City of Bainbridge Island Municipalization Preliminary Feasibility Study May 10, 2017 www.ceadvisors.com TABLE OF CONTENTS Defined Terms........................................................................................................................................................................... 5 Qualifications............................................................................................................................................................................. 6 Executive Summary ................................................................................................................................................................ 7 SECTION 1: INTRODUCTION ........................................................................................................................................... 12 SECTION 2: THE MUNICIPALIZATION ALTERNATIVE ......................................................................................... 14 2.1 Overview ......................................................................................................................................................... 14 2.2 State of Washington Law and Municipal Authorities.................................................................... 14 2.3 Feasibility Study ........................................................................................................................................... 16 2.4 Recent Municipalization Experience ................................................................................................... 18 2.5 Case Studies of Recent Municipalization Activity........................................................................... 21 SECTION 3: BAINBRIDGE ISLAND COSTS TO FORM AN ELECTRIC UTILITY.............................................. 24 3.1 Introduction ................................................................................................................................................... 24 3.2 Acquisition Costs .......................................................................................................................................... 24 3.2.1 Transmission and Distribution System Assets ................................................................................ 25 3.2.2 Land and Right-of-Way Easements ...................................................................................................... 27 3.2.3 System Separation Costs ........................................................................................................................... 28 3.2.4 Severance Costs ............................................................................................................................................ 31 3.2.5 Going Concern Value .................................................................................................................................. 31 3.2.6 PSE’s Legal and Consulting Costs .......................................................................................................... 32 3.2.7 Summary of Acquisition Costs ................................................................................................................ 32 3.3 Bainbridge Island Transaction Costs ................................................................................................... 33 3.4 Start-up Costs ................................................................................................................................................ 33 3.5 Total Costs to Bainbridge Island—Base Case................................................................................... 34 SECTION 4: BAINBRIDGE ISLAND COSTS TO OPERATE AN ELECTRIC UTILITY ...................................... 35 2 4.1 Introduction ................................................................................................................................................... 35 4.2 Bainbridge Island Electric Utility Revenue Requirement ........................................................... 35 4.3 Debt Service: Principal and Financing Costs .................................................................................... 36 4.4 Purchased Power Supply .......................................................................................................................... 37 4.5 Transmission Expense ............................................................................................................................... 40 4.6 Operations and Maintenance, Customer Accounts, and Administration and General Expenses .......................................................................................................................................................... 42 Concentric Energy Advisors, Inc. 4.7 Energy Efficiency Program Expenses .................................................................................................. 42 4.8 Low-Income Assistance Program Expenses ..................................................................................... 43 4.9 Taxes ................................................................................................................................................................. 44 4.10 Projected Revenue Requirement for Bainbridge Island Municipal Electric Service........ 45 SECTION 5: FORECAST OF PSE REVENUE REQUIREMENTS AND RATES .................................................... 46 SECTION 6: PRELIMINARY FEASIBILITY STUDY FINANCIAL RESULTS ....................................................... 47 6.1 Introduction ................................................................................................................................................... 47 6.2 Base Case Results ......................................................................................................................................... 47 6.3 Scenario Analyses ........................................................................................................................................ 48 6.4 Sensitivity Analyses .................................................................................................................................... 52 SECTION 7: OTHER FACTORS TO BE CONSIDERED .............................................................................................. 54 7.1 Future Investment Considerations of Bainbridge Island ............................................................ 54 7.2 Services To Be Provided By PSE and Bainbridge Island .............................................................. 54 7.3 Other Nonquantifiable Considerations ............................................................................................... 55 Concentric Energy Advisors, Inc. 3 TABLE OF FIGURES Figure ES-1: Preliminary Estimate of Acquisition Costs ........................................................................................ 8 Figure ES-2: Preliminary Cost Estimate of Providing Service.............................................................................. 9 Figure ES-3: Base Case and Scenario Results............................................................................................................ 10 Figure 1: United States Municipalization Efforts: 2001–2016 ......................................................................... 20 Figure 2: 2018 Projected Residential Rate Comparison ...................................................................................... 23 Figure 3: Estimated 2021 Replacement Cost Depreciated .................................................................................. 27 Figure 4: Preliminary Estimated Value of PSE Land ($2021) ............................................................................ 27 Figure 5: 2021 Preliminary Estimated Value of Transmission Easements ($000) ................................... 28 Figure 6: Preliminary Estimated Land Value ($Million) ...................................................................................... 28 Figure 7: PSE Transmission System Map ................................................................................................................... 29 Figure 8: Point of System Separation ........................................................................................................................... 30 Figure 9: Preliminary Estimate of Acquisition Costs in 2021 ............................................................................ 32 Figure 10: Transaction Costs ($Million) ..................................................................................................................... 33 Figure 11: Start-Up Costs ($Million).............................................................................................................................. 33 Figure 12: Preliminary Estimate of Bainbridge Island Costs—2021 Transition ....................................... 34 Figure 13: BPA Rates........................................................................................................................................................... 39 Figure 14: BPA Projected Transmission Capacity Availability .......................................................................... 40 Figure 15: BPA Transmission Services and Rates................................................................................................... 41 Figure 16: 2021 Projected Transmission Expense ................................................................................................. 41 Figure 17: Benchmarking Metrics Operating Expenses ....................................................................................... 42 Figure 18: Participation of Bainbridge Island Customers in PSE’s Energy Efficiency Programs ($000) ....................................................................................................................................................................................................... 43 Figure 19: Bainbridge Island Projected Revenue Requirement........................................................................ 45 Figure 20: Base Case Scenario: 2021 Transition .................................................................................................... 48 Figure 21: Scenario Assumptions .................................................................................................................................. 49 Figure 22: Lower Bound Scenario: 2020 Transition............................................................................................... 50 Figure 23: Upper Bound Scenario: 2024 Transition .............................................................................................. 51 Figure 24: Sensitivity Analyses to Key Assumptions ............................................................................................. 52 Figure 25: Estimated Cost of Undergrounding Distribution Primary Conductor...................................... 54 4 Concentric Energy Advisors, Inc. DEFINED TERMS BPA Bonneville Power Administration City City of Bainbridge Island Commission Colorado’s Public Utilities Commission Concentric Concentric Energy Advisors, Inc. HBU Highest and Best Use HLH Heavy Load Hours JPUD Public Utility District No. 1 of Jefferson County LLH Low Load Hours OATT Open Access Transmission Tariff PSE Puget Sound Energy RCLD Reproduction Cost Less Depreciation RCNLD Replacement Cost New Less Depreciation WUTC Washington Utilities and Transportation Commission Concentric Energy Advisors, Inc. 5 QUALIFICATIONS Concentric Energy Advisors, Inc. (“Concentric”) is a management consulting and financial advisory firm focused on the North American energy industry. Concentric has offices in Marlborough, Massachusetts and Washington, D.C., and specializes in utility regulation, energy markets, finance, mergers and acquisitions, valuation, management operations and planning, as well as civil litigation and alternative dispute resolution. Neither Concentric nor any of its employees have any present or contemplated future interest in the assets appraised in this report. Neither our engagement by Puget Sound Energy, Inc. (“PSE”) nor our compensation is in any way contingent upon the value estimates contained in this report. This report was prepared under the direction of Ann E. Bulkley, Senior Vice President, of Concentric. Ms. Bulkley is a certified general appraiser licensed in the Commonwealth of Massachusetts and the State of New Hampshire. Ms. Bulkley has nearly two decades of management and economic consulting experience in the energy industry. Ms. Bulkley has directed and supported numerous valuations of public utility and industrial properties for ratemaking, purchase and sale considerations, ad valorem tax assessments, and other accounting and financing matters. These valuations require expertise in utility finance and regulation, electricity and natural gas markets, and utility risk assessment. Prior to joining Concentric, Ms. Bulkley held senior expertise-based consulting positions at several firms, including Reed Consulting Group and Navigant Consulting, Inc., where she specialized in valuation. Ms. Bulkley holds an M.A. in economics from Boston University and a B.A. in economics and finance from Simmons College. All of the statements, assumptions, opinions, positions and conclusions set forth in this Preliminary Feasibility Study are solely and exclusively provided by and attributable to Concentric and to no other party whatsoever. Concentric is solely responsible for the contents of this Preliminary Feasibility Study. Nothing in this Preliminary Feasibility Study is intended, nor shall be construed, to be information, admissions, statements, assumptions, opinions, positions or conclusions made or provided by or on behalf of PSE. 6 Concentric Energy Advisors, Inc. EXECUTIVE SUMMARY Concentric has performed this preliminary independent assessment of the costs and implications of the City of Bainbridge Island (“City”) acquiring PSE existing utility assets and assuming responsibility for providing electric service to PSE’s Bainbridge Island customers.1 Our report presents facts and industry insights for the primary stakeholder constituencies regarding a choice between the establishment of a new municipal electric utility by the City or the continuation of service from PSE. This includes information that pertains to the rates that may be charged either by PSE or the City, as well as the services that are currently provided by PSE or may be provided by the City. It is appropriate to jointly consider the rates and services to be provided by PSE or the City to provide an apples-to-apples comparison between the two alternatives. The key determinants of the rates that customers can expect to pay under the two alternatives are: (1) the City’s cost of acquiring PSE’s utility assets and other initial actions necessary to prepare to serve as the electric utility, (2) the City’s annual costs of providing electric service, including operating and maintaining, continuing to invest in utility assets, and acquiring power supplies and having them delivered to Bainbridge Island, (3) a forecast of the City’s expected cost of providing service based on the initial investment and ongoing operating costs, and (4) a forecast of PSE’s rates to serve as a benchmark for comparing the municipal electric utility alternative. There are several other financial and nonfinancial factors that should also be considered when making an informed decision. The City will have more control over decisions that uniquely affect its electric utility, the services that it provides, and the rates that customers pay. For example, the City could decide to develop a community solar project, increase spending on energy efficiency programs or provide customer incentives to install solar panels on their rooftops. A City-owned utility could also decide to underground more of its distribution network. Of course, the ability to make these decisions comes with the knowledge that Bainbridge Island customers will pay for all the costs. Customers will continue to care about the quality of service that they receive and their interactions with the utility when requesting a new service, asking questions or registering concerns. PSE is organized to provide this function in a centralized manner with staffing, processes and systems that are sized to serve the needs of its 1.1 million customers. The City may be able to replicate this function with local personnel or may decide to rely on a combination of outside vendors and City functions. In either case, the City will be challenged to achieve the economies of scale that are possible at a large utility. On the other hand, the claim is often made that local personnel may be more responsive to customer concerns. There is also a difference in governance between the two alternatives as it relates to oversight of customer service, pricing, key decisions and other matters. PSE is regulated by the Washington Utilities and Transportation Commission(“WUTC”) with its staff of attorneys, economists, accountants and engineers. The City will need to establish a governance organization to approve key decisions and oversee the quality of service provided by the municipal electric utility. 