Opening the Back Door to Public Power: How the Vermont Public May Soon Operate their Investor-Owned

Transmission Utility

By: Brian Buckley Vermont Law School JD/MELP/Energy Certificate Candidate 2013

TABLE OF CONTENTS TABLE OF CONTENTS.. 1 I. INTRODUCTION.... 2 II. CONSOLIDATION OF THE AMERICAN ELECTRIC UTILITY INDUSTRY: HISTORICAL TRENDS............. 4 A. PUHCA and the Energy Policy Act of 2005... 4 B. FERC and Utility Consolidation...... 5 III. ELECTRIC UTILITY MERGER AND ACQUISITION IN AMERICA TODAY.. 6 A. Constellation-Exelon Merger and Conditions. 7 B. Northeast-Nstar Merger and Conditions.. 8 C. Duke-Progress Merger and Conditions.... 8 IV. PROPOSED MERGER OF CVPS AND GMP. 9 A. GMP, CVPS, Transco, and Velco.... 9 B. Vermonts Unique Utility Landscape... 10 C. Merger Approvals Required. 11 V. POSSIBLE CONFLICTS PRESENTED BY THE CVPS-GMP MERGER.. 12 A. Unresolved Prior Obligations... 13 i. The Windfall Sharing Mandate. 13 ii. CVPSs Penalty for Fortis Acquisition Agreements Withdrawal... 14 B. Questions Resulting from the Proposed Merger... 14 i. The Acquisition Premium.. 14 ii. Rate Adjustment through Alternative Regulation Plans... 14 iii. Market Distortion and the Fate of Smaller Utilities. 14 iv. Parent Company Influence and Velco Dominance.. 15 VI. PROPOSED SOLUTIONS FOR ENSURING THE PROTECTION OF THE PUBLIC INTEREST IN THE CONTEXT OF VELCO. 15 A. The Public Ownership Model.. 16 i. Economic Considerations.. 17 ii. Environmental Considerations. 18 iii. Reliability Considerations... 18 B. The Cooperative Ownership Model. 19 i. Economic Considerations.. 19 ii. Environmental Considerations. 20 iii. Reliability Considerations... 21 C. The Corporate Governance Reform Model. 21 i. Economic Considerations 24 ii. Environmental Considerations 24 iii. Reliability Considerations 24 VII. CONCLUSION AMD RECOMMENDATIONS 25

I. INTRODUCTION Since the days of Samuel Insul, the American electric utility industry has been regulated by state and federal commissions whose job it is to balance the need to incentivize investment in utilities with competing public policy interests, including but not limited to the rights of ratepayers.1 This is because the electric utilities exist within an industry deeply affected with the public interest due to the natural bottleneck created by its transmission system.2 The typical system used to ensure that this regulation is just and reasonable is a board of state public utility commissioners who must approve or reject any major action proposed by a utility.3 The electric utility industry has operated in this manner for more than a century. However, present history offers another option. This option casts aside the shackles of short-term, profit maximizing motives and pragmatically blends them with long-term public policy considerations; a conscious mind to supplement the invisible hand. President Roosevelt stated in his 1932 Portland Speech that public utility commissions have an inherent duty to advocate for the public interest4. This paper examines a scenario where an investor-owned utility (IOU)s board of directors might be held to a similar duty. Imagine a system that injects the public good directly into the design process of an electric utilitys proposals- before they are presented to regulators. This system would allow for advocacy of the
The regulating commission, my friends, must be a Tribune of the people, putting its engineering, its accounting, and its legal resources into the breach for the purpose of getting the facts and doing justice to both the consumer and investors in public utilities

-President Franklin D. Roosevelt, Portland 1932

See Generally, Forest MacDonald, Samuel Insull and the Movement for State Utility Regulatory Commissions, Vol. 32, No. 3, Autumn (1958) 2 Munn v. People of State of Illinois, 94 U.S. 113, 139, 24 L. Ed. 77 (1876) 3 Fed. Power Comm'n v. Hope Natural Gas Co., 320 U.S. 591, 601, 64 S. Ct. 281, 287, 88 L. Ed. 333 (1944) 4 Franklin D. Roosevelt, The Portland Speech, 9/21/1942, available at: http://newdeal.feri.org/speeches/1932a.htm, Accessed 4/21/12

public interest from a proposals inception; rather than using the term as a comparative regulatory yardstick. Specifically, this new option involves placing a majority population of well-informed public servants onto an IOUs board of directors. The duty of these directors, dictated through the bylaws and articles of incorporation of that utility, could provide decision-makers with an obligation to consider externalities relevant to the public good when utilizing their business judgment.5 The aim of this document is to examine ideas regarding transmission utility governance observed by the author in the context of Vermont Public Service Board (VT PSB) hearings and testimony. These hearings, known to the VT PSB as Docket 7770, explore the facets of the proposed acquisition of Central Vermont Public Service Corp (CVPS) by GazMetro, the parent company of Green Mountain Power (GMP) and subsequent merger of CVPS and GMP.6 This paper will examine several unique features of the relevant energy landscape and explain ideas from the frontier of electric utility governance. First, it will explain historical trends of the American electric industry as a whole; it is in the midst of a consolidation cycle.7 Second, it will examine specific actors throughout this industry to understand what steps they have taken to improve merger and acquisition prospects.8 Third, this paper will examine the Vermont energy landscape and--most specifically--the proposed merger of CVPS with GMP.9 Fourth, the paper will detail the conflicts that have begun to emerge as a result of the proposed

