Utility Sale Perspective

I have been searching for the right place to start in relaying information to everybody about the utility sale in a clear way. It has been exceedingly difficult to even get started due to the sheer volume of info. Yesterday, I addressed a question on Facebook, and the narrative finally came pouring out. I am re-posting it here for the benefit of a wider audience, with some minor adaptations for the blog format.  It may be somewhat of a “stream of consciousness” so forgive me if it jumps around a bit. It does give good information, however.

In 2013, Sawvel and Associates concluded the Electric and Natural Gas Cost of Service and Rate Study.  The rate study made several recommendations. The rate study identified that rates were high on gas and low on electric. At that time, we were under favorable market prices for gas. It recommended that the City implement a specific mechanism to ensure customer charges are fully covering the cost of the supply. The methods by which this could be accomplished was to increase the base rate to cover the fixed supply cost, and institute a variable rate “rider” which would be adjusted periodically to cover variable costs associated with purchasing the gas and electric on the market (transmission costs, market purchases, gas transport costs, etc.). None of those recommendations were implemented, though rates were adjusted to bring cost and expenses closer together. This had the opposite effect of what the study recommendations intended.

In the case of the cost of the gas supply, prices increased at the same time our rates were adjusted down. The result was less revenue and greater expenses. The net negative impact has been roughly $930,000 in less than one year. It is true that market rates have since stabilized, however there is a lag in the figures I am presenting to you here. $930,000 negative impact is the result prior to the recent upswing of gas market prices that we experienced this summer. The negative fiscal impact will likely be greater than $930k by the end of the fiscal year.  We will have to wait and see.  That doesn’t need to alarm anyone, as we have the fund balance to cover this impact, though it can not be allowed to continue in this manner.  So what will rates look like if we keep the utilities? Good question. I can’t predict them without a comprehensive analysis, which will need to take future utility rate structure changes and organizational changes into account.  We can’t complete this until later. I don’t need an analysis to tell you that the utility rates will go up if we don’t sell though, and please understand that I do not say this as a scare tactic either. I’ll explain.

We made it from 250 residents to 25,000 residents on the current system and have done relatively well, all things considered. The size and scope of the business now require significant changes to the business model to protect and insulate residents from the effects of supply cost volatility. Here are the expenses we know about if we keep the utilities:

  • We will hire additional staff to increase service levels and infill losses from employee attrition.
  • We will hire a rate analyst or contract with an analyst firm.
  • We will invest some capital on system improvements and additional work vehicles, which we denied in the last budget cycle due to the potential sale.
  • We will likely need to install electric infrastructure to to serve White Hills. This cost is estimated at approximately $1,100,000. (RMP will not be maintaining that service area if the city retains the utilities.  By law they can require us to take over the service territory, and they have indicated that they will as this will be somewhat of an “orphaned” service territory.)
  • In the near future, we will need to hire or retain a FERC (Federal Energy Regulatory Commission) attorney to manage utility regulatory matters.  Due to pending federal regulations which will affect the expense of maintaining and inspecting our high pressure gas line, we may have additional expenses with gas.

We will also change the structure of the rates to follow the recommendations made in the rate study. This means we will have a variable component of our rate to make certain we are covering all costs.

We are facing brand new EPA regulations which will have a destabilizing effect on gas and electric rates. The key regulations are Mercury & Air Toxic Standards, and also section 111 of the Clean Air Act. I have reports which identify the short-term impacts of new regulations, and one of the key impacts will be the closure of about 20% of the existing coal power plants in the country by 2017.  That means that by 2017, 60 gigawatts of coal-generated electricity will be taken offline and must be replaced by some other source. The only technology that is currently ready to take the place of coal is natural gas. This increase in demand on gas will place some pressure on gas markets, and it will also increase the correlation between gas prices and electric prices.

We own power generation resources that serve less than 2% of our consumption needs.  We produce 0% of our gas needs.  RMP owns power generation resources that serve over 90% of their customer needs. Questar Gas produces 50% of its gas through Wexpro. The ability to produce your own commodity builds in relative fixed cost which allows for better forecasting of business revenues and expenses. The utility industries are prone to price volatility, and resource ownership is perhaps the most effective way to turn variable costs into long term fixed costs. Where RMP and Questar Gas can build in supply cost stability, we have almost 100% market risk. Some of that market risk is long term and some is short term.  We currently manage market risk by entering into “long term” contracts, though those too will expire and must be renegotiated at whatever the prevailing market prices are at that time.  We can manage some of our risk through hedging, though, hedging is, by nature speculative.

