Division Between LIPA and NG Had Spawned Confusion Over Responsibilities, Lack Of Accountability, Misaligned Incentives

Written by Jon Lentz on March 25, 2013.

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(Photo Credit: Bruce Bennett)

It was the worst storm to hit Long Island in a generation. Torrential rains and high winds knocked out power for more than half a million customers of the Long Island Power Authority, making it the largest customer outage in LIPA’s coverage area in over a quarter century. Thousands of workers were deployed to clear fallen trees and repair downed electric lines. A week later, some frustrated residents were still waiting to turn on their lights.

In the days after the storm made landfall, Gov. Andrew Cuomo blasted LIPA and demanded that it quickly restore power. He warned that National Grid, the public utility’s private contractor, might even lose its contract. “Today, tens of thousands of Long Islanders are still in the dark,” he said. “I have also received numerous complaints about poor communication to LIPA’s customers during the restoration effort.”

What the governor failed to mention was that LIPA and National Grid were not the only figures responsible for the response on Long Island. Cuomo himself has a clear if indirect role in overseeing the public utility—and, like his predecessors, it is a role he had often neglected.

Though he has the power to fill nine of the 15 seats on the board, including the chair, prior to the storm the governor had installed only one LIPA trustee. The utility had limped along for months with the chief operating officer filling in as CEO. Lawmakers had pushed for legislation to subject LIPA to regulatory oversight, but Cuomo watered it down. A few months after taking office he had directed the New York State Inspector General to investigate the utility’s rates, but to this day no audit has been released.

Some observers wondered if the governor was deliberately steering clear of LIPA. Michael Fragin, a former trustee who had left the board earlier in the year, guessed that Cuomo was keeping the unpopular utility at arm’s length because of its electricity rates, which are among the highest in the country, and its $7 billion debt, which exceeds its assets by more than $3 billion.

“If the second floor doesn’t want to deal with those head-on, then they might be making an astute political move by allowing LIPA to kind of drift on its own for a while,” Fragin suggested in the days following the storm.

This may sound like the aftermath of Superstorm Sandy, but in fact it was Tropical Storm Irene, which hit New York in August of 2011. Despite the damage that Irene inflicted and the challenges it exposed at LIPA, the governor was able to maintain some distance from the public utility for a while longer. Board seats stayed vacant. The CEO position remained unfilled. A review of LIPA’s performance during Irene was conducted, but the utility was not required to make any changes.

But if the lessons of Irene did not spur a sufficient response, the unprecedented destruction of Superstorm Sandy just 14 months later made dealing with LIPA unavoidable. Only after Sandy slammed Long Island in October 2012 did the governor finally take a serious look at the Long Island Power Authority in search of a solution to its longtime problems.

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In a cabinet meeting in the Red Room of the Capitol in early January 2013, the governor’s Moreland Commission, which was created to investigate utility storm preparedness in the wake of Superstorm Sandy, presented its preliminary findings. Cuomo congratulated his commissioners for their quick work and said that he wanted to incorporate their “big ideas” into his State of the State address that week.

Benjamin Lawsky, the state’s Department of Financial Services commissioner and a co-chair of the Moreland Commission, explained during a PowerPoint presentation that the structural relationship between LIPA, a not-for-profit government authority, and its for-profit contractor was fundamentally flawed. The division between owner and operator had spawned confusion over responsibilities, a lack of accountability, misaligned incentives and—especially during Superstorm Sandy—a breakdown in communications with customers.

The commission weighed several restructuring options, Lawsky said. One would end the relationship with the private contractor by having LIPA assume the duties it had outsourced, resulting in a traditional municipal or public power utility. Another option called for an investor-owned utility to buy out LIPA, eliminating direct government involvement.

The commissioners recommended privatization. They argued that LIPA would benefit from an investor-owned utility’s private sector expertise and “synergies,” while the privatization would also subject LIPA for the first time to oversight by the Public Service Commission (PSC), the state’s utility regulator.

