The Austin Chronicle

http://www.austinchronicle.com/news/2012-06-15/total-utility/

Total Utility

The pain and politics of raising electric rates as a means of controlling our destiny

By Mike Kanin, June 15, 2012, News

Just after 10am on Monday, May 14, Austin City Council Member Bill Spelman stepped behind the podium in the press conference room at Austin City Hall. To his left stood Council Member Chris Riley and Mayor Pro Tem Sheryl Cole. Spelman and Cole were fresh off re-election victories; Spelman managed to avoid a run-off in a very crowded field, and Cole defeated her sole opponent by roughly 40 points. The singular mix of celebration and relief that accompanies victory was palpable. But not just because of the election. After 18 years without council action, two years of preparation, several crowded weeks of tedious public work sessions, and – at that point still – no clear end in sight, Spelman, Cole, and Riley were putting forward their vision of what it would take to save Austin Energy.

They were flanked by supporters, including two former key skeptics. Joshua Hous­ton of Texas Impact represented houses of worship that had been convinced a rate hike of the sort suggested by the utility would bury them. Austin Independent School District Superintendent Meria Carstarphen and AISD General Coun­sel Mel­ Waxler had worried the rate increase would offer similar challenges to schools. Yet here they were to support the new proposal – and a rate increase that could return AE to relative solvency.

Still, absentees might better define that morning's event. City management and staff rarely take part in these occasions, as they are generally happy to leave the policy side of decision-making for elected officials. That practice sidesteps a certain truth here: Thanks to politics, the utility had been allowed to lapse into a precarious financial predicament. Worse, when council members were finally ready to tackle the issue, old-fashioned bureaucratic rigidity – some of which came thanks to a set of operational changes visited upon City Hall in the wake of the 2010 open meetings controversy – kept them from the sort of nimble discussion that might have resolved this problem sooner. To all of that, one could add the relatively recent hire of AE General Manager Larry Weis. Though no doubt an able hand, Weis found himself in the impossible position of inheriting the mantle of Roger Duncan, a trusted veteran of the Austin political apparatus whose advice was thusly received.

No member of the Texas Legislature attended the press conference either. With his appearance at a handful of Austin Energy rate hearings, state Rep. Paul Work­man, R-Austin, has made it clear he's ready to challenge any rate increase on the floor of the state House. State Sen. Craig Estes, R-Wichita Falls, has already tried to put AE in Texas' deregulated energy zone; word is that he's ready to do it again. Indeed, council members seem to worry about this as much as they worry about a nearly guaranteed challenge from ratepayers who live outside city limits, and thus have the right to ask the state's Public Utility Commission to alter the rate increase. The collection of disparate interest groups standing behind the council members – and by extension, the utility – represented formidable lines of defense against what could come next. Like it or not, without Austin Energy – and the programs it sustains – there would be considerably less of what people like to think of as Austin.

State Rep. Eddie Rodriguez, D-Austin, represents portions of East and South Austin, where affordability is particularly key. He notes that Austin is getting more expensive, and while he's concerned about the impact of a dramatic rate increase, he says the utility remains an important municipal cog. "The city is reliant on Austin Energy for things other than Austin Energy," he said.

Those who stood behind Spelman, Riley, and Cole agreed with the basic premise that rates need to rise citywide by roughly $71 million immediately; they'd even signed on to specific provisions that offered some measure of protection to their respective sectors as their rates looked to climb.

By the time City Council voted on June 7 to approve the Spelman-Cole-Riley rate proposal, other interest groups, representing poor residents and low-energy consumers, had also won concessions through last-minute amendments. The vote to approve the final proposal was unanimous.

Still, the electric utility business can't be fully understood in a crash course, no matter the intentions of policymakers. And whatever action council took was going to represent a relative stab in the dark. Council's carefully crafted rate solution may spread revenue increases perfectly across its ratepayer base in a way that makes everyone happy, saves the utility from challenges at the PUC and the Legis­lat­ure, and gives it enough cash to survive any economic hurdle for the foreseeable future. It could just as easily do none of that. Somewhere in between rests the fate of an entity economically critical to the city. How we all got here illustrates the unsightly mix of uncertainty and political maneuvering that gets poured into rate-making.

