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HomeMy WebLinkAboutElectric Systems Community owned-east end towns-1995Final Report Community-Owned Electric Systems For The Five East End Towns Submitted to Towns of East Hampton, Riverhead, Shelter Island, Southampton and Southoid Entek Research, Inc. along with Duncan and Allen and RW Beck March 31, 1995 Executive Summary The report contains a preliminary study of the establishment of community-based electric utility systems ("munis''a) prepared for the Towns of East Hampton, Riverhead, Shelter Island, Southampton and Southold.b It was prepared by Entek Research, Inc. along with its sub-contractors, the law firm of Duncan & Allen and the engineering finn of RW Beck. A. Purpose of study A principle purpose of this initial study is to examine, on a preliminary basis, the legal feasibility of the Towns' proceeding with the establishment of community-based electric systems. In addition, certain other "generic" issues affecting the establishment of a muni (i.e., those issues that would affect any East End Town) were also examined. Specifically excluded Rom this first stage stutiy were the Town-specific engineering cost evaluations of the cost of acquiring LILCO's distribution system; the Towns determined that such cost studies would be made as a follow-up effort should the Towns proceed toward the establishment of munis. For this reason, the overall economic feasibility of the establishment of munis was not investigated as part of this study. In reviewing the factual and legal analyses set forth in the report, it is important to bear in mind that the scope of services provided for these analyses requires that they be preliminary in nature. Each of the issues discussed requires further study and integration into a specific factual and political context before any definitive plan of action is adopted by the East End Towns or any of them. B. Background on the power industry and munis Major changes are occun'ing in the electric power industry in the United States during the 1990's. Changes in federal law have opened the wholesale market for power to greater compelitiora However, to date, the retail market for electricity has not been directly affected by the changes inTederal law. At this time, there is no federal nor state law that. except under very rare circumstances, requires an electric utility to "wheel" (transmit) power that a retail consumer has purchased directly from an alternative supplier. In other words, with very few exceptions, retail customers do not yet have the right to purchase power from a supplier of their choice and to have that power delivered to their facilities. In the absence of such a right to "retail wheeling," many consumers are resorting to various mechanisms to lower their power costs. 'II~ese mechanisms include self-generation, seeking access to "economic development" power, "municipalization" (i.e.. establishing a muni), and cutting deals with utilities after first threatening the utility with of one of these alternatives. In the worst case (at least as far as the region is concerned), people and businesses simply leave the region for areas with lower cost power. Federal law provides munis like all utilitie~mportant opportunities. Specifically, munis, as wholesale power purchasers, can purchase power from any source and are entitled to ~ In this report we shall refer to any community-based electric utility system by the shortened term "muni" which is the term commonly used in the electric utility industry. It is derived from the term "municipal electric utility." b We will refer to the towns jointly as the "East-End Towns" or, more shnpty, the "Towns." ENTEK RESEARCH, INC. have intervening utilities wheel the power from the source to the muni's system at federally regulated rates. A muni, then, has full access to the wholesale market for power and can shop around for reasonably ptieed power. In the past, a local government considering municipalization in New York would be considering at a complete, or nearly complete, take-over of the utility's distribution system in the area bounded by its political jurisdiction. As a result of the Energy Policy Act, new alternatives have become available that may considerably lower the barriers both in terms of cost and in terms of the time needed to accomplish the legal procedures--to corrununities desiring to break through the regulatory wail that separates them from the wholesale market for power. C. Overview of key findings The issues studied in this report are complex and a full appreciation of these complexities and the nuances involved can only be obtained from the main bcxiy of the report With this in mind, however, some key conclusions stand out and we summarize them below: 1. New York's General Muuicipai law provides the legal basis for the Towns to establish, own, and operate "munis" (i.e., community-owned eleclric systems) and the Towns may work either alone or cooperatively to establish, operate and finance munis. There may be practicai considerations, however, that would complicate any attempts to finance munis jointly. 2. The General Municipal Law provides flexibility with respect the implementation of the establishment of a muni and the Towns could proceed incrementally or in phases in creating such a service. 3. The franchises under which LILCO provides electric service to the Towns and the Villages within the Towns do not grant an exclusive right to LILCO to provide electric power service and would not pose an obstacle if the Towns elected to proceed to establish munis. 4. The Towns may establish munis through severai means including 0) acquiring LILCO's existing dis~bulion system through negotiation or condemnation or (ii) creating a competing service through the construction of duplicate distribution equipment. 5. The Long Island Power Authority Act could potentially be an impediment if the Towns sought to establish munis through condemnation. There are various means for mitigating or eliminating this potential problem including proceeding through an approach that did not involve condemnation. 6. 'Under federal law, munis have the right to seek access to the transmission system of other utilities that own transmission lines for the purpose of transmitting power to the muni's system from a distant supplier. 7. The cost of power as delivered to an East End muni from a power supplier would be approximately 6 e/kWh under the costs of power supply and wheeling that prevail in 1995. When combined with additional costs of establishing and operating a muni that were. considered in the study the total would increase to 8.4 e/kWh. Not included in this estimate is the cost of acquiring LILCO's Community-Owned Electric Svstems for the East End Towns P;qeiii distribution system or of constructing new distribution facilities and certain additional costs. LILCO's current residential rates are about 16 C/kWh. The total of the cost elements that we have not examined in this study are likely to be significantly less than the approximately 7.5 ¢ differential between LILCO's rates and the cost elements we did examine. Hence, it appears highly likely that municipalization would be econoniically advantageous for the Towns. D. Legal Feasibility This section provides a summary of the legal analysis developed in this study, adapted from Appendix A. 1. GENERAL LEGAL AUTHORITY General Legal Authority to Establish Munls: Under New York's General Municipal Law, the Towns have the individual ability to establish municipal electric utilities within their respective geographic jurisdictions. Article 14-A of the General Municipal Law is a broad grant of power by the State of New York to each of its municipal corporations to "construct, lease, purchase, own, acquire, use and/or operate any public utility service within or without its territorial limits, for the purpose of furnishing to itself or for compensation to its inhabitants, any service similar to that furnished by any public utility company specified in article four of the public service law." Towns may work cooperatively: Them is clear statutory and constitutional authority for the Towns to work jointly to establish, operate, and to finance munis. Complications may arise with respect to financing jointly: Joint action financing of a municipal utility serving more than one of the East End Towns may be complicated by praclical considerations that could require each Town to undertake liabilities with respect to a possible default of other Towns. The East End Towns would have to carefully and thoroughly evaluate the effects of cross-coverage and step-up requirements in determining, as a practical matter, whether it is worthwhile to proceed with a joint action financing. 2. PROCESS OF MUNICIPAL UTILITY FORMATION a) Individual Municipal Utility Formation Five Step Process: The General Municipal Law lays out a five-step procedure for local legislation for the establishment of a municipal utility: (i) initial resolution of the town board adopting a plan of utility establishment; (ii) newspaper notice of the resolution; (iii) submission of the resolution for referendum at a general or special election; (iv) financing re~01mi0n of the town board for issuance of local obligations to finance the acquisition of plant and facilities; and (v) referendum on financine resolution, as and if applicable to the mode of financing adopted. The initial resolution must specify the proposed method of acquiring utility plant and facilities, the maximum and estimated cost of acquiring plant and facilities, and the method by which the municipal utility will furnish service. Phased implementation of municipalization: Considerable flexibility is allowed in the plan for establishing a mtmi and the Towns may, for example, proceed incrementally to establish a municipal utility consistently with the limitations on their ability to finance under Article VIII of the New York Constitution and the Local Finance Law. EN3EK RESEARCH, INC. Pa;e I¥ ~recu#ve Summary PSC Regulation of munis: New York municipal utilities are subject to regulation of their rates and with respect to the terms and conditions of service by the New York Public Service Commission. Article 4 of the Public Service Law provides for specific regulation of municipal utility rates and imposes financial reporting requirements and filing requirements for contracts and rate schedules. Municipal utilities are generally "self-franchising" within their own territorial boundaries under New York law; but, if they seek to provide service in another municipality which has previously granted a franchise to another.utility, they must fa'st obtain a franchise and certification of the Public Service Commission. 3. ACQUISITION BY EMINENT DOMAIN Acquisition through eminent domain proceeding: The Towns may acquire utility facilities through eminent domain (condemaation) proceedings and they may exercise this power jointly under the General Municipal Law. Joint financing of any such purchase or condemnation is also generally authorized under the General Municipal Law. Procedures under Eminent Domain Law: The Eminent Domain Procedure Law CEDPL") specifies how the eminent domain authority granted by General Municipal Law is to be exercised. There have been no reported condemnations of electric utility property under the EDPL. The.basic procedural framework of the EDPL is described below. Public hearings the Towns are required to hold public hearings to consider the general purposes and potential effects of the condemnation; · Offer to negofiatc ',,he Towns would be required to submit a price offer to LILCO and must attempt to negotiate the acquisition with the condemnee. The offer must be equal to the highest approved appraisal of the property. ·Court action--wbere negotiations are unsuccessful, the Towns would be able to seek a court order to acquire the property. · Determination of compensation--qbe condemnee files a claim for compensation in the Supreme Court. Condemnation process may permit immediate take-over: The EDPL process permits the possibility of immediate use of the property and facilities by the condemnor, prior to the point final compensation is determined or made. Rtsks associated with condemnation: The EDPL may pose certain risks in the acqnisilion of utility assets through condemnation, including: · Changing of cost over time: There may be potential conflicts between General Municipal Law Section 360(3), which requires the Town to establish the maximum and estimated cost of getting into business at the outset of the utility formation process, and the foreseeably lengthy and uncertain process of finally fixing compensation (after acquisition) under the EDPL · Delay and uncertainty: The EDPL provides for two rounds of judicial oversight of the condemnation