1 It will be appropriate to update this assessment and any subsequent formal valuation studies as new information becomes available that will have a meaningful impact on the results. Concentric Energy Advisors, Inc. 7 The estimate of electricity rates under the City utility option begins with the costs of forming the utility, composed of acquisition costs that are established by the condemnation process as well as certain transaction and start-up costs. As shown in Figure ES-1, Concentric estimates the cost of forming a utility at $146.8 million, assuming a 2021 acquisition.2 Figure ES-1: Preliminary Estimate of Acquisition Costs Cost Category 2021 ($Million) Acquisition Costs $109.1 Transaction Costs $8.7 Start-Up Costs Total $29.0 $146.8 Acquisition costs include acquiring PSE’s transmission and distribution assets in service as of the transaction date, land and easements, and compensation that is due to PSE for modifying facilities to “separate” the Bainbridge Island utility system and establish a new point of delivery for the City to receive its supply of electricity. Transaction costs include legal fees and underwriting costs necessary to issue debt to finance the acquisition costs and fund the start-up efforts that prepare the municipal electric utility to exercise its responsibilities. Start-up costs include new systems, inventory, facilities and machinery that will be necessary to operate and maintain the transmission and distribution system, manage customer relationships, and provide detailed billing of the electric service and financial reporting. Federal law prohibits the use of tax-exempt debt to finance the acquisition of utility property from an investor-owned utility. Concentric assumed that the acquisition costs would be financed with 30year taxable revenue bonds. All other costs are assumed to be financed with 30-year tax-exempt debt. Debt service costs are a major element of the cost of providing service as shown in the Figure ES-2. 2 This is a preliminary estimate that can only be refined after a complete system inventory is conducted. Additional scenarios have been included in Section 6, assuming a transaction close date of 2020, which is optimistic and 2024, which may be more reasonable. 8 Concentric Energy Advisors, Inc. Figure ES-2: Preliminary Cost Estimate of Providing Service Excluding the debt service, the largest cost of providing service is the power supply and delivery costs, which include the cost of acquiring supply and the transmission charges to transport power to Bainbridge Island. Concentric has assumed that the City municipal electric utility will be able to secure power from the Bonneville Power Administration (“BPA”). In addition, Concentric has assumed that the transmission costs will be limited to the BPA transmission rates and that the City municipal electric utility will not be required to compensate the BPA for any new investments in transmission capacity required to meet its load. For comparison purposes, Concentric assumed that PSE’s rates will increase by approximately 3.2 percent in 2018 based on PSE’s current rate case request and 3.0 percent every second year beginning in 2020. The Base Case analysis yields a 10-year net present value cost increase resulting from municipal ownership and operation of the electric utility on Bainbridge Island of $36.6 million. However, given various uncertainties, Concentric prepared alternative “Lower Bound” and “Higher Bound” scenarios to reflect the timing of the municipal acquisition of the system and that costs may be lower or higher than expected. These scenarios are based on an internally consistent set of assumptions developed around transaction dates that are either aggressive (2020 for the Lower Bound scenario) or reflect an extended condemnation process (2024 for the Upper Bound scenario). In addition, these scenarios reflect the range of potential operating and acquisition costs. In fact, the acquisition of Public Utility District No. 1 of Jefferson County (“JPUD”) has resulted in rates that are significantly higher than initially forecast during the feasibility study phase due to a number of Concentric Energy Advisors, Inc. 9 factors including unrealistically low estimates of acquisition costs and transaction costs.3 Residents and businesses of Bainbridge Island will want to consider the expected costs of the two alternative scenarios and the potential that the costs of either alternative will be significantly higher than expected. The results of the Base Case and the two alternative scenarios are presented in Figure ES3. Figure ES-3: Base Case and Scenario Results4 As shown in Figure ES-3, the Lower Bound scenario assumes that the municipal acquisition and operation of the electric utility begins in 2020. This scenario results in lower acquisition costs that reflect less incremental capital investment between the valuation date of 2017 and the operation date of the new electric utility. In addition, because this scenario assumes that the acquisition occurs earlier, the transaction costs are estimated to be lower than the Base Case. In the Lower Bound scenario, with this aggressive timing assumption, the costs of municipalization are $15.3 million higher than continuation of PSE service over a 20-year period. The Upper Bound scenario assumes that the acquisition and municipal operation occur in 2024. The acquisition costs include capital investment and replacement that is projected to occur in each year 3 4 10 The initial feasibility study for the formation of JPUD estimated an acquisition cost of $47 million when the final acquisition cost was more than twice that at $103 million plus start-up expenses. In that case, just compensation and other contractual issues were resolved through negotiation. Total costs for Bainbridge Island are slightly higher than in Figure ES-2 because they include foregone property tax revenues that will no longer be paid by PSE to the City. Concentric Energy Advisors, Inc. from 2017 through 2023. In addition, the transaction costs reflect a more prolonged process for acquiring the assets, including higher legal and consulting fees. In addition, the Upper Bound scenario considers the high end of the range of potential costs for other key assumptions. A list of the assumptions that differ from the Base Case is presented in Figure 21. Based on the assumptions in the Upper Bound scenario, the cost of service for a municipal electric utility is $251.2 million higher than continuation of PSE service over a 20-year period. Finally, and as important as the cost of electric service, Bainbridge Island voters will want to make a realistic assessment of the ability of a City-owned utility to execute on its obligations to provide safe and reliable electric service at levels of customer service that approximate or exceed the level of service provided by PSE. This is referred to as “operating risk” and often receives short shrift in municipalization assessments where the municipality is entering a new business that is critically important to the health and safety of its citizens. A realistic view with respect to future system investments is part of this analysis. Concentric Energy Advisors, Inc. 11 SECTION 1: INTRODUCTION Concentric has performed a preliminary independent assessment of the costs and implications of the City acquiring PSE existing utility assets and assuming responsibility for providing electric service to PSE’s Bainbridge Island customers (a “Preliminary Feasibility Study”).5 As an independent assessment, the Preliminary Feasibility Study presents certain facts and perspectives that inform the primary stakeholder constituencies: PSE as the current asset owner and service provider, the City of Bainbridge Island and its officials, and the residents and businesses that depend on reasonably priced, reliable and safe electric service. Concentric has evaluated the current and future cost of providing electric service under the two alternatives: (1) continuation of PSE as the service provider, and (2) service provided by a newly formed City municipal electric utility. The City alternative requires the purchase of certain transmission, distribution, land holdings, and other assets from PSE at a price that will either be agreed upon or determined through a condemnation process pursuant to State of Washington law. Financing of the acquisition will be included in the cost to provide service and recovered along with other costs through the electricity prices that will be charged by the City. However, it is not sufficient to only compare the electricity prices under the City and PSE options; it is also necessary to ensure that the comparison reflects an apples-to-apples comparison between the services that would be provided by either the City or PSE. For example, certain services are currently provided by PSE throughout PSE’s service area and are either included within the charge for basic electric service or are separately identified, priced and paid for in accordance with a specific PSE tariff. The cost of those services (e.g., energy efficiency or support for solar energy) will need to be considered as part of the service provided by the City to provide a fair comparison to the PSE tariffed service. In addition, PSE currently collects payments through its customer bills that benefit the Bainbridge Island community. Under municipal operation, it is possible that certain of those payments to the City (e.g., property taxes) will no longer be collected from PSE or paid by the City utility, and the loss of these tax revenues also needs to be reflected in the analysis. There are also certain nonfinancial factors that should be considered by the City and residents in deciding whether to assume responsibility for providing electric service. For example, the City will have greater control over decisions that relate to the specific services to be provided by the City and control over spending priorities that determine the capital and operating budget. However, the City will also be responsible for operating and maintaining the electric system, including responding to outages and other unforeseen challenges. The City will also need to determine which of the many oversight and regulatory services currently provided by the WUTC will need to be replicated by the City with appropriate governance procedures. The Preliminary Feasibility Study begins in Section 2 with a discussion of the municipalization process as informed by State of Washington laws and recent experience, which includes the 2013 5 12 This Preliminary Feasibility Study will provide a high-level analysis of the valuation of the PSE assets. A more detailed and certified appraisal report is likely to be required should the acquisition be approved by a vote of Bainbridge Island voters. Concentric Energy Advisors, Inc. acquisition of PSE’s service territory by JPUD. This review provides important context for the decision faced by the City. Section 3 presents various factors that are relevant to the determination of a fair acquisition price and presents a preliminary range for acquisition costs that the City can expect based on a reasonable set of assumptions. It also addresses the costs of considering, planning and starting an electric utility, referred to as “transaction and start-up” costs. Section 4 summarizes the City’s cost of providing electric service, including the financing costs attributable to the acquisition along with all other costs of providing service. Section 5 presents the alternative of continuing PSE services, including value that is provided to the City in the form of property taxes. Finally, Section 6 brings all the relevant considerations together in a summary comparison of the two alternatives. In addition, Section 6 provides a sensitivity analysis that demonstrates the effect of key assumptions on the Preliminary Feasibility Study. Concentric Energy Advisors, Inc. 13 SECTION 2: THE MUNICIPALIZATION ALTERNATIVE 2.1 OVERVIEW Forming a municipal electric utility can be a daunting challenge, even under circumstances where there is a compelling economic and public benefits case to be made. The municipality is making a likely irrevocable decision to finance and acquire assets from the existing utility provider, assume the obligations of providing reliable, safe and affordable electric service, and form an organization and governance structure to manage and operate the utility. The municipality is not only committing to acquiring existing assets, but to maintaining electric facilities according to national standards and to continue making investments that support the services that local residential and business customers expect. The Bainbridge Island City Council and residents, as the ultimate decision makers, will need to make a well-informed decision that considers both economic and other considerations, recognizing that expected electricity prices may turn out to be higher or lower due to factors that are both within and beyond the municipality’s control. The impetus for considering municipalization varies among municipal governments, but often centers around issues such as: (1) desire for local control; (2) the prospect of obtaining a greener supply of electricity; (3) dissatisfaction with the existing utility supplier attributable to price and/or perceived service issues; (4) perception that electricity prices will be lower with municipal ownership due to financing advantages or the belief that it will be possible to bypass costs that are incurred by the existing utility to provide service. 