LIPA Feeling The Heat - Ability to keep rates down is threatened

By Tom McGinty- Staff Writer- NY Newsday - March 8, 2002

Propelled by a 20-percent reduction in power bills, the Long Island Power Authority coasted through its first two years as the popular successor to the Long Island Lighting Co.

But now, as LIPA nears its fourth anniversary as Long Island's electrical utility, its ability to keep rates down is being threatened by two years of soaring fuel costs, an expensive effort to meet increased demand for electricity and a massive pile of debt that leaves little room for maneuvering.

"The honeymoon's over and there are some hard decisions ahead," said former LILCO executive Matthew Cordaro, who teaches at the C.W. Post Campus of Long Island University. "It's going to take some skill and creativity to keep rates at reasonable levels. It's just the nature of the beast."

LIPA's budget crunch has been overshadowed by a spirited debate over its option to buy KeySpan's power plants, at a price of a half-billion dollars or more.

But recently, the LIPA board also has turned its attention to an issue with even more serious fiscal implications: the soaring cost of fuel burned by the plants.

The board voted on Feb. 28 to continue charging a 5.8-percent fuel surcharge on power bills, which was instituted in early 2001 to partially cover mammoth cost overruns. According to an internal analysis of the issue prepared by LIPA staffers in February 2001, the increase in fuel costs "is probably the most pressing matter for LIPA from a financial, credit and political/media perspective."

The political problems are obvious: LIPA's positive image is staked on the 20-percent reduction in power bills it implemented after taking over LILCO's system. The surcharge represents a significant erosion of those savings, whether it's called a rate increase or not.

The financial and credit concerns are more complicated. During 2000 and 2001, the fuel and electricity LIPA bought cost $507 million more than the amount that was built into its rates.

If LIPA had charged its customers for the full amount of the overruns, the surcharge would have reached politically untenable levels: 13 percent in 2001 and 9 percent in 2002. Also, LIPA Chairman Richard Kessel argues that large surcharges would have dragged down the Long Island economy.

Instead of charging the full freight to its customers, LIPA chose to collect just half of the $507 million through the surcharge, keeping it at 5.8 percent.

To cover the rest, LIPA used a quarter-billion dollars that had been earmarked for the early retirement of $4 billion in debt associated with the defunct Shoreham nuclear power plant, a burden the authority had assumed as part of the LILCO takeover.

While the maneuvers prevented a ratepayer revolt, they unnerved the credit analysts whose ratings of LIPA's financial condition affect both the authority's ability to borrow money and the interest rates it must pay.

Last year, Standard & Poor's analysts assigned a "negative outlook" to LIPA's strong credit, citing the authority's failure to fully recover the costs of the fuel and the power it buys from generators other than KeySpan.

Moody's analyst Dan Aschenbach agreed that LIPA's approach presented problems. "LIPA's major challenge is the debt level it has," he said. "LIPA can't have too many things go wrong without it impacting the financials."

Aschenbach's assessment is not news to the LIPA board, which plans to retire the $4 billion in Shoreham-related debt by 2013, 16 years ahead of schedule.

Kessel said the plan to retire the debt early was conceived by Gov. George Pataki when the authority bought out LILCO in 1998.

Prior to that, consultants had projected LIPA would pay 7-percent interest on its bonds. By the time the authority sold the securities, interest rates had fallen to closer to 5 percent, Kessel said.

The savings could have allowed LIPA to lower LILCO's power rates by 28 percent, but Pataki insisted that some of the money be used instead to pay off the debt ahead of schedule, Kessel said.

Due to the high fuel prices, LIPA made much lower early debt payments in 2000 than it had intended, and in 2001 the payments ceased. Kessel said LIPA would still be able to retire the $4 billion in bonds by 2013.

A more immediate financial concern is Long Islanders' growing demand for electricity in the summer. After barely keeping the lights on during a heat wave last August, LIPA enlisted five companies to quickly erect 10 new power plants that they hope will be done in time to meet this year's demand.

The companies will pay to build the plants, but LIPA will have to spend $83 million to connect them to the Island's energy grid. LIPA will fork out an additional $32 million to connect a privately owned 330-megawatt cable that will stretch under Long Island Sound from New Haven, Conn., to Shoreham.

Despite all the pressures, Kessel said, LIPA will keep its pledge to hold the 20-percent reduction in LILCO rates through five years, to May 2003.

"The challenge next year is to see whether or not we can continue that freeze," Kessel said.

The official projections LIPA has issued to its bond holders call for a 1-percent rate increase in June 2003 and an additional 1-percent increase at the beginning of each succeeding year through 2008. By January 2008, that would represent a total increase of just over 6 percent, excluding excess fuel surcharges that may crop up.

"We are not going to be able to keep the rates frozen forever," Kessel said. "Even if we can extend the rate freeze for another year or two, rates are going to go up. But the kind of rate increases you see two or three years down the road aren't the kind you saw with LILCO."