process, which can inject considerable elements of delay and uncertainty in the utility formation process. Community-Owned Electric Systems for tho East End Towns Paqe v Commianent of capital: It is possible for the condemnee to elect to treat a condemnor's offer as partial compensation. In the event that this happens, it is logical but untested to assume that the condemnor could obtain immediate occupancy subject to a subsequent final determination of compensation. It may also be possible, however, that immediate occupancy may not be available to the condemnor. In such a situation, the condemnor's funds could be tied up by the condemnee with no operational benefit to the condemnor over what, again, could be a rather long period for carrying unproductive debt se~ice. E. Analysis of specific legal issues 1. WHAT STRATEGIES DO UTILITIES TYPICALLY EMPLOY TO OPPOSE ACQUISITION EFFORTS BY LOCAL GOVERNMENTS? There are three main components to the typical investor-owned utility's anti- municipalization strategy, each of which is directed at eroding the public will to create a municipal utility: · Raise the cost: Attempting to make the process of utility establishment too expensive to complete. The single most common responsive strategy of an investor-owned utility confronting the establishment of a muni is to claim "sU'anded investment"--to allege that the new muni has financial responsibility for high cost generating assets that will not be used when the muni's customers are no longer purchasing from the IOU. · Create procedural obstacles: Challenging, at every possible point, the municipality's compliance with whatever procedural requirements are incumbent upon it. The name of the game here is both delay for its own sake, and disruption of the possibility of municipal financing of the establishment of its utility. · Propaganda: The extensive use of propaganda 0ncluding misinformation) to dissuade popular support for municipalization. 2. HOW WOULD UTILITY PROPERTY BE VALUED UNDER A CONDEMNATION PROCEEDING? There is no one valuation method that is uniformly accepted by the New York courts as the way to value utility property. Comparable sales represent the best evidence of the value of property in any condemnation context, but there are relatively few consensuai sales of electric utility property to use as reference points. There may be a slight, but discernible, policy preference for capitalization of eanfings as a valuation approach. If accepted by the relevant court, capitalization of earnings, in practice, reduces to book value (original cost less depreciation), plus severance damages. Utilities almost always try to claim "stranded investment" as severance damages. This argument has not been categorically rejected by the New York courts; neither has it ever been accepted. ENTEK RESEARCH, INC. 3. WHAT CAN BE LEARNED FROM THE TOWN OF MASSENA MUNICIPALIZATION EFFORT? The fundamental lesson to be learned from the Town of Massena mtmicipalization is that a nigh level of enduring public commitment to the formation of a municipal utility is the single most indispensable ingredient in that process. The process of establishing a muui took Massena about eight years. During that period, Niagara Mohawk, the IOU from wnich it was seeking separation, spent approximately as much money opposing the municipaUTation as the facilities originally at issue were worth. The other principal lesson of the Massena municipalization is that,given an economically viable alternative source of power supply, the long-term, nigh-intensity public commianent required to complete the creation of a municipal mility will ultimately result in substantial benefits to the community that undertakes the commitment The passage of EPAct will make the process of obtaining transmission rights a good deal quicker and more certain than it was in Massena's case. In addition, many of the specific legal issues that Massena had to comfront were resolved in its favor and therefore likely will not confront the East End Towns in precisely the same form. 4. WHAT ARE THE IMPLICATIONS OF LIPA ACT REGARDING EFFORTS BY LONG ISLAND COMMUNITIES TO MUNICIPALIZE? LILCO would undoubtedly argue that two court decisions---LILCO v. Suffolk and COEP v. Cuomo~---establish that the enabling legislation for the Long Island Power Authority pre-empts the authority of municipalities in LILCO's service territory to acquire LILCO's assets by purchase or condemnation. LILCO would argue that these decisions, read together, frustrate any possible exercise of municipal eminent domain powers against LILCO's facilities. On the one hand, the State has "occupied the field" of possible public acquisition of all or any part of LILCO's facilities--thereby leaving no room for individual municipal action in this area (L1LCO v. Suffolk). On the other hand, the State, having accomplished its principal objective under the LIPA Act of stopping Shoreham, it nonetheless continues to occupy the field to the exclusion of municipal acquisition activities--even though it has no discernible present intention to do anything further under the LIPA Act (COEP v. Cuomo). There are at least four possible approaches that could conceivably eliminate or neutralize the LIPA preemption issue: · Declaratory judgment: seeking a declaratory judgment, prior to the initiation of condemnation proceedings, that the LIPA Act does not bar municipal condemnation of LILCO assets; · Entering into understanding with LIPA: entering into an arrangement with LIPA under wnich LIPA would either (i) condemn facilities and transfer them to the East End Towns, or (ii) authorize the East End Towns to exercise their own eminent domain authority, or (iii) some combination of the foregoing; ~ Citizens for an Orderly Enerev Policy v. Cuomo. 78 N.Y.2d 398, 576 N.Y.S.2d 185,582 N,E.2d 568 (t991) (hereafter "~OEP v. Cuomo") and Lone Island Liehdng Co. v. County of Suffolk, 119 A.D.2d 128, 505 N.Y.S.2d 956 (2d Dept. 1986), aooeal denied N.Y.2d ENTEK RESEARCH, INC, Community-Owned Electric Systems for the Eq~( I~nd Towps Paqe¥ii · Seeking legislative clarification: seeking one or more legislative claflfications of the L1PA Act to eliminate the preemption question; and · Establishing muni through alternative procedures: establishing a competing municipal utility without condemning LILCO assets. 5. WHAT ARE THE IMPLICATIONS OF EAST END TOWNS' PRESENT FRANCHISE ARRANGEMENTS WITH LILCO? Franchises do not pose obstacle to municipalization: None of the franchises granted by the Towns or Villages within the Towns with respect to LILCO for electric service poses an obstacle to the formation of a municipal utility by any one or more of the Towns. Obtaining consent of Villages: LILCO has franchises from both Towns and from Villages ~vithin the Towns. This may counsel in favor of getting the villages on board; otherwise, the extension of service to the villages would (a) require their consent, ~ (b) require approval of the Public Service Commission. Franchises are not exclusive: There is no necessa~ exclusivity of utility service areas under New York law. None of the franchises we reviewed were exclusive, either by their terms or by operation of law. Towns may establish competing utility service: A franchise is a property right under New York law, and is thus generally protected from curtailment or taking without just compensation. However, no "taking" occurs where a municipality establishes a competing utility--at least where the municipality lias not granted an exclusive franchise. A critical implication of this is that the Towns can establish competing utility services without condemning existing utility property. 6. WHAT ARE THE IMPLICATIONS OF THE 1992 FEDERAL ENERGY POLICY ACT REGARDING TOWN EFFORTS TO ESTABLISH MUNIS? Right,to transmission service: Under federal law. munis may request the Federal Energy Regulatory Commission CFERC") to order a utility to transmit power across its system in order to permit the muni to purchase power from a supplier that is not located in its service territory or which is not the surrounding IOU. The federal Energy Policy Act of t992 ("EPAct") outlines basic requirements for a FERC order for mandatory transmission service. It seems likely that, should the Towns establish munis, these munis would be able to satisfy the criteria such a wheeling order. No authority to order retail wheeling: Except in very unusual circumstances, EPAct does not provide the FERC with the authority to order retail wheeling (transmission of power directly to a retail customer). The circumstances in which FERC can order retail wheeling directly to an ultimate customer, or through an entity to an ultimate consumer are if the entity requesting such retail wheeling 0) is a political subdivision of a state and (ii) would use transmission or distribution facilities that it owns or controls to deliver electric energy to the consumer. Alternative approaches to establishing a muni: Given the high cost, both politically and financially, of acquiring an investor-owned electric utility's facilities serving a municipality, creation of a municipally-owned utility without undertaking the burden of acquiring significant transmission or distribution facilities is a desirable option to consider. ENTEK RESEARCH, INC Paqe viii Exm~u#ve Summm~ 3 Such an option appears to be feasible under the Energy Policy Act of 1992. The possibility of municipalities creating their own electric utilities and benefiting from the emerging competition in the wholesale power marLet without having to bear the burden of uneconomical power delivery costs attendant to condemning or duplicating the existing power delivery services is a legally untested, but intriguing hypothesis. Local governments seeking to construct duplicate delivery facilines will have to overcome is the prohibition on retail wheeling and sham wholesale transactions in Section 212(h) of the Federal Power Act. Given the Commission's relatively aggressive reading of the Energy Policy Act generally, it is likely that such an entity may enjoy the benefits of access to the wholesale markets afforded by the Act without having to endure the cumbersome process of acquiring an entire transmission or distribution system. 7. WHAT WOULD BE THE TAX STATUS OF MUNICIPAL BONDS USED TO FINANCE CONDEMNATION OF UTILITY FACILITIES? In 1987, Congress amended Section 141 of the Internal Revenue Code (26 U.S.C. Section 141) to restrict severely thc ability of municipal utilities to usc tax exempt financing to acquire the operating assets of investor-owned utilities. As a result, interest on municipal bonds initially used to finance the condemnation of utility asSets will generally be taxable. In the first year following the formation of the muni, 10% of the capital investment can be I~nanced using tax exempt bonds. In the second year, 20% and so on until the tenth year when the full amount can be financed using tax exempt bends. However, it should also be noted that bonds used to finance acquisition of utility property may be subject to favorable tax treatment if they qualify as "exempt private activity bonds." Table of Contents I. INTRODUCTION A. Purpose of Study .................................................................................................. l B. Questions Addressed ............................................................................................. C. A Caveat ............................................................................................................... 2 D. Organization of the Report .................................................................................... 2 II. BACKGROUND A. US Electric Industry Undergoing Major Changes .................................................5 B. Municipalization as a Route to Lower Rates ......................................................... 6 III. POWER SUPPLY AND WHEELING A. Introduction ......................................................................................................... 7 B. Types or'Power Purchase Arrangements ................................................................ 7 C. Cost of'Power Supply ........................................................................................... 8 1. Investor-owned utilities ...................................................................................... 8 2. New York Power Authority ............................................................................... 9 3. Power marketing companies ............................................................................. 10 4. Independent power producers .......................................................................... !0 5. Summary of'power supply prices ...................................................................... 