This is a very interesting assessement of the problems plaguing ECP and the derailing of HGS. It was written by the chairman of the Montana Public Service Commission, Greg Jergeson:
I have been asked to offer some observations about the causes and effects of the demise of the proposed coal-fired Highwood Generating Station. These observations are my own and do not reflect the position of the Montana Public Service Commission, since there is no legal context in which the Commission could approve or disapprove the project. Nothing in these comments should be mistaken as an argument that Montana abandon the legal framework that makes Cooperatives self-regulated member-owned business entities, and put them under the regulatory authority of the PSC.
I agree that it was green issues that did this project in. However, it was not environmental “green”, as seems to be the common wisdom on the matter, but rather financial “green.” A doubtful and flawed business plan has always been the Achilles heel of this project.
When the project first came to my attention, it was easy enough to not give it a great deal of thought. The ownership of the project was under the auspices of a cooperative and, therefore the PSC would have no jurisdiction over the matter. Second, siting authority is not with the PSC, but rather with the Department of Environmental Quality. Besides, the PSC had plenty on its plate dealing with the disastrous “electricity deregulation” regime enacted by the 1997 legislature, among other things.
Only when the peculiar membership structure of Southern Montana Electric (SME) became apparent, did I contemplate that the PSC might have anything to do with the matter. Unlike most “Generation and Transmission Cooperatives” which are cooperatives of cooperatives, SME was set up to have six members of which five were local cooperatives. The sixth member, Electric City Power (ECP), established as a power marketing entity by the City of Great Falls, was meant to operate under the legal framework of “electricity deregulation.” I privately surmised that this association of five cooperatives and one non-cooperative would not prove to be a marriage made in heaven. More about that later.
In any case, ECP was required, under terms of the 1997 “electricity deregulation” act, and amendments adopted by the 2003 legislature, to secure a power marketing license from the PSC. As I was contemplating whether those contested case proceedings before the Commission could or should become a referendum on the Highwood Station, leaders of cooperatives along Montana’s highline and Rocky Mountain front began to proffer their opinions to me that the Highwood Station was a flawed business proposition.
From those conversations, it became apparent that an enormous schism had developed among Montana’s electric cooperatives. Before SME, those five cooperatives were members of Central Montana Generation and Transmission Cooperative. When those five cooperatives couldn’t convince Central Montana G&T to build a coal fired plant to replace their expiring BPA contracts, they essentially seceded from Central and formed SME.
As I understand it, the assessment of the cooperatives that stayed with Central G&T was that the Highwood Station project would not provide low-cost power for their loads, and they were unwilling to obligate their memberships to an expensive and risky proposition.
As a consequence of those conversations, I began examining the economic and business issues at stake in the proposition for the Highwood Station. From that examination, I have concluded that Highwood Station proposal was, from the beginning, a seriously flawed business proposition and subsequent events have only proven that to be the case. If the membership of SME had been solely made up of cooperatives, my reaction would have been que sera sera. However, the inclusion of ECP was predicated on the notion that ECP would go out and capture customers from NorthWestern Energy (NWE) under the regime of “electricity deregulation.” SME needed ECP in order to develop a larger load that better matched the size of the Highwood Station since the member load of the five cooperatives was nowhere close to output proposed from Highwood.
Trying to match the characteristics of a base-load generation facility with a customer use profile given to peaking and troughing is like trying to drive a square peg through a round hole. It doesn’t fit. While there are technological reasons for a coal-fired plant to be operated as a base-load generator, the financial imperative is unequivocal. While the fuel, coal, is relatively inexpensive, the capital costs for coal fired plants are enormous. With enormous capital costs, a coal fired plant must be run near capacity 24/7 in order to achieve an amortized cost per unit of output, typically $/MWh, that anywhere matches the conventional wisdom that coal fired electricity is relatively inexpensive. Lets say for instance, that a coal fired plant could generate electricity for $50 per MWh when operated at capacity, that cost would nearly double if the plant were operated at 50% of capacity.
In order to understand why it is so important to match the characteristics of the generation resource to the customer load it is important to keep in mind that electricity is the ultimate in perishable commodities. Electricity electrons travel at near the speed of light, slowed only by the resistance of the wires over which it travels. Essentially it must be consumed as it is produced. If load is greater than production from a plant, the utility must secure other generation from resources flexible enough to ramp up in a timely manner. During those peaking hours, the cost of that electricity is typically quite high on the market. If load is less than production, surplus electricity from a coal fired plant will need to be sold on the market, typically at off-peak hours when prices are relatively low, frequently less than the stated cost of production for Highwood. The peak and non-pea k profile of the SME customers is very much in sync with the profiles of other customers in Montana and the northwest. As a consequence, these transactions will be a buy high, sell low proposition that will always have negative consequences for the member-owners of SME.
