Privatize to Eliminate a $2-Billion Problem
Will the citizens of Los Angeles lose $2 billion because of circumstances at the Department of Water of Power? I think they might. Can the likelihood of this great loss be reduced? I know that it can.
According to a 1996 DWP-commissioned study by Price Waterhouse, the nation’s largest municipally owned utility must reduce its cost structure, among other things, if it hopes to survive industry competition. As the study shows, DWP has $4 billion in balance-sheet debt and another $4 billion in indirect debt from contractual obligations. Therefore DWP does not have any margin for error in executing a successful business plan.
Many of the bond indentures require DWP to set rates high enough to repay these debts. Under DWP’s present cost and rate structures, competitive forces are likely to leave DWP unable to cover payments on its outstanding debt, leaving the citizens of Los Angeles responsible.
The DWP study also notes that the utility’s costs must be reduced by $400 million each year. But consider:
* DWP’s rate structure is skewed unfairly against large industrial customers, who are most able to leave the system. These rates are about 20% too high. Commercial rates are about 15% too low and residential rates are about 20% too low.
* Through its part ownership of coal and nuclear plants outside California and their associated transmission systems, DWP is obligated to buy electric power at approximately 6 cents per kilowatts per hour versus a market value of well below 3 cents per kwh. These obligations run until 2027, resulting in more than $2 billion of over-market payments in current dollar terms.
* DWP needs major help in basic administrative functions such as operations management, wholesale trading, marketing and customer service and information technology.
Interestingly, this diagnosis is not new; in fact, it’s a third opinion. In February 1994, the Mayor’s Special Advisory Committee on Fiscal Administration (of which I was chairman) reported many of the same maladies. We predicted certain consequences, too, if they went untreated--among them business flight. Certainly we can’t say that DWP’s unusually high industrial rates are the sole reason for manufacturers leaving Los Angeles, but compelling evidence shows that most of them moved to places with much lower power rates. Unfortunately, DWP was not persuaded by our report. Instead, it ordered another study, which ultimately confirmed our findings and suggested even more changes.
The solution to the DWP disaster is not the present process, which will siphon off the energy trading opportunities to an out-of-state “strategic partner.” Requests for proposal for these trading activities must be reopened--and this time they should not preclude the two California companies--Edison International and Pacific Gas & Electric--that have the marketing and asset-management capabilities to assist DWP with all its long-term problems, not to mention the assets ($24 billion and $27 billion respectively) and the industry reputation (a recent Fortune survey ranked them as the fourth and fifth most admired electric and gas utilities in the United States). They are the most logical partners.
The ultimate solution is to extract the DWP from its uneconomic position as the nation’s largest municipally owned utility, which limits management compensation, limits financing techniques (including the use of equity securities) and enmeshes it in city politics.
Recently, Niagara Mohawk, a New York investor-owned utility, solved many problems similar to DWP’s by issuing equity securities to eliminate obligated over-market payments for power and to avert bankruptcy. This is simply more evidence that DWP should become a truly private enterprise to reduce the business and financial risks to the citizens of Los Angeles.