Alissa Mickels, Beyond Corporate Social Responsibility: Reconciling the Ideals of a For- Benefit Corporation with Director Fiduciary Duties in the US and Europe, 32 Hastings Intl & Comp. L. Rev. 271, 282 (2009) 6 Documents and Summary available at: http://psb.vermont.gov/http%3A/%252Fpsb.vermont.gov/docketsandprojects/electric/CVPS_GMP_Merger 7 . See infra text accompanying notes 13-21 8 . See infra text accompanying notes 22-27 9 . See infra text accompanying notes 28-39

combined corporation.10 Fifth, this paper then analyzes the solutions that have been proffered during the hearings of Vermonts public utility commission, the VT PSB.11 Finally, the paper concludes with comments on the proposed regulatory solution, a publicly-operated but investorowned transmission utility.12

II. CONSOLIDATION OF THE AMERICAN ELECTRIC UTILITY INDUSTRY: HISTORICAL TRENDS In order to best understand forces behind the merging of CVPS and GMP, one must first review a brief history of the American electric utility industry. This history will begin with background on the Public Utility Holding Company Act (PUHCA). It will then explain a trend toward consolidation in the electric utility industry since 2005. Finally, this explanation of historical trends will examine a recent rulemaking procedure of the Federal Energy Regulatory Commission (FERC). Analysis of these historical trends will help explain patterns of utility consolidation in the United States as they are today. A. PUHCA and the Energy Policy Act of 2005 On September 21st 1931, President Franklin Delano Roosevelt delivered an impassioned speech to the people of Portland denouncing electric utility monopolies and their regulators susceptibility to corporate capture.13 Shortly after, a Depression Era Congress was able to secure passage of the Public Utilities Holding Company Act (PUHCA). PUHCA spelled the end of an era defined by influence peddling of large public utility holding companies through: (1) imposition geographic contiguity requirements upon utility franchise area and (2) confinement of

10 11

. See infra text accompanying notes 40-53 . See infra text accompanying notes 54-93 12 . See infra text accompanying note 94 13 Roosevelt, Supra, at note 4

business pursuits to within only the energy industry. 14 In 2005, Congress passed the Energy Policy Act of 2005 (EPAct 2005), which effectively repealed PUHCAs aforementioned aspects and gave FERC oversight of public utility holding companies.15,16 In accordance with EPAct 2005, FERC could approve a utility merger if it found the merger: (1) to be in the public interest and (2) not to result in cross subsidization of a non-utility affiliate.17 This resulted in greater ability for utilities and non-utility firms to consolidate in pursuit of economies of scale. IOUs are driven to pursue economies of scale because, like most other entities that issue stock, they have a fiduciary duty to maximize profits for their shareholders. In most other industries, this profit maximization is accomplished through growth. A sluggish economy and the energy markets recent efficiency focus have forced IOUs to look outward for growth, in search of mergers and acquisitions.18 B. FERC and Utility Consolidation In 2010, the Department of Justice and Federal Trade Commission issued new rules on relaxing market concentration standards. These rules identified a market is not highly concentrated only if it has a Herfindahl-Hirschman Index (HHI) of 2,500 or more, and that a

14

The America Utility Industry After PUHCA Repeal: What Happens Next? , 2005, American Public Power Association. Available at: http://www.publicpower.org/files/PDFs/APPAreportAfterPUHCARepeal.pdf Accessed 4/21/12 15 Id. 16 For Congressional testimony regarding PURPA repeal and probable effects upon industry consolidation see 109th Congress. US House. Subcommittee on Energy and Air Quality. Energy Policy Act 2005 (H. RPT 109-1) available at: http://www.gpo.gov/fdsys/pkg/CHRG-109hhrg99906/pdf/CHRG-109hhrg99906.pdf Accessed 4/21/12. It contains the testimony of: Alan Richardson, CEO of the APPA (at 149-152); Mark Cooper, on behalf of the Consumer Federation of America and Consumers Union (at 171-173); Marty Kanner, on behalf of Consumers for Fair Competition (at 198-201); the Edison Electric Institute (at 208); the American Public Power Association (at 210-216); and Gerald Norlander, on behalf of the National Association of State Utility Consumer Advocates (at 402407) 17 18 C.F.R. 366, Energy Policy Act of 2005 1289 18 Adam Aston, Utilities Turn to Mergers as Demand for Power Slows, NY Times: Dealbook, Published 6/16/11 Available at: http://dealbook.nytimes.com/2011/06/16/utilities-turn-to-mergers-as-demand-for-power-wanes/ Accessed 4/21/12.

merger would be permitted if it didnt raise the HHI by any more than 200 points.19 FERC then conducted a year-long notice and comment process regarding this rule, which it decided to scrap in favor of its own, more rigorous definition of highly concentrated as 1,800 HHI points with mergers defined as anticompetitive if they would cause the HHI to rise more than 100 points. As justification for their decision, FERC noted that relaxing market concentration thresholds would not be in the public interest due to the distinctive characteristics of electric markets.20 This discussion of PUHCA and historical trends of industry consolidation will help one better understand the issues surrounding todays electric industry. This historical analysis shows that we are in the midst of another cycle of electric utility consolidation as a result of EPAct of 2005. IOUs are searching for growth through pursuit of mergers and acquisitions. An analysis of FERCs recent decision regarding electric utility consolidation further proves this analysis; FERC understands that this pattern warrants caution. This insight regarding the historical trends that underlie the electric utility industry in America is important for an evaluation of the recent wave of merger and acquisition activity, and subsequently, for understanding the CVPS-GMP merger.21

III. ELECTRIC UTILITY MERGER AND ACUISITION IN AMERICA TODAY The next logical step in understanding the forces behind the CVPS-GMP merger is to compare it to other electric utilities throughout current-day America. For the purposes of this analysis, the author has chosen three sets of utilities seeking regulatory approval for --or who
19