In the wake of the great 2003 blackout that hit the nation’s northeastern states, I have had occasion to attend several workshops and forums devoted to the issue of reliability. The professionals who work in this field get really antsy at the proposition that a single generating plant will be dedicated to serving a discreet load. With a single plant, the odds of “Murphy’s law” coming into play are enormous. When that plant goes down, the utility’s customers are either without power or the utility must scramble to bring alternative supplies on-line immediately. Going to the market for those kinds of emergency purchases is an extremely expensive proposition.
It always struck me as a bit curious that the public pronouncements from SME about the costs of power from the Highwood Station were always just a bit lower than the estimates Montana Dakota Utilities (MDU) was supplying to the PSC about their proposed construction of Big Stone II in South Dakota. When MDU suggested the cost from Big Stone II would be $47 per MWh, the proponents of Highwood claimed their cost at something less. Kind of reminds me of my neighbor whose crops, without fail, always outyielded mine by 5 bushels per acre and he always sold them for a dime more than I got. Keep in mind that MDU has a well deserved reputation for having one of the sharpest pencils in the industry. Maybe that is why they were able to go 20 years without asking the Montana PSC for an increase in customer rat es. Since their plan is to locate Big Stone II where a plant already exists, their siting issues are minimal. They already have a handle on coal supplies and the necessary rail and transmission infrastructure. Finally, Big Stone II would be just one plant integrated with all the other resources MDU owns and has at its disposal. Despite all these advantages MDU has with Big Stone II, the champions of Highwood always claimed less expensive electricity from their facility. Of course, one might just chalk this up to pure coincidence.
By the end of the 2005 legislative session, there was growing consensus that Montana’s experiment with “electricity deregulation” had proven disastrous. Consequently, the Electricity and Telecommunications Interim Committee of the Legislature and the Montana PSC began cooperating in drafting legislation to reverse the primary legal underpinnings of deregulation and move NorthWestern back into the paradigm of a vertically integrated utility owning its own generation assets with rates regulated by the PSC based on cost. That effort ultimately culminated in HB 25 which passed the 2007 session.
During the interim between the 2005 and 2007, various versions of the legislation were in circulation. The City Manager of Great Falls, John Lawton, asked for an opportunity to discuss that legislation with the PSC and request it be drafted in a manner that would not adversely impact their plans through ECP and SME to construct the Highwood Station. During that presentation, he laid out a very ambitious timeline during which ECP would consummate contracts with customers sufficient to match ECP’s ownership share of the project. Interestingly, later, as a spokeswoman for the City of Great Falls offered testimony to the House Federal Relations, Energy and Telecommunications committee (FRET) in opposition to HB 25, that testimony included information on ECP’s success in attracting customers. That testimony indicated that ECP was falling far short of the projections Mr. Lawton had presented to the PSC. Apparently, the potential commercial and industrial customers ECP was soliciting were not convinced that the product being offered them by ECP and SME was in their best financial interest.
While environmental challenges to the project have been blamed for the delays that made the project financially questionable, there were inevitable delays inherent in the role that ECP was to play in the whole project. While the cooperatives’ customer loads were locked in, ECP needed to lure their customer base away from other providers, primarily NorthWestern Energy. And as we have seen, by their own testimony on HB 25, ECP and the City of Great Falls were falling far short of their goals in attracting those customers. By the time HB 25 was heard in the Senate Energy Committee, the City was asking for a two to three year delayed effective date in HB 25 so that they would have that extra time to secure the customers they needed from NorthWestern. While the legislature did not approve that del ayed effective date in HB 25, the whole episode was further evidence that ECP and the City were unable to secure the customer load necessary for the project to proceed.
As it became apparent that ECP would be unable to attract customers representing load equal to their ownership share of output from the Highwood Station, ECP’s ownership share of SME and, ultimately, the Highwood Station, was reduced. Because new members could not be found to take up the ownership share no longer held by ECP, that burden shifted to the five Cooperatives. Like a bride’s dowry having been found to have been overstated, the marriage between ECP and the Cooperatives had been shaken.
Financing for the project was always problematic.
Reflecting this marriage not made in heaven, the financing arrangements would necessarily need to be bifurcated to reflect the status of the two kinds of owners of SME. The Rural Utilities Service (RUS) would be approached to finance the ownership share of the project represented by the Cooperatives, ECP’s share would be financed by the sale of tax free revenue bonds. RUS financing is limited to cooperatives, hence they could not be asked to finance the ECP share.