We are in a city that is growing its energy consumption by about 9-10% per year. Every bit of new demand we place on the supply increases the market risk to the utility business, and ultimately to the customers’ prices.  If we keep the utilities, setting up the organization to better manage supply cost and mitigating risk will be my primary focus.

If you think this explanation is complicated, trust me, it goes SOOOO MUCH deeper.

Is it possible that we can be effective at keeping our utility rates below those of RMP and Questar Gas while experiencing sustained rapid  population growth, with new EPA regulations that remove coal energy from the market and place greater strain on natural gas? Yes. It is possible. Would I bet that we can keep rates below those of RMP and Questar Gas? I would not.

We are good at many things in concern to our utilities and we have great employees who know our system.  The size and needs of the utility business are quickly growing in scale and scope and there is good reason to think critically about our own ability to provide better rates and service than other options such as Rocky Mountain Power and Questar Gas.  They have both served communities throughout Utah with good results.  These new EPA regulations represent a brand new reality for the entire gas and electric utility businesses and will have an impact on our utilities.  The question we must ask ourselves is, “Who is better equipped to deal with these changes as we grow to our projected population of 114,000 people over the next 35 years?”  I think you know what my answer is, and I will vote accordingly.  I encourage each of you to vote on November 4th armed with this information, and ready to accept the changes that will be coming whether we sell or whether we retain our utilities.  This is our last opportunity to sell the utilities.  If we keep them, we do not have time to rethink our direction. We will move forward with purpose and focus as a committed utility provider.

$26,000,000 in bond debt will be eliminated and we will have an anticipated $10 million or more in available funds to put towards future projects, or to retire other debt of the city if the sale goes through.

22 thoughts on “Utility Sale Perspective

  1. Future projects? Let me be among the first to offer a suggestion: Rec Center! Similar to Lehi, with INDOOR, pool! Thanks for considering EM citizens’ voice in this matter mayor! Your rockin it!

    • George and Tiffiny, I would love to see a rec center or aquatic center in Eagle Mountain. The finances behind a rec center make this a tough sell with me though. Construction of a rec center is anywhere from 5 to 10 million dollars for a smaller facility. Research has shown that aquatic centers are more successful than rec centers from a revenue standpoint, meaning they lose the least amount of money every year. The initial capital investment is the inexpensive part ( though this one project could easily consume every dime of the utility sale proceeds). The ongoing operation and maintenance expense is the difficult part. The expense of O&M carries forward until the facility’s life-span has ended. Lehi spends over $800,000 just to continue operating the Legacy Center. On this fact alone, I can say that a city funded rec center is not in our immediate future. Our budget simply doesn’t have room for additional expenses at even 1/4 of Lehi’s ongoing expenses. Now that I have given you the bad news, let me give you the good news. (At least I think it’s good news) In my campaign I committed to bringing the city to a place where we can operate from financial strength and not weakness. It is within our grasp! It will take continued hard work however. In considering how to spend your tax dollars, I am looking at what will reduce future expenditures, what will benefit the community while having the smallest impact to future budgets, and also, what will help grow our revenues. This city has been tied to a post by debt since it was formed in 1996. It’s time to cut that tether. I am working hard to prioritize expenses and to get all possible ongoing expenses on a schedule. A prime example is roads. We have now catalogued the condition of every mile of our roads in the city and ranked their condition and need for maintenence. We will place them on a five year rotating schedule. This way repairs cost may be $100,000 for a stretch of road maintenence instead of $1,000,000 for road replacement. There is currently $11,000,000 in needed road repairs in case you were wondering. Did you know that nice roads bring in revenue? Cities with nice roads just “feel” like nice places to live and do business don’t you think? Most people don’t realize that, but it’s one if those sub-conscious associations we make. A place with nice roads sends the message to visitors that “this city takes good care of itself”. The effect is quite noticeable. Think about Pony Express and Ranches Parkway. Do you remember what it was like before? Does that “place” feel different to you now? Increasing business development helps bring in more revenue and that helps us dig out of our hole faster. Investing in finishing off unfinished projects helps too. The cemetery, Mid Valley Park, and other projects will help complete our sense of identity, and this will also encourage home buying and business development. Every step we take builds in additional success if we do this right. The financial “healing” will accelerate quickly if we use good judgement and have discipline. After we have accomplished our goals, we can consider investing your hard earned dollars on a rec center or similar facility. If we continue to rely on debt to get what we want, we will always feel squeezed, and we will continue to have “less-than” amenities. If we do this right however, we can live quite comfortably on our tax revenues and be free of debt. It’s going to take some time and some restraint, though I promise, we will be better off for it. Sorry I can’t just tell you we will be building a rec center. That message would be more fun to deliver…