Re Analysis of Horizontal Market Power Under the Federal Power Act, Docket No. RM11-14-000, 138 FERC 61,109, Feb. 16, 2012 (F.E.R.C.). 20 4060 PUR Util. Reg. News 1 PUR UTILITY REGULATORY NEWS March 2, 2012 Mergers & Acquisitions FERC MAINTAINS STATUS QUO ON REVIEW STANDARDS 21 See Generally for 2011 US Utility Franchise Map: http://www.eei.org/whoweare/ourmembers/USElectricCompanies/Documents/EEIMemCoTerrMap.pdf Accessed 4/21/12

have recently consummated-- a merger agreement. These three pairs include the ConstellationExelon merger, the Northeast Utilites-Nstar merger and the Duke-Progress merger. A review of these transactions and the conditions of their regulatory approval will demonstrate that while the CVPS-GMP merger is unique, it is reflective of a much broader trend in the industry; a new type of merger where utilities have much to offer regulators in return for approval. A. The Constellation-Exelon Merger and Conditions The Constellation-Exelon merger, which closed on March 12th 2012, offers a numbers of public benefits in order to encourage regulatory approval. Exelon itself plans to sell a number of coal fired power plants so the combined company may reduce its coal generation capacity from 12% to roughly 6% of its total capacity.22 The combined company also plans to produce a number of other direct benefits including: a $100 rate credit to customers within 90 days; $113.5 million over 3 years into a fund for energy efficiency to serve low income ratepayers; 285300Mw of new generation based in Maryland; 120Mw of renewables and roughly 30Mw of solar in 3 years; a jobs freeze; divestiture of Baltimore Gas and Electric if Exelon goes bankrupt or drops six levels below investment grade; a new headquarters in Baltimore; and payment of a $245 million dollar fine to settle a suit brought by FERC for alleged price manipulation.23,24 This comprehensive list of conditions is indicative of an industry that is reaching for growth, and willing to offer quite a bit to achieve it.

22 23

Aston, Supra, at note 18 Ben Mook, PSC Approves Exelon-Constellation Merger, The Daily Record. Published 2/17/12. Available at: http://benmook.wordpress.com/2012/02/20/psc-approves-constellation-exelon-merger/ Accessed 4/21/12. 24 Hanah Cho, Constellation $245 Million Settlement for Trading is Largest Ever, Baltimore Sun. Published 3/12/12. Available at: http://articles.baltimoresun.com/2012-03-12/business/bs-bz-constellation-merger-completed20120312_1_ferc-baltimore-s-constellation-energy-group-grid-operators Accessed 4/21/12.

B. The Northeast Utilties-Nstar Merger and Conditions The Northeast Utilities-Nstar Merger, planned to close on April 4th 2012, also offers a number of public benefits in order to encourage regulatory approval. For example, Massachusetts regulators conditioned the approval of the merger on a power purchase agreement with Cape Wind. Nstar agreed that it would purchase one-quarter of the power produced by the fabled wind farm.25 Connecticut regulators were able to obtain several public benefits to make the merger more appealing including: a one-time credit of $16 million to Connecticut Light & Power customers; an almost 3 year rate freeze; $15 million to fund an energy efficiency program; $300 million in distribution investments; preservation of 1,000 undeveloped acres and the opportunity to preserve 8,500 more; employment freezes for line men; $40 million worth of Irene expenditures the utility wont ask to recover from ratepayers; and synergies that will send $350 million to Connecticut ratepayers over a ten year period.26 This long list of public benefits illustrates that state public utility commissions have a broad range of options when leveraging concessions from merger applicants. C. The Duke-Progress Merger and Conditions The Duke-Progress merger, set to close on July 1st 2012, doesnt offer much to state regulators in an effort to sweeten the proverbial pot. However, one condition FERC has imposed as a prerequisite of the merger is that the combined company would commit to spending $110 million to improve transmission reliability.27
25

Janice Podsada, CT Set to Rule on NU Settlement Today, But Lack of Alternative Energy in Settlement Rankles Some, Hartford Courant. Published 3/25/12. Available at: http://www.courant.com/business/hc-nu-mergeralternative-energy-20120325,0,2492823.story Accessed 4/21/12. 26 Luther Turmelle, Northeast Utilities, Nstar Merger in Home Stretch, New Haven Register, Published 3/26/12. Available at http://nhregister.com/articles/2012/03/26/business/doc4f711f04cd512614101824.txt Accessed 4/21/12. 27 Duke, Progress Submit New Merger Plan, The Times News, Published 3/26/2011. Available at: http://www.thetimesnews.com/articles/plan-53822-power-merger.html Accessed 4/21/12.

After reviewing three other proposed transactions it seems obvious that, while unique, the CVPS-GMP case is reflective of a broader trend in the utility industry. Electric utility investors are looking for growth, and one of their only avenues for growth in the age of efficiency and conservation is through mergers and acquisitions. While the Duke-Progress merger offers little to regulators by way of incentives for gaining approval, the Constellation-Exelon and Northeast Utilites-Nstar mergers show that state public utility commissions often have a broad range of options when leveraging concessions from merger applicants. As this document will soon discuss, this leveraging ability can also be seen in the Vermont Public Service Boards approach toward regulatory approval of the CVPS-GMP merger