The assertion has been made by the leadership of SME that the RUS denied financing for the project due to pressure from environmentalists and Representative Henry Waxman of California. As I understand it, the truth of the matter is that the RUS could not be convinced that the SME business plan was sound since it carried all the features of a merchant generation plant. In order to capture economies of scale, the plant was sized well in excess of the current and anticipated load of the cooperatives’ customers. Since a base-load coal-fired plant has to be run as close to capacity as possible in order to minimize per unit costs, the Highwood Station would be generating surplus energy relative to their native load. That surplus would have to be sold on the market. Since the largest surpluses of electricity from the Highwood station would be generated during off-peak hours, there was enormous risk that that power would be sold during those periods when prices are lowest, frequently below the cost of production.
While conventional wisdom holds that government programs like USDA RUS might be relatively lax in their assessment of financial risk, I don’t believe that to be the case. When NorthWestern Corporation filed for bankruptcy in 2003, we had our PSC staff study the case histories of several utility bankruptcies around the country. Among those case studies, there were bankruptcies involving cooperatives financed by RUS. The outcomes of those bankruptcies were less than satisfying for those cooperatives, their members, and the RUS. Ever since, the RUS has been much more vigilant in their assessment of the business plans brought to them.
It is telling how Terry Holzer, manager of Yellowstone Valley Electric Cooperative, the one cooperative that has decided to terminate their relationship with SME, characterized the RUS denial for the loan. According to a story published in the March 18, 2009 Billings Gazette, at the annual meeting of the cooperative, Holzer cited financial unfeasibility as the reason for the RUS denial.
The ability of ECP and the City of Great Falls to sell revenue bonds in order to fulfill their financing obligation for the project was equally as problematic. These bonds would not be general obligation bonds backed by the “full faith and credit” of the City of Great Falls. Rather, as revenue bonds, they would be backed by the revenues of ECP from the customers they signed up for their service. Potential purchasers of those revenue bonds would only have to look at the inability of ECP to enroll the number of customers using the projected levels of electricity earlier projected to anticipate that ECP would similarly be unable to generate revenue sufficient to pay off the bonds. As if that were not bad enough, the commercial and industrial customers ECP had enrolled actually used less po wer than ECP had anticipated creating a whole new series of costs and losses, due, I believe, to the nature of their current power supply contract.
Late last year, the Great Falls Tribune reported that ECP and the City of Great Falls had discovered that, although their power supply rates per MWh were less than if they had taken their power from NorthWestern Energy, their power costs were actually more than if they had taken their power from NorthWestern. There appears to be only one logical explanation for this seeming contradiction. I believe their power supply contract was for a fixed amount of power, at per unit rates less than the NWE rate. However, when the ECP commercial and industrial customers, ever vigilant to guard their bottom lines, used less electricity than ECP had contracted for, ECP was still obligated to pay for the contracted quantity. Revenues from the customers fell short of the revenues needed to meet the ECP obligations i n the contract.
This last phenomenon lead to the final coup de grace that confirmed that the marriage between ECP and the cooperative members of SME was not made in heaven. Responding to grumblings from city leaders that the Great Falls operation would have been better off staying with NorthWestern Energy, SME suddenly announced a new, lower “blended” rate for ECP, which was readily accepted. However, I have seen no evidence that SME had suddenly secured a new, low-cost power supply in order to offer this new, lower “blended” rate to ECP. If they had, shouldn’t the benefits of such a lower cost supply been used to benefit all the customers of SME? Instead, it’s obvious they raised the rates on the cooperatives’ members in order to secure the cash to lower the rates for ECP. As confirmation of this observation, the March 18, 2009 Billings Gazette article reports “Holzer also railed against substantial cost breaks given to the city of Great Falls, at the expense of SME’s member co-ops. While the co-ops were hit with surcharges and rate increases, the city got a pass, he said.” “All of these (breaks) have added up to million and millions of dollars of subsidies (from the co-ops) to the city of Great Falls,” he said.
I also agree with Terry Holzer’s assessment of the gas-fired plant SME now says it is considering. While I described the coal-fired plant as akin to trying to drive a square peg through a round hole, this gas plant would be like trying to drive a round peg through a square hole. Again, the mismatch of the resource with the load profile would constitute a major flaw in the business plan and that flaw would constitute a huge obstacle for financing.
At this winter’s Council of Cooperatives meeting in Helena, a leader from one of the non-SME cooperatives asked me “When is someone going to finally drive a stake through the heart of this beast?” I agree that it is well past time to stop throwing good money after bad. However, there is no state government entity with authority to end the project, not the PSC, not the Legislature, nor the Governor. That authority rests solely with the voters of Great Falls and the members of the four remaining SME cooperatives. There are municipal elections in Great Falls this year, and cooperatives have annual meetings every year where their members elect some of their board members. To be sure, the incumbent power structure, in both the City of Great Falls and at each of the four cooperatives, is likely to resist. But an aroused and engaged electorate and membership can work their will.
Greg Jergeson, Chairman
Montana Public Service Commission