2.2 STATE OF WASHINGTON LAW AND MUNICIPAL AUTHORITIES Under State of Washington law, a city has the authority to “construct, condemn and purchase” and subsequently maintain and operate the electric utility plant and facilities for purposes of furnishing electricity to the municipality and its residents.6 The process, currently being followed by the City, requires that, “[w]hen the governing body of a city or town deems it advisable that the city or town purchase, acquire, or construct any such public utility, or make any additions and betterments thereto or extensions thereof, it shall provide therefor by ordinance, which shall specify and adopt the system or plan proposed, and declare the estimated cost thereof, as near as may be, and the ordinance shall be submitted for ratification or rejection by majority vote of the voters of the city or town at a general or special election.”7 Title 8 of the Revised Code of Washington specifies eminent domain procedures to be followed to determine the scope and extent of damages the condemning authority is required to pay to the party that is being condemned. The City must file a petition with the superior court. This initiates a twophase proceeding wherein the court must first determine if the proposed acquisition is necessary and whether the proposed acquisition is in the public interest. If the court sustains the public use 6 7 14 RCW § 35.92.050. Id., at § 35.92.070. Concentric Energy Advisors, Inc. and necessity of the proposed taking, the second phase is a damages trial, typically before a jury, where the amount of “just compensation” to be paid to the condemnee is determined. Generally, “just compensation” includes an amount equal to the fair market value of the assets to be acquired and any severance damages. State of Washington law also provides a mechanism where the party being condemned can recover its costs and attorneys’ fees from the condemning authority. As described in Section 3, there are many factors to be considered in arriving at just compensation. Although it may be possible for the municipality and existing utility to reach an agreement regarding such compensation, the courts are frequently called upon to make this determination, particularly if the existing utility is not a willing seller and/or if there is a wide gap in the perceived value between buyer and seller. Even after the court issues its decision, either party may appeal the decision to a higher court, adding one or more years and additional costs before a final resolution of just compensation is established.8 In addition to acquiring the physical assets of the existing utility, the City will need to secure contractual arrangements to acquire electricity supply and have it delivered to the City via interconnections with transmission facilities that continue to be owned by the seller or by other third parties (e.g., the BPA). Efforts to secure electricity supply contracts and transmission service typically proceed in parallel with the condemnation process. Just compensation is a primary driver in determining whether municipalization makes economic sense. However, public consideration of the municipal option often proceeds on a more accelerated path than a final determination of just compensation, creating a risk that the City Council and voters will decide to acquire assets based on a price that is well below the final determination. A typical sequence of activities is as follows: The City Council decides to retain an outside contractor to perform a feasibility study addressing the cost of and plan for acquisition and subsequent operation of the electric utility. Based on this study, the City Council decides whether or not to move forward by enactment of an ordinance. If approved, the ordinance adopted by the City Council is then referred to the voters, to be voted on at either a general or special election. If approved by a majority of voters, the condemnation process to acquire the utility assets is authorized to begin. Legal processes commence to determine the public use and necessity of the proposed taking, and if this is approved by the court, then there is a subsequent trial before a jury to determine the amount of just compensation to be paid to the utility. This process can take years to complete and the decisions made by the trial court are reviewable by courts of appeal. After the legality of the acquisition and just compensation are determined, the community prepares to assume responsibility for management and operation of the utility, a process that can take up to a year to complete. 8 The initial phase decision addressing public use and necessity may also be appealed, further extending the condemnation process. Concentric Energy Advisors, Inc. 15 The process for municipalization of an electric utility can take many years and require considerable out-of-pocket expense to retain legal and consulting services.9 2.3 FEASIBILITY STUDY As the primary source of information relied upon by municipal officials and voters, it is essential that a feasibility study be performed, meeting at a minimum the following criteria: Understandable: should be understandable by any voter interested in making an informed decision, relying on plain language to explain electric industry concepts to the extent possible; Informed by Relevant Law, Policy, and Precedent: as necessary to accurately define the requirements that a municipality must satisfy and the future operating environment in which investment and other decisions will need to be made; o Objective: avoid any bias in the framing of the analysis or specifying assumptions, with conclusions and recommendations informed by relevant expertise and experience; o Comprehensive: inclusive of all relevant quantitative and qualitative considerations; Rigorous: analytically sound, consistent with professional standards; Include Risk Analysis: both “Acquisition Risks” through the presentation of analyses that reflect a reasonable range of acquisition and start-up costs based on alternative sets of reasonable assumptions that capture the range of uncertainty and “Operational Risks” that will be assumed by the City when it assumes responsibility for operating the utility, including the obligation to respond to significant storms and other extraordinary events; and Documented: all source materials, assumptions and calculations should be fully documented. Among these criteria, elaboration is required with respect to the “Comprehensive” criterion. As noted above, the feasibility study should address quantitative, hard-to-quantify and qualitative considerations. The quantitative assessment should produce a comparison of the municipal option and the continuation of the current electric service by the incumbent utility. An important metric is the projected electricity price that residential and business customers can expect to pay, under a “Base Case” or “most likely” set of assumptions and under alternative and realistic assumptions (i.e., risk analyses). There are other important metrics, including the impact of the acquisition on the municipality’s financial condition, the ability to access capital markets on reasonable terms, and any foregone municipal revenues (e.g., property taxes). The cost of providing electric service includes the following costs: Debt Service: principal and interest payments on the debt incurred to fund the acquisition costs and finance incremental investments. 9 16 The recent acquisition of the electric utility assets by JPUD took approximately five years, even though just compensation and other contractual issues were resolved through negotiation. Concentric Energy Advisors, Inc. Working Capital: the cost associated with maintaining cash balances to support day-to-day operations of the utility and respond to unanticipated events, including securing outside crews and equipment to assist with emergency storm restoration.10 Purchased Power: the cost of purchasing power from the BPA to serve Bainbridge Island customers. Transmission Expense: the cost of transporting power across the integrated transmission system to the expected point of delivery to the Bainbridge Island system. Operating and Maintenance Expense: the cost to operate and maintain the transmission and distribution systems, including substations, transmission and distribution lines, transformers, and communication facilities, as well as costs attributable to vegetation management, and utility crews and equipment. Administrative and General Expense: salaries and wages, office supplies, outside services, rents and other expenses not attributable to a specific utility function (i.e., distribution, transmission or supply). Customer Service: the cost of billing and collection, including maintaining customer information systems. Taxes: Washington public utility taxes. Customer Programs: the cost of providing energy efficiency and energy assistance programs. Replacement Capital: investments required to replace transmission and distribution system assets, including assets that have failed and assets that are beyond their economic and functional life. System Expansion/Upgrade: investments required to extend the distribution system, connect new customers, and improve reliability. This category also includes system upgrades that are made before the end of the economic or functional life of the assets, such as meter replacements to upgrade technology and underground distribution system lines. It is also necessary to account for the property taxes that will no longer be made by PSE to the City. Although not a cost of providing electric service, Concentric has reflected this foregone source of revenue as a “cost” of municipalization to provide an apples-to-apples comparison. The financing costs for the municipal option are based on borrowing costs and the amount being financed, where the latter is the sum of the just compensation for acquired assets and start-up costs. As described in Section 4.3, while municipal utilities can issue low-interest, tax-exempt debt to finance their future capital needs, the City’s initial acquisition of the utility assets must be financed with taxable debt, similar to the debt relied upon by PSE and other investor-owned utilities that finance investments to replace aging infrastructure, modernize the network, and support new 10 Concentric relied on 45 days of working capital, estimated at $3.1 million in the first year, for the Base Case. Working capital is included in total debt service. Concentric Energy Advisors, Inc. 17 services. All financing costs are included in the total costs of providing basic electric service (commonly referred to as “revenue requirements”) and recovered through electricity prices.11 Most utilities offer services that are more than what is required to meet “basic” service. These services may be provided to all customers, offered to all customers as an option, or offered to a subset of customers based on the specified criteria, such as the presence of solar panels on their rooftops. It is necessary to consider these harder-to-quantify factors in order to present a valid apples-to-apples comparison between the City and PSE ownership alternatives. For example, there may be aspects of the existing utility service that the municipality may decide to expand, reduce or abandon. These include public benefits programs and services provided by PSE under the oversight of the WUTC, including conservation and energy efficiency programs (e.g., in-home audits; insulation and appliance rebates), low-income assistance, and financial support for solar energy that is located on the customer’s premises but connected to the utility distribution grid. The municipality may also include potential value-added utility services that require an investment in infrastructure and new information systems, such as a time-of-use rate that provides customers with an incentive to shift their electricity usage to a lower-cost time period or a demand response option that pays customers to consume less electricity when called upon. PSE offers all of these services and recovers the costs from its entire base of approximately 1.1 million customers. However, if these same programs are to be provided by the City, these costs will now be borne (or avoided) only by customers on Bainbridge Island. An example is illustrative. Should a greater proportion of Bainbridge Island customers elect energy efficiency programs or install rooftop solar panels than has been experienced for the larger PSE customer base, this will place upward pressure on Bainbridge Island electricity rates after the acquisition. The comparison between the City-owned utility and continuation of service from PSE will need to take these harder-to-quantify considerations into account to provide an apples-to-apples comparison. Finally, there are several qualitative considerations that will affect the comparison between the municipal option and continuation of service from PSE. These include comparable levels of service quality including customer service, reliability under “blue-skies” conditions and the ability to respond to storm-related and other extraordinary outages. PSE’s service quality is subject to oversight by the WUTC through several regulatory authorities. The City will need to establish a governance structure to oversee the municipal electric utility’s reliability, safety and affordability of service, as well as a process for resolving customer billing and other inquiries. 2.4 RECENT MUNICIPALIZATION EXPERIENCE As shown in Figure 1, only 12 of 39 national municipalization efforts since 2001 have been approved; seven of these have been completed and the eighth is scheduled to begin service in fall 2017. Five additional communities are currently considering or seeking the necessary approvals for municipalization. One community acquired the system from the regulated utility and sold the system back to the utility 12 years later. The remaining communities have decided not to proceed either 11 Under both the PSE and municipal options, the utility will need to recoup the investment through an annual charge (i.e., depreciation) and a separate financing cost. These are frequently referred to as the return “of” and “on” capital, respectively. 18 Concentric Energy Advisors, Inc. because the municipalization effort has been rejected by voters, denied by regulatory commissions or otherwise abandoned by the municipality during the process. Municipalizations fail to proceed for a variety of reasons, including abandonment by the municipal government after consideration of a feasibility study or rejection by voters after government officials decided to bring the decision to a vote. Municipalization efforts have also been abandoned if costs and time necessary to complete the effort greatly exceed original estimates.12 Feasibility studies performed on behalf of municipalities frequently underestimate both the time and cost of completing municipalization efforts that do not have the cooperation of the existing utility service provider. 12 In the case of Las Cruces, New Mexico, the consultant projected in 1991 that it would cost that city $13 million to $26 million to acquire the system. In 1999, Las Cruces abandoned its takeover effort after the costs escalated to over $105 million. Concentric Energy Advisors, Inc. 19 Figure 1: United States Municipalization Efforts: 2001–2016 As shown in this figure, the recent Washington experience is similar to the national trend. Three of the four Washington proposals in the last decade were defeated with only the JPUD transaction being completed, adding electric service to an existing public utility district organization. In fact, there have been few publicly owned and operated utilities formed in Washington since the 1950s. Prior to JPUD, the most recent example of a municipalization in Washington was Asotin County PUD No. 1 in 1994, but this was a unique transaction as it primarily functions as a water utility, as it only provides electric service from a single three-mile distribution line to a local golf course and its own water production facilities. Several municipalizations have been completed at costs that greatly exceeded original estimates. For example, Winter Park, Florida’s costs escalated from an original estimate of $16 million to nearly $50 million by the time the takeover was completed. The initial feasibility study for JPUD’s acquisition of 20 Concentric Energy Advisors, Inc. PSE’s electric assets estimated an acquisition cost of $47 million, less than half of the final acquisition cost of $103 million, excluding start-up expenses. Increased acquisition and transaction costs translate directly into higher than projected municipal electricity rates. 