Furthermore, Lawsky said, privatization would also be “more cost-effective than the ‘expand state authority’—the municipalization option.”

Cuomo left little doubt that he preferred privatization over full municipalization.

“The option that says, ‘Expand LIPA’—whatever number that was, Mr. Lawsky—if I had something to throw at the screen, I would have then,” he said. “It doesn’t work now. I don’t think any expansion for them is an option.”

In his State of the State address two days later, Cuomo made selling off LIPA a key part of his 2013 agenda.

“When it’s come to the Long Island Power Authority, it’s never worked, it never will, the time has come to abolish LIPA, period,” he said. “We want to privatize the Long Island service, which will be regulated by a new and empowered PSC that will happen simultaneously, and we want to do it in a way that protects the ratepayers and freezes the rate for a period of years.”

In the ensuing months, the Cuomo administration has struggled to sell its case for privatization.

Utility experts warn that electrical bills will go up, even if rates are frozen, while Long Island lawmakers are exploring public power and other alternatives. Some welcome the governor’s newfound interest in fixing LIPA but worry that he is being driven by politics, not policy.

And in the end, it’s far from certain that his proposal will be successful, either for him or for Long Island.

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On the North Shore of Long Island, about a 55-mile drive east of Queens, a massive concrete structure of teal and gray looms over a wetland area bordering the Long Island Sound. It is here where the Long Island Power Authority’s troubles began.

In 1973 the Long Island Lighting Company, a private utility, began constructing the Shoreham nuclear power plant on the site, the first of several nuclear facilities planned for Long Island. LILCO’s project was assailed by wealthy landowners and opponents protesting the expansion of nuclear power, and plagued by delays and cost overruns. The partial nuclear meltdown at Pennsylvania’s Three Mile Island in 1979 fueled the fears of local residents.

Nonetheless, construction continued, and the plant was largely completed by 1983, but then Gov. Mario Cuomo halted the project. In 1986 lawmakers created the Long Island Power Authority, and the new state entity took possession of the Shoreham facility three years later. As part of the agreement, LIPA assumed the full cost of constructing the defunct facility, which had ballooned to more than $6 billion.

In 1998 Gov. George Pataki orchestrated LIPA’s acquisition of LILCO’s transmission and distribution system, pushing through the deal with a pledge to lower electricity rates. His administration also took the unusual step of contracting out the operation and maintenance of LIPA’s utility system to a private utility. Among the 2,000 public power utilities dotting the country, only a handful of them outsource operations.

Over the years LIPA did little to pay down its debt, a failure critics attribute to a lack of oversight, a legacy of political appointees with little understanding of the utility business and a misguided emphasis on restraining rate increases.

A Long Island Power Authority truck in Queens on Nov. 12, 2012. More than 70,000 LIPA customers were without power that day, two weeks after Superstorm Sandy. (Photo Credit:Craig Ruttle)

The Shoreham facility, which was built so solidly that it is too expensive to tear down, now stands as a monument to the dashed hopes for cheap, reliable electricity and the ongoing energy challenges of Nassau and Suffolk counties.

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Following the Moreland Commission’s presentation early in January 2013, a reporter asked why the public utility wasn’t overhauled two years earlier, when Cuomo first took office.

“There’s something called ‘political will,’” Cuomo replied. “Why haven’t a lot of things happened? Why haven’t we passed gun control in this state and in this nation, right? ‘Well, it was so obvious.’ Well, a lot of things are obvious, but you need the political will to change them, and sometimes you need an event that galvanizes public opinion to actually move the process.”

The governor had that political will, another reporter countered, as well as the opportunity to appoint trustees. So did he bear any blame for LIPA’s poor performance?

“Absolutely not,” Cuomo insisted.

Why is that?

“Because LIPA was flawed from inception,” Cuomo said. “There’s nothing you can do with the existing structure. Whether it had 10 people on the board or 14 people on the board, do you think that was a difference?”