IV. PROPOSED MERGER OF CVPS AND GMP Following the analysis of the forces that motivate utility consolidation in America today, this paper will now outline the constituent elements of the CVPS-GMP merger. First, it will discuss the specific IOUs at issue in this transaction: CVPS, GMP, Velco, and Transco. Second, it will explain the general electric utility landscape in Vermont. Third, it will discuss the hurdles to regulatory approval faced by merging electric utilities. This discussion will outline the constituent elements of the proposed merger and provide further insight and context as to why the CVPS-GMP merger presents possible conflicts for Vermont ratepayers. A. GMP, CVPS, Transco, and Velco On July 11th 2011, CVPS and GMP entered into a merger agreement where CVPS agreed to merge with Danaus Corp. (a wholly-owned subsidiary of Gazmetro created for the purposes of

the merger).28 There are four specific investor owned utilities directly involved in this merger: CVPS; GMP; Velco; and Transco. CVPS is the state of Vermonts largest utility, serves 160,000 customers, and sold 2.9 million Megawatt-hours of power in 2011.29 GMP is Vermonts second largest utility with 90,000 customers and covers many of the states urban areas.30 Additionally, there are 18 other municipal, cooperative, or transmission-only electric utilities throughout Vermont who will be indirectly affected as a result of this transaction.31 B. Vermonts Unique Utility Landscape Vermont is unique because its transmission system was the first transmission-only investor owned utility in the United States.32 Transco was formed in 1956 to bring hydropower from Quebec into Vermont. It is collectively owned by its investors, the states electric utilities. Each electric utility in the state can be responsible for providing equity during times of capital calls. The transmission system was split along the lines of an owner/operator distinction into Transco and Velco respectively in 2006.33 Transco owns the states transmission assets. It is collectively owned by the states electric utilities in a manner roughly proportionate to their investment in those assets.34 Velco operates the states transmission facilities. It is collectively owned by the states electric utilities in a manner roughly proportionate to the amount of load that each utility typically carries.35

28

Central Vermont Public Service Co. Schedule 14a filing with Securities and Exchange Commission, page 3. Available at: http://www.sec.gov/Archives/edgar/data/18808/000121465911002911/s817110defm14a.htm Accessed 4/21/12. 29 http://www.cvps.com/AboutUs/AtAGlance.aspx Accessed 4/21/12. 30 http://www.greenmountainpower.com/customer-service/maps.html Accessed 4/21/12. 31 Micheal Dworkin, Pre-filed Direct Testimony, VT PSB Docket 7770, page 9 32 See Generally, VT Electric Power Company Brochure, Available at: http://www.iso-ne.com/committees/comm_wkgrps/othr/clg/mtrls/2011/mar32011/03_03_11_clg_johnson.pdf Accessed 4/21/12. 33 Id. 34 Ellen L. Burt, Pre-filed Direct Testimony, VT PSB Docket 7770, page 7 35 Id.

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The Vermont electric utility landscape is currently based on system which centers upon GMP and CVPS, with roughly 16 other municipal and cooperative utilities on the periphery (plus Velco and Transco).36 Electric utilities in Vermont are regulated and the state has not restructured. This means that a customers geographic area determines their electricity provider according to franchise and the states public utility commission must approve or reject major actions of the states utilities.37 Vermonts electric systems are within the jurisdiction of ISO-NE and must be accountable to FERC for purposes of wholesale market regulation (et. al.) In Vermont, the Department of Public Service (DPS) is an office of the states executive branch that, amongst other things, advocates on behalf of the consumer when a public utility brings a rate case to the VT PSB.38 These unique aspects of the Vermont electric utility landscape, including a transmission-only IOU that has been separated along the lines of ownership and operation, make possible unique concessions from the proposed combined company. C. Merger Approvals Required The final important element that must be explained about the CVPS-GMP merger is that it must be approved by a plethora of organizations. These organizations include the FERC, the VT PSB, the Department of Justice, the Free Trade Commission, the Committee on Foreign Investment in the United States (Gazmetro is a Canadian-owned company), the Federal Communications Commission, the Nuclear Regulatory Commission, and some of the neighboring public utility commissions (including those of New York, New Hampshire, and

36 37

See Generally for VT Utility Service Map: http://www.cvps.com/CustomerService/2007ElectricFranchiseMap.pdf Supra, at note 28, page 54 states: CVPS is subject to the jurisdiction of the VPSB. Under 30 V.S.A. 104, 107, 109 and 311, the approval of the VPSB is required in connection with the amendment to the articles of incorporation of, and with the acquisition of a controlling interest in, or merger involving any company under its jurisdiction. In considering the merger, the VPSB is required to determine that it will promote the general good of the state and will not result in obstructing or preventing competition with respect to any product or service sold, purchased or manufactured by us and Gaz Mtro. 38 See Generally: http://publicservice.vermont.gov/about-dps/about-dps.html Accessed 4/21/12.

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Maine).39 This immense organizational mix of necessary approvals complicates this interaction far beyond what is required of a non-utility company for merger approval. Analysis of the constituent elements of the CVPS-GMP merger helps to convey a basic, tangible understanding of the actors within the context of the agreement. Discussion of CVPS, GMP, Velco, and Transco helps illustrate that the utilities are in fact interrelated, even before the advent of the proposed merger. The general examination of the Vermont Electric utility landscape presents a background upon which to juxtapose this agreement. The discussion of normal regulatory hurdles faced by merging utilities in the context illustrates the immense amount regulatory approval required to complete a merger or acquisition in the regulated electric utility industry. This understanding of the actors, background, and normal hurdles for regulatory approval provide further insight as to why the CVPS-GMP merger must face great scrutiny in an attempt to resolve conflicts before merger approval.

V. POSSIBLE CONFLICTS PRESENTED BY THE CVPS-GMP MERGER The CVPS-GMP merger must face several conflicts before it can gain regulatory approval, most specifically, from the Vermont Public Service Board. For the purpose of this paper, these conflicts are divided into two major categories: (1) Conflicts arising from unresolved prior obligations of the electric utilities and (2) Questions arising from the newly signed merger agreement. Solutions to these conflicts are a large source of the conditions that have been placed upon CVPS-GMP before the merger can be approved. Insight toward the conflicts inherent in the merger will be instrumental in understanding a discussion of the proposed solutions.