  2. Mayor Pengra,
    Would it be beneficial for us to retain control over our utilities by using solar panals or wind turbines?

    Holly Williams

    • I think this is a great question. I would really like to see the numbers on this.

      Without the numbers this is just speculation, but what I would expect to see happen is that prices for residents will go higher than RMP is offering in the short term, but long term the benefit would far outweigh the upfront investment. The are many examples of municipality owned utilities that have in the long term been able to stay much lower than what privately owned utilities charge. Las Vegas has seen huge increases with the doubling of prices in just over 5 years of becoming privately owned. Sacramento CA has prices far lower than the surrounding area that are privately owned. And there are many more examples like these.

      I am normally someone who likes a smaller government and I believe in the free market being the best solution. The problem is that with utilities the free market doesn’t exist, it is a monopoly that has many govt regulations that keep it that way. Utilities are some of the few items that have a track record of long term municipality ownership being beneficial.

      For reference, I have worked in the oil and gas industry as well as the solar industry, the examples I gave are from personal experience.

      • Mike,

        I can give you one very reliable example along with some details. Right now, coal power prices are between $50-55 per megawatt hour. Wind is just over $70 per megawatt hour. Eagle Mountain “invested” in Horse Butte Wind Project out of Idaho in 2010. We have purchased a 5 megawatt share of the project. With wind, we pay for the potential output capacity (if the wind blew all the time and all turbines were operating at full capacity). Of course this is never the case. Some times the wind simply doesn’t blow. Some turbines go down for maintenance, etc. we pay for 5 megawatts, though the actual output is around 1.8 megawatts. We pay debt service on this project and we pay for the power as well. Our cost per megawatt is about $78.00 right now. This project added about $363,000 to our power cost annually according to the 2013 utility rate study. This is for less than 2% of our power that we deliver to customers. Here is some other information if it is helpful. http://southdakotamagazine.com/renewable-energy-costs

      • Mike,

        Here is an article which seems to speak to the point you are making. http://www.greentechmedia.com/articles/read/5-more-charts-that-prove-wind-and-solar-just-keep-getting-cheaper

        There is one critical component of the study that makes all the difference. As noted in the article, the value of solar specifically was analyzed without consideration for the cost of electricity storage. In other words, if solar is connected directly to the grid then the cost are close. There is really much more to this debate however. Regional power availability, resource costs, land availability and land price, etc all have an effect on the market prices. In local markets, the cost of renewables has proven to be significantly higher.

        In order for renewables to be more competitive, energy storage must be included. Coal and Natural Gas power generation have a distinct advantage over most renewables for this reason. Because we do not use power only during the daytime production hours of solar energy electric storage would be needed to make solar or wind true competitors as a base load product. When electric storage is included in the analysis, it places solar energy as one of the most expensive energy solutions.

    • Holly,

      This is a great question. In short, the answer is no. While renewable energy sources such as solar and wind have their place, they are somewhat limited in reliability and in output. The cost of power generated via wind turbine and solar panel array is considerably higher than power generated by fossil fuels or hydro. If not for federal subsidies, renewables would be even more expensive. This isn’t to say that they don’t have their place, only that they are a poor at providing consistent power at low cost. With our consumption growing so much each year, we need access to consistent and cheap power to keep cost down. If the sun doesn’t shine or the wind doesn’t blow, these types of resources don’t produce power, but you still have to pay the debt service on the bonds that built them. I hope this helps.