2.5 CASE STUDIES OF RECENT MUNICIPALIZATION ACTIVITY Concentric provides brief summaries of three recent municipalizations that highlight some of the challenges faced by communities as they proceed down the path toward municipalization. Boulder, Colorado—Despite a narrow public vote in support of exploring utility formation in 2011, Boulder has aggressively pursued municipalization over the past five years despite delays and rising costs. The effort has cost Boulder, a city with approximately 45,000 electricity customers, millions of dollars to date. Boulder has been collecting a “Utility Occupation Tax” of $1.9 million per year since 2011 that is being used to support the effort to condemn the utility property. In 2014, Boulder spent $1.9 million on consulting, legal regulatory and purchased services related to the municipalization effort. In 2015, Boulder budgeted an additional $7.9 million for the costs of the municipalization effort for 2015–2017.13 Recently, the city indicated that with the Utility Occupation Tax expiring in 2017, additional funding would need to be financed from the general fund, resulting in a reduction in other services. The city’s acquisition and separation plan was filed with the Colorado’s Public Utilities Commission (“Commission”) in 2015. The Commission recently established public hearings beginning July 26, 2017. If the Commission decides in favor of the city, Boulder will need to file at a state district court to determine the compensation it owes to condemn the utility. The parties will also likely need to seek resolution of stranded cost responsibility from the FERC. Even without any further delays, it is reasonable to expect that this effort will take years to resolve and considerable legal and consulting costs. Winter Park, Florida—Winter Park formed an electric utility in 2005, exercising a right to purchase clause that is unique to Florida franchise conditions. Despite agreeing to compensation through arbitration (rather than litigation), the effort took six years. The city utility lost approximately $11 million over the first four years of operation and was put on credit-watch negative by rating agencies.14 The shortfall resulted from a four-year rate freeze at the pre-acquisition levels that were being charged by Progress Energy Florida. Winter Park’s financial challenges were compounded by a decrease in electric sales and an increase in the cost of bulk power in 2008, causing its debt service ratio (annual net revenue divided by debt service obligation) to fall to 0.73, well below the target minimum of 1.25.15 Winter Park has subsequently increased its rates to comply with its debt covenants. Public Utility District No. 1 of Jefferson County —JPUD acquired PSE’s assets and service area in 2013, approximately five years after the acquisition was approved by the electorate and at an acquisition 13 14 15 City of Boulder, Colorado, Information Packet provided to the Members of City Council, Boulder’s Energy Future Budget Update, May 19, 2015, at 3. City of Winter Park, Florida Bond Issuance Prospectus, Electric Revenue Bonds, Series 2005A and Series 2005B, Initial Auction Date June 6, 2005, at C-30. City of Winter Park, Florida 2008 Comprehensive Annual Financial Report, at 121. Concentric Energy Advisors, Inc. 21 cost of approximately $110 million—or more than double original estimates. The acquisition was a negotiated process and driven by JPUD’s desire to obtain local control over electric service. JPUD was successful in securing power from BPA but its retail rates currently exceed the rates charged by PSE. JPUD initiated the municipalization process in 2008, employing D. Hittle & Associates, Inc. to develop a preliminary feasibility study on electric system acquisition. The feasibility study provided a 10year comparison of the cost of continued electric service with PSE compared to the cost of service for a PUD. The study assumed that JPUD would be able to acquire PSE’s assets for approximately $47.2 million, with total financing requirements of $66 million including initial acquisition costs, separation, start-up and legal costs, working capital and financing expenses.16 The study concluded that JPUD could provide service beginning in 2011 at rates that were slightly higher than PSE’s rates for the first three years of operation, but that rates would decrease noticeably in the fourth year, when low-cost BPA power became available. The study further noted that (1) if the acquisition year was assumed to line up more closely with the BPA power supply, and (2) if the parties relied on “more realistic” acquisition costs for PSE assets and different financing assumptions, the acquisition would result in lower rates for PUD electric service in all 10 years of the study.17 Actual acquisition and transaction costs were substantially higher than projected in the JPUD feasibility study.18 Through a negotiated sale agreement with PSE, JPUD’s purchase of PSE’s asset was completed in 2013 at a sale price of $109.3 million, 2.3 times the $47.2 million projection provided in the feasibility study.19 Actual operating costs and electricity rates under JPUD operation have been much higher than projected, altering the rate comparison with PSE. JPUD’s initial rates for the 2013–2016 period have remained comparable with PSE’s 2013 rates. PSE has increased rates 1.4 percent per year over the past five years.20 However, JPUD projects the need to increase rates in each year from 2017–2020, beginning with an 8 percent increase in 2017 and a 5 percent increase in 2018. After considering rate increases through 2018, JPUD’s rates are expected to be higher than PSE rates and JPUD projects additional increases of 3 percent per year in 2019 and 2020. These rate increases are required to fund JPUD’s construction in progress, maintain reserves, continue to meet its loan covenants, implement a low-income customer assistance program that has not been provided to customers since JPUD acquired the system, and pass through increased BPA rates. Figure 2 compares the projected monthly cost in 2018 for a typical residential customer using 1,000 kWh of electricity under PSE rates and the projected JPUD rates. As shown in Figure 2, based on 16 17 18 19 20 22 Preliminary Feasibility Study (D. Hittle & Associates, Inc.), Public Utility District No. 1 of Jefferson County Electric System Acquisition, October 24, 2008, at 21. Id., at 5. JPUD did not rely on D. Hittle & Associates, Inc. for purposes of its negotiations with PSE. Rather, JPUD retained Brown & Kysar, Inc. to do a subsequent analysis. Brown & Kysar’s predicted acquisition cost varied depending upon stated assumptions, but ranged from $58 million to $83 million. WUTC Docket No. UE-132027 (prefiled direct testimony of Karl R. Karzmar). WUTC Docket No. UE-132027, at 1. Concentric recognizes that PSE recently filed with the WUTC, requesting a 3.2 percent rate increase. The outcome of that case will not be determined for several months. Therefore, the rate comparison assumes that this rate increase is adopted by the WUTC. Concentric Energy Advisors, Inc. JPUD’s projections, residential customers will see a higher total energy bill than they would have under PSE rates. Figure 2: 2018 Projected Residential Rate Comparison Utility JPUD PSE Customer Charge 1st 600 kWh Remaining kWh Total Bill $17.00 $0.0860 $0.1048 $ 110.5 $8.92 $0.0918 $0.1117 $ 108.7 This contrasts with the D. Hittle & Associates, Inc. feasibility study that had projected that JPUD rates would initially be higher than PSE’s rates and level off over time.21 21 Preliminary Feasibility Study (D. Hittle & Associates, Inc.), Public Utility District No. 1 of Jefferson County, Electric System Acquisition, October 24, 2008. Concentric Energy Advisors, Inc. 23 SECTION 3: BAINBRIDGE ISLAND COSTS TO FORM AN ELECTRIC UTILITY 3.1 INTRODUCTION The City will incur three major categories of costs to acquire and establish an electric utility: Acquisition Costs: the costs of acquiring PSE’s physical transmission and distribution system assets (e.g., distribution poles, lines, meters, etc.) at fair market value and other categories of just compensation (e.g., equipment that no longer has any use, foregone value of the business, etc.) as determined by State of Washington law. These other categories include land and rightof-way easements that represent the fair market value of property that is owned by PSE and easements that provide access to land that may be used by PSE. They include system separation costs incurred by PSE that are required to reconfigure the remaining PSE facilities to maintain safe and reliable service for both PSE and Bainbridge Island and compensation for assets that were acquired by PSE or contractual obligations entered into to serve Bainbridge Island but that will not have any continuing value to PSE after the transaction. These are referred to as severance or stranded costs. Just compensation includes an estimate of the “going concern” value of the assets sold by PSE to Bainbridge Island, recognizing that the value of the business being acquired by Bainbridge Island is greater than a collection of physical assets. Finally, the City may be required to compensate PSE for certain legal and expert assistance attributable to the condemnation process. Transaction Costs: The City will incur legal, consulting, and financing costs to pursue the condemnation process and close the transaction. Start-Up Costs: The City will incur start-up costs necessary to prepare to perform as an electric utility, including new systems, inventory and machinery that will be necessary to operate and maintain the transmission and distribution system, manage customer relationships, provide detailed billing of the electric service and provide financial reporting. Each of these categories will be addressed in the balance of Section 3, including a summary of total costs that will be incurred by the City to begin serving as an electric utility. As noted above, the acquisition costs will be financed with taxable debt; the City is allowed to finance the transaction and start-up costs with tax-exempt debt. These annual financing costs, combined with salaries and other costs required to maintain and operate the distribution system, are addressed in Section 4. This section assumes that a condemnation process will be pursued initially and that any negotiation, should it occur, would also result in just compensation for PSE’s assets, as determined pursuant to State of Washington laws. 3.2 ACQUISITION COSTS A valuation methodology is necessary to arrive at a fair value or just compensation for the various components of acquisition costs. Physical transmission and distribution utility assets are usually valued by employing a cost-based valuation methodology; land and going concern value is generally 24 Concentric Energy Advisors, Inc. estimated based on market principles that may include recent comparable transactions or the value of a future income stream. Two commonly used cost valuation methodologies are Reproduction Cost Less Depreciation (“RCLD”) and Replacement Cost New Less Depreciation (“RCNLD”). Both methodologies estimate the cost to duplicate the existing transmission and distribution system assets, without making any adjustments for changes in technology. The RCNLD methodology estimates the cost to replace the system with new technology, then deducts depreciation to reflect the current condition of the existing assets. The RCLD approach begins with the net book value of the existing assets, which already reflects the depreciation, and escalates this net book value to current dollars. This approach is sometimes referred to as the trended net book value RCLD methodology. The RCLD methodology generally underestimates the value of the assets as compared to the RCNLD, which accounts for current siting and construction challenges. The RCNLD replaces the existing assets with functionally equivalent assets of current materials and technology. The RCNLD value represents an estimate of the cost to construct a new system today with commercially available equipment and technology and considering the current construction limitations. To the extent that the system would be reconstructed in substantially the same manner today as it is currently constructed, the RCNLD and RCLD values should be similar. It is likely, however, that it would not be possible to reconstruct the electric transmission and distribution assets in the same configuration or to apply the same development and construction practices. Some existing transmission routes might not be feasible under current regulations, and as a practical matter, it may not be possible to site all of the existing transmission and distribution lines in the same location today if they were built in areas that are currently classified as wetlands, environmentally sensitive, or are densely populated. Each of these factors increases the costs associated with approvals and construction. Even routes that are acceptable under current regulations might face local community opposition if the attempt was made to establish them today. This is particularly evident with transmission facilities, which face challenges that increase the costs of planning, permitting, and acquiring rights-of-way. 3.2.1 TRANSMISSION AND DISTRIBUTION SYSTEM ASSETS Concentric’s preliminary estimate of the value of the assets on Bainbridge Island is based on the RCLD methodology, a relatively conservative approach that avoids the need to redesign the transmission and distribution network for valuation purposes. The RCLD is applied by escalating the existing net book value to current value; i.e., the trended net book value approach. This methodology reflects the results of PSE’s most recent depreciation study that has been accepted by the WUTC in PSE’s rate proceedings. For purposes of estimating a preliminary value for this feasibility study, Concentric did not compile an inventory of the specific assets on Bainbridge Island (including the in-service date and original cost) and has relied on the net book value of PSE’s systemwide assets. Concentric has estimated the net book value of the assets on Bainbridge Island by allocating the net book value of Concentric Energy Advisors, Inc. 25 PSE’s system transmission and distribution assets and multiplying by the ratio of the number of customers on Bainbridge Island to PSE’s total number of customers.22 The adjustment factors used to escalate costs by PSE asset type are based on application of the Handy-Whitman Index.23 The Handy-Whitman Index is a generally accepted industry standard cost index used for conducting reproduction cost studies. The Handy-Whitman Index has tracked utility labor, materials and equipment costs over time and includes specific indices for various types of utility assets that reflect the percentage change in the cost of goods in most utility plant accounts for every year from 1912 to the present, with 1973 as the base year (i.e., 1973 = 100 for all asset types). Using the Handy-Whitman Index, an adjustment factor is calculated by dividing the index for the most recent period by the index for the vintage of the property in question. The Handy-Whitman Index reports separate indices for many regions of the United States to reflect regional cost differences and trends. For purposes of this analysis, Concentric has relied on the Handy-Whitman Index for the Pacific region of the United States, which includes the State of Washington. The Handy-Whitman Index data was used to trend costs to current value as of 2016. To estimate a value that reflects assets in service as of an assumed 2021 acquisition date, it is necessary to (1) adjust for transmission and distribution investments that will be made between 2016 and the acquisition date, and (2) escalate the value of all existing and new plants to the acquisition date. Concentric has assumed that PSE will continue to replace aging infrastructure at a rate of 4 percent per annum. Concentric has escalated all costs to 2021 using the five-year historical compound annual growth rate in the Handy-Whitman Index as the basis for escalation. Concentric’s preliminary estimate of the value of PSE’s transmission and distribution assets based on the RCLD methodology and escalated to 2021 is $58.6 million, as shown in Figure 3. 