39

Supra, at note 28, page 8-9

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A. Unresolved Prior Obligations The conflicts which result from unresolved obligations that CVPS and GMP had before the merger are not insurmountable. These problems will be explained in the two subsequent paragraphs and include: (1) how to utilize the windfall sharing mandate, and (2) the payment of CVPSs penalty for withdrawing from a previous acquisition agreement with Fortis. The Windfall sharing mandate is the result of a 2001 VT PSB order which allowed CVPS and GMP to recoup from ratepayers money that had been lost on an imprudent power purchase agreement with Hydro-Quebec.40 A mandate was written into the order stating that if either utility was ever acquired, that the ratepayers would share in the benefit through a return of the rate increase.41 The money associated with the ratepayer bailout of CVPS is currently worth roughly $21 million after inflation.42 The American Association of Retired Persons (et. al.) would like to see this money paid back directly to ratepayers.43 Others would rather utilize this money as an investment in energy efficiency or weatherization so that Vermonters might benefit through thermal efficiency and therefore lower electric capacity needs. Advocates for investing the money in efficiency have three basic arguments. First, many of the ratepayers who paid the increase may no longer reside at the same location or in the same state.44 Second the money could be used to leverage other funds and provide even greater benefits to the consumer.45 Third, efficiency and weatherization programs benefit ratepayers by decreasing demand for capacity and therefore reducing the amount of investment necessary to maintain transmission, distribution and generation assets.46
40 41

In re Cent. Vermont Pub. Serv. Corp., 6460, 2001 WL 1002730 (June 26, 2001) page 58 Id. page 85 42 . Asa Hopkins, Pre-filed Direct Testimony, VT PSB Docket 7770, page 11 43 . Silkman/Bradford, Pre-filed Direct Testimony, VT PSB Docket 7770, pages 19-21 44 Hopkins, Supra at note 42, pages 14-22 45 Hopkins, Supra at note 42, pages 14-22 46 Hopkins, Supra at note 42, pages 14-22

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The termination fee that CVPS owed to Fortis will have a large influence on whether CVPS can find approval for its acquisition by GMP. CVPS is responsible for roughly $20 million in fees for withdrawing from an agreement with Fortis, a previous purchaser; GMP agreed to cover this fee if the CVPS-GMP deal were to actually go through.47 This puts the VT PSB and DPS in an interesting position because if the deal were to fall through over objections of regulators then CVPS could find itself facing bankruptcy or asking for another ratepayer funded loan. The problems which have arisen from dealings before the agreement are not insurmountable, but they are important and should be addressed so that ratepayers receive their fair share and are not demystified by the typical rhetoric of efficiencies and synergies offered during mergers of this nature. B. Questions Resulting from the Proposed Merger The questions arising from the newly signed merger agreement have slightly tougher solutions. These include questions regarding the acquisition premium, the new cost of service, possible market distortion, and Velco dominance. The acquisition premium is a tough sell, but ratepayers are going to have to deal with it if they want to benefit from increased synergies/efficiencies in the long term, especially if they want their share of the $144 million payment they have been promised.48 Also, there is concern by some that the rates charged to the newly combined company would no longer reflect the true cost of service.49 To remedy this, a short rate freeze can be implemented while the newly combined entity is given time to submit an amended alternative regulation plan (ARP).50 Vigilant regulation is the only way to ensure that

47 48

Supra at note 28, page 80 Supra at note 28, page 30. 49 Goulding, Pre-filed Direct, Vermont Public Service Board, Docket 7770, page 11 50 Memorandum of Understanding, Public Service Board Docket 7770, filed 3/27/12 page 11-15

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CVPS-GMP (the Combined Company) cannot use its influence to distort power markets or wipe out smaller cooperative or municipal utilities. The largest hurdle that proponents of the merger face is the uncertain agenda of parent companies/subsidiaries and their ability to peddle influence regarding transmission and distribution. Ring fencing and transparency will be among the most likely solutions to these problems.51 Ring fencing is a method of separating business accounts in a way that prohibits comingling of funds between separate entities.52 Transparency is accomplished through a requirement that the combined company submit a copy of their accounting books to regulators and notify regulators when any large financial transaction occurs.53 Solutions to the aforementioned conflicts can be guided by prior examples and precedent; this is not the first time two utilities have merged in the United States. However, the question of how to ensure protection of the public good when a foreign-owned power producer controls the transmission system finds little precedent. This question was a major focus of the Vermont Public Service Board testimony contained in Docket 7770. It is also the focus of the rest of this paper.

VI. PROPOSED SOLUTIONS FOR ENSURING PROTECTION OF THE PUBLIC INTEREST IN THE CONTEXT OF VELCO Opportunities such as this are rare. The Velco/Transco relationship and the proposed GMP-CVPS merger presents unique conditions in the Vermont utility landscape. The conditions provide the opportunity to try a different model for governance of electric transmission facilities,

51 52

See Generally: Supra at note 50. Supra at note 50, page 8 53 Supra at note 50, page 8-11

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which are is deeply affected with the public interest.54 During VT PSB hearings, witnesses and advocates for a just and reasonable solution to this situation presented several proposals related to Velco ownership. After examining the broader industry context, the proposed action, and conflicts presented by the proposed action, this paper has one remaining purpose. That purpose is to evaluate the characteristics of the three traditional utility models presented through the testimony at Vermont Public Service Board and propose an answer to the conflicts presented by the proposed action. These models are: (1) The Public Power model, which I characterize as state-ownership (2) The Cooperative model (3) The IOU model, with a focus on good corporate governance A. The Public Ownership Model Public power ownership can materialize in a variety of ways. The Vermont Public Power Supply Authority represents various municipally owned utilities and participated in Docket 7770. One particularly notable advocate of public power and municipal ownership during the Docket 7770 debate was VT State Senator Vincent Illuzi, who championed a bill in a Vermont legislative committee to study state purchase of Velco.55 After gaining some support and publicity, the bill was released to the floor with a negative outlook, meaning it will probably never reach debate. However, public power lives on through the 14 municipal utilities that buy wholesale power from the grid and distribute it to their citizens.56 Public power has a fairly long history in Vermont, where hydroelectric dams were often built by localities who would later harvest their energy. In order to analyze the possibilities of a public power solution as it relates
54