      • Again, numbers would be nice to see. Mayor Pengra your arguments are just speculation without them, and with all respect I hear people say that Solar (specifically) is more expensive than fossil fuels, or that it is unreliable, or that if it is cloudy they don’t produce. The truth is that those assertions are simply not true; the only argument that holds any merit is the the cost may be more currently than fossil fuels, however when inserting time into the equation Solar typically wins, even without govt subsidies.

        Can we see the numbers on the costs of providing our energy through renewable energy?

  3. In the citizen-written argument Against the sale, Ashly mentions $700,000+ going to the General fund and $220,000 to our Water expense that come from Utility revenues. Is that just in 2013? Or is that something that happens annually? Or am I not understanding that correctly? Is that in addition to revenues used to pay off the debt in the prescribed time? I looked at the financials information posted but couldn’t make sense of it, I guess it’s been too long since Accounting class in college! Thanks!

    • Great question Banyan, the figures presented in the against argument were incorrect and have been accounted for. I will have a post soon to clarify each of those figures from the document you have seen online.

      • Yes – Banyan. They were incorrect according to the city’s spreadsheet. Their spreadsheet shows the amount difference the water fund pays (more) in electric will be an extra $245,000 (not the $220,000 I stated), and they state $669,842 that usually goes to the general fund instead of the $700,000 I stated. However, they did not include street light costs (because they will add a charge on citizens bills to cover this) and they only counted $160,000 loss in Fees/Penalties (even though when budgeting for half a year they lowered this amount by $100,000, now for some reason they think the other half the year will only lower it by another $60,000 instead of another $100,000.)
        However, the city does have a plan to cover most of the losses – the money we get from growth, refinanced bonds, etc. will cover this (which is extra money we would have otherwise).

    • Also, Banyan….

      Yes, these are amounts that happen annually (though previous years this amount has been much higher as we use to transfer MUCH more to the general fund from these utilities).
      Yes, that is in addition to the revenues used to pay off the debt in the prescribed time. We HAVE to pay our bond payments each year – if you look at pages 180 of the FY2014-2015 budget online it shows $1,730,267 from electric paid to the bonds in FY2014 (you can view the transfers at the bottom of page 181 for electric debt). You’ll see on page 186 the gas paid $931,700 to bonds (and you can see the transfers at the bottom of page 187 – the transfers are shown as administration charges).
      You can see the fines/late fees/penalties that go to the general fund on the bottom of page 87 (FY2014 shows $382,149 year) – these are all related to utilities except the Library fines & services ($10,578).

      As far as me saying the water will cost an extra $220,000 per year….. you can watch the utility bid city council meeting video online and this is the number given in this meeting by the city.

      Just wanted to give you a background on how I got those numbers!

  4. Mayor, I like your follow up comment about the upkeep of the roads and being conservative with our tax dollars. I disagree with your statement in your initial post that this will be our only opportunity to sell our utilities. And could you please look into and consider a reservoir, developed in the stages as Herriman did? All kids and families should grow up with a local swimming hole.

    • Jellysprite007,

      Thank you for your comments. First, I would like to clarify why I made the statement that we will not be able to sell if we don’t do so now. The sale of the utilities as it is proposed today, represents the best possible scenario under which such a transaction could take place. First, we had two organizations bidding on our electric utility at the same time. When there is more than one party interested in purchasing anything, they will inevitably put their best offer on the table if they find value in it. For many different reasons, there would not be two bidders in the future which would result in a lower price. Secondly, our bonds are tied together for both gas and electric. We currently have firms from both industries looking to purchase the respective utilities. There is no guarantee that would happen again, in fact, It would be unlikely. The larger our system and operations grow (as we operate our own utilities), the more difficult it becomes for a new entity to take over and build it/run it as they wish. By far the biggest reason we would not be able to sell the utilities if the sale does not go though is because we will inevitably make additional investment into power generation as we move forward, as well as enter into new contracts. Every new contract or bond commitment that we enter into makes such sales less likely to happen. Contracts come with commitments and those commitments can not just be broken and left where they lie, the seller is usually burdened to find another entity who will assume the contract and take on the sellers burden. Power contracts are not such that you can just swap like a baseball card, and as a result they are very difficult to negotiate. In short, this is not what we would consider a “liquid” market. It is easy to sell a car because there is usually a good pool of buyers that may be willing to buy what you are selling at a price not too far from what you are asking. Houses are a little less liquid, meaning there is a smaller pool of buyers and sellers that are actively looking to buy. Small businesses are even less liquid. A small business owner who operates a restaurant for instance, may be looking to sell their restaurant, but it will be more difficult to find a buyer, much less agree on terms. Scale that up to not one but two utilities and you are dealing with a transaction that each take a tremendous amount of work in their own right, but together this is really a one time shot. Hopefully that makes sense.