1 ! D Availability and Cost of Wheeling Capacity ......................................................... 12 1. Background on wheeling .................................................................................. 12 2. Availability of transmission capacity ................................................................. 13 3. Wheeling rates ................................................................................................. 14 4. New submarine cable ....................................................................................... ! 5 E. Muni's Cost of Power ......................................................................................... 15 I. Cost or'power supply and wheeling .................................................................. 16 2. Certain costs of setting up a muni ..................................................................... 16 3. Cost of operations ............................................................................................ 16 4. Summary regarding economics of'municipalization ........................................... 17 IV. LEGAL AND ENGINEERING COSTS A. Full Municipalization ........................................................................................... 19 B. Alternative approaches ........................................................................................ 19 APPENDIX A PRELIMINARY LEGAL FEASIBILITY ANALYSIS I. GENERAL LEGAL AUTHORITY A. Process of Municipal Utility Formation ............................................................. A-3 I. Individual Municipal Utility Formation ........................................................ A-5 2. Joint Action Authorization ........................................................................ A-10 B. Acquisition By Eminent Domain .............................. .' ....................................... A-13 II. EMINENT DOMAIN PROCEDURE LAW IH. ANALYSIS OF SPECIFIC LEGAL ISSUES A. Generic Utility Defensive Strategies in Opposing Municipalization Efforts ...... A-19 1. The "~tranded Investment" Argument ....................................................... A-20 2. Other Litigation Challenges ....................................................................... A-23 3. Propaganda ............................................................................................... A-25 B. Valuation Methods Applied to Condemnation of Utility Property Under New York Law .............................................................................................. A-25 1. There is Some Arguable Support for Capitalization of Earnings as a Preferred Approach to Valuation of Utility Property in Condenmation ...... A-26 2. Additional Observations on Capitalization of Earnings .............................. A-27 3. Additional Observations on Market Value and Comparable Sales .............. A-29 C. Strategic Overview and Lessons from Towns of MassenafNiagara Mohawk Municipalization ............................................................................................. A-30 D. Possible Preemption of Municipal Acquisition Authority Under the LIPA Act and Possible R. esponsive Strategies ................................................................. A-32 1. The LIPA Act ........................................................................................... A-33 2. The Pre-Emption Problem ........................................................................ A-37 3. Possible Approaches ................................................................................. A-41 E. Analysis of East End Towns Present Franchise Arrangements with LILCO ...... A-46 1. Town of Southampton .............................................................................. A-46 2. Town of P,.iverhead .......i ........................................................................... A-46 3. Town of Southoid ..................................................................................... A-46 4. Town of East Hampton ............................................................................. A-46 5. Town of Shelter Island .............................................................................. A-46 F. Implications of Energy Policy Act of 1992 ....................................................... A-48 1. Overview of Section 211 .......................................................................... A-49 2. "Muni Lite". ............................................................................................. A-50 G. Federal Income Taxation Issues Concerning Municipal Bonds Used to Finance Condemnation of Utility Facilities .................................................. A-58 H. Legal Issues Concerning Formation of Municipal Joint Action Agency ............ A-59 APPENDIX B PRELIMINARY ENGINEERING COST ANALYSIS: ACQUISITION OF ELECTRlC PROPERTIES EXECUTIVE SUM MA RY ...................................................................................... B- ! BASIC COST OF ELECTRIC SERVICE ................................................................ B-3 Costing Methods ................................................................................................. B-3 Existing Electric Properties .................................................................................. B-4 SEPARATION AND RECONNECTION UNDER SEPARATE-SYSTEMS .............. B-5 Southampton ....................................................................................................... B-5 East Hampton ...................................................................................................... B-7 P, iverhead ............................................................................................................ B-8 Southhold ............................................................................................................ B-9 Shelter Island ..................................................................................................... B- ! 0 SEPARATION AND RECONNECTION UNDER JOINT-SYSTEM ..................... B-l 1 COMPARISON OF SEPARATION AND RECONNECTION COSTS ................... B-12 ENGINEERING EXPENSES .......................................................................... B- 13 UTILITY OPERATIONS AND START-UP COST ............................................ B- 15 OPERATING AND MAINTENANCE EXPENSES ............................................. B-17 I. Introduction This report contmns a preliminary study of the establishment of community-based electric utility systems ("mums''~) prepared for the Towns of East Hampton, Riverhead, Shelter Island, Southampton and Southold.b The report was prepared by Entek Research, Inc. ("Entek'~) along with its sub-contractors, the law firm of Duncan & Allen and the engineering firm of RW Beck ("Beck"). Entek was initially awarded a contract by the Town of Southampton to examine the feasibility of that Town's proceeding to establish a mum. Subsequent to the selection of Entek by Southampton, the other four East-Ead Towns decided to join with Southampton to undertake this preliminary study. A. Purpose of study A principle purpose of this initial study is to examine, on a prelimina~ basis, the legal feasibility of the Towns' proceeding with the establishment of community-based electric systems. In addition, certain other "generic" issues affecting the establishment of a mum were also examined. Specifically excluded from this first stage study were the Town-specific engineering cost evaluations of the cost &acquiring LILCO's distribution system; the Towns detemUned that such cost studies would be made as a follow-up effort should the Towns proceed toward the establishment of mums. For this reason, the overall economic feasibility of the establishment of mums was not investigated as part of this study. B. Questions addressed This study addresses the following key questions related to the establishment of munis by the Towns:, · What are the legal bases in federal and New York taw for establishing a Town- owned and operated electric utility system and what are the legal processes involved in such an undertaking'? · What legal impediments may stand in the way of a Town that seeks to establish a mum? · What are a Town's alternatives with respect to the nature of a muni and the procedures through which it proceeds to establish one'? · What are the franchises under which LILCO provides power to the Towns and what fights does LILCO have under those franchises? · If any of LILCO's assets are to be acquired for the purpose of establishing a muni, on what basis is the value of those likely to be determined? a In this report we shall refer to any community-based electric utility system by the shortened term "munl" winch is the term commonly used in the electric utility industU. It is derived fi.om the term "mumcipal electric utility." ~ We will refer to the towns jointly as the "East-End Towns" or, more simply, the "Towns." ENTEK RESEARCH, INC. Paae 2 Final Report · What are the estimated costs of the legal and engineering work required to establish a muni? · What power supply options would be available to a Long Island muni and how much is power likely to cost? · How would power be wheeled to a new muni and how much is wheeling likely to cost? · To what extent would savings result by a joint effort by some or all of the East End Towns to establish and operate a muni instead of having each town proceed independently? C. A caveat In the context of thc scope defined for this study, the funding allocated, and the acknowledged "preliminary" nature of this study, we believe it to be thorough. However, it should be emphasized that the purpose of this study was not to perform an exhaustive investigation of every nuance of each subject area covered since the resources required for such an effort would have been much greater. Hence, while we have made reasonable efforts to review the salient factors necessary to understand the issues listed above, additional study will be required to further flesh out the details in certain areas. Furthermore, it is important to note that the law is "organic," in that it is constantly evolving, and imperfect, in that in a given area, there may be ambiguities or, more rarely, even outfight contradictions. Legal analyses, therefore, cannot be predictive in the same way as, for example, would be engineering analyses. For these reasons, the Towns will have to base their decision as to whether to proceed to the next step in establishing munis, not on the basis of whether or not there is certainty a~ to how the effort will proceed, but on the basis of reasonable expectations derived from the historical record of prior attempts to establish mums and a review of the existing law particularly with regard to the new oppommities that have been created by recent changes to federal law. When all i~ said and done, a utility's behavior in confronting a challenge to its monopoly is not predictable with precision. Thus, while we have outlined the legal basis for and the sorts of counteractions utilities have undertaken in the past, we can make no claims to predicting the actions LILCO's may or may not take in the future in response to the Towns' preceeding to establish mums. D. Organization of the report Following this introductory section, Section II provides a background discussion of the broad changes that have been taking place in the electric utility industry in the United States and the implications of these changes for those seeking alternatives to continuing to purchase power their local investor-owned utility. Section III reviews the potential sources of power supply for an East End mum and the availability of wheeling capacity to transmit power to the mum and also provides representative costs of power supply and wheeling for power delivered to the East End. Appendix A, prepared by Duncan & Allen, provides an analysis of the legal basis in New York and federal law for local governments to establish mums, to acquire utility property, and to purchase and wheel power, and it reviews the impediments that a Town would face in Community. Owned Electric SYstems for the East End Towns Paae :~ efforts it undertook to establish a muni and the altemative methods by which Towns can proceed to provide electric service. Appendix B, prepared by RW Beck, provides a preliminary engineering and cost comparison of the relative benefits of the Towns proceeding jointly towards the establishment of munis as opposed to proceeding alone. ~oTnmunltv-Owned Electric SYstems for the East Eod Towns Paae $ II. Background A. US Electric Industry Undergoing Major Changes Major changes are occuning in the electric power industry in the United States during the 1990's. Many observers of the industry believe that these changes will result in the dis- aggregation of the traditional, vertically-integrated