22 23 26 For example, if a Bainbridge Island asset inventory was available, an investment in an overhead conductor that was made in 1990 that has an original cost of $1,000 would be trended to reflect the value of that asset in current dollars, based on an adjustment factor that reflects the change in price levels for the overhead conductor from 1990 to current dollars. Depreciation would then be applied to the current reproduction cost new of the assets to estimate the RCLD. To the extent that the depreciation of the assets on Bainbridge Island is expected to be similar to the PSE system as a whole, these approaches would result in a similar current value. However, differences in the expected remaining life of the assets on Bainbridge Island as compared with the PSE system could result in the value of the assets being overstated or understated using this approach. Any final acquisition cost should include a complete inventory of the assets located on Bainbridge Island, including the specific ages and overall condition. The Handy-Whitman Index is considered an accurate and reliable resource for valuation experts, has a long history of providing dependable data, and has been published continuously since 1924 by Whitman, Requardt and Associates, an engineering firm. The Handy-Whitman Index has been used to reflect price inflation by escalating construction costs from the investment year to current dollars. The Handy-Whitman Index has been used and is generally accepted for rate-setting purposes as well as for many other purposes. For example, it has been used to value utility property for sale purposes, to perform stock valuations, and to make ad valorem tax calculations. In addition, the Handy-Whitman Index has been used for insurance purposes and for engineering estimates of new construction project costs. Concentric Energy Advisors, Inc. Figure 3: Estimated 2021 Replacement Cost Depreciated 2021 Replacement Cost Depreciated ($Million) Asset Category Transmission Distribution Substation Meters Incremental Capital (2017–2021) Total $4.4 $35.0 $5.0 $0.4 $13.8 $58.6 3.2.2 LAND AND RIGHT-OF-WAY EASEMENTS Land value is composed of the value of land owned in fee by PSE and used for the purposes of the transmission and distribution system as well as the value of transmission and distribution easements acquired by PSE and used for the network on Bainbridge Island. Figure 4 presents the preliminary estimated value of land owned by PSE based on the value of adjacent property with identical zoning (designated as “Current Value”) as well as the value of land, assuming that it is applied to its “Highest and Best Use” (“HBU”). This is also a standard real estate valuation concept. Both estimates are based on values calculated by applying a per-foot valuate to the size of the parcel, and are presented in 2021 dollars. Figure 4: Preliminary Estimated Value of PSE Land ($2021) Property Tax Lot # SIZE (Sq. Ft.) Est. HBU Value/Sq. Ft. Est. HBU Value 1. Pt. Madison substation 032502-3-013-20-01 53,579 $8.00 $473,000 2. Murden Cove substation 222502-1-024-20-09 92,783 $2.20 $225,000 3. Future substation 272502-2-073-20-02 77,972 $3.56 $306,000 4. Winslow substation 4178-000-028-02-04 87,556 $2.25 $217,000 5. Corridor 032502-3-026-20-06 67,082 $8.00 $592,000 6. Corridor 032502-3-053-20-02 9,583 $8.00 $87,000 7. Corridor 332602-1-007-20-06 17,860 $10.63 $210,000 8. Corridor (Agate Point) 4131-000-029-02-09 16,553 $13.50 $247,000 TOTAL Concentric Energy Advisors, Inc. $2,357,000 27 Transmission easement values were calculated taking into consideration the value per acre of parcels by zoning (residential, agricultural, commercial and industrial) and the acreage of easements by zoning category. As shown in Figure 5, the preliminary estimated value of transmission easements is estimated to be $21.3 million in 2021. This includes an estimate to reflect “damage to remainder” and a corridor value that reflects the additional value attributable to having rights to an assemblage of integrated individual easements. The concept of “damage to the remainder” in a valuation context refers to fact that the placement of utility facilities on land will diminish the value of parcel of land, a particularly important valuation concept for residential property. Corridor value can range from 20 percent to 50 percent of the value of the parcels, depending on the location of the corridor that is created. For the purposes of this analysis, Concentric has estimated that the incremental value associated with the corridor is 30 percent. Figure 5: 2021 Preliminary Estimated Value of Transmission Easements ($000) Zoning Class Residential Agricultural Commercial Industrial Fee Count ($/acre) 114 $ 149,162 1 $ 49,136 5 $ 904,430 1 $ 380,497 R/W Width 50 50 25 25 Length (in feet) 65,953 300 2,858 445 Area (acre) 75.70 0.34 1.64 0.26 Total Estimated Easement Value $12,464 $19 $1,638 $107 Damage to Remainder Value 20% $2,493 $4 $328 $21 Corridor Value 30% $3,739 $6 $491 $32 Total Value $18,696 $29 $2,457 $160 $14,228 $2,846 $4,268 $21,342 PSE has 2,899 distribution easements on Bainbridge Island as of January 2017. PSE estimates that the fair market value of those easements is approximately $2,500 per easement, resulting in a preliminary estimated value of approximately $7.25 million. Figure 6 summarizes the estimated value of land and easements that would be included in the acquisition of PSE’s assets on Bainbridge Island, adjusted for a 2021 acquisition date. Figure 6: Preliminary Estimated Land Value ($Million) 2021 ($Million) PSE-Owned Land Transmission Easements Distribution Easements Total 3.2.3 $2.36 $21.34 $8.00 $31.70 SYSTEM SEPARATION COSTS As shown Figure 7, Bainbridge Island is currently served by PSE’s 115 kV transmission facilities from two locations: (1) from the south by a transmission line extending from PSE’s Bremerton substation up the Kitsap Peninsula and across the Agate Pass Bridge, and terminating at the Port Madison substation on Bainbridge Island; and (2) from the north by a transmission line extending from PSE’s 28 Concentric Energy Advisors, Inc. Foss Corner substation down the Kitsap Peninsula and across the Agate Pass Bridge, and also terminating at the Port Madison substation. Figure 7: PSE Transmission System Map PSE indicates that it is likely to establish the system separation point that will serve as the point of delivery at the Kitsap Peninsula side of Agate Pass. There are two possible options for system separation: a switching station and a lower cost solution. Further research and system analysis need to be conducted to determine the appropriate engineering. If PSE determines that a switching station is needed to prevent disturbances on the Bainbridge Island system from impacting PSE’s system, as well as associated communications, controls, protection improvements and metering, the estimated cost would be $6 million. PSE indicates that it is also possible that a lower cost solution will resolve the operational issues, thus avoiding the need to build a switching station. The switching station and associated facilities, or lower cost solution if feasible, would constitute separation cost to be recovered by PSE from the City as part of the acquisition. The City would own all the transmission and distribution assets from the point of delivery onto Bainbridge Island, including the two lines and four towers that span the Agate Pass Bridge. PSE would also need to reconfigure various systems Concentric Energy Advisors, Inc. 29 and update displays at PSE’s Load Office that would be included in separation costs.24 Also PSE would remove, or sell, any metering, communications, control or status points at Port Madison, Winslow and Murden Cove substations and include these net costs in separation costs.25 The most cost-effective solution can only be determined by performing what is referred to in the industry as a “system impact study.” This study will evaluate the ability of alternative solutions to adequately address reliability concerns that result from the new point of delivery. A more refined estimate of the cost of the optimal solution will then be established through a more detailed scoping assessment or “facilities study.” These studies represent standard industry practice when utilities are evaluating modifications to the distribution network to serve growing load and/or maintain reliability. The process will be initiated when BPA or Bainbridge Island makes a formal request to PSE for long-term firm point-to-point transmission service from BPA’s Kitsap substation to the point of delivery pursuant to PSE’s Open Access Transmission Tariff (“OATT”). Figure 8: Point of System Separation Asset ownership changes at West side crossing Steel Towers Agate Pass 24 25 30 The change in ownership and configuration, including the new point of delivery, will need to be communicated to the regional reliability coordinator (peak reliability) and to the California Independent System Operator (CAISO). The System Control and Data Acquisition (SCADA) data from these substations is currently fed into PSE’s Energy Management System. The SCADA link to the Load Office server would be terminated with load data, presumably redirected to BPA. The City would have to acquire or lease a means to transmit the data to BPA (e.g., telephone; fiber optics). PSE is currently using leased fiber optics communication (owned by Kitsap PUD) for control and protection between Port Madison, Foss Corner and U.S. Navy Keyport substations. Bainbridge Island may need to secure continued use of this fiber optics communications system (if they choose to) with Kitsap PUD for their portion of the system. Concentric Energy Advisors, Inc. Given the uncertainty associated with the need for a switching station, Concentric has assumed that separation costs will be $500,000 in the Lower Bound and Base Cases that are presented in Section 6, and $6.8 million in the Upper Bound to reflect the cost of a switching station and associated facilities. These costs will not be determined until the system impact study and facilities study have been performed, or sometime after the City votes to proceed with a condemnation process. 3.2.4 SEVERANCE COSTS Severance costs are the costs of assets that were built or acquired by PSE to serve Bainbridge Island customers but which will not be acquired by the new municipal electric utility. These costs are typically referred to in the electric industry as “stranded costs,” and could include contract fees and the remaining undepreciated value of PSE’s “stranded” generation, transmission and distribution assets. Concentric has not performed an analysis of severance costs for purposes of this preliminary report. Rather, Concentric has assumed that these costs will be $500,000. By way of comparison, JPUD severance costs included certain AMR technology, telecommunications and SCADA systems, billing services and inventories that were in the range of $725,000–$750,000. Actual severance costs for Bainbridge Island would need to be established in the condemnation proceeding, based on a detailed review of PSE’s inventory of assets associated with service to Bainbridge Island, and the damage to these assets attributable to the taking that has not already been accounted for in the valuation of transmission and distribution assets discussed in Section 3.2.1. 3.2.5 GOING CONCERN VALUE Going Concern value is considered in the determination of just compensation under State of Washington law. “Going concern” represents the incremental value attributable to the fact that the transmission and distribution assets that are the subject of a condemnation are not just a collection of physical assets, but together comprise a business unit that is complete, functional and can be run as a business unit on day one of the acquisition. This value is derived from all the elements that contribute to the complete operating business segment, including the establishment of a customer base, records, maps, and the time and cost of building the business. The estimate of going concern value is typically based on an income capitalization methodology. Its simplest form, direct capitalization, assumes that there is some stabilized annual income that can be expected from the business over time. The expected annual income of the enterprise is divided by a discount rate to arrive at an estimate of the total value of the business. The going concern component is calculated as the value of the business less the value of the physical and tangible assets that are used to generate the income. However, this methodology usually produces a going concern value of hundreds of millions of dollars. Rather than relying on an income capitalization methodology, going concern value in the municipalization context is often based on annual revenue from the going concern multiplied by a factor that ranges from 0.5 to 5 times the revenue of the business. 26 26 A well-respected legal treatise, Nichols on Eminent Domain (3rd Edition) notes that, “…in the ‘fair-value’ era [courts] regularly valued the going concern element as an added percentage of the cost of reproduction Concentric Energy Advisors, Inc. 31 For the Base Case, Concentric applied the lower end of this range (0.5), estimating going concern, and arrived at a preliminary estimated going concern value of approximately $14 million. In the Lower Bound scenario, Concentric relied on going concern costs that were estimated at 10 percent of the RCNLD of the assets ($8.4 million); the Upper Bound scenario calculates the going concern at 30 percent of the RCNLD of the assets ($29.2 million). A full and thorough analysis of going concern damages could produce a significantly higher number. 3.2.6 PSE’S LEGAL AND CONSULTING COSTS The legal process for establishing the acquisition price of the system can extend over several years and involve several legal and regulatory authorities, particularly if the outcome is determined through condemnation rather than negotiation. As noted in Section 2.2, under State of Washington law the City may also be responsible for PSE’s legal costs and fees, in addition to its own legal costs and fees that are part of the City’s transaction costs and discussed in Section 3.3. Based on the reported experience in other transactions, a conservative estimate of legal and consulting expenses to complete the municipalization effort could be in the range of $3 to $5 million. 3.2.7 SUMMARY OF ACQUISITION COSTS As shown in Figure 9, Concentric estimates the acquisition costs at $109.1 million, based on a transaction closing in 2021. The valuation summarized below is a preliminary estimate that can only be refined after a complete system inventory is conducted. Figure 9: Preliminary Estimate of Acquisition Costs in 202127 Asset Category Land and Easements T&D Assets Energy Efficiency Payback Separation Costs Severance Costs Going Concern Legal Costs & Fees Incremental Capital Investment (2017-2021) Total ($Million) $31.7 $44.8 $0.3 $0.6 $0.6 $14.0 $3.3 $13.8 $109.1 of the physical assets (between 7.5% and 25%).” Under State of Washington law, courts have allowed testimony on going concern value as percentages of structural value varying from 12 percent to 30 percent. 27 32 The estimates for separation and PSE legal costs reflect the low end of a range in this figure. Concentric Energy Advisors, Inc. 3.3 BAINBRIDGE ISLAND TRANSACTION COSTS The City will incur legal, consulting, and financing costs to pursue the condemnation process and close the transaction. Legal and consulting fees can range from $4 to $10 million. As noted above with respect to PSE’s legal fees, the legal process for establishing the acquisition price of the system can be a lengthy process that involves several legal and regulatory authorities, particularly if the outcome is determined through condemnation rather than negotiation. Figure 10 summarizes the transaction costs estimated in the Base Case feasibility study. Figure 10: Transaction Costs ($Million) Transaction Costs Legal/Consulting Costs Flotation Costs Total ($Million) $6.6 $2.1 $8.7 Concentric has estimated that financing or underwriting fees will be approximately $2.1 million associated with the taxable debt to fund the acquisition of the assets and the tax-exempt debt used to fund transaction fees, start-up costs, acquisition costs, working capital and an initial debt issuance to fund the first few years of capital expenditures. 3.4 START-UP COSTS The City will also incur certain one-time start-up costs that are necessary to operate the newly formed municipal electric utility. Figure 11 summarizes the Base Case estimated start-up costs. Figure 11: Start-Up Costs ($Million) Start-Up Costs Inventory @ 3% of Total Operations Start-Up Costs Power Supply Start-Up Costs Initial Capital Expenditure Fund for First 4 Years Initial Debt Service Reserve Total ($Million) $1.8 $1.7 $1.1 $17.8 $6.6 $29.0 Start-up costs include new systems, inventory and machinery that will be necessary to operate and maintain the transmission and distribution system, manage customer relationships, provide detailed billing of the electric service and provide financial reporting. Those costs are estimated at $4.6 million. In addition, the City will need to establish a debt service reserve fund roughly equivalent to Concentric Energy Advisors, Inc. 33 one year of interest and principal ($6.6 million). Finally, the City will need to have access to capital to make replacement capital, prudently assumed to be four years of investment or $17.8 million.28 Based on these estimates, the total start-up costs are estimated to be approximately $29 million. The total cost to Bainbridge Island in the Base Case, addressed in Section 3, is $146.8 million, assuming the transaction closes in 2021. 