Historical Friction

Spelman had begun that day with a history lesson. "Two years ago, the director of Austin Energy announced that AE was running in the red," he said. "AE had not raised its rates since 1994, and the director proposed that a rate increase was needed to cure large and systemic deficits." Large the deficits certainly were, in terms of Austin Energy's fiscal situation, but it was the "systemic" that presented the real problem.

Two weeks later in his City Hall office, Spelman elaborated. For him, it came down to AE's cash reserve funds. The utility's reserves are intended to perform a series of roles that, collectively, soften the impact of the volatile world of energy production and sales. In simple terms, as commodities prices rise and fall, the fuel costs associated with them naturally mirror those actions. One of the reserve funds is designed to mitigate that issue. Another fund is supposed to serve as backup for emergency power purchases or infrastructure costs – the potential results of, say, an extreme summer or a strong hurricane – both of which can be inordinately expensive.

The utility's reserves also play directly into its bond rating – and thus its ability to borrow money on the cheap. If the reserve fund balances stay in a sweet spot as defined by the three major ratings agencies, that should theoretically contribute to a high bond rating. The higher the utility's bond rating, the less interest AE will have to pay to get people to buy their utility bonds.

Spelman says his phrasing referred directly to the depletion of the reserve funds. "The graph that I had in mind when I used those words was the graph of the reserve levels, which started off at basically zero, ballooned up [until] 2005, and then have been dropping to close to zero since then," he said. "It strikes me – given all the discussion we've had of their not hiring new [employees], of their trying to be tight with their money – I'm persuaded that somebody's watching this stuff. If our reserves are dropping that fast, then there is a reason for it, and we're not going to be able to cure that reason through internal trimming – it's just too big."

Yet despite the fact that the utility hadn't had a rate increase since 1994, as recently as 2005, its financial numbers seemed to point to no immediate danger. Austin Energy remained flush with cash, thanks largely to the ever-brimming popularity of Austin as a destination. Current AE General Manager Larry Weis noted that his observations might be a touch "judgmental" since he was nowhere near Austin at the time. "From 1990 to 2000, the utility had back-to-back years of great growth – 6 percent over the year before it, you know, those kinds of numbers," Weis said. It was right about then – before the 9/11 financial retreat or the much later onset of the housing-spurred recession – that Weis suggests AE should have picked up a signal.

Former Council Member Roger Duncan took the helm at Austin Energy in 2008. He'd already spent a significant amount of time as a city staff member in various key positions, both within and outside of AE. "You go through the budget each year, and department heads all come in. They say: 'I'm going to need this. I'm going to need that,'" he says. "The reality is that, not only me, but my [GM] predecessors have been saying for a while, 'We need a rate increase.' At the same time, the water and wastewater department is saying, 'We need a rate increase.' Trans­portation is saying, 'I've got to add $1 to the transportation fee' and so forth. So the response coming back to us [from council] would be, 'Have you absolutely, critically got to have a rate increase this year?' And the answer, ultimately as long as times were good and we were growing, was, 'No, we can put it off another year.'"

[page]

"If we had continued with the high growth rate that we had and the recession hadn't hit, we probably still would be sliding it off into a future year," Duncan continued. "But, the recession did hit."

Mayor Lee Leffingwell first got to council as the Place 1 representative in 2005. "Even then, looking out four or five years, the red flags were starting to come up," he said. "Of course, it takes a little time to set those wheels in motion."

The situation was further compounded by a troublesome existential fact. There are roughly 50,000 AE customers who live outside Austin's city limits. Those ratepayers cannot vote in city elections, and therefore have no say in the operations of the utility. However, out-of-towners have the right to appeal any rate increase to the PUC, whose members are appointed by the governor. Moreover, a handful of legislators perennially threaten to put Austin into Texas' deregulated energy zone, a move that would open the region to competition and effectively kill AE. So even as basic structural inadequacies persisted in AE's rates, it was easy to see why no one really wanted to tackle them. "As we know now, this takes quite a bit of political courage and effort to set this up, to do this," notes Weis.

Council Member Mike Martinez agreed: "Nobody that's an elected official ever wants to raise taxes or fees or rates on their constituents," he said.

