Offers Towns Prepayment Savings
(from Maine Townsman, May 1997)
By Lee K. Bragg, Esq., Bernstein, Shur, Sawyer & Nelson
Central Maine Power Co. (CMP), Maines largest electric utility company, has obtained a rate tariff from the PUC which authorizes the company to sell electricity to towns and schools at substantial discounts. The contracts are available to customers with annual power bills in excess of $100,000. The contracts can range from 3 years to 10 years. The basic structure of the proposal is straightforward. CMP gets all of the purchase price up front and the town gets a discount which is based on CMPs cost of capital. The arrangement works primarily because the town can borrow money at interest rates which are lower than the interest rates available to CMP.
The money which the town gives CMP replaces the money which CMP would otherwise have to borrow at taxable rates. CMP passes all of its savings on to the town through the discount. The savings are equal to the difference between the discount and the amount of interest the town must pay on the money it borrows. The proposal is being driven by CMPs desire to strengthen its capital position and client base in the face of deregulation.
CMP has teamed up with an investment banking firm to market these contracts. The banking firm serves as the lender in the transaction. Its sole purpose is to loan money to CMPs customers so that they can buy the energy contracts. The transaction is similar to buying a new car and financing it through the car dealers financing agency.
From an economic standpoint, the CMP proposal is attractive in its current form. Based on annual energy costs of $100,000 a municipality could achieve savings of more than $5,000 per year under the 5-year proposal ($25,000 total) and savings of more than $10,000 per year under the 10-year proposal ($100,000 total). These projected savings are based on an interest rate of 6.9%. It may be possible to restructure the deal at a lower interest rate and substantially increase the savings to the town.
Municipalities will be able to terminate the contract with no penalty and receive a pro-rated refund if another source of electricity becomes available at a lower cost. The original contract which was approved by the PUC on November 5, 1996 does not contain a satisfactory escape clause. The minimum penalty for cancellation would be at least $10,000 under this version of the agreement. The amount of the penalty could be higher for towns buying more than $1 million worth of electricity.
A revised draft of the agreement contains a new section which eliminates the penalty if the reason for termination is the availability of electricity from another source at lower cost. The language in the draft contract has also been improved to state more clearly that the company will provide a refund of the non-utilized portion of the towns payment.
The primary flaw in the CMP proposal is the lack of security for the towns payment. Deregulation will be a reality within a few years. CMP may cease to generate its own electricity as a result of new legislation or as a result of competitive forces in the marketplace. It is not clear who would fulfill CMPs obligations under the contract if this happens. More importantly, CMP might lose the financial ability to refund the towns money if the contract is terminated.
Some consideration must also be given to the possibility, however remote at the present time, of a bankruptcy filing by CMP and the consequences for a town participating in this program. It is unlikely that a town would be able to recover any of its payment under the proposed arrangement. It will be necessary for the town to negotiate additional protection into the transaction before a contract is signed.
Towns and school administrative units should consult legal counsel familiar with public finance, energy issues, Public Utilities Commission proceedings and bankruptcy laws before entering into an agreement with CMP. A town could save a significant amount of money under this arrangement if the contract is negotiated carefully. It is not clear whether CMP will have the willingness or ability to address the issue of security for the municipalitys payment. Without additional security the CMP proposal presents too much risk to be a viable option for municipalities.