the range varies not only with the condition of the physical assets, but also the way that it is valued. He understands R. W. Beck doing a physical appraisal to know exactly what the condition is, but the question of book value versus replacement cost seems more important. He recommended that the City request that the City Attorney’s Office look into that question and see if there is a legal precedence for establishing the real course measure of how these assets are valued.
Howard Ash, Energy Utilities Analyst made the following comments:
I have seventeen years of experience as an Energy Utilities Analyst and was recently appointed by the Board of Supervisors to the PUC Rate Fairness Board. There are issues about my comments about troubling statements that are missing from the Final Report that were in the original report about community aggregation versus municipalization, about some basic math, and about whether the $500,000 or $600,000 is necessary. Most of my extensive written comments were ignored where it was suggested that certain omissions would be corrected or more detail needed--for example, the customer responsibility surcharges and the detailed net present value model. There isn’t enough there to be convinced about the assumptions and the results.
There is a number of troubling statements in the Draft Report that are missing from the Final Report. One is the fact that a municipalized utility would have a tough time getting positive net present values, especially in the early years of the purchase. Those are gone from the Final Report. The Draft Report indicated that most of the benefits come from the elimination of these non by-passable charges late in the time horizon. Why did the net present value benefits occur now in the Final Report if not from the elimination of these non by-passable charges? From the Draft Report to the Final Report, R. W. Beck had gone from a 7 percent debt to a 6 ¼ percent debt. Obviously, that is going to help the financial situation, but there is no explanation why that change is made. If you are going to look critically at this report, you have to ask some critical questions as to what changed between the Draft Report and the Final Report.
The comparison between municipalization and community aggregation is missing. Mr. Mellor stated that they would provide that kind of comparison, and it is not in the Final Report. In the Final Report, R. W. Beck suggests a net income of $70 to $200 million per year from municipalization. San Francisco spends about $120-$125 million on distribution annually. If you add up all of the customer class and the rates they pay for distribution only, it is about $120 million. Can we really buy the system, pay the additional debt, spend the same for operations and maintenance, upgrade the old system that they are suggesting in the report, and still save 60 to 160 percent of our distribution cost? At the high level, the numbers are odd and suggest further analysis and inquisition by this Commission.
The $500,000 or $600,000 is not a good place to spend the money right now. It is obvious that a higher cost is going to be detrimental to the economics, and a lower cost is going to be favorable to the economics. Putting a finer point on that is not necessary at this time. Mr. Mellor stated at the December 12, 2003 LAFCo meeting that municipalization versus aggregation comparison should be the next step.
Ms. Young stated that the adoption and recommendation of next steps would be discussed at the February 20, 2004 LAFCo meeting.
Nancy Miller, Esquire stated that typically after meetings are concluded, a Resolution is brought to the next meeting that accepts the premises of the Report and then a recommendation is sent to the Board of Supervisors. The Commission may want to discuss this issue in more detail today or on February 20th since there are a couple of next steps given the testimony today. We could ask further questions of the consultant or come back with a recommendation on this appraisal. The appraisal is not necessarily a LAFCo study. You do have the authority to make special studies of governmental services. An appraisal of the type that Mr. Mellor was talking about is a necessary step to implementation. It is also a study that presumably the Board of Supervisors would want to weigh in that next step. We will provide you on February 20th with that range of alternatives so that you can consider it in more detail. We did receive comments from SFPUC, which were responded to by the consultant and other written comments. The range of options will be available in sufficient time for the public.
Vice-Chairperson Commissioner McGoldrick asked if the range of options would be available in sufficient time for public access.
Ms. Miller stated the information would be available.
Alternate Commissioner Fellman recommended that the Commission ask the SFPUC to provide comments on the Final Report and recommendations that Mr. Smeloff offered. That would be useful to have in time for the next meeting.
Mr. Smeloff stated the comments would be available a week in advance of the next meeting.
Mr. Mellor discussed Mr. Ash’s comments regarding the comparison of AB117 and full municipalization and made the following comments:
He is correct and I did say we should do that. We had a problem because the AB117 analysis was based on different load and revenue projections that were different in the assumptions used in the AB117 study. A lot of things changed. In order to do the kind of thing that he wanted would have required us to go back and spend a whole bunch of time redoing the AB117 study. A graph on the comparison of municipalization and community aggregation was discussed and is available at the Clerk of the Board’s Office, Room 244, City Hall.
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