      • Can I also include it may be difficult to sell again later because if we tell both RMP and Questar NO now, who will offer later? They went to all this work to buy now, how soon will they forget the headache and be willing to even consider us again? I would bet at least 10-20 years.

  5. I think paying off UNNECESSARY debt is a priority on my list. Not all debt, is unnecessary though. I related a story to a friend about if you have $10,000 with a 3% loan, and if there was a situation that that money could generate 4% interest gains, is it worth it to pay off the money or invest it? Well, it’s certainly worth investing to me because that’s a 1% net increase. If the city has a debt that is in a similar situation, I don’t see why it would be beneficial to sell outside of the headache of managing it.

    I’ve had experienced with Questar and Rocky Mountain Power when I was living in Pleasant Grove and to be honest they were great. I, unfortunately, do not have a crystal ball about whether this will caused a temporary or even permanent increase in rates. I think the larger utilities do have a greater ability to maintain and expand the infrastructure than the city can, but there’s always risk in change. All I can say is to really look at the information and search for more in any way you can about it. Vote your mind!

  6. Before I vote, if we approve the sell, the city will lose revenue, correct? If yes, that means that the lost in revenue will have to come somewhere else. Raising taxes is the next thing going that will follow.
    Cities like Murray City have had their own system in place for many years with success. If any citizens of EMC think that we can continue to have the lowest rates are clearly not seeing get the picture. If we did all you said in your post with the upgrades, additional staff, rate hike, etc. can we be competitive with RMP and QS?
    Or is this a situation where we are not able to handle the government regulations while at the same time providing the residents with the lowest cost possible?

  7. Chett,

    Those are good questions. The answer to your concern about raising taxes is no, we will not need to raise taxes. Here is a spreadsheet that shows the impact. http://www.emcity.org/vertical/sites/%7B1E82B5A1-7214-4119-8B22-41B2DC9546EB%7D/uploads/Fiscal_Impact_-_Utility_Sale.pdf

    When I took office in January, we went through the budget process and cut half of the money from the transfer to get ready for the possibility of the utility sale. There is on exception and that is for white hills residents. They are paying less tax on their utilities which is 3% vs. The 6% the rest if the city is paying. We will equalize those rates to 6%. Just as our personal budgets account for our paychecks as revenue, the city budget projects all revenue sources as well. We have used conservative figures to make these projections, and they are typically quite accurate. We rely on formulas and not guesswork. Based on the projected budget we will not have any impact. These figures are pretty conservative and it doesn’t account for the refocused effort we will put into giving the government operations a tuneup. I have already identified areas where we can save money by simply operating more efficiently to reduce expenditures. If by chance we have miscalculated and we have greater expenditures than revenues, we are now topped out at the state limit for our general fund balance and we will have an additional 10 million plus in the bank to allow us time to grow our revenues through economic development and population. In short Chett, I am very confident that we will be just fine and we will not be raising taxes.

    To the second part of your post, I can not see into the future and as a result I can not tell you that we can’t compete. I can tell you that over the last 10 years, eagle mountain has not been competitive with rates. This year our gas rates are lower than Questar’s for the first time. Of course our rates did not meet the cost of the service we delivered and we have sustained a negative fiscal impact of over 900k so far. This could easily be a much longer and detailed explanation, but the likelihood of is being able to compete are not good. We have regulations, economies of scale, increased investment of capital (through debt) as just a few of the factors working against us. I hope that helps, but if it doesn’t, please call me at 801-564-9342. That’s my cell and I’m happy to answer your questions.

  8. Chett, one significant issue that presents a monumental challenge is our double digit growth. It requires huge time and financial resources to successfully manage the risk of growing two businesses at double digit rates every year. If not executed well, the customer will ultimately pay the price through rates. While I believe I am able to do the job if asked to do so, it is not my expertise to run utilities.

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