generation/transmission/distribution utility. In this evolution, the industry will likely see generation function separated from the power delivery (transmission and distribution) functions and deregulated. The power delivery functions will likely remain subject to some level of regulation of rates and of the terms and conditions of service at the state and federal levels. This process of change actually began with the 1978 Public Uffiity Regulatory Policies Act which required electric utilities to purchase power from privately-owned power generating fa(rifles that used renewable resources or were based on efficient cogeneration systems. Private power producers quickly proved themselves capable of generating power at a lower cost than utilities and were able to keep their plants operating at higher capacity factors. By the end of the 1980's many state regulatory commissions had indicated thd, r preference for open solicitations in which such independent power producers could submit bids as the process through which their utilities would procure power in the future. In 1992, Congress furthered the process of deregulation at the wholesale level by passing the Energy Policy Act of 1992 CEPAct") which had two major purposes: (i) it established the right of private producers to construct, own and operate any type of power generation facility free of federal or state price regulation~ and provided access to transmission tines so such "exempt wholesale generators" could "wheel" (transmit) their power to wholesale consumers; and (ii) it considerably eased the requirements that transmission-dependent utilities (such as local governments operating electric systems) needed to meet to obtain access to the transmission Systems of surrounding utilities in order to purchase power on the wholesale market. EPAct has begun to transform the wholesale market for electricity. Munis, which in the past, were forced to purchase from the surrounding investor-owned utility ("IOU') because they were refused transmission access are now exercising their new rights to obtain wheeling under EPAct and are entering into power purchase arrangements with non-adjacent milities. Also, power marketing companies, which neither own nor operate electric generating equipment, have been formed and are beginning to serve as intermediary brokers, purchasing power from utilities with surpluses and selling to utilities either needing power or looking for a lower cost source of power. At the saree time as these regulatory changes were taking place, the disparity between the utility rates for power and the price at which power is available on the wholesale market diverged sharply in certain market areas (including Long Island). This has been especially true a While PURPA required utilities to purchase form facilities that Inet its resource use and efficiency qualifications, there is no comparable requirement under EPAct that utilities purchase from exempt wholesale generators. ENTEK RESEARCH, INC. Pa~e 6 ~ln~l where ulilities had invested in large, nuclear facilities with runaway budgets. In such areas, many energy consumers are seeking access to lower cost power. The transition from regulated monopoly to free consumer choice is incomplete, however. To date, the retail market for electricity has not been directly affected by the changes in federal law. At this lime, there is no federal nor state law that, except under very rare circumstances, requires an electric utility to wheel power that a retail consumer has purchased directly from an alternative supplier. In other words, with very few exceptions, retail customers do not yet have the fight to purchase power from a supplier of their choice and to have that power delivered to their facilities. In the absence of such a tight to "retail wheeling," determined consumers are resorting to various mechanisms to lower their power costs. These mechanisms include self-generation, seeking access to "economic development" power, "municipalization" (i.e., establishing a muM), and cutting deals with utilities after first threatening the utility with of one of these alternatives. In the worst case (at least as far as the region is concerned), people and businesses simply leave the region for areas with lower cost power. B. Municipalization as a Route to Lower Rates For our purposes, a municipal electric utility is simply a utility owned and operated by a municipality under the provisions of Section 360 of the General Municipal Law of New Yorlc In general, munis typically own and operate the distribution grid and the meters that deliver power to electric power customers. The muni may or may not also own generation and transmission equipment. If it does not own generation equipment, it would purchase power from other investor- or consumer-owned utilities, power marketing companies, or independent power producers.' Federal law provides munis---tike all ulilities--qmportant opportunities. Specifically, munis, as wholesale power purchasers, can purchase power from any source and are entitled to have intervening utilities wheel the power from the source to the muni's system at federally regulated rates. A m, uni. then, has full access to the wholesale market for power and can shop around for reasonably priced power. Nalionally, there are thousands of munis. The largest is the City of Los Angeles' Department of Water and Power. The smallest is operated by the town Radium, Kansas which serves only 28 customers. In New York there are nearly fifty munis. In most cases, these munis were always independent systems. However, in some cases, they were once part of an Investor- owned system but, at some point, established themselves as separate entities. In the past. a local government considering municipaUzation in New York would be considering a complete, or nearly complete, take-over of the utility's distribution system in the area bounded by its political jurisdiction. As a result of the Energy Policy Act, new alternatives have become available that may considerably lower the barriers--both in terms of cost and in terms of the lime needed to accomplish the legal procedures--to communities desiring to break through the regulatory wall that separates them from the wholesale market for power. These alternatives are discussed in Appendix A to this report. a A muni can also generate some of its power and purchase the remainder. ~= NTEK RESEARCH, INC, Community-Owned Electric Systems for the East End Towns l=aae 7 III. Power Supply and Wheeling Introduction Power for new munis on Long Island is potentially available from a variety of sources: Traditional investor-owned electric utilities ("IOUs') such as Consolidated Edison Company, Niagara Mohawk Power Corporation, Northeast Utilities (New England), or even LILCO · The New York Power Authority ("NYPA') Power markedng companies · Independent power producers ("IPPs")~these may be off-Island IPPs, IPPs located on the Island but not on the East End, or a new 1PPs on the East End · From power plants built and operated by the muni itself B. Types of power purchase arrangements The wholesale market for power is characterized by a wide variety of arrangements representing the differing needs and objectives of the purchasers and sellers in entering into power sales arrangements. Some examples of contractual arrangements are · Long-tenn full-requirements A supplier is obligated to provide the full requirements of the muni (usually within certain broad limits) and the mtmi is obligated to purchase all of its power from that supplier for a specified period of time (typically five to ten years or longer). The supplier does not generate the power that is delivered to the muui from a specified power plant but, instead, is generally obligated to provide the power from any of its sources. · Base load power---Power intended ~o be used to supply the "base" portion of the user's load; that is the portion that is there all or most of the time. Pricing is characterized by l'Jgher capacity charges (fixed monthly charges) but lower energy charges (variable charges). · Peaking power-~Power intended to be supplied during the user's peak load period. Pricing is characterized by higher energy charges but lower capacity charges. This source can also be used when the user's primary source or' power is not available. · Economy power Power transactions made available on a short-term, "oppormuislic" basis~ a The term "opportunistic" is used here to mean that both the buyer and seller are motivated entirely by short- term economics considerations~4he seller call make a profit selling from capacity that. for the momem, is not needed and the buyer can save money by buying from a source that is cheaper than the "finn" sources he would otherwise rely on. The buyer's need for long or short-term power generating capacity is not a motivating factor and the seller is not making any conunitment to supply capacity. Poq¢ 8 Final Re~ort An electric utility, as a retail distributor of power must find a cost-effective and reliable mix of power supplies to meet loads that vary by time of day, by day of the week, and by season of the year. A large supplier of power-~such as an IOU--has available to it a mix of generating units of various types, enabling it to economically meet variations in load and to provide back-up when generating facilities are out of service. Generally speaking, it makes sense for a mum to purchase most if not all of its power requirements from such a suppLier; otherwise the muni itself must take on the task of finding a suitable mix of generating sources to economically and reliably match its loads. While it may be suitable for a large mum or a group of munis working cooperahvely to undertake the responsibility for creating a portfolio of power generating resources from different suppliers, undertaking lltis responsibility may make less sense for an individual, smaller muM. For this reason, many mums enter into full-requirements contracts with a large power supplier. Traditionally, IOU'$ have played the role of such suppliers. However, as the industry changes, power marketing companies are stepping into this role as well. C. Cost of Power Supply As the discussion in Section B above makes clear, there are "apples" and "oranges" in the power supply business and it is important to distinguish between them when comparing one power source with another. The price of economy power is low because the seller only needs to cover his variable costs of power generation. In contrast, a full requirements supply will reflect the aggregate capital and variable cost of a mix of base-load, intermediate-cycle, and peak load generating units as well as the backup power needed to reliably supply power when units are out of service. Obviously, economy power will be cheaper than a long-term full requirements supply but the former is only provided on an as-available basis and cannot be relied upon to serve customers' loads. Below we provide a representative sampling of power supply prices. While the prices that are most relevant to a new mum would be those referencing full-requirements contracts, we have provided examples of firm as well as non-~m (L e., "economy" or "spot") prices because we believe~they provide a broader picture of the overall state of the power market today and this can help in understanding where the market is likely to go in the years ahead. In most cases, these price estimates are based on publicly available contracts (which we list explicitly) and on our private discussions with power suppliers. In the latter cases, where requested, we have maintained the confidentiality of the source. 