3.5 TOTAL COSTS TO BAINBRIDGE ISLAND—BASE CASE Figure 12 presents a summary of the three categories of costs to be incurred by the City: acquisition, transaction, and start-up. Concentric has assumed that the acquisition costs will be financed with taxable debt; transaction and start-up costs will be financed with tax-exempt debt. The total costs in the Base Case are $146.8 million. Scenario analyses are presented in Section 6. Figure 12: Preliminary Estimate of Bainbridge Island Costs—2021 Transition Cost Category Acquisition Costs Transaction Costs Start-Up Costs Total ($Million) $109.1 $8.7 $29.0 $146.8 28 The Feasibility study assumes that the City has sufficient assets and capacity and will not need to acquire additional real estate or buildings for office space, operations and a service center. 34 Concentric Energy Advisors, Inc. SECTION 4: BAINBRIDGE ISLAND COSTS TO OPERATE AN ELECTRIC UTILITY 4.1 INTRODUCTION The going forward costs of operating the utility is referred to as the “cost of service” or “revenue requirement,” including debt service, and contemplates that the revenues must be sufficient for the City to maintain an investment grade credit rating related to its utility debt. This analysis assumes that the City will generally replicate the services that are currently being provided by PSE. Financial feasibility in this context implies that the City will be able to raise the capital necessary to acquire PSE’s assets and fund the start-up operations and, once operational, generate sufficient revenue to maintain investment grade credit ratings from electricity rates that Bainbridge Island customers are willing to pay. The Base Case analysis is performed over the 20-year period of 2021–2040, assuming a 2020 acquisition. This section presents Concentric’s assumptions used to perform the financial feasibility analysis, including operating costs of the electric transmission and distribution system as a newly formed municipal electric utility. Concentric’s Base Case reflects the expected operation of the existing electric transmission and distribution system, assuming baseline forecasts of customer growth, operating and maintenance costs, and capital replacement. The potential to underground portions of the transmission and distribution system on Bainbridge Island is considered as a scenario. 4.2 BAINBRIDGE ISLAND ELECTRIC UTILITY REVENUE REQUIREMENT The typical annual operating expenses for an electric utility that are included in the revenue requirement are: Debt Service: principal and interest payments on the debt incurred to fund the acquisition costs as well as investments required to replace assets that have failed and assets that are beyond their economic and functional life and capital investment to fund system expanstion and upgrades. Purchased Power: cost for purchasing power to serve Bainbridge Island customers. Transmission Expenses: cost of transporting power across the transmission system to the expected separation point between PSE and Bainbridge Island at Agate Pass. Operating and Maintenance Expenses: cost to operate and maintain the distribution system. Administrative and General Expenses: cost of administrative and management services for the electric utility operations. Customer Service: cost of billing and customer information systems and employee salaries required to issue bills, collect revenues, operate online and mobile tools for billing, outages and other services, and operate a call center to respond to customer requests. Concentric Energy Advisors, Inc. 35 Customer Program Expenses: Incremental costs of providing energy efficiency, energy assistance and other customer programs. Taxes: Washington State municipal utilities tax and any other taxes that are collected through utility rates. Each of these cost categories are described in the remainder of this section. Many of these costs are impacted by the number of customers served by the utility, their total energy usage, and system peak demand requirements. Concentric assumed that the starting number of customers (12,300) would grow at Bainbridge Island’s forecast of population growth or 0.70 percent per year for the next 20 years. Concentric assumed that peak demand would grow at the same rate and that the systemwide load factor and monthly usage patterns would remain unchanged during the forecast period. 4.3 DEBT SERVICE: PRINCIPAL AND FINANCING COSTS Concentric’s Base Case feasibility analysis assumes an aggressive timeline, where the City begins operation in 2021. This schedule reflects less than three years for the completion of the process and the transition to City operation and is considered aggressive, given the likelihood that a condemnation process will be required to establish the level of just compensation. The scenario analysis presented in Section 6 considers a shorter timeline for acquisition, completed in 2020, and a transition that is more typical of a condemnation proceeding of five to seven years, which would result in an acquisition date of 2024. As presented in Section 3, the City will need to raise capital sufficient to fund acquisition costs ($109.1 million) and related transaction costs ($8.7 million), and finance transaction and start-up costs ($29 million). Due to a federal law prohibiting the use of tax-exempt debt to finance the acquisition of utility property (i.e., $90.3 million of the acquisition costs) from an investor-owned utility, the City will be required to finance the acquisition with taxable revenue bonds. Other costs, including start-up, inventory, working capital and legal and consulting fees (totaling $56.5 million) can be financed with tax-exempt debt. Concentric assumes that both tax-exempt debt and revenue bonds would be issued for a term of 30 years.29 Annual debt service costs will be determined by the amount to be financed and the relevant interest rate. Concentric based its interest rate for tax-exempt debt on the Bloomberg value curve 30-year debt costs for State of Washington municipalities, with consideration given to an historical review of tax-exempt bond issuances, and the expectation that interests will rise between now and 2020. Since November 1, 2016, the yield on 30-year Treasury bonds has already increased 40 basis points (0.40 percent). In addition, the Federal Open Market Committee increased interest rates by 25 basis points in December 2016 and March 2017, and is projecting two additional 25-basis-point increases in 29 Shorter financing terms could be achieved and may provide for lower borrowing costs; however, the annual debt service on shorter term debt would be higher to reflect the prepayment of principal over fewer years. 36 Concentric Energy Advisors, Inc. 2017. Therefore, it is reasonable to assume that the coupon rate on tax-exempt debt would be 100 basis points higher than recent issuances to reflect a higher interest rate environment at the time when an acquisition would require financing. Based on these considerations, Concentric assumed a tax-exempt interest rate of 4.5 percent. To establish the interest rate differential (spread) between taxable revenue bonds and tax-exempt bonds, Concentric reviewed the interest rates for 30-year debt issued by Washington State PUDs over the last 10 years. Comparing bond rates issued by the same utility for the same duration normalizes the results for differences in interest rates that varying borrowing lengths and utility credit ratings. This analysis indicates that the spread between taxable and tax-exempt debt for issuances of similar term and credit rating is between 150-200 basis points. Concentric’s Base Case assumption for financing costs relies on the low end of the range, applying a 150-basis-point spread to the taxexempt interest rate of 4.5 percent to establish the taxable debt rate of 6.0 percent. Underwriting fees and other issuance expenses or “flotation costs” are assumed to be 1.5 percent of the borrowed amount, which is consistent with industry practice. These costs, which total $2.1 million, comprise the transaction costs category. In addition to financing the initial acquisition and start-up costs, the City will need to continue to reinvest in the system to replace aging infrastructure and to maintain the reliability of the system. Concentric assumed that the capital replacement program would be based on the depreciation rate of the assets. Typically, the determination of the depreciation rate of the system requires a statistical study of the aging of the existing infrastructure. Depreciation of transmission and distribution assets is usually in the range of 3.0 percent to 4.0 percent per year. Concentric has assumed a capital replacement rate of 4.0 percent and applied that to the average annual rate base of the new municipal electric utility, taking into consideration both the RCND of the existing system assets and additional investments made over the study period. It is assumed that capital replacement will be debt funded through incremental debt issuances every four years at tax-exempt rates. To the extent that interest rates continued to escalate, and tax-exempt debt costs increased over the study period and incremental debt issuances would need to be financed at higher rates. 4.4 PURCHASED POWER SUPPLY Purchased power is the largest component of the revenue requirement for any electric utility. The City is likely to have the option to procure power through the BPA. The BPA rate structure is a twotiered structure. BPA provides power under the “Tier 1” rate at below market rates. “Tier 2” rates are market based. Concentric understands that the BPA has set aside 250 MWa of “Tier 1” power to serve newly formed public utilities.30 The following are the standards of service that are applied by BPA to determine if a utility is eligible to be a BPA customer: Be legally formed in accordance with state and federal laws; Own a distribution system and be ready, willing and able to take power from BPA within a reasonable period of time; 30 The BPA has allocated 250 MWa to this program to be phased in over five two-year periods at a rate of 50 MWa per period. Concentric Energy Advisors, Inc. 37 Have a general utility responsibility within the service area; Have the financial ability to pay BPA for the federal power it purchases; Have adequate utility operations and structure; and Be able to purchase power in wholesale, commercial amounts.31 Once a utility meets these criteria, the utility can apply for Tier 1 power and the allocation of that power supply. The newly formed public utility is required to make a commitment to BPA to receive the service and must demonstrate the financial ability to pay for the power commitment. The commitment period is three years; The amount of Tier 1 power a newly formed public utility can receive is capped at the average percent of Tier 1 received by current subscribers; The total set-aside is 250 MWa, which will be phased in over five two-year periods of 50 MWa each; Larger utilities (with demand greater than 10 MWa) will phase in under Tier 1 service over a five-year period and the utility must contract for firm BPA transmission service. Based on data provided by PSE, Concentric estimates that the annual load for Bainbridge Island averages approximately 41 MWa. It is reasonable to assume that, at this load, Bainbridge Island would be able to meet its full load requirements at Tier 1 rates. While Concentric recognizes that the BPA process could result in up to a three-year waiting period to receive an allocation of Tier 1 power, the Base Case of this feasibility study conservatively assumes that BPA power would be available to Bainbridge Island at Tier 1 rates at the beginning of City ownership and operation. Concentric’s feasibility study also assumes that load per customer will remain flat, based on the expectation that customers would engage in energy usage management efforts to minimize any increases in electricity use. Customer growth was estimated to be consistent with Bainbridge Island’s projected population growth of 0.70 percent. The BPA capacity commitment period is three years, which means that the City would have a predetermined amount of capacity from BPA available for the first three-year commitment period. If load were to increase beyond the contractual commitment during the three-year period, it is possible that Bainbridge Island would need to procure the incremental power supply from either the regional power market or BPA Tier 2 rates. While it is expected that the market power prices and the BPA Tier 2 rates will be higher than the BPA Tier 1 rates, Concentric has assumed that Bainbridge Island could continue to receive Tier 1 power throughout the study period for its full requirements in this preliminary study. Figure 13 summarizes BPA’s 2016 rates and proposed 2018 rates. Concentric calculated the average Tier 1 rates assuming a split of 65/35 for the Heavy Load Hours (“HLH”) and Low Load Hours (“LLH”). The monthly average rates were then spread throughout the year based on Bainbridge Island’s historical usage per month as a percentage of the total annual usage. 31 38 See https://www.bpa.gov/power/pl/subscription/SFS_71a.doc. Concentric Energy Advisors, Inc. Figure 13: BPA Rates 2016 Energy Rate (mills/kWh) Month October November December January February March April May June July August September HLH 36.71 37.41 38.07 38.87 38.50 34.23 33.21 30.95 32.00 36.28 39.15 40.60 LLH 32.60 33.33 33.67 33.88 33.53 30.92 29.89 26.38 25.96 30.43 33.26 34.55 2018 Energy Rate (mills/kWh) HLH 38.81 39.00 41.27 41.56 42.19 36.27 31.98 28.50 28.39 36.25 41.99 40.80 LLH 33.60 35.75 36.87 35.21 37.25 33.2 29.92 20.83 17.86 28.80 33.61 34.32 The Base Case of the feasibility study assumes BPA’s power rates escalate at 3.5 percent every two years which is reasonable based on BPA’s historical and expected power rate increases. The feasibility study estimates power costs for 2021 to be $8.6 million. Purchased power expense increases over the study period based on the assumed increase in usage and the escalation in BPA rates. The assumption that the BPA power continues to be available at below market rates for the full requirements is a conservative assumption. As the FERC relicenses hydroelectric generating facilities, there have been additional restrictions placed on the usage of the rivers that power the hydroelectric fleet in the United States. Water volume restrictions intended to regulate river depths result in less output from hydroelectric facilities. While there are no specific license restrictions identified for the BPA assets at this time, assuming that the capacity of the fleet will not be affected by tighter environmental controls over a 20-year study period is a conservative assumption. It is important to note that BPA power prices depend in part on revenues that BPA is able to realize from sales to California. These revenues are likely to decrease as California develops solar and wind resources to meet its mandated Renewable Portfolio Standard of 50 percent renewable energy by 2030, resulting in lower sales and downward pressure on market prices. As California’s renewable capacity grows, CAISO expects curtailment of renewable energy capacity (due to insufficient load) to increase from 6,000–8000 MW in spring 2017 to possibly 13,000 MW by 2024. As California power prices trend downward due to an oversupply of power, and many industry experts expect prices to go negative at certain times of the year, BPA’s revenue from such sales will continue to erode and the result will be significant, long-term upward pressure on BPA’s power prices in order to maintain its financial reserves and preserve its credit rating. Concentric Energy Advisors, Inc. 39 4.5 TRANSMISSION EXPENSE Bainbridge Island will need to reserve and pay for transmission service to transport power first from BPA’s generating plants to BPA’s Kitsap substation and, second, from BPA’s Kitsap substation to the Agate Pass point of delivery to Bainbridge Island to serve its customers. This involves reserving transmission capacity on both the BPA transmission system and the PSE transmission system. On the BPA system, Bainbridge Island would need to obtain capacity on the Cascade North transmission path. Figure 14 summarizes the BPA projected transmission capacity availability on its system through 2027. Figure 14: BPA Projected Transmission Capacity Availability Long-Term Firm Available Transfer Capability (ATC) Cascade North 2018 2019 2020 2021 2022 2023 2024 2025 2026 TTC (MW) 547 380 213 41 0 0 0 0 0 As shown on Figure 14, BPA is projecting that the capacity on the Cascades North path will be fully subscribed by the end of 2021. These projections do not reflect the potential requirements to serve Bainbridge Island. Considering the timeline for the municipalization, it is uncertain whether or not Bainbridge Island would have access to sufficient BPA transmission to transport BPA power to its distribution system without an investment that either expands BPA’s capacity on the Cascades North path or some other investment that adds sufficient transmission capacity to serve Bainbridge Island. Concentric has not attempted to quantify the cost to alleviate the constraint, or to assess how that cost would be allocated across BPA’s system or assigned directly. Concentric has made the conservative assumption that transmission service would be available from BPA, and that there was no incremental charge assessed to alleviate any constraints on the Cascades North path. In addition to BPA transmission, Bainbridge Island would also need to obtain firm capacity on PSE’s transmission system and pay for this service under PSE’s point-to-point firm transmission rates under its OATT. Under this scenario, Bainbridge Island would incur transmission costs on two transmission systems to receive BPA power at its transmission facilities. For the purposes of this study, Concentric assumed that BPA would absorb the cost of the PSE transmission system, resulting in a transmission expense to Bainbridge Island that is equivalent to the BPA tariff rates. 