Vacancies have continued to be an issue. In December Moody’s Investors Service placed LIPA under review for a possible downgrade, in part due to a recent exodus of trustees, including the chairman, and the failure to quickly appoint replacements. The new departures, combined with the other longstanding vacancies, meant that the utility barely had enough trustees to constitute a quorum, hindering its ability to take action for a brief period. The governor has since appointed a chairman, but today four board seats remain vacant, all of them for gubernatorial appointees.

“The inability of government officials to promptly address the expiring terms is, in our opinion, a governance deficiency, and one that could severely impede prompt decisive leadership, which we believe is needed given the challenges at LIPA,” the ratings agency wrote.

Cuomo may not have judged the political winds to be auspicious when he took office, but he could have started restructuring the utility earlier in his term. When he was elected, the trustees were asking the same question the Moreland Commission is trying to answer today. National Grid’s contract was set to expire in 2014, and the utility was weighing whether to privatize, municipalize or tweak its existing structure. A consultant deemed the decision “very important, indeed central, to LIPA’s future operational performance and strategic success.”

Had the governor quickly appointed his full slate of trustees, they would have constituted a majority and could have begun the long process of restructuring LIPA any way he wanted well before Superstorm Sandy. Instead the board went with the status quo, modifying somewhat but sticking with the dual structure criticized by the Moreland Commission.

Another key commission recommendation was to strengthen the Public Service Commission and grant it the authority to regulate LIPA.

“We empowered a Moreland Commission which said, basically, and I quote, ‘Put real regulatory and enforcement teeth into the Public Service Commission, which has for too long been a toothless tiger,’ ” Cuomo explained in his State of the State address.

But in 2011 the governor rebuffed efforts to boost oversight of LIPA, sources said. He rejected a bill that required Public Service Commission approval before LIPA could raise its rates, a provision already applied to other utilities.

“Gov. Paterson vetoed the bill, saying it would affect LIPA’s bonds, which I strongly disagreed with,” said Assemblyman Bob Sweeney, who sponsored the legislation. “Everyone I spoke with disagreed with that, but that was his position. So we dashed the bill. When Cuomo became governor, he took the same position. But he also said, ‘Can we talk about this?’—to his credit. And so we did.”

In February 2012 the governor signed a weaker bill, which requires a periodic audit of LIPA’s management and operations. Under the law, the utility’s customers also can register complaints with the state’s consumer protection division.

“So the Public Service Commission does now have the ability and is required to audit LIPA on a periodic basis and produce that report as a public document,” Sweeney said. “But it doesn’t give them authority over rates or anything.”

Sweeney said he had hoped for more, but at least the law provides some oversight.

“One of the problems arguably with LIPA up until my bill was [that] nobody had any oversight over LIPA—literally, nobody,” the lawmaker said. “They could do whatever they wanted to, essentially. And there was nobody there to say ‘This is right’ or ‘This is wrong’ or to audit them and publicly provide that information.”

Matt Wing, a Cuomo spokesman, said Sweeney’s original legislation had nothing to do with the actual regulation of LIPA or holding the authority accountable when it failed to perform for customers. “It was a gimmick to claim that action was being taken against rate hikes, though in reality LIPA has never proposed rate increase at the level stipulated under the bill,” said Wing, adding that the legislation the governor ultimately signed “improved the law so that it actually resulted in new oversight for the first time.”

Wing also disputed the idea that the governor had neglected LIPA, saying it was “inaccurate” to characterize Cuomo as having any oversight since he has no role in day-to-day operations and no regulatory power to issue fines or in any way hold LIPA accountable.

“The idea that the number of LIPA trustees would have had any impact on LIPA’s abysmal performance during Sandy is absurd,” Wing said. “As the Moreland Commission report makes clear, LIPA failed to respond to the disaster because its bifurcated structure is completely dysfunctional.”

As for the delay in releasing the Inspector General’s report on LIPA’s rates, which was initiated early in 2011, Wing said that its findings were referred to the Moreland Commission and would be incorporated into its final report.