Supra at note 2 Vincent Illuzi, Pre-filed Direct, VT PSB Docket 7770, page 2-3 56 VT Utility Franchise Map available at: http://www.cvps.com/CustomerService/2007ElectricFranchiseMap.pdf Accessed 4/21/12.
55

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to Velco ownership I will use a three-pronged analysis based upon the economic, environmental, and reliability effects of a 51% state-owned Velco. This three pronged analysis shows that while public ownership presents many benefits, it also poses many downsides due to liability exposure and capital requirements. There are several economic factors to consider when evaluating whether state ownership of Velco is a prudent investment. Critics of this approach would argue that it is too expensive57, would affect the states credit rating and ability to borrow capital (they would need about 500 million for 51%)58, would cost consumers slightly more in rates59, and leave Vermont liable for any bad financial choices Velco makes (especially if something unpredictable were to happen like a large storm or the sudden advent of distributed generation.)60 Proponents of state ownership of Velco would argue that Velco is guaranteed a 14% return on equity and therefore very profitable.61 They would also argue that Vermont and Velcos credit rating are both very high --AAA62 and A 63respectively-- and therefore would pose little risk to borrowing power or interest rates for the state of Vermont. Governor Peter Shumlin had come out as against state ownership for liability/budgetary reasons.64 One DPS witness also noted that the state of

57

See Senate Finance Committee Hearings, Testimony of VT State Treasurer Beth Pearce, 2/14/12 Stating: Velco purchase by state of VT would roughly double the states budgetary needs. 58 (Quoting Beth Pearce) CBS Moneywatch, Vermont Senate Committee Talks Power Line Purchase. Published 2/9/12 . Available at: http://www.cbsnews.com/8301-505245_162-57373940/vt-senate-committee-talkspower-line-purchase/ Accessed 4/21/12. 59 Foley, Direct Pre-filed Testimony, VT PSB, Docket 7770, page 7 60 Escalating New England Transmission Costs and the Need for Policy Reform, Environmental Northeast Available: http://www.env-ne.org/public/resources/pdf/ENE_TransmissionReport_Summary_20111003_FINAL.pdf Accessed 4/21/12. 61 John Dillon, Vermont Senate Committee Talks Powerline Purchase, VPR News. Published 2/8/12. Available at: http://www.vpr.net/news_detail/93340/vt-senate-committee-talks-power-line-purchase/ Accessed 4/21/12 62 Bruce Edwards, Strong Credit Rating Helping Vermonts Bond Sales, Times Argus. Published 3/5/12. Available at: http://timesargus.com/article/20120305/BUSINESS03/703059995/0/MEDIACENTER Accessed 4/21/12 63 VELCO Brochure, Available at: http://www.iso-ne.com/committees/comm_wkgrps/othr/clg/mtrls/2011/mar32011/03_03_11_clg_johnson.pdf 64 Supra. at Note 58

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Vermont had tried to be a wholesaler of power before, through a piece of legislation known as S. 130.65 This bill authorized the state to buy and sell power, but failed to authorize the necessary increase in personnel needed to carry out those functions. These types of unforeseen economic burdens are the main reason state ownership of VELCO would have too many downfalls to be a viable solution. There are a several environmental factors to consider when thinking about state ownership of VELCO. One environmentally-based argument is that the state might be able to inject public policy into the decision process and only build new transmission to connect renewables to the grid. However, one might counter that the state could be driven by taxpayer greed and overbuild its resources due to a pressure for the state to use the cash-cow as a way to reduce taxes.66 There are a number of examples of the how public ownership of electric assets will affect reliability. Government ownership of electric utilities works well in many places. For example, the Long Island Power Authority67, the New York Power Authority68, and the entire state of Nebraskas grid69 are all publicly owned and rarely experience reliability or liability problems. However, there are also examples of places where public ownership had an adverse effect on reliability. This includes the city of Harrisburg, PA, who recently entered receivership do to an imprudent investment in municipal power and is having trouble juggling its affairs in an attempt to maintain reliability.70

65 66

Dworkin, Supra, Note 31, page 30 See Generally: Seeking the Current, Available at: http://www.seekingthecurrent.com/ (costs 4 dollars for 3 days of streaming access) Accessed 4/21/12. 67 See generally: http://www.lipower.org/company/ Accessed 4/21/12. 68 See generally: http://www.nypa.gov/about/mission.htm Accessed 4/21/12. 69 See generally: http://www.nppd.com/about-us/public-power/ Accessed 4/21/12. 70 See http://www.nytimes.com/2011/10/13/us/harrisburg-pennsylvania-files-for-bankruptcy.html Published 10/13/11. Accessed 4/21/12

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After an evaluation of the economic, environmental, and reliability factors that are inherent in Velcos public power path, it seems that while there are arguments on both sides, the capitalization issue is too large a liability for the state to willingly engage. Therefore, there must be some other sort of solution for ensuring the public interest regarding Vermonts investor owned transmission-only utility. B. The Cooperative Ownership Model The Washington Electric Cooperative, whose ideas were presented by Mr. Avram Patt, was one of the most fervent advocates for cooperative ownership of Velco during the Docket 7770 hearings of the Vermont Public Service Board. Cooperative Power was born out of the Rural Electrification Administration and was the model that eventually brought electricity to 71% of the Continental USs land mass.71 The primary principles of any cooperative are (1)