32 Based on 32 It is Concentric’s understanding that BPA has absorbed the transmission costs for transporting power across other systems for its customers. Therefore, Concentric has relied on this assumption in the 40 Concentric Energy Advisors, Inc. these assumptions that transmission service is available on BPA’s system without incremental cost and that Bainbridge Island’s transmission costs would be capped at the BPA tariff rates, Concentric considers the estimated transmission expense to be conservative. To estimate the transmission expense on the BPA transmission system, Concentric relied on the rates published in the BPA OATT shown in Figure 15. Figure 15: BPA Transmission Services and Rates Rate Schedule NT-18 ACS-18 ACS-18 Service Network Integration Rate— Long-Term Firm Service Scheduling, Control, Dispatch Service—Long-Term Firm Regulation and Frequency Response Rate $1.726/kW/month $0.368/kW/month $0.00013/kWh PW-18 WECC Service Rate $0.00005/kWh PW-18 PEAK Service Rate $0.00005/kWh Billing Factor Customer Load at BPA Peak Hour in Month Customer Load at BPA Peak Hour in Month Customer Total Load in Control Area Customer Total Load in Control Area Customer Total Load in Control Area As shown in Figure 16, BPA’s rates are charged on both a demand basis ($/kW-month) and a usage basis ($/kWh). Concentric applied these rates to Bainbridge Island’s estimated demand and usage. As shown in Figure 16, the estimated annual expense for transmission service from BPA in 2021 is $1.2 million, based on the assumption that BPA will absorb the cost of wheeling on PSE’s transmission system. Figure 16: 2021 Projected Transmission Expense BPA Rates NT-18 ACS-18 ACS-18 PW-18 PW-18 Description Network Integration Rate—Long-Term Firm Service Scheduling, Control, Dispatch Service—Long-Term Firm Regulation and Frequency Response WECC Service Rate PEAK Service Rate Total Expense $954,152 $203,435 $32,763 $12,601 $12,601 $1,215,552 Preliminary Feasibility Study. At this time, Concentric is not aware of any agreements made between BPA and Bainbridge Island with respect to transmission costs. At PSE’s current OATT rate of $1.95/kw-month times Bainbridge Island’s peak load of 80,000 kW, the annual cost would be $1.95 X 80,000 X 12 months = $1,872,000/year, not counting ancillary services, losses or taxes. Concentric Energy Advisors, Inc. 41 BPA Transmission expenses were escalated based on two factors: increased usage and the expectation of rate increases from BPA. BPA transmission rate increases were assumed to be 6 percent every two years, consistent with BPA’s expected escalation rate. 4.6 OPERATIONS AND MAINTENANCE, CUSTOMER ACCOUNTS, AND ADMINISTRATION AND GENERAL EXPENSES Concentric reviewed the most recently reported financial statements and budgets for several Washington municipal utilities: Ferry, Franklin, Grays Harbor, Jefferson, Kittitas, Mason, and Pacific Counties. Concentric relied on the average expense per customer for the benchmark group as the Base Case operating costs for a newly formed municipal electric utility on Bainbridge Island. The benchmark data was used to establish the first-year cost estimates. The projections assume that all expenses were assumed to increase with inflation. Figure 17: Benchmarking Metrics Operating Expenses Expense Item Operations and Maintenance Customer Accounting Bainbridge Island Projected Expenses 2021 ($Million) $249.7 $89.1 Administrative and General $312.7 Total $651.6 In addition, Concentric considered low- and high-end cost estimates in the scenario analysis presented in Section 6. 4.7 ENERGY EFFICIENCY PROGRAM EXPENSES All Washington utilities that have at least 25,000 customers are required to offer energy efficiency programs under Chapter 19.285 RCW. Bainbridge Island, as a stand-alone utility, will not be required to provide energy efficiency programs to its customers. However, Bainbridge Island residential and business customers have taken advantage of PSE’s energy efficiency programs. As shown in Figure 18, participating residential and business customers on Bainbridge Island have received rebates and other investments with an average annual value of approximately $640,000. This figure represents the out-of-pocket payments to customers and does not include any allocation of the administrative costs incurred by PSE that are incurred to design, market, administer and report the results of these programs. 42 Concentric Energy Advisors, Inc. Figure 18: Participation of Bainbridge Island Customers in PSE’s Energy Efficiency Programs ($000) Residential 2012 2013 2014 2015 2016 Average $431.9 $612.9 $435.7 $366.5 $461.2 $461.7 $124.6 $224.6 $157.2 $282.0 $177.1 $737.5 $660.3 $523.7 $743.2 $638.8 Commercial $97.2 Total $529.1 PSE has other energy efficiency programs in partnership with retailers, including discounts and rebates for lighting and energy efficiency showerheads, that are not tracked by customer location within the PSE service area and therefore these programs are not included in the total energy efficiency program costs summarized in Figure 18. There are distinct considerations regarding energy efficiency programs and the effect of these programs on the Preliminary Feasibility Study: (1) whether the energy efficiency programs will be offered by a municipal electric utility; and (2) how the municipal electric utility will address the costs of commercial energy efficiency investments that were made under long-term customer agreements with PSE. While there is no obligation for the City to continue to offer energy efficiency programs through a municipal electric utility, in the Base Case of the feasibility study Concentric assumes that these programs will continue at average funding levels over the past five years to preserve an applesto-apples comparison with continuation of PSE service. Concentric has assumed that funding levels are reduced by 50 percent in the Lower Bound scenario presented in Section 6. Should the City acquire the utility, it will be necessary to reimburse PSE for the investment made in energy efficiency programs for commercial customers if those investments were made within the last 10 years.33 PSE estimates this obligation to be approximately $250,000 from 30 customers based on a 2017 transition. In all cases, Concentric assumed the continuation of PSE’s investment in energy efficiency incentives for commercial customers until the assets were to transfer ownership, which results in a buyout amount for these incentives of approximately $275,000 in 2021. 4.8 LOW-INCOME ASSISTANCE PROGRAM EXPENSES Concentric assumed that a newly formed municipal electric utility would continue to provide the same level of support for those customers as would be provided if those customers continued to receive service from PSE. Over the period from 2010 through 2016, PSE has provided a total of $188,950 of low-income assistance to customers on Bainbridge Island, an annual average expense of $27,000. In the Base Case, Concentric relies on this annual estimate of the contributions to this program and escalated the cost at the rate of inflation for the study period. 33 The terms of PSE’s agreements with commercial customers require that the customers continue to receive service from PSE for a period of 10 years after PSE invests in energy efficiency measures for the benefit of those customers. Concentric Energy Advisors, Inc. 43 4.9 TAXES There are three taxes that affect the utility revenue requirement, the rates that customers pay, and the funds available to the City to fund community services. Washington Public Utility Tax: Pursuant to Chapter 82.16 RCW, PSE collects the Washington public utility tax, currently assessed at 3.873 percent of gross revenue. This tax is collected in PSE’s rates. The majority of these revenues (over 95 percent) are credited to the state general fund. A Bainbridge Island municipal electric utility would also collect the public utility tax. The tax contributes to revenue requirements and would be included in the calculation of electricity rates under either utility ownership option. Bainbridge Island Municipal Utility Tax: Bainbridge Island assesses a separate municipal utility tax. In 2016, the revenue generated through this tax was $1.4 million. This tax is not embedded in PSE’s tariffed rates, but is itemized on the PSE invoice for Bainbridge Island customers. PSE acts as an agent to collect this tax. The entire amount of this tax is transferred by PSE to the City. If Bainbridge Island establishes a municipal electric utility, the tax would continue to be collected as a surcharge to customer rates, with the municipal electric utility now serving as the agent. Since the tax is collected via a surcharge and all revenues are transferred to Bainbridge Island, municipal utility tax revenues are not included in utility revenue requirements and are not reflected in the calculation of electricity rates under either utility ownership option. Property Tax: PSE, as a private corporation, pays property taxes on the assessed value of its assets located on Bainbridge Island. These taxes are included as an expense in PSE’s revenue requirements and are reflected in the calculation of electricity rates paid by all of PSE’s customers. Property taxes benefit the City (approximately 63 percent of property tax revenues) and Kitsap County (the remaining 37 percent). If the City were to own and operate the electric utility, PSE will no longer pay property taxes and these revenues will no longer be available to fund services provided by the City and Kitsap County. In the case of Bainbridge Island, the City would need to find an alternative source of funds (approximately $150,000) to maintain the current funding of City services. These services include schools, fire department, general fund obligations, parks and services. In the Base Case, Concentric’s analysis assumes that a Bainbridge Island electric utility would replace the funding for the local services that are currently funded through the PSE property taxes. In 2016, the portion of the property tax rate that was related to these services was approximately 6.75 percent of the assessed value of PSE’s property on Bainbridge Island. Over the study period, Concentric assumed that the revenue derived from property taxes would increase at the rate of inflation, which is a conservative assumption based on the historical escalation in property assessments on Bainbridge Island. In 2016, Bainbridge Island property value assessments increased substantially, 10.1 percent for the average residential property. In the Preliminary Feasibility Study, Concentric estimated the revenue from property taxes in each year based on the depreciated value of the asset purchase and the incremental investments made to maintain the system. 44 Concentric Energy Advisors, Inc. 4.10 PROJECTED REVENUE REQUIREMENT FOR BAINBRIDGE ISLAND MUNICIPAL ELECTRIC SERVICE Figure 19 summarizes the projected revenue requirement for electric utility service for the 20-year period from 2021 through 2039. Figure 19: Bainbridge Island Projected Revenue Requirement Concentric Energy Advisors, Inc. 45 SECTION 5: FORECAST OF PSE REVENUE REQUIREMENTS AND RATES The assessment of the financial feasibility of the Bainbridge Island municipal option depends critically on the rates that Bainbridge Island customers can expect to pay should PSE continue to serve Bainbridge Island. This section summarizes the assumptions used to project the cost of service if Bainbridge Island were to continue to receive service from PSE. Changes to PSE’s retail rates are approved by the WUTC and occur primarily through rate cases that update the calculations required to establish rates to reflect changes in the cost of service as well as changes in the number of customers and energy demand by customer class. Changes to the cost of service determine the revenue requirements that rates will be designed to collect; changes to the number of customers and energy demand will affect the allocation of these revenue requirements to each class of customers (residential, commercial, industrial, etc.) and the calculation of the specific rates that appear on customer bills. PSE will also change the total rate for electricity by petitioning the WUTC to change rates to reflect a significant change in the cost of power supply. For purposes of this Preliminary Feasibility Study, Concentric has estimated the periodic changes through rate cases, beginning with the ongoing PSE rate case that was filed in January 2017. The ongoing rate case requests a 3.2 percent increase in rates in Docket UE-170033. Based on the WUTC’s allowed suspension period, the rates that are decided in that case will be in effect in 2018. For purposes of this Preliminary Feasibility Study, and to be conservative, Concentric has assumed that PSE is granted its full rate increase by the WUTC.34 Concentric projected the revenue requirement increases for PSE over the remainder of the 20-year study period by estimating the timing of future rate cases and the average expected increase for each rate case. The basis of those projections is a review of the history of PSE rate cases over the past decade, a period in which PSE and other utilities have been experiencing slowing sales growth and continuing investment to replace aging infrastructure. This historical period is a reasonable indicator of the next two decades. Based on that analysis, Concentric’s Base Case assumption is that PSE will file a rate case every two years and receive a 3 percent increase in rates that is applied equally to all customer classes and rate elements.35 34 35 46 The WUTC rarely approves the full amount of a requested utility rate increase. PSE’s requested 2018 increase is slightly higher than 3 percent at 3.2 percent. Concentric Energy Advisors, Inc. SECTION 6: PRELIMINARY FEASIBILITY STUDY FINANCIAL RESULTS 6.1 INTRODUCTION This section presents the quantifiable assessment of the two alternatives: municipalization and continuation of service to Bainbridge Island by PSE. Concentric has also assessed certain nonquantifiable but important considerations in Section 7. The determination of net financial consequences to Bainbridge Island customers from the decision to form a municipal electric utility is assessed by a comparison of the revenue requirement that is projected for municipal operation of the electric utility to the electricity expenditures by Bainbridge Island customers under a continuation of service with PSE. The quantifiable impacts are addressed in this section through consideration of a “Base Case” and two scenarios that bound the results. The discussion in Sections 3 and 4 focus primarily on the reasoning for Base Case assumptions, although the discussion also identifies sources of variability and uncertainty, implying that an assessment of these uncertainties will provide useful insights. Each scenario, including the Base Case, represent an internally consistent and integrated set of key assumptions. A major driver of financial results is the timing of a transition from PSE to a City municipal electric utility. The uncertainty with respect to timing is attributable to the initiation and duration of a condemnation proceeding. As described in Section 2.5, a municipalization can take anywhere from 4 to 10 years. The total costs will increase as the duration is extended due to higher legal and consulting fees and continued escalation of both capital and operating costs. These elements are present on Bainbridge Island, as well as potential increases in BPA-related supply and transmission expenses due to unique circumstances. Concentric has assumed that the transition occurs in 2021 in the Base Case, 2020 in a scenario designed to arrive at a reasonable Lower Bound on costs, and 2024 in a scenario designed to determine a reasonable Upper Bound. Additional insights are provided by testing the sensitivity of the Base Case results to a change in a single assumption. Scenario and sensitivity analyses combine to provide a more robust understanding of the potential financial feasibility of a municipal electric utility than is possible by limiting the assessment to a single Base Case. 6.2 BASE CASE RESULTS Figure 20 compares the Base Case revenue requirement that is projected for a municipal electric utility beginning in 2021 to the Base Case projected revenue from PSE’s continued service to Bainbridge Island. As shown in that figure, the net present value of the comparison indicates that there would be a net financial loss of $74.5 million over a 20-year period from municipal ownership and operation of the electric utility as compared with a continuation of service with PSE. Concentric Energy Advisors, Inc. 47 Figure 20: Base Case Scenario: 2021 Transition As shown in this figure, the Bainbridge Island operating cost is greater than the PSE operating cost in each year of the study. Debt service is approximately one-third of the operating cost in the initial years of the feasibility study. On a net present value basis, over 10 years, the incremental cost of municipal operation of the Bainbridge Island electric utility is $36.6 million. 