But by 2009, it had become clear that something needed to change. For two years, the utility crunched numbers and ran through possibilities. AE staff unveiled their proposal at the final City Council meeting of 2011 – declaring that the utility needed $126 million in extra annual revenue. The new rate structure would feature a $22 monthly fixed fee for residential customers – to help take some of the volatile edge off bills that are dependent on energy sales – and a complicated rate structure that was designed to reward conservation with lower prices. The States­man reported that AE charges would rise by roughly 14% per household, or $16 a month.

That's when the shit hit the turbine.

Are You Talking to Me?

Nearly everyone found something offensive about Austin Energy's first pitch. As presented, Spelman, Cole, and Riley's plan formalized a much-discussed cut of more than $50 million from AE's initial stated annual revenue requirement. At a much leaner $71 million – a number that had been hollowed out by council members and utility officials over many months – that figure represents a compromise that still leaves the utility with uncomfortable fiscal gaps. Still the cuts aren't as bad as they could have been, or even as painful as the process that everyone went through in order to sort out the situation.

Council members responded to AE's initial proposal by scheduling work sessions to help them make a series of interrelated policy decisions that would, in turn, ultimately dictate the specifics of the rate increase. That plan also produced a cramped schedule that kept council members juggling AE, the city's budget, an election, and all of their regularly scheduled programming.

All council members say the result was worth the effort. But many had to skip at least a handful of the work sessions – Spelman found himself the chair at many meetings – and late in the process, members settled on a "decision-point list" that aimed to pull all of their work together. It was something that the Electric Utility Commission had figured out many months before council asked for it.

Some of this meandering was also a consequence of the cloud that hangs over a sizable chunk of the council and determines how members do business: the county attorney's ongoing investigation into possible open meetings violations. Martinez cited the attempt he'd made with colleagues Laura Morrison and Kathie Tovo to implement a shorter interim rate increase that might allow for more deliberations before a comprehensive solution would have been reached next year. "The minute that I began talking to ... Morrison and Tovo ... that really was it," he said. "The line of communications had been drawn because I had already spoken to two other council members about something I was contemplating proposing with them. So I couldn't engage – and didn't engage – with other council members."

And so it was that members found themselves scheduled for 11 AE work sessions in seven weeks. Despite the transparency benefits, there was no question that – under the old way of doing business – council members might have had their questions dispatched more efficiently. As fees for outside consultants mounted, as council was forced into a complicated process that simultaneously lent an air of over-simplicity to the proceedings, and as officials were forced out into the open – where, let's face it, one is often forced to be less-than-fully-revealing – a question lingered over the proceedings: Is it worth it?

"We've held a bunch of work sessions where staff have been talking at us – and we've been talking to each other to a lesser extent," said Spelman. "Although most of the discussion has been from the staff ... I think we would not be needing as many work sessions if we could just talk to each other."

Time was another important factor. The utility has said that its operations are currently running at a net loss each day. That pushes it to use more reserve funds. As the reserve funds are depleted, the chance of fiscal disaster in the face of an emergency – that hurricane or plant shutdown – multiplies. There is also the fact that a revenue increase visited in summer is (thanks to air conditioning and the like) going to produce more income than one begun in fall.

The Telecon Advocate

Heated setting? Certainly. Confusion abounding? Regularly. But nothing quite reached the absurdity brought by the arrival of Paul Chernick, the president of a consultancy called Resource Insight based just outside of Boston. He'd been brought on as an independent residential advocate – someone to look after the interests of low-income and residential AE ratepayers. Utility critics worried that, without the participation of such an adviser, those classes of ratepayers would be sent down the proverbial shaft in favor of larger or industrial customers.

Chernick got here late in two ways. Council members were swayed by community concerns over the adviser originally hired by AE to fill the residential advocate role earlier in the process, so they turned to outside help for the work sessions. In addition, Chernick had been the second choice for the role, hired only after the first choice had to beg off due to a family emergency. Chernick was said to be the choice of deeply skeptical utility critics who doubt AE's methods and worry that too much has been sacrificed by city residents.