Voluntary and open membership (though, this isnt as applicable in the case of electric cooperatives) (2) Democratic member control (3) Member Economic Participation (4) Autonomy and Independence (5) Education, training and information (6) Cooperation among cooperatives and (7)Concern for Community.72 Cooperative Power in Vermont has a long history, highlighted best perhaps by ardent supporter of Cooperatives and former VT governor, the late George Aiken. In order to analyze the possibilities of a cooperative power solution as it relates to Velco ownership I will use a three-pronged analysis based upon the economic, environmental, and the reliability effects of a cooperatively owned Velco. Economic effects are probably the most important considerations when evaluating prospects for a cooperatively owned Velco. Most cooperatives get their funding from one of two places: (1) the National Rural Utilties Cooperative Finance Corporation (CFC) or (2) the Rural
71

Kreis, Donald M., The Next Greatest Thing: An Electric Cooperative Manifesto. Vermont Law School Research Paper No. 11-18. at page 1 72 id. page 3, within footnote 5

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Utility Services.73 To qualify as a cooperative, however, tax law explicitly states that an entity must appropriate at least 85% of its income from selling a good to its members. 74 Enforcement of this requirement would severely limit options for load-sharing between Velco and the rest of ISO-NE. Also, as one DPS witness points out, Velco/Transco is already a form of cooperative in that its collectively owned and managed by its members, the IOUs. That same witness also notes an unpleasant experience that Vermont Electric Cooperative had with the Rural Utility Service when it was dragged through bankruptcy a few years prior.75 After evaluating the financial factors, it seems that the cooperative model has potential problems of its own as a solution for the Velco transmission system. One must also examine possible environmental effects when evaluating the cooperative model as a possibility for Velco. Since cooperatives are primarily operated and directed by ratepayers, their main objective is often to keep rates low. To this end, a cooperatives management team is sometimes described as Philosophically progressive, but fiscally conservative.76 This can lead to trouble when one is trying to plan for something with long term benefits and high front end costs. For example, implementation of smart grid technology is a front loaded cost, but could save money and allow for greater integration of intermittent renewable resources over time. Others note that cooperatives are well known for their reliance on coal fired power plants due to their rural proximity and fiscal conservatism.77 Still others argue that with the right leadership, the cooperative model can make environmentally sound and forward-thinking decisions. For example, the Washington Electric Cooperative in Vermont has made the active choice to no longer buy nuclear power, and instead has invested in a landfill
73 74

Jim Cooper, Electric Cooperatives, From New Deal to Bad Deal IRC 501(c)(12)(a) (2006) 75 Dworkin, Supra, at note 31, page 27 76 Avram Patt, Lecture, VT LAW SCHOOL, 3/21/12 77 Kreis, Supra, at note 71, page 11

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methane gas recovery plant for a majority of its generation needs.78 After evaluating the cooperative model in terms of environmental factors, there seems to be mixed arguments as to whether it would be a useful model for Velco governance. In terms of reliability, one must consider the black box effect as observed in the cooperative industry. This term is used to describe the lack of ratepayer participation in the cooperative governance process. Cooperatives are based on a business model that depends on its members staying informed and participating in the cooperative democratic process.79 This black box effect has at times led to instability within the industry and it is not clear that one could count on widespread public participation on the Velco scale. Many ratepayers simply want their power to be available when they plug in their devices and are reluctant to exert time and effort toward governance of their electric utility. While there is an argument to be made for utilizing sunshine laws to keep people informed,80 it seems evident that reliability of the transmission grid is not a burden which should be placed upon the average citizen. After an evaluation of economic, environmental, and reliability factors, it becomes obvious that while the cooperative model may have its advantages, the uncertainty inherent in the cooperatives democratic process could result in an unstable and unreliable transmission system. C. The Corporate Governance Reform Model The DPS, whose interest were represented by Michael Dworkin among others, was one of the most fervent advocates for reforming the VELCO corporate structure while leaving the system of investor ownership in place. While this has never actually been done in the realm of

78

See generally: http://www.washingtonelectric.coop/wp-content/uploads/2011/03/wec-sources-of-power-2010.pdf Accessed 4/21/12 79 Kreis, Supra, note 71, page 13-14 80 Kreis, Supra, note 71, page 17

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electric transmission utilities, one can draw upon examples from the non-profit realm, the public power model, and the investor owned model to understand how the different facets of the hybrid public-private model might work. Critics of this approach argue that it is unnecessarily redundant. They state that Velcos reliability is already regulated under the federal guidelines provided by FERC and that Velco may be held accountable as a member of ISO-NE.81 They also note that while FERC regulates wholesale power markets and transmission, it is the state of Vermont and its PSB who retains jurisdiction over approval of transmission siting.82 The DPS has suggested a number of different approaches to enact this model.83 Most recently however, they have settled with the proposed combined companys representatives and agreed to support the merger on the condition that independent directors chosen by the DPS are appointed to the board of Velco.84 The details of this agreement state that including the five public power members already seated on the Velco board, there will be three more publicly appointed board members.85 This model seems to embody the appealing aspects of public/cooperative power without the economic liabilities. It effectively proposes a publicly controlled board of directors (8/13) that operates the states transmission grid while the states IOUs supply the capital. Hence, the title of this paper: Opening the Back Door to Public Power Proposals similar to this have been written previously, but never with regard to an investor owned transmission system such as Vermonts Velco/Transco. Micheal Dworkin, who testified for the DPS about the advantages of placing common good directors on the Velco board of directors, has written about similar issues. Most notably, he published an article on
81 82

Brownell, Pre-filed Direct Testimony, VT PSB Docket 7770, pages 6-14 id. at page 14-15 83 Dworkin, Supra at note 31, pages 32-38 84 Supra at note 50, page 2-6 85 Id.