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By late last month administration officials had grown cautious about the prospects of privatization. At a Senate hearing in Albany, top state energy officials testified that it was premature to identify the best structure for LIPA, and declined to say whether selling it off would increase costs or raise rates.

Gil Quiniones, who heads the New York Power Authority, repeatedly reminded the senators that an analysis was ongoing and that the governor would select whichever option would best meet several criteria, including stabilizing rates and property taxes, improving service and positioning the utility to weather the next storm.

“We are open to any plan that others may have that can be clearly demonstrated to meet those objectives,” Quiniones said. “In the end, what Gov. Cuomo wants is what’s best for Long Island ratepayers.”

Robert Lurie, a senior vice president at NYPA, described a potential privatization scenario in which LIPA’s transmission and distribution system would be sold for about $3.5 billion, leaving $3.5 billion in debt from the Shoreham facility. That debt would then be separated out and paid for as a charge on customers’ bills distinct from the actual rates.

State Sen. Carl Marcellino asked Lurie how LIPA could transition from a public utility to a private one that makes a profit without raising rates. Lurie said he didn’t know.

“If the only factor were the transition from a tax-exempt entity to a taxpaying entity, then certainly the costs of privatization would be a nonstarter, and it would not even be on the table,” Lurie said. “But there are other factors, including the synergies which reduce costs substantially and other factors that will be included that may or may not offset the cost that you rightly point out, but that’s exactly what we’ve got to determine.”

A battle over Shoreham nuclear plant led to the creation of the Long Island Power Authority in 1986. The defunct plant now stands as a monument to Long Island’s enduring energy challenges. (Photo Credit: Daniel S. Burnstein)

Past reports exploring that question have concluded that privatization is more costly. A 2010 Navigant Consulting draft report predicted that dropping the private contractor and fully municipalizing LIPA would lower costs by 1 percent, while privatization would raise costs by 7 percent to 12 percent over a decade. “Of the strategic options under consideration, the privatization option would likely result in significant revenue requirement increases for energy delivery to Long Island electric customers,” the Navigant report found.

In October 2011 the Brattle Group issued a study that echoed the Navigant report. “Cost and rate impact analysis clearly indicates that implementation of the privatization option would result in an average rate increase for LIPA’s customers,” the Brattle report said. “This serves to remove privatization as an option at the current time.”

Wing, the governor’s spokesman, said the reports are generally outdated and have three basic flaws: overstating how much equity is needed, overestimating the benefit of tax-exempt borrowing since interest rates have fallen while municipal and corporate rates have converged, and failing to fully account for synergies with a private, investor-owned utility buyer.

Not everyone agrees. On the day of Cuomo’s 2013 State of the State, Moody’s issued a brief stating that the governor’s proposal would have no immediate impact on LIPA’s credit rating. It also predicted that the costs of privatizating would outweigh the synergies of combining with another utility.

Some of the reasons for the higher costs projected are straightforward. As a private utility, LIPA could no longer issue tax-exempt debt, and its existing tax-exempt debt would have to be replaced by taxable debt. Eligibility for FEMA assistance would be curtailed. A portion of the utility’s profits would have to be diverted to shareholders.

Matt Fabian, managing director of debt research at Municipal Market Advisors, said the process would face other hurdles, like requiring the termination or rewriting of interest rate swaps.

“The problem is that it’s such a big and complicated debt structure that it’s really hard to speculate on the net impact,” Fabian said. “It’s going to be very difficult to be done at all, so I would place their probability at being able to do it as fairly low. In theory, they would only do it if they could demonstrate a neutral impact on ratepayers and a promise of better service delivery.”

Cuomo administration officials have floated the idea of issuing bonds to pay off the debt that would remain after a sale of the transmission and distribution system. Of course, the debt will still be there, and someone will still have to pay for it.