6.3 SCENARIO ANALYSES As noted above, scenarios have been developed by moving the transition date forward one year to 2020 to establish a Lower Bound on the costs to form and operate a municipal electric utility and back three years to 2024 to establish a realistic Upper Bound. All assumptions have been adjusted to create internally consistent sets of assumptions for each scenario. In certain cases, the assumptions vary based primarily on the impact of capital or operating cost escalation periods. However, in certain other respects, the variations among scenarios are attributable to more substantive variations. Substantive variations are explained in Figure 21, which presents the most significant variations among the three scenarios. 48 Concentric Energy Advisors, Inc. Figure 21: Scenario Assumptions ($Million, unless otherwise indicated) Cost Category Lower Bound 2020 Base Case 2021 Upper Bound 2024 Explanation 1. BI: Forming the Utility - Severance switching station costs range from $0.5 to $8.1 million Acquisition Costs $100.9 $109.1 $153.1 - Going concern value ranges from $8.4 to $29.2 Million - Incremental capex $10.1 to $29.5 Start-Up Costs $26.0 $29.0 $39.7 - Initial capital expenditure range from $17.0 to $23.7 million 2. BI: Operating the Utility Operating Costs ($/Customer) $434 $574 $802 - Benchmarking dates for Lower and Upper Bounds set by low/high of study. Base Case is mean of study. Cost of Debt (Revenue Bonds) 5.75% 6.0% 6.5% -Base Case is expected financing, Lower/Upper Bound are theoretical. 4% every two years 3% every two years 2.3% every 3 years 3. PSE: Rate Increase (%) As shown in Figure 21, the key assumptions that have the most significant effect on the feasibility study include costs related to the formation of the municipal electric utility, specifically the acquisition costs and the start-up costs. In addition, the capital replacement rate, operating costs and cost of debt have a significant effect on the cost of municipal electric service. Finally, since the Feasibility Study is a comparative analysis, the results are also affected by the assumptions made with respect to the timing and magnitude of PSE’s projected rate increases. The results of the Lower and Upper Bound scenarios are summarized in Figures 22 and 23. Concentric Energy Advisors, Inc. 49 Figure 22: Lower Bound Scenario: 2020 Transition 2020 2021 2024 2023 2034 2033 {5000} P3P Est Rate Retenue 5 25,602 5 25,602 5 23,204 5 31,442 5 36,465 5 40,621 Bainhridge Island Municipal Electric Cost of Sen-ice Deli-t Set-rice {Principal 3: Interest} 5 3,631 5 3,631 5 10,226 5 12,003 5 13,323 5 16,363 Supply Delitery Purchased Power 5 3,445 5 3,445 5 3,313 5 3,230 5 10,531 5 11,253 EPA Transmission Esp ense 5 1,216 5 1,216 5 1,230 5 1,533 5 1,231 5 2,065 03:11 Expenses Operations and Maintenance Expense 5 4,243 5 4,243 5 5,222 5 6,112 5 2,162 5 3,332 Customer Accounting 462 Administrative General 5 1,044 5 1,044 5 1,143 5 1,346 5 1,526 5 1,342 Energy Assistance Pro gram ?'ashington State Utility Tax 5 331 5 331 5 1,031 5 1,212 5 1,411 5 1,5 24 Energy E?ciency 532 Total BI Hunicipal Cost of Sen-ice 5 26,233 5 26,233 5 23,021 5 32,343 5 36,310 5 43,606 Replacement Property Taxes 243 Total Bainbridge Island Cost 5 26,356 5 26,356 5 23,242 5 33,032 5 32,030 5 43,355 {lity Estimated Sawings 3 "fear 5 {1,350} 5 {1,350} 5 {1,033} 5 {1,535} 5 {564} 5 {3,134} Net Present Value 10 "fear Savings 5 {3,620} Net Present Value 20 "fear Savings 5 {15,322} ("mHm'CEHgIms' In: Figure 23: Upper Bound Scenario: 2024 Transition The Lower Bound scenario assumes acquisition in 2020. As a result, the acquisition cost assumption is lower because it does not include the additional year of incremental capital investment. In addition, this scenario assumes lower estimates of going concern, operating costs, financing costs and capital replacement as shown in Figure 21. Finally, the Lower Bound scenario assumes that PSE’s rate increases are greater than historical precedent. Even with these more favorable cost assumptions, the municipal operation would result in a cost that is greater than the cost of service from PSE. Over a 10-year period, the cost increase is $8.7 million on a net present value basis. The Upper Bound scenario considers an acquisition date of 2024 and higher acquisition costs. Based on the Upper Bound assumptions summarized in Figure 21, the cost of municipal ownership and operation of the Bainbridge Island distribution system would exceed the cost of PSE service by $87.6 million over a 10-year period on a net present value basis. Concentric Energy Advisors, Inc. 51 6.4 SENSITIVITY ANALYSES Concentric also performed several sensitivity analyses examining the effect on the Base Case results of changing one assumption at a time. These analyses are described in Figure 24 on a line item basis. Figure 24: Sensitivity Analyses to Key Assumptions Change in 10-year NPV of Savings/(Costs) Figure 24 demonstrates the sensitivity of the feasibility study to key assumptions. As shown in that figure, a 10 percent change in the acquisition cost has an annual effect of approximately $1.0 million and a net present value of $6.7 million over 10 years. A 1 percent point change in the capital replacement rate from 4 percent to 5 percent, applied to an increasing rate base, results in an increase in cost of $7.9 million on a net present value basis over 10 years. 52 Concentric Energy Advisors, Inc. Changes in power and delivery costs of 10 percent result in a change in the cost to customers of $6.6 million on a net present value basis over 10 years. The operating and maintenance costs have a lesser effect on value than the other key assumptions, $2.2 million on a net present value basis over 10 years. Changing the cost of debt has a much smaller effect on value compared to other key assumptions. A 0.5 percentage point increase in cost of debt to 6.5 percent results in a $1.3 million decrease on a net present value basis over 10 years. Lastly, changes in PSE’s rates have a significant effect on value. A rate increase of 2.3 percent at a frequency of every 3 years results in a decrease in value of $8.1 million, whereas a rate increase of 4 percent every other year leads to an increase in value of $5.4 million on a present value basis over 10 years. Concentric Energy Advisors, Inc. 53 SECTION 7: OTHER FACTORS TO BE CONSIDERED 7.1 FUTURE INVESTMENT CONSIDERATIONS OF BAINBRIDGE ISLAND In its RFP, the City identified the possibility of undergrounding the transmission and distribution systems on Bainbridge Island as possible improvements to the system under City ownership.36 Because the net present value of the feasibility study was not positive, meaning that the cost of operation under City ownership would be greater than PSE ownership, Concentric did not evaluate the cost of undergrounding the transmission and distribution systems and the effect of those investments on the revenue requirement over the study period. However, a high-level estimate of the cost of undergrounding the system per mile was developed and Concentric applied that to the existing overhead primary conductor on Bainbridge Island as a means to assess the cost of undergrounding distribution systems. Figure 25 summarizes the cost estimates to underground the overhead primary conductor located on Bainbridge Island. Undergrounding of overhead secondary conductor and secondary services as well as the cost to rebuild a customer’s service entrance from overhead to underground are not included in the analysis. Figure 25: Estimated Cost of Undergrounding Distribution Primary Conductor Type 1 ph Lateral 2/3 ph Lateral Feeder Total Cost Approx. Circ. Miles 81 31 29 Conversion Cost Range Avg. High $70,894,926 $110,335,203 $30,241,895 $60,068,173 $45,466,954 $86,472,229 $146,603,775 $256,875,605 In addition, a high-level cost estimate to underground the existing 115 kV transmission links on Bainbridge Island was also developed as a means to assess the cost of undergrounding these lines. Based on approximately 15.75 miles of transmission lines, it is estimated that the range of potential costs to underground the transmission would be between $90 million and $180 million. Additional considerations in the cost of the project include adverse digging conditions, access issues, the cost of acquiring additional rights-of-way, permitting engineering, rerouting, legal expenses and environmental considerations. 7.2 SERVICES TO BE PROVIDED BY PSE AND BAINBRIDGE ISLAND An examination of PSE’s tariffs reveals the extent of services that are offered by PSE. The City will need to determine whether to offer all of these services or a more limited set. Differences between 36 The potential for a City utility to develop broadband service has not been considered in this study to preserve an apples-to-apples comparison between the two options. PSE does not currently contemplate entering the broadband business for Bainbridge Island or other parts of its service territory. 54 Concentric Energy Advisors, Inc. the service menu and the costs of providing each service should be considered when comparing the two options. PSE offers two residential services (individual customer and master-metered), twenty commercial and industrial services (with variations by size, type of customer, and commitment to serve), ten outdoor lighting services, and several ratemaking adjustments that are associated with services such as low-income, energy conservation, and distributed energy production.37 For example, the City will need to measure and bill net energy produced by customer-sited solar according to a published tariff. This will require a determination as to how much compensation is provided to customers that produce more electricity than they consume during a billing period. PSE essentially compensates customers at the applicable retail rate for energy production that either reduces purchases from the utility or provides excess supply to PSE. This effectively shifts the responsibility for recovering fixed costs of providing delivery service from the solar customer to all other customers, a matter of controversy in many states. The City will need to determine how it wants to compensate its solar customers and then implement the approach. To the extent that a higher proportion of customers take advantage of PSE’s net energy metering tariff than other parts of PSE’s service area, this will place upward pressure on electricity rates unless the City decides to reduce the level of compensation to solar customers. This is just one example of the need to carefully evaluate each and every service that is currently being provided by PSE and determine whether— and on what terms—the service will be provided by the City utility. 7.3 OTHER NONQUANTIFIABLE CONSIDERATIONS There are several nonquantifiable considerations that have an impact on the comparison of the two options. These include the ability to provide adequate regulatory oversight and supervision, potential impacts on reliability and the quality of service more generally, the ability of the two utility options to take advantage of technological advancements, and the ability to execute on clean energy and other societal goals. PSE is regulated by the WUTC. This oversight takes several forms. It includes a review of every major investment decision by PSE and approval of the terms under which new services can be offered, including price. It also includes the oversight of quality-of-service issues, including the resolution of customer complaints. The WUTC reviews supply, transmission and distribution planning activities to ensure that they support the provision of safe, reliable and affordable service as well as other public policy objectives. These functions respond to the recognition that electricity is an essential public service that enables the well-being of citizens, the ability of local businesses to thrive and grow, and the achievement of environmental objectives. The WUTC wields considerable regulatory authority over PSE, subject to legal restrictions that require that PSE be allowed a reasonable opportunity to earn a fair return on invested capital. The WUTC can preclude PSE from both a return 37 By way of example, JPUD terminated a favorable rate that had been provided to public schools, resulting in significantly higher costs to these customers. Concentric has assumed that the current service offerings and character of service will be continued by the City. Concentric Energy Advisors, Inc. 55 on and return of any investment that it deems to have been imprudent. The WUTC is composed of three members appointed by the Governor, supported by a professional staff of 150. The public interest requires that the City establish mechanisms to perform these same functions. This is achieved in various ways and may include a publicly elected “light board” that reviews all major decisions and approves any changes in the prices to be charged. While local authority has its advantages, it should be weighed against potential organizational and competency challenges of overseeing a relatively complex industry. In particular, overseeing quality of service requires the ability to assess the trade-off between desired improvements in the quality of service and both the implementing actions and costs of achieving such improvements. This may require periodic retention of outside engineering and financial expertise to perform these oversight functions. The electric industry is currently undergoing a transformation that is being driven by a goal to interconnect solar energy and other distributed resources to the network and advances are being made in information and communications technologies necessary to operate and maintain the distribution network with larger penetrations of these resources. Many utilities are also implementing smart meters and associated systems in an effort to improve the efficiency of the network and provide opportunities to customers to save on their energy bills by changing their usage patterns. There are substantial economies of scale associated with the information and other systems that are required to support distributed resources and smart meters. Large utilities can plan, implement and operate these systems. 56 Concentric Energy Advisors, Inc.