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Regional Transmission Organization (RTO) governance with Rachel Goldwasser in the Journal of Energy Law.86 Dworkin had also written a letter to former chairman of the FERC Pat Wood which is cited in the aforementioned article and stated his views on the public interest and transmission organization accountability as follows: If at some point in the future the Commission did appoint an RTO board, we would like to see consideration given to the following principles. First, we believe public interest representation, of some sort, is warranted on an RTO board since any regional regulatory body should be charged with protecting the interests of all the consumers in our state, both large and small. The board should have a fiduciary duty (expressed in its Articles of Incorporation and filed at the FERC) solely to the public interest. Meaningful participation by public interest representatives on the RTO board is critical. Public interest representatives on the RTO board will at least give a voice to those who are most affected by its actions. We are not wedded to any particular proposal for choosing such public interest representatives although we would suggest that a significant minority of the members (e.g., one-third) be selected from a pool of nominees designated by state governments (whether by legislative, executive, or regulatory bodies). However, once-chosen, all board members should have fixed, staggered terms to protect the12 board against undue short-term political influence.87 While the RTOs described in this passage are different from the Velco corporation, this passage shows that Dworkin has cultivated views on a similar subject subject throughout his experiences as a state regulator; these views are founded in experience. Other authors have also previously written on a similar subject. Allen White, and Leondard D. Goldberg (et al.) have written of modifying a for-profit corporations board of directors to include directors who are accountable to the public, but never have they been in a position allowing them to leverage such a proposal into existence.88,89

86

Michael Dworkin and Rachel Goldwasser, Ensuring Consideration of the Public Interest in Governance and Accountability of Regional Transmission organizations. Energy Law Journal. Volume 28:543 (2007). Page 543601 Available at: http://felj.org/docs/elj282/Governance_of_RTOs.pdf Accessed 4/21/12. 87 Michael Dworkin, Letter from the Vermont Public Service Board to Pat Wood, III, Chairman of the FERC at 5 (Jan. 17, 2002) Available at: http://www.state.vt.us/psb/letters/woodltrl.pdf Accessed 4/21/12 88 For further reading, see: Allen White and Marjorie Kelly, Corporate Design: The Missing Business and Public Policy Issue of Our Time Available at: http://www.tellus.org/documents/CorporateDesign.pdf Accessed 4/21/12.

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In consideration of whether this corporate governance reform model can be implemented in the context of Velco, one must consider economic, environmental, and reliability factors. From an economic perspective, reforming Velco governance could allow for the consideration of long-term policy based perspectives in a similar way to how the public power model might, but without the burden of state exposure to possible liabilities. Specifically, proponents of this model argue it might institutionalize a role for representatives of the general good within Velcos strategic decision-making process.90 A counter-argument to this however, is that long term policy perspectives dont always align with a companys normal business judgment, and therefore could result in inefficient or ineffective corporate operations.91 After this analysis however, it becomes obvious that the public-private hybrid presented by the corporate reform model may entail the best aspects of both approaches. A public-private hybrid like the proposed Velco governance structure would likely have positive impacts from an environmental perspective. The articles of incorporation and bylaws of Velco will soon be outlined and recorded as a result of transparency measures conditioned upon the proposed merger. Some believe that the new bylaws should dictate that the Velco board of directors must take all environmental health and safety related externalities into consideration during their decision-making process.92 This internalization of externalities is embodied on the corporate scale in a business model known as the benefit-corporation.93 This business model is a recent edition to the differing corporate structural frameworks allowed in Vermont. If this model were imposed upon the combined corporation as a condition of the merger, its board of directors
89

For further reading see: Thomas M. Jones and Leonard D. Goldberg, Governing the Large Corporations: More Arguments for Public Good Directors (1982) Available at: http://www.jstor.org/discover/10.2307/257227?uid=3739952&uid=2&uid=4&uid=3739256&sid=47698919056647 Accessed 4/21/12. 90 Dworkin, Supra, at note 31, pages 21-22 91 Chris Dutton, Pre-Filed Testimony, VT PSB Docket 7770, pages 24-26 92 Illuzi, Supra at note 55, pages 3-4 93 11A V.S.A. 21.13

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would be open to shareholder suits for failure to consider externalities during their decisionmaking process. While this could have drastic effects on the economic liabilities of the corporation, it would also ensure that environmental considerations are at the forefront of the corporate decision-making process. A public-private hybrid like the proposed Velco governance structure would likely have positive impacts from a reliability perspective. The ability inherent within this structure to mix short-term profit maximizing with the consideration of long term externalities could bring about greater reliability for the ratepayers of Vermont. This is because the new company would be obligated to consider sustainability (an issue which is intimately intertwined with reliability and security) rather than solely motivated by profit maximization.

VII. CONCLUSION After an evaluation of the three traditional electric utility models and their economic, environmental, and reliability implications when applied to the transmission utility Velco, several things become obvious. While transforming Velco into a public power/municipally owned model might seem appealing at first, the resource strain and liabilities make this option less than perfect. The cooperative model also has great appeal given the historical influence of cooperatives in Vermont. However, this model presents problems related to capitalization and good governance when applied on the scale occupied by an investor owned transmission utility VELCO. The public/private corporate board combination advocated by the DPS however, retains many of the benefits of public ownership without the liability or capitalization downfalls faced by the municipally-owned and cooperative models. This is especially true in the context of Velco/Transco relationship.

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The Velco/Transco relationship allows for one entity or group of entities to own the transmission grid while another entity or group of entities makes all of the decisions relative to the operation of that grid. In the realm of corporate governance, the importance of this distinction cannot be stressed enough. It becomes plainly obvious that through (1) careful articulation of the VELCOs corporate purpose (2) a majority of public servants on its corporate board, and (3) steps which ensure transparency/accountability, the IOU that is Transco might come to be publicly controlled by its operating entity, Velco. This board of this operating entity-through its four profit seeking board members and nine public servants--might be able to better shape transmission system policy for the good of all Vermonters, rather than the profit of Transcos investors.94

94

The author would like to thank Robert Glover and Theo Fetter for their continued feedback on this papers earlier drafts.

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