“Either it’s ratepayers or it’s not ratepayers,” Fabian said. “Ratepayers can pay through the rate structure, or they can pay through some other tax on their properties that is collected, or it can be paid by a statewide levy or a regional levy or some other money that shares the burden. It’s just restructuring how they pay. You could stretch out the terms, but LIPA’s debt is already pretty long. So stretching it out further wouldn’t necessarily be prudent.”

Given the challenges and costs of privatization, some lawmakers suggest returning to the public power model which was initially intended at LIPA’s inception. In 1986 Gov. Mario Cuomo’s “Sawhill Commission” concluded that a LIPA takeover of LILCO could result in significant savings for utility customers. A generation later, Gov. Andrew Cuomo seems intent on undoing his father’s work and having LIPA revert to being a private company, despite evidence that the elder Cuomo got it right when it comes to the costs.

In fact, Pataki made an executive decision to outsource LIPA’s operations to a private company—a decision that required no change in legislation. As such, if Cuomo wanted to fully municipalize LIPA, he could do so with relative ease.

“The traditional concept of privatization is something that has been looked at and rejected in the past because it doesn’t work financially,” Assemblyman Sweeney said. “It’s not a benefit to the ratepayers. The governor seems to think that he can avoid the pitfalls of that, but until we know the details, we don’t know whether that’s the case or not. LILCO, going back years ago, was the private utility company that provided utility services, and then it was so disliked that it ended up being replaced by LIPA. I’m not sure that the best option is to go back and forth between private and some other form. Maybe we ought to just take LIPA and look at it the way it was originally intended to be and make it work.

“It never has been a true municipal utility,” he added. “And so, from my point of view, the original concept of LIPA has never been given an opportunity to succeed.”

Despite the governor’s opposition to fully municipalizing LIPA, public power has a strong track record in the United States, where it serves 47 million people, or about 14 percent of the nation’s electricity customers. There is some evidence that public utilities provide electricity at lower rates, and proponents tout the advantages of local control.

“Another benefit is obviously that public power companies are not-for-profit, so they don’t have shareholders,” said Ursula Schryver, a vice president at the American Public Power Association. “So all of the revenue from the utility is invested back into the utility or the community, and rates tend to be lower.”

Gary Krellenstein, a managing director at the energy finance consulting firm Oxford Advisers, said that LIPA would be in far better shape if it had followed the management practices of successful public power utilities like the Los Angeles Department of Water and Power and the utility systems in Orlando and San Antonio, all of which are AA-rated.

“The argument that a private utility is inherently better doesn’t follow historical precedent,” said Krellenstein, who previously headed the utility group at Kroll Bond Rating Agency and was as an investment banker at J.P. Morgan. “Historical precedent is that both ways can work, but as a general rule municipal utilities offer slightly better service and slightly lower costs.”

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In the debate over restructuring, the fate of LIPA is as likely to pivot on political considerations as on the outcome of cost-benefit analyses and financial concerns. Public utilities only garner attention when rates go up or power lines go down. Privatization may be simply the most attractive solution for a politician who wants to distance himself from a troubled state entity while demonstrating decisiveness in responding to a brutal natural disaster.

“For the most part this is a political decision,” said Fabian, the managing director at Municipal Market Advisors. “This is not being driven by economics. So in order to make it work, you may need more political intervention for it to happen, because it’s not necessarily a market-driven change or an economics-driven change.”

Krellenstein said there was little to be gained by pointing fingers regarding LIPA’s mishaps, and he cautioned the governor against getting swept up in the politics of the moment and making a rash decision as a result.

“It’s really got to be thought through, and so they’ve got to be careful of doing a knee-jerk reaction just to satisfy the public,” Krellenstein said. “You really want to do what’s in the long-term best interest of LIPA’s customers, the utility’s state, the reliability of service—I mean, electric power is so essential now. There is a health and safety aspect, not just an economic one, to doing LIPA right.”

Despite his reluctance to assign blame, Krellenstein said he did see a pattern of culpability.

“I’m afraid that New York State politicians created this problem, and now they’re blaming it on everybody but themselves to fix it,” he said.