Chernick quickly proved an aggressive participant. As whispers circulated about his true knowledge of the Texas electric utility picture – matched by the flat public refutation of a handful of his suggestions by AE staff – Chernick repeatedly chiseled deep into utility staff members with brusque assertions that questioned their integrity, their intelligence, or both. In the middle of a discussion about a difficult section of the utility's finances, for example, Chernick proceeded to dismantle the utility's position with a dripping soliloquy that was punctuated with forceful inflections that seemed to question the abilities of staff present at the hearing. "This is something that I proved in a paper in 1980, and everybody has known for a long time," he said of one part of the argument. After one of his appearances before council, Chernick was overheard asking longtime local consumer advocate Paul Robbins if his approach was more along the lines of what Robbins had expected from a consumer advocate. It might have been, but it was also getting under the skin of some council members.

[page]

Then came the issue of Chernick's fees. At the close of their April 30 work session, members heard from utility attorney Andy Perny that Chernick had run up a bill in excess of $76,000 for work done on the rate case over a month's time. Council members had only authorized $52,000 to cover his efforts. Chernick asked members to provide a sum to cover the difference, plus another $17,000 to $30,000 more – depending on whether or not they would like him to appear at each of the remaining work sessions in person. "I am shocked by that figure, and staggered by it," Council Member Kathie Tovo, a strong supporter of the need for a residential advocate, told her colleagues at the time.

Flustered by Chernick's bill and smarting from his gruff and ineffective approach, members henceforth relegated their residential advocate to work session participation via speakerphone from his office in Massachusetts. Chernick chimed in a few more times – godlike from the rafters, still airing petulant objections – but was largely sidelined. His stint with the city cost taxpayers about $96,000* for just under two months of work.

Dueling Banjos

Morrison, Tovo, and Martinez were also among those not at the Spelman-Cole-Riley presser. Some of this, no doubt, had to do with open meetings issues that would prevent the latter trio from interacting with any other member about the specifics of their proposal. But Morrison, Tovo, and Martinez were also architects of an earlier plan, one that aimed for an interim hike that would have generated considerably less revenue for the utility while council pursued a yearlong rate study. Indeed, the idea for the work sessions – which all members agreed were necessary – came out of the Morrison-Tovo-Martinez proposal, first pitched in February.*

The idea of a modest interim hike did not sit well with utility staff, nor with the rest of council, who voted 4-3 to ditch it. But it was in response to that proposal that the utility began its defense of a revenue number of $71 million. "An immediate $71 million rate increase is necessary for the utility to maintain 'reserve neutrality' at this time, with an additional $31 million increase required in October 2014 to resolve Austin Energy's financial challenges," Weis wrote in a report to council. For the record, $71 million would do nothing to replenish the utility's reserve funds – a key desire of both AE officials and, argues city bond counsel, bond ratings agencies. Rather, the first $71 million would be supplemented by another rate increase shortly thereafter that would aim to begin refilling utility reserve funds. At their press conference, Spelman, Cole, and Riley included a two-phased rate redesign as part of their announcement.

Weis likes to say that in at least some portion of energy rate-making, there is more art than science. Still, $71 million became the hard figure on which to base discussion, if not consensus. Just as Spelman, Cole, and Riley got behind it, Morrison, Tovo, and Martinez began chipping away. They questioned utility officials about one of the many arcane quarters of utility finances, what has been loosely termed "off-system" sales. In simple terms, AE both generates power and sells it. If the utility should generate "extra" electricity, it can sell that supply to other utility systems on the state electric power grid. In FY 2009, it did so to the tune of $35 million. But AE removed those figures from a study of FY 2009 that it based its rate study on.

Morrison, Tovo, and Martinez plugged away at the idea that those figures should be included, and, moreover, that they could offset AE costs and provide some savings to ratepayers. AE said that the $35 million it made in FY 2009 was an anomaly and couldn't be counted on in any rate projections. The utility further argued that, thanks to a 2010 change in how the Texas grid conducts its business, what had been known as off-system sales really don't exist any more.

Nevertheless, Morrison, Tovo, and Mar­tin­ez kept at it – and on more than just off-system sales – as did the utility. Then, at the same April 30 work session where Cher­nick's bill became an issue, matters came to a head. Morrison and Tovo had pitched another tweak – this time in the debt-to-equity ratio that the utility uses to fund its capital projects. Their colleagues had gone for it. They read it as a reason to reduce the utility's revenue requirement. The utility disagreed.

"I don't know how it could still be $71 [million] after we've said, 'Let's look at a scenario where we've shifted the debt-to-equity ratio,'" Morrison said at the work session. She returned to the idea a bit later, only this time she also – inadvertently perhaps – summed up the frustration she and the rest of the utility's many doubters were feeling. "I guess I'm confused. We're looking at changing the revenue requirement based on policy changes, but I'm hearing you [AE] guys say that we can't change the revenue requirement."

Morrison was pointing out the odd position she and her colleagues were in. They'd wanted to make a change – a change based on the policy stuff that the management side of the city was supposed to leave to the electeds – and yet there they were, listening to AE officials say they couldn't quite do that. So the $71 million stuck. Two weeks later it showed up at Spelman, Cole, and Riley's presser.

How It All Rates

The June 7 council meeting became Rate Decision Day as the work sessions pushed into late May. When Spelman, Cole, and Riley held their presser, their efforts became the focus of discussion in the media and on the dais. With roughly a week to go before the vote, it seemed as if Mor­ri­son, Tovo, and Martinez were ready to accept $71 million. In return, Spelman, Cole, and Riley were ready to let their colleagues take their best shots at a handful of adjustments to other portions of the rate proposal. So on June 7, rates went up, and everyone – remarkably – even seemed satisfied (see " The End Result," June 15, 2012).

A week before the decision came down, Ott was ready to take the credit. "This city manager chose to address the issue that had not been addressed for 17 years," he said. Ott has about a third of a point. Someone needed to have the intestinal fortitude to muster a change in AE's rate structure. Things were bad, getting worse, and – as everyone agreed – the utility's survival as a municipally owned organization is critical to the city. But in November 2009, it was Duncan who delivered a surprise kick in the pants that set the rate case in motion – a PowerPoint presentation that illustrated AE's dire financial picture. It was something only he – as a well-respected former council member, and then on his way out the door after a long city career – could pull off.

Ott notes that even he was surprised by Duncan's announcement. "It wasn't until near his departure that [Duncan] announced to everyone, including me for that matter, that we were on the brink of this financial crisis," he says. Weis, a newcomer to Austin, was handed the unenviable task of crafting a new rate structure and selling it to a City Council he barely knew. "I think Roger certainly had a lot of credibility with a lot of people," says Riley. "Larry didn't have that history with people in the community, so it might have been a little more challenging for him and his staff."

There was a further side effect of Dun­can's departure: With a replacement, Ott could bring the utility closer to the City Manager's Office. He'd often send Assistant City Manager Robert Goode along with Weis for formal meetings with council members. For the utility, this provided some insulation. "From the very beginning, Marc Ott said one thing to us over and over and over again," says Mark Dreyfus, AE director of regulatory and government affairs. "He said, 'You bring your best business case to the council, and let me handle the political environment.' So he directed Larry to develop that best business case, that's what we did." Still, it removed some of the unfiltered frankness and total access that Duncan brought with him.

Nevertheless, the council and the utility put forth a ton of effort just to arrive at a place where everyone was sort of happy. Whether or not the issue comes up the next time anyone's up for re-election remains to be seen.

Of course, none of it may matter. Council members remain hopeful that they'll be able to fend off the near-certain attempt by the Legislature to deregulate the region. They've taken pains to conduct a process that could make for a successful defense of the utility's rates before the PUC. But the reason no politician wants to raise any sort of fee – as Martinez put it – illustrates the extreme post-Goldwater/Reagan setting where public sentiment remains challenged to see the benefit of paying for any large civic endeavor. Though a utility isn't exactly your typical battleground for social empowerment, if the "shrink it!" idea visits Austin Energy, we could all be in for something of a tragedy.

This reporter spoke on the record to every council member, the city manager, an Austin state representative, two current AE executives, and one former GM in preparing for this story. Each one said it is critical that the utility remain in municipal hands. Without the income provided to the city by the utility, a host of city programs – potentially from parks to public safety – would face cuts. Control over the utility also allows city officials to set conservation and green generation priorities that might otherwise be ignored by a private, profit-driven firm.

"We need control over our destiny," said Spelman. "If we are being served by the usual mélange of wirage companies and retail companies, we don't."

*Two changes have been made to reflect the correct month a proposal was made by Council Members Morrison, Tovo, and Martinez, and the total amount the city paid to a consumer advocate.

Copyright © 2014 Austin Chronicle Corporation. All rights reserved.