1. INVESTOR-OWNED UTILITIES a) Role in the market There are seven IOUs in New York. Due to low load growth during the 1990's and the large growth in the number of IPP projects brought into service during this period, most have surplus capacity available for sale. Where they can find buyers, utilities have been selling under a variety of short- and long-term arrangements. b) Representative prices Northeast Utilities Service Company ("NUSCO") is an active seller of power in the Northeast United States and has expressed interest in selling to wholesale purchasers on Long Island. Below are two contracts that NUSCO has entered into recently. ENTER F~ESEARCH, INC. Community-Owned Electric Systems for the East End Towns Paae 9 · Northeast Utilities sale to Town of Madison: In May of 1994, NUSCO entered into full-requirements power sales agreement with the Town of Madison (Maine). This agreement covers sales during the period 1994-2008. The power sales price in 1995 under this agreement can be calculated to be 4.0 The price rises to 8.5 c/kWh in 2003. Transmission charges through the Central Maine Power system add 0.5 c/kWh to these rates; however, NUSCO agreed to pick up these transmission costs during the period 1999-2003 and a portion of these costs in the period following 2003. NUSCO sale to Bozrah Light and Power Company~--- In January 1995, NUSCO entered into an agreement with Bozrah Light and Power. The power sales price in 1995 under this agreement is 3.5 ¢/k'~qhd. 2. NEW YORK POWER AUTHORITY a) Role in the market NYPA was originally created as a public authority to develop the hydropower resources of the St. Lawrence and Niagara Rivers. Later it was given a role in the development of auclear power in the state. It now owns and operates approximately 5000 MW of power generating capacity, consisting primarily of hydroelectric and nuclear power stations. Most of NYPA's power is sold to muuls, to governmental customers, and to large industrial customers. NYPA also sells power to the IOUs. Under an arrangement worked out in 1976, when Con Edison was experiencing financial difficulties associated with the construction of two power plants, NYPA purchased the two plants and also obtained the right to serve governmental consumers of power in Con Edison's service area. NYPA currently serves the three existing muuls on Long Island¢ as well as some thirty to forty Long Island "economic development" customers. It also sells power to LILCO. b) Representative prices Sales to existing munis Most of the power sold by NYPA to the existing munJs is hydroelectric power-so-called 'q?reference Power"---generated by NYPA in the St. Lawrence or Niagara stations. Because these plants were built many years ago with cheaper dollars, the cost of power from these plants today is very low--about 1.0 c/kWh. A new muui satisfying the requirements of the Niagara Redevelopment Act would be eligible to apply for this low cost power. However, this supply of power is fully allocated by contract and it is unrealistic a Information regarding this saie is detailed in the August 1993 contract between NU and Madison and the May 1994 amendment to that con~'act which is filed with the Federal Energy Regulatory Commission. ~ This effective annual price was derived from the actual two-part tariff consisting of a demand charge of $50/kW-yr in 1995 and rising to $125/kW-yr in 2003 and an energy charge which is 3.4 c/kWh during on-peak periods and 2.4 c/kWh during off peak periods in 1995 rising to 6.2 c/kWh during on-peak periods and 4.9 c/kWh during off peak periods in 2003. The effective cents per kilowatt-hour prices given in the text in this and in the succeeding cases in this section are derived assuming a load factor of 50% which is typical for utility whose loads are not dominated by high load-factor industrial customers. ¢ Information regarding this sale is available in FERC Docket ER95-513 NU a The actual two-part tariff consists of a demand charge of $25/kW-yr in 1995 and an energy charge which is 2.9 g/kWh. ~ Freeport, Greenport and Rockville Center ENTEK RESEARCH, INC. Paae 10 F~nal Reeort to expect that additional allocations of any sizable mounts will be available in the near future. Furthermore, should additional allocations become available in the future, there would likely be competing applicants. Sales to LILCO NYPA sells power from the Fitzpatrick nuclear power plant to LILCO under an annually-renewable contract. In 1994, the price at which that power was sold to LILCO was 5.1 C/kWh (price as delivered to LILCO's system),a 3. POWER MARKETING COMPANIES a) Role in the market Several dozen power marketing companies have received FERC authorization to function pursuant to the 1992 Energy Policy Act. These entities act as brokers operating on the wholesale market, purchasing power from utilities and independent power producers and reselling to utilities and munis. b) Representative prices Power Markets Week, a weekly newsletter covering the power marketing business, reports spot market prices (prices for non-finn power) every week by region of the country. Prices are obtained from surveys of buyers and scllers~power marketing companies and utilities--and are quotoa for regional markets throughout the United States. Due to a surplus of generating capacity in the Northeast United States, power prices are unusually depressed now. For the Northeastern region, Power Markets Week has reported spot market prices varying between 1.8-3.0 C/kWh over the past four months with most transactions taking place near the middle of trds range---that is, at about 2.0-2.3 e/kWh. Such prices are barely above the marginal cost of generating power from even the most cost-effective units and they are not close to recovering thc full capital, fuel and O&M costs of power from a new power plant. Hence, in considering the cost of power supply, it is important to recognize that the prices currently prevailing on the spot market are not representative of the long-term cost of power supplies. 4. INDEPENDENT POWER PRODUCERS a) Role in the market Some 350 power plants, owned by over one hundred IPPs, currently generate about 6000 MW of power in New York from natural gas-fu'ed combined-cycle systems, hydroelectric power stations, and from wood and waste-to-energy plants. When all IPP projects currently under construction are completed, the total level of generation will be close to 7000 MW or over one fifth of the state's total generating capacity. Some 60-70 of these plants are natural gas fired cogeneration facilities and represent the bulk of the power generated. The largest independently-owned plant in the state is the Independence station on Lake Ontario, owned and ~ The actual two-part tariff consists of a capacity charge of $161/kW-yr (which includes wheeling to LILCO's system) and an energy charge of 1.7 c/kWh. Because NYPA also makes available additional amounts of power on an as available basis for the energy charge alone, the effective cost to LILCO of the power purchased under this contract is substantially less than the 5.1 c/kWh stated in the text. Community. Owned Electric Systems for the East End Towns P;~qe 11 owned and operated by Sithe Energies; at 1000 MW, this plant ranks among the largest power plants in the state. Hem on Long Island, there are about 400 MW of independently-owned power plants ranging in size from a few kilowatts to 135 MW. Most of them are required to sell all of their power to LILCO under the terms of their power sales agmemeats with the utility, but at least two of them also sell electricity to the "host" facilities to which they am selling thermal energy. The largest independently-owned power plant on Long Island is the 135 MW Holtsville facility, owned and operated by NYPA. b) Representative prices The prices at which IPPs sell electricity to utilities in New York vary as there are a number of different contract formats. One common pricing arrangement---derived from the "6 e law" in effect from 1981 to 1992~ets prices under a PSC-determined tariff rate at a minimm level of 6 e/kWh. For most IPPs selling power under such arrangements, prices are effectively still at the 6 e level since fuel costs~one of the key determinants of the tariff rate---are at relatively low levels. However, the 6 ¢ minimum price was set during the 1980's when power generating costs were higher than they are today. At today's gas prices, an IPP constructing a new natural gas-fired combined cycle unit that is greater than 150-200 MW in capacity and contracting for fuel supplies is likely to have total costs of about 5 e/kWh or even lower for the larger, more efficient units. A benchmark of the cost of power generation on Long Island is NYPA's contract for the sale of power from the Holtsville plant. The pricing in this contract is a complex set of formulas which, essentially, set base prices and escalators (where appropriate) for each component of the owner's costs of generating electricity. Today, the total effective price is approximately 5 c/kWh. While, due to its tax-exempt status, NYPA has certain financing advantages not available to a typical IPP, this is counterbalanced by the fact that NYPA's gas purchase contract was executed some four to five years ago and may not be representative of the favorable pricing that has prevailed in the gas industry since then. One t~pstate IPP has quoted us a price of approximately 4.5 e/kWh (available in 1995). Approximately half of this price represents capital amortization and operating and maintenance costs. The other half represents fuel supply and transportation costs. Under a long-term contract, the portion of this price representing fuel costs can be expected to track increases in fuel costs. While this price is somewhat on the low side, it may not be unrepresentative of the cost structure of a large, efficient combined-cycle unit with good transmission access to competitively-priced gas supplies. 5. SUMMARY OF POWER SUPPLY PRICES In the short mn, economy power can be obtained on the spot market in the region at prices as low as 2 e/kWh. However, while they indicate the state of today's market for non- firm power, these prices are not directly relevant in evaluating the economics of power supply for a mum. A more relevant guide as to the tong term cost of base-load power supply is the price from new gas-fired combined cycle facilities. As indicated above, in 1995 this price is approximately 4.5-5.5 e/kWh, depending on where the power plant is built, the financial structure of the owner, the size and efficiency of the facility, fuel supply and transportation costs, and the load factor of the purchaser. About 40% of this price would be associated with ENTEK RESEARCH, INC. Paoe t2 [:inal Renort capital amortization which would remain flat; 10% associated with O&M costs which would increase with inflation; and 50% associated with fuel costs which would escalate with the delivered price of fuel. It is important to understand that base-load power such as this would only be appropriate for a portion ora muni's needs; it would need to be supplemented with other purchases to supply intermediate and peaking power as well as backup for outages. A full-requirements contract would normally be expected to be somewhat higher than the cost of base-load power since it incorporates a mix of power generating sources of different types with an adequate allowance for the extra capacity needed to provide a reliable supply. This type of arrangement is all-inclusive and would address all ora muni's power needs; it could be entered into as the sole source ora muni's power supply. The NUSCO sale to Madison mentioned above in Section C-1 is an important indicator of today's market for full-requirements power in the Northeast. The 1995 price in this contract is 4.0 t/kWh. This price is lower than the full price of power t~om a new power plant and demonstrates the favorable market for purchasers of power that exists in the mid 1990's due to the surplus power situation in which the Northeast finds itself today.' As the following section will makes clear, the location of the power supply is also a critical factor in determining the overall cost of power as delivered to a muni since wheeling can add substantially to the delivered cost of power. D. Availability and cost of wheeling capacity 1. BACKGROUND ON WHEELING "Wheeling" in electric utility jargon refers to the transmission of eleetricity across a utility's system for a f~e. Usually, wheeling charges are applied by a utility when it is neither the source nor the purchaser of the power; rather, wheeling charges are applied by a third- party utility whose sole function is to transmit the power across its system. Wheeling charges may be paid either by the purchaser or the seller of power. The Federal Energy Regulatory Commission has ulthnate jurisdiction over wheeling rates but the FERC typically defers to state public utility commissions where such commissions employ FERC-approved methods for calculating wheeling rates. The level of any wheeling charges that would apply to purchases of power by munis established by the Towns depends on the number of utility systems through which the power must be wheeled and the wheeling charges of each of those systems. Some examples illustrate how this concept would apply to power wheeled to the East End: · Purchases from an IPP on Long Island--If the IPP were located such that its power could be delivered directly to the muni's transmission/distribution system, no wheeling would be required. If transmission through LILCO-owned transmission lines were required, then LILCO wheeling charges would apply. · Purchase from IPP or Power Marketing Company from Upstate Source Power would be wheeled through LILCO's system, across a submarine cable, through Con Edison, and, depending on the location of the source, through another utility system as well. Note that the price schedule in this contract has the effective rate rising at about 10% per year to a level of 8.5 c/kWh in 2003, reflecting the expectation that power surpluses will gradually be reduced over that period. Con;t~unRv-Owned Electric Systems for the East End Towns Paoe 13 · Purchases from NYPA's Fitzpatrick plant-~Power would be wheeled through LELCO's system, across a submarine cable, through the Con Edison system, and along NYPA's upstate transmission lines. Wheeling charges would be paid to all three utilities as well as for the submarine cable. · Purchases from New England~Assuming the power was supplied by Northeast Utilities, which has a direct intertie with Con Edison, the power would be wheeled through the Con Edison and LILCO systems and wheeling charges would be paid to each of these utilities as well as for the submarine cable. 2. AVAILABILITY OF TRANSMISSION CAPACITY The limiting factor in bringing additional power from upstate sources to Long Island is the capacity of the submarine cables that link Long Island to Westchester and to CoaneeticuL The table below shows the intertie capacity on submarine cables between Long Island and Westchester and between Long Island and Connecticut. There is a total of 1485 MW of capacity on these three interties. However, of this, some 272 MW of this capacity is allocated to Con Edison. Also, on-land transmission connections to Norwalk, Connecticut are inadequate to provide reliable service. Taking these two portions out of the total leaves 927 MW of firm interlie capacity available for transmission to the LILCO system/ Transmission Intertie Capacity to Lonq Island Cable Capacity [MW] Y-50 (Shore Road, LI--Dunwoody, Westchester) 599 Y-49 (Garden City--to Sprainbrook, Westchester) 600 Northport to Norwalk. CT 286 Sub-Total 1485 Less Con Edison entitlement -272 Net LILCO entitlement 1213 Net MLCO w/o Northport to Norwalk 927 The current tn'm-power utilization of the transmission capacity as used to deliver power to or through the l .H .CO system is shown in the table below, NYPA employs 175 MW of this capacity to deliver to the munis, to the Nassau and Suffolk County Municipal Distribution Agencies, and to economic development customers on Long Island. LILCO uses 305 MW to transmit power from its share of the Nine Mile 2 nuclear power plant and from its Gilboa and Fitzpatrick purchases from NYPA. The total usage thus amounts to 480 MW. In addition, LILCO also uses capacity on the these lines on a non-firm basis to bring in "economy" power; i.e., power for which there is no firm purchase commitment but which is purchased on an opportunistic basis when it is cheaper than power that would otherwise be generated by LILCO. However, this non-firm usage is lower in priority than f'nan usage and new firm use customers would take priority over the use of the line to transmit economy power. a In LILCO's planning studies, the utility txeats the Northport to Norwalk line as capable of carrying [00 MW of capacity. Hence, the analysis here is probably conservative in that it assumes that there is no firm capacity available from this line. ENTEK RESEARCH, INC. Pa~e 14 Final Report Current Utilization of Transmission Interties Purpose Capacity NYPA--saIes to three existing munis NYPA--sales to MDA's and eco. dev. customers LILCO-Nine Mile 2 18(; LILCO--Giloba 4E LILCO-pumhase of Fitzpatrick power from NYPA 7~ Total 48( In summary, there is approximately 450 MW of firm capacity available on the existing transmission interties. The level of available l'mn capacity could potentially Increase if I .ri .CO ceased purchases of Fitzpatr 14k power . .e.g., due to a decrease in its loads if additional customers (such as the East End Towns) leave its system or if transmission upgrades were made in the Norwalk region, permitting the firm utilization of the Northport to Norwalk line. The available capacity would decrease if other entities on Long Island sought to use it to purchase firm power from off-Island sources. 3. WHEELING RATES Wheeling charges are regulated by the FERC. Traditionally, transmission rates have been calculated based on the costs utilities incur in providing transmission service. These costs are dominated by the capital amortization of the original and any succeeding investments. Operating costs for transmission lines are relatively low. Aa important principle of regulation is that customers obtaining the same service should pay the same charge. Hence, in general, a new muni wheeling power to its system would pay LILCO and other utilities, as applicable, the same rates as apply to existing muuls. Charges that currently apply to power delivered to the existing munis are as follows: · LILCO on-land system-~$2.10/kW-mo for delivery at primary voltage.' · Charges for submarine Intertiesb Y-50 (older cable): $0.61/kW-mo. For the newer Y49 intertie, the charge is significantly higher: $4.42/kW-mo. · Con Edison--$1.12 S/kW-mo for power transmitted to the Westchester end of the Y49 intertie. · NYPA-~NYPA's wheeling charges for transmission from its upstate facilities (located on Lake Oswego) to the Con Edison system range from $1.60- 2.19/kW-mo a There is a $0.87/kW-mo surcharge for delivery to the secondary distribution system which is the voltage level at which LILCO delivered to Greenport. Freeport and Rockville Center receive power at the primary level and this surcharge does not apply to them. b LILCO and the three Long Island munis are engaged in a dispute as to the charges that should apply for transmission on the submm'ine cables. As the text makes clear, the rates on the older Y-50 interlie are much lower than the rates on the newer Y49 intertie. Until 1993, the municipalities paid the lower Y-50 rote. However, LILCO has sought to treat the power for the munis as being transmitted on the newer line and to have the munis pay the higher rate. This dispute is as yet unresolved. Communi~-Owned Electric Systems for the East End Towns Applying these rates to particular situations and convening to a cents per kilowatt- hour measure of the cost~ results in the following illustrative examples,b · Purchases from IPP on Long Island---Wheeling charges would be zero or 0.6 c/kWh depending on whether or not there was a need for transmission through LILCO's system · Purchase from IPP or Power Marketing Company from Upstate Source 2.0-3.2 e/kwh · Purchases from NYPA's Fitzpatrick plant 2.0-3.2 e/kwh · Purchases from Northeast Utilifies---l. 1-2.1 e/kWh 4. NEW SUBMARINE CABLE As has been mentioned, three submarine transmission interties¢ connect Long Island with Westchester and Connecticut. The most recent intertie~the Cross Sound Cable project--was completed in 1991 at a total cost of $325 million. This intertie provides 600 ~ of transmission capacity. The charge for finn capacity on this line is $4.42/kW-month which, on a cents per kilowatt-hour basis, is equivalent to 0.6 e/kwh if power is taken at 100% load factor or 1.2 e/kWh if power is taken at the 50% load factor of a typical utility. There are several possible routes for a new submarine intertie: One is between Shoreham and Millstone since there are excellent on-land transmission connections at each end. Because of the length of the submarine cable, the cables would have to carry DC current and AC-DC inverters would be necessary at each end. LILCO has prepared some rough ,estimates showing that a 900 MW intertie would cost over $600 million. On a cents per kilowatt-hour basis, these costs would translate to about 2 C/kWh or more. However, it should be emphasized that, as far as we are aware, virtually no engineering work has been done regarding such a project and any cost estimates are rough at best. Eo Muni's cost of power The scope of this study does not include the development of an estimate of the rates that would be charged by a muni. However, the information that has been prepared-~,he costs of power supply and wheeling, and various costs to set up and operating a muni--does provide most of the data needed to estimate such rates. From the information in this report, we can develop the following components that would make up the rates ora new muni:d a For this conversion, we have assumed a 50% load factor for the purchasing mtmi b Wheeling charges are shown as ranges because of uncertainties due to the dispute between LILCO and the three LI mtmis as to how wheeling rates will be computed tbr the submarine interties and beoanse charges for wheeling upstate depend on which transrmssion liues wilI actually be needed tbr a particular purchase. The low end of the range assumed the lower cost for upstate transmission, where applicable, and, tbr wheeling across the submarine cable, that there would be a 50/50 blending of the cost of the Y-50 and Y-49 thterties. The higher end of the range assumed the higher cost for upstate transmission and that the charge for the submarine interties would be the full cost of the more expensive Y-49 intertie. ~ Each submarine intcrtie actually consists of several individual cables. a All of the costs provided are in 1994 dollars. ENTEK RESEARCH, INC. P;~qq 16 Final Reoort COST OF POWER SUPPLY AND WHEELINGa Power supply is likely to cost 4.0-5.5 c/kWh for full-requirements supply. Power may be obtained near the lower end of this range in the near future. As the current surpluses of generating capacity in the Northeast are reduced, the cost of full requirement power is likely to rise.b The cost of wheeling can range from 0-3.0 c/kWh, depending on the location of the supplier. If power is obtained from off-Island power suppliers, wheeling charges ot'2-3 c/kWh are likely to be incurred. Over time, it is reasonable to expect that power supplies are likely to be available from Island-based sources, assuming new IPP projects are built on the Island and--assuming the industry is restructured as many expeet-~as LILCO's generating resources are transferred to competitive suppliers. As an example of thc combined cost of power delivered to an East End muni, we can take the 1995 price under the NUSCO sale of full-requirements power to the Town of Madison as described in Section C-I of this part of the report. Assuming the power is delivered by NUSCO to the Con Edison border at the prices quoted in the NUSCO/Madisen contract, the total power supply and wheeling cost would be 6.1 f/kWh in 1995. It is interesting to note that this estimate for the cost of power delivered to mania on the East End is also very close to the figure that would be obtained if the power supply were assumed to be new generating sources located on the Island (Lc., if the nfix of ganeration were based largely on new gas-fired combined-cycle and simple-cycle units). In this case, wheeling would be required only through LILCO's system. 2. CERTAIN COSTS OF SETTING UP A MUNI In Appendix B, Beck has prepared estimates of various costs associated with setting up a muni and certain of the costs associated with acquiring physical assets are described and estimated. These include engineering, disconnection and reconnection, start-up, and working capital costs. In addition, the cost of acquiring the 69 KV transmission line that loops around the East End was also estimated. Not included in these costs is the cost of acquiring the distribution system. Assuming the five towns proceed together towards the establishment of munis, the total amount of these cost elements is estimated to be $29 million without the 69 KV line and $58 million with the transmission line. To estimate how much these costs contribute to the rates that would have to be charged by an East End munl, we have converted these capital costs into a cents per kilowatt-hour rate using the following assumptions: 30 year debt financed at an 8% interest rate and the total East End load as given in Appendix B. The net effect of these cost elements on rates is estimated to be 0.3 f/kWh without the 69 KV line and 0.6 f/kWh with the 69 KV line. 3. COST OF OPERATIONS In Appendix B, Beck has prepared an esttmates of the annual cost of operations and maintenance for East End muins. Beck estimates that these costs would be $15,250,000 per a Price estimates given in this section are based on currant 1995 price structures. As such, they do not reflect changes that may occur in the costs that suppliers must pay to generate power, in particular, fuel prices variations could have s substantia| effect on these prices. b Note according to current PSC and utility projections, it may be ten years before the surpluses are el/mmated. ENTEK ~ESEARCH, INC. Communit~Owned Electric Systems for the East End Towns Page 17 year (1995 dollars) assuming the Towns worked cooperatively. This is equivalent to 1.7 ~/kWh. If the Towns proceeded alone, the costs would be very slightly higher. 4. SUMMARY REGARDING ECONOMICS OF MUNICIPALIZATION Adding together the est'unatexl cost of power supply and wheeling, the partial costs of setting up a muni as outlined in the previous sections, and the costs of operations, the sum total is approximately 8.4 c/kWh. Besides these cost elements, the total costs a mm would have to recover would also include in lieu of tax payments, reserve for depreciation, and debt service on the remaining acquisition costs. Of these, the latter are the most significant as the remaining costs of acquisition would include the costs of the distribution system (including service drops and meters) as well as any other costs that may be imposed through the condemnation process, if the process of acquisition is through condemnation. LILCO's current rotes are just under 16 C/kWh.a The difference between LILCO's current rotes and the 8.4 c/kWh that we have esfunated for the specified cost elements examined in this study is about 7.5 c/kWh. Based on our experience with utility systems asset valuations, this differential is significantly greater than the likely costs of the remaining cost elements. Hence, while we have not performed a complete economic evaluation of the establishment of a mtmi, it appears highly likely that such an evaluation would conclude that mumcipalization would be economically advantageous to the Towns. This value does not include the gross receipts tax. ENTEK RESEARCH, INC. Gommuni~,-C,~,,~~ Electric Systems for the East End Towns peqe 19 IV. Legal and Engineering Costs The legal and engineering costs for the establishment of a muni vary depending on the process the Towns choose for proceeding (full, conventional municipalization involving condemnation of assets as compared to setting up a competing service), the degree and type of opposition on LILCO's part, and whether the Towns elect to work together or to proceed individually. A. Full municipalization For full municipalization, the legal costs for a single town are estimated to be between $1-2.4 million for a single Town proceeding alone. There are major scale econormes in the legal effort if the Towns proceeded to work together; if the five Towns proceeded together,, the legal effort is estimated to increase by only about 10% for the entire effort. Engineering costs for full municipalization for a single Town proceeding alone are estimated to be $1.15 million. As with the legal effort, major scale economies would apply if the five Towns proceeded together; in this case the total effort is estimated to cost $1.35 million. The total of the engineering and legal expenses is thus estimated to be about $4 million if all of the Towns proceeded together with the fifll, conventional municipalization approach. B. Alternative approaches If one of the alternative approaches discussed in Appendix A were adopted instead~one of the so-called "muM-lite" approacber~costs would be substantially lower. Legal costs for such an effort would range from $50-200,000, depending primarily on the level of opposition by LILCO and the need to become involved in court appeals. Again due to scale economies, there would be little change in this estimate whether a single Town proceeded alone or all Towns proceeded together. Until one of the alternative approaches was better detined in terms of its physical scope, it is not possible to develop an engineering cost estimate. ENTEK RESEARCH, INC Table of Contents APPENDIX A PRELIMINARY LEGAL FEASIBILITY ANALYSIS I. GENERAL LEGAL AUTHORITY ...................................................................... A-2 A. Process of Municipal Utility Formation ................................................................... A-3 1. Individual Municipal Utility Formation .............................................................. A-5 2. Joint Action Authorization .............................................................................. A-10 B. Acquisition By Eminent Domain ............................................................................ A-13 II. EMINENT DOMAIN PROCEDURE LAW ........................................................... A-14 III. ANALYSIS OF SPECIFIC LEGAL ISSUES ......................................................... A-18 A. Generic Utility Defensive Strategies in Opposing Municipalization Efforts ............A-19 1. The "Stranded Investment" Argument ............................................................. A-20 2. Other Litigation Challenges ............................................................................. A-23 3. Propaganda ..................................................................................................... A-25 B. Valuation Methods Applied to Condemnation of Utility Property Under New York Law .................................................................................................... A-25 1. There is Some Arguable Support for Capitalization of Earnings as a Preferred Approach to Valuation of Utility Property in Condemnation ............ A-26 2. Additional Observations on Capitsli×ation of Earnings .................................... A-27 3. Additional Observations on Market Value and Comparable Sales .................... A-29 C. Strategic Overview and Lessons from Towns of MassenafNiagara Mohawk Municipalization ................................................................................................... A-30 D. Possible Preemption of Municipal Acquisition Authority Under the LIPA Act and Possible Responsive Strategies ....................................................................... A-32 1. The LIPA Act ................................................................................................. A-33 2. The Pre-Emption Problem ............................................................................. A-37 3. Possible Approaches ....................................................................................... A-41 E. Analysis of East End Towns Present Franchise Arrangements with LILCO ............ A-46 1. Town of Southampton .................................................................................... A-46 2. Town of Riverhead ......................................................................................... A-46 3. Town of Southold ........................................................................................... A-46 4. Town of East Hampton ................................................................................... A-46 5. Town of Shelter Island .................................................................................... A-46 F. Implications of Energy Policy Act of 1992 ............................................................. A-48 1. Overview of Section 211 ................................................................................ A-49 2. "Muni Lite". ................................................................................................... A-50 G. Federal Income Taxation Issues Concerning Municipal Bonds Used to Finance Condemnation of Utility Facilities ........................................................ A-58 H. Legal Issues Concerning Formation of Municipal Joint Action Agency .................. A-59 APPENDIX A Preliminary Legal Feasibility Analysis of Establishment of One or More Municipal. Electric Utilities by the Towns of East Hampton, Riverhead, Shelter Island, Southampton and Southold, New York BY: Donald R. Allen, Esq. John P. Williams, Esq. John P. Coyle, Esq. DUNCAN & ALLEN 1575 Eye Street, N.W. Washington, D.C. 20005 Telephone: (202) 289-8400 This is a preliminary analysis of the legal feasibility of the establishment of one or more municipal electric utilities by the Towns of East Hampton, Riverhead, Shelter Island, Southampton and Southold, New York ("East End Towns"). In general, the East End Towns have the ability individually to establish municipal electric utilities within their respective geographic jurisdictions under the powers granted by New York General Municipal Law Article 14-A, Sections 360 through 366. The East End Towns are also empowered, by General Municipal Law Article 5-G, Section 119- o, to exercise jointly the municipal utility authority conferred on them by General Municipal Law Article 14-A. General Municipal Law Section 360(2) grants to municipalities in the State of New York the power to "construct, lease, purchase, own, acquire, use and/or operate any public utility service within or without its territorial limits, for the purpose of furnishing to itself or for compensation to its inhabitants, any service similar to that furnished by any public utility company ." As discussed in Part III.D of this Appendix, one significant question involved in any decision by the East End Towns concerning how to exercise their municipal utility powers under Article 14-A of the General Municipal Law -- by either construction, purchase or acquisition -- is whether and to what extent the Long Island Power Authority's enabling legislation (Public Authorities Law, Section 1020 through 1020-hh (the "LIPA Act")) places any limitations on the exercise of those municipal powers with respect to the facilities of the Long Island Lighting Company ("LILCO"). Part I of this Appendix discusses the general legal authority of the East End Towns under General Municipal Law - 2 - Article 14-A and the laws of New York generally, either individually or collectively to (a) form a municipal electric utility, and (b) condemn LILCO's assets. Part II reviews the general framework of the process of condemnation under New York Eminent Domain Procedure Law. Part III analyses the following specific legal issues: Generic Utility Defensive Strategies In Opposing Condemnation Proceedings; Valuation Methods Applied to Condemnation of Utility Property Under New York Law; Ce Strategic Overview and Lessons from Town of Massena/Niagara Mohawk Municipalization; De Possible Preemption of Municipal Authority Under the LIPA Act and Responsive Strategies; Analysis of East End Towns Present Franchise Arrangements with LILCO; Fe Implications of Energy Policy Act of 1992 Federal Income Taxation Issues Concerning Municipal Utility Bonds Legal Issues Concerning Formation of Municipal Joint Action Agency. In reviewing the factual and legal analyses set forth in this Appendix, it is important to bear in mind that the scope of services provided for these analyses requires that they be preliminary in nature. No specific legal advice as to any particular course of action is recommended in this Appendix, and each of the issues discussed herein requires considerable further study before any definitive plan of action is adopted by the East End Towns or any of them. Io GENERAL LEGAL AUTHORITY In 1934, the New York Legislature enacted Article 14-A of the General Municipal Law, apparently as enabling legislation for a municipalization effort then contemplated by the City of New York. See Tierney v. Cohen, 268 N.Y. 464, 198 N.E. 225 (1935); New York Edison Co. v. City of New York, 268 N.Y. 669, 198 N.E. 550 (1935). Article 14-A of the General Municipal Law (Sections 360 through 366) is a broad grant of power by the State of New York to each of its municipal corporations~/ to "construct, lease, purchase, own, acquire, use and/or operate any public utility service[~/] within or without its territorial limits, for the purpose of furnishing to itself or for compensation to its inhabitants, any service similar to that furnished by any public utility company specified in article four of the public service law." General Municipal Law Section 360(2). Article 14-A of the General Municipal Law is within the scope of permissible delegations of power to municipalities by the Legislature under Article IX of the New York Constitution. Villaqe of East Rochester v. Rochester Gas & Electric Co., 262 App. Div. 556, 31 N.Y.S.2d 754 (1941), aff'd, 289 N.Y. 391, 46 N.E.2d 334 (1943); O'Fl~rnn v. Villaqe of East Rochester, 292 N.Y. 156, 54 N.E.2d 343 (1944), cert. denied sub nom. Despatch Shops, Inc. v. Village of East Rochester, 323 U.S. 713 (1944). Article 14-A also provides a fairly precise description of the procedural steps that a New York municipality is to follow in establishing municipal utility operations. These steps, and both the specific and general authorization of joint action by New York municipalities in the formation and operation of municipal electric utilities, are outlined in the next section of this Appendix. A. Process of Municipal Utility Formation One of the key features of Article 14-A is its requirement that two central elements of establishing il General Municipal Law Section 360(1) defines "municipal corporations as meaning "a county, city, town or village." "Public utility service" is defined by General Municipal Law Section 360(1) as meaning "any service authorized to be furnished by any public utility company pursuant to article four of the public service law and shall include works, structures, poles, lines, wires, conduits, mains, systems, waterpower and any and all other real and personal property used or necessary for, connected with or appertaining to the furnishing of such service." - 4 - municipal utility operations be established in advance by local law (General Municipal Law Section 360(3)): (1) the proposed method of constructing, leasing, purchasing or acquiring the plant and facilities necessary for utility service, together with both the maximum and estimated costs of those activities; and (2) the method of furnishing'utility service. As discussed in detail below, this requirement limits to some extent the ability of a New York municipality to make major changes in its plan of utility establishment quickly in response to developments in the implementation of that plan,3/ while at the same time requiring full public disclosure, debate and approval for both the initial formulation of the plan and any subsequent major adjustments to it. In addition, neither case law nor statutory provision explains (or limits) what the phrase "method of furnishing service" means -- i.e., whether the phrase requires that local law establish the source of power supply, the structure of the utility or the entire plan for acquiring facilities and power supply and delivering electricity to the utility's consumers. The most reasonable, abstract interpretation of the requirement that local law establish the ,'method of furnishing service" would appear to be that a Town (or group of Towns) needs to establish, with such detail as is reasonably possible in advance, the basic conceptual plan for acquiring power supply and facilities and delivering electricity to consumers. For these reasons, among others, the procedural requirements of Article 14-A for adoption of a plan of utility establishment also counsel in favor of completing a detailed and exhaustive feasibility analysis of the process of establishing a municipal utility prior to adopting implementing legislation, because of the rather lengthy process involved in making major changes to the plan in response to unforeseen developments. 3/ As discussed in more detail below, the plan may be amended after its adoption, but the process of amendment is subject to the same notice and referendum requirements as the original plan. - 5 - We first summarize the process of municipal utility formation under General Municipal Law Article 14-A for an individual Town. We then review the process for the joint exercise of municipal utility powers under (1) the specific delegation for joint powers under General Municipal Law Section 361(2), (2) the general delegation for joint powers under General Municipal Law Section 119-o, and (3) the constitutional provisions for joint powers under Article VIII, Section i and Article IX, Section 1(c) of the New York Constitution. 1. Individual MuniciDal Utility Formation In broad outline, General Municipal Law Sections 360 and 362 lay out a five-step procedure for local legislation for the establishment of a municipal utility. The process involves two distinct phases: the establishment phase and the financing phase. The acquisition of utility property by eminent domain -- as opposed to acquisition through construction or negotiated purchase -- adds several steps to the process, which are discussed separately in Part 2 of this section. The five basic steps in the legislative procedure are: a. Resolution of the town board adopting a plan of utility establishment, which must specify (General Municipal Law Section 360(2)): The proposed method of acquiring utility plant and facilities; ii. The maximum and estimated cost of acquiring plant and facilities; and 111 · The method by which the municipal utility will furnish service. be A minimum six consecutive weeks' newspaper publication of (i) a notice of submission of the resolution for mandatory referendum and (ii) the text of the resolution itself (General Municipal Law Section 360(5)); - 6 - Submission of the resolution for the plan of utility establishment for referendum at a general or special election (General Municipal Law Section 360(5)); Financing resolution of the town board for issuance of local obligations to finance the acquisition of plant and facilities (General Municipal Law Section 362; Local Finance Law Sections 30.00 through 33.000); and Referendum on financing resolution, as and if applicable to the mode of financing adopted (Local Finance Law Section 35.00). The specifics of the steps in the establishment phase of the process are discussed below, along with certain specific background on the legal principles applicable to these steps. At this point in the East End Towns' examination of the process of utility formation, a detailed discussion of the financing phase would be premature. a. Statutory Drovisions General Municipal Law Section 360(3) requires in relevant part that, where a New York Town proposes to establish a municipal utility exercising the powers vested under General Municipal Law Section 360(2): The proposed method of constructing, leasing, purchasing [or] acquiring the plant and facilities for such service, together with both the maximum and estimated costs thereof, and the method of furnishing such service shall be fixed · by a resolution of the town board in the case of a town. General Municipal Law Section 360(4) specifically confers "authority to adopt such a resolution . . ~ upon the town board of the town" seeking to establish a municipal utility. Under General Municipal Law Section 360(5), the action of the town board in adopting a resolution to establish a municipal utility is then subject to ratification or - 7 - rejection in a mandatory referendum preceded by six weeks of publication of the relevant resolution in one or more newspapers of general circulation. General Municipal Law Section 360(5) specifically provides, in relevant part, that: Any such action by the town board of a town shall be submitted for the approval of the electors of the town at the next general election to be held not less than ninety days after the adoption of such resolution; or at a special election called in the same manner as provided in the town law for submission of a proposition at a special town meeting or a special town election. Such submission shall be in the manner provided by, and in accordance with[,] the provisions of the town law for the submission of any other question by referendum on petition, except that the referendum on the proposition provided for in this section shall be mandatory. Every such . resolution of the town board and the notice of the submission thereof, shall be published in one or more newspapers published within the town to be designated by the ~e~islative body of the municipal corporation affected, once in each week for six consecutive weeks immediately preceding such election Once established, a New York municipal utility is generally subject to regulation with respect to the rates, terms and conditions of its service by the New York Public Service Commission under the provisions of Article 4 of the Public Service Law "so far as the same are applicable." General Municipal Law Section 364(1). It is important to observe here that the regulatory regime established by Article 4 of the Public Service Law does not, by its terms, regulate municipal utilities in the same manner as investor-owned utilities. Some of the more important provisions applicable to municipal utilities are noted below. Under Article 4 of the Public Service Law, the New York Public Service Commission generally has jurisdiction over the rates charged by municipal utilities. Public Service Law Section 66(5). However, municipal utility rates are generally subject to Public Service Commission review only upon a - 8 complaint in writing signed by 25 or more consumers residing in the municipal utility's service territory. General Municipal Law Section 364(2) (b); Public Service Law Section 71. Municipal utilities are subject to Public Service Commission reporting requirements as to such matters as their amount of bonded indebtedness, employee salaries, expenditures for facilities and operation and maintenance and other operational matters (Public Service Law Section 66(7)), and are required to file their contracts and rate schedules with the Public Service Commission (Public Service Law Section 66(12)). Municipal utilities are generally not required to obtain a certificate of authority from the Public Service Commission under Section 68 of the Public Service Law (General Municipal Law Section 364(2)), and are therefore generally "self-franchising" within their own territorial boundaries under New York law.g/ However, as discussed under Part III.E below, a municipal utility that seeks to extend its service within the territorial boundaries of another municipality which has previously granted a franchise to another utility (a situation that might exist with respect to the Villages of Southampton, Sag Harbor and Dering Harbor) must first obtain a franchise and certification of the Public Service Commission pursuant to Section 68 of the Public Service Law. General Municipal Law Section 361(1). b. Leqal considerations There are very few court decisions interpreting and applying the statutory requirements of General Municipal Law Section 360~ Two sets of court decisions, the Town of Massena cases in the mid-1970s and the earlier Villaae of East Rochester cases from the mid-1940s, offer some important guidance on two basic legal issues arising under Section 360 and related statutes. The first principle established by the case law is that, given the limitations on the borrowing power of New York municipalities under Article VIII of the New York Constitution and the provisions of the Local Finance Law implementing The one exception to this principle is that, where a municipality owning a municipal utility seeks to sell surplus power to a municipality that is presently served by a public utility, "such extension shall not be effected without the approval of the public service commission" presumably under Section 68 of the Public Service Law. General Municipal Law Section 361(1). - 9 - Article VIII of the Constitution, municipalities may proceed incrementally to establish a municipal utility consistently with the limitations on their ability to finance. O'Flynn v. Villaqe of East Rochester, 292 N.Y. 156, 164-165, 54 N.E.2d 343, 347 (1944), cert. denied Dub nom. DesDatch Shods, Inc. v. Villaqe of East Rochester, 323 U.S. 713 (1944). This principle is of significant benefit to municipalities seeking to establish a utility, both under phased condemnation proceedings as contemplated by Section 401(C) of New York's Eminent Domain Procedure Law, and where a municipality determines to construct its own utility facilities rather than to acquire the facilities of an existing utility through condemnation. The second important principle in the case law is that the plan for establishing a municipal utility is allowed considerable flexibility in its implementation. As the New York Court of Appeals recognized in Town of Massena v. Niaqara Mohawk Power CorD., 45 N.Y.2d 488, 489-490, 410 N.Y.S.2d 276, 280-281 (1978): In any instance when a municipal corporation endeavors to enter the public utility field, necessarily a time gap occurs between the drafting of the initial outline and actual completion of the project. During this interval, usually not of short duration, several contingencies may suggest or even necessitate a change of direction: e.g., spiraling costs may render the undertaking economically unfeasible; technical developments may make the plans obsolete; and demographic shifts may require a revamping of the system. In view of these and other pragmatic considerations, flexibility in implementation of a section 360 project is obviously necessary. To adopt a narrow interpretation, therefore, might well destroy for practical purposes the very statutory scheme which the Legislature has seen fit to enact. Furthermore, since a project once implemented may be altered freely without referendum submission (see 2 Opns. St. Comp., 1946, p. 582; 2 Opns. St. Comp., 1946, p. 556; Illinois Power Co. v. City of Jacksonville, 18 10 - Ill.2d 618, 165 N.E.2d 300), it would be absurd to insist on such strict adherence to the approved method. Given the limited number of electric municipalizations that have occurred in New York, the limits of this principle of flexibility recognized by the Court of Appeals in Town of Massena are both unclear and largely untested. The specific facts of the case involved abandonment of part of a plan of utility establishment providing for construction of a transmission line and substation, in favor of a plan to contract for transmission service. Thus, while there is clearly some flexibility permitted in implementation of the plan, it is not clear that such flