Does DWP Have Power to Survive?

As the limping relic of the giant that built Los Angeles, its obituary already written, the Department of Water & Power nonetheless is attracting proposals from partners eager to help it change, profit, grow and survive.

This week will be critical for the organization that between 1913 and 1927 traded water for annexation of neighboring communities and made Los Angeles the largest metropolitan area in the United States. Today DWP supplies electricity to 1.3 million households and businesses.

On Tuesday, William McCarley, DWP’s general manager since 1994 and a high official at City Hall before that, will recommend to the City Council the DWP’s choice for a strategic alliance partner to give it the skills of trading electric power as if it were wheat or cotton and of selling customers electricity in a variety of forms and prices.

The three candidates McCarley has in mind are new kinds of electric companies: Duke-Louis Dreyfus, a joint venture of a North Carolina utility and a Connecticut-based trading company; Enron, a Houston natural gas company that has become a power in electricity; and PacifiCorp, the union of utilities in Oregon and Utah that now supplies power to other companies throughout the West.

But even with an alliance, experts question DWP’s survival chances. Its $7.9 billion debt is enormous, and its 8,900 employees, mostly civil service and unionized, are not seen as readily adaptable.

Yet experts may be misjudging the new environment. With electricity in oversupply everywhere, trading companies can knock 50% off the price of power. Changes of great magnitude are coming.

And DWP has other suitors for its customers, very much among them Edison International, the Rosemead-based utility that is the state’s second-largest power company. San Francisco-based Pacific Gas & Electric is first, DWP is third.

Edison is making a bid to be DWP’s alliance partner, but McCarley is rebuffing it, saying that Edison lacks innovation and would make a weak partner as both organizations prepare for electricity competition in 1998.

Edison, to be sure, has cut its dividend and is regarded as threatened by out-of-state competitors. But new California laws, ruling that write-offs of uneconomic power plants be stretched over decades and borne by utility customers, promise rising cash flows and financial strength for the state’s investor-owned utilities.

And, thanks to a ruling giving utility customers a short-term price cut but paying for it with new 20-year bonds, both Edison and PG&E; will get a cash windfall of $2 billion each right away. Edison will use its windfall to reduce debt and buy in stock, says a spokesman.

Word of the rising cash flows are already drawing investors to Edison and other California utilities, says analyst Kit Konolige of Morgan Stanley. The prospect is that Edison will have a strong stock to use for acquisitions as the competitive free-for-all heats up.

DWP could well be one of those acquisitions. If the municipal utility can’t solve its problems in the next few years, then Edison ultimately may offer the Los Angeles City Council a price to take DWP off the city’s hands.

The City Council and the mayor have some major decisions to make. If they want DWP to continue as a city-owned provider of electricity, they will adopt the plan McCarley outlines to them on Tuesday and in the weeks to come. If not, they can resign themselves to severe problems and ultimate sale.

A lot is at stake for Los Angeles residents, who own DWP just as residents of Anaheim, Burbank, Glendale, Pasadena, Riverside and other Southern California cities own their electric companies.

Municipal power companies reflect an old idea that cities could supply an essential resource more cheaply than could commercial utilities. Instead of paying taxes and dividends, municipal companies pay into city budgets. “Municipal power companies help keep property taxes down,” observes investment analyst Edward Tirello of NatWest Securities. “But now they’re threatened.”

DWP last year paid $109 million to Los Angeles, plus subsidies in the form of lower rates for the police and fire departments that McCarley estimates at another $60 million. Politics influence municipal finances too. DWP rates for residential and small commercial customers are lower than those of Edison or PG&E;, but they are higher for big customers, such as USC, UCLA, oil refineries, the Port of Los Angeles, etc. Those big electricity users are ready to flee DWP for other suppliers starting next year.

“Edison is already soliciting my customers,” growls McCarley.

So DWP must adjust--raise residential rates, lower those for big customers and get its debt down. The debt stems from politics too, because public officials approved energy schemes in the oil-short 1970s that are uneconomic today.

What can be done? Short-term, the help of Enron, Dreyfus or PacifiCorp could help DWP earn more with which to pay down debt. The Legislature could grant municipal companies the cash-flow-enhancing terms it gave investor-owned utilities.

McCarley suggests that DWP reduce its payment to the city budget to $60 million a year and use the other $50 million to reduce debt. But the city would have to find budget funds elsewhere or raise taxes. So politicians may not go for it.

In that case the day will come in the next five years when DWP faces defaulting on its bonds or raising rates drastically. At that time, Edison or another cash-rich utility will offer the City Council a deal to take DWP and its problems--but also its attractive customer base--off the city’s hands.

Will that make a difference? Yes, says McCarley, 57, who insists he is retiring from public service at the end of this month after 32 years in city government. “I think this department has potential as one of the most tremendous development tools the city ever had,” he says, referring to the traditional role power companies play in soliciting and supporting local business.

But investor-owned utilities, Edison included, also support local business. McCarley recognizes that for all DWP’s history--”this city would not be here were it not for DWP”--times change and “we must be competitive.

“I tell the politicians, you can kill this cow and have one big barbecue or get it well and have milk and cheese for a long time.”

Given current levels of political fortitude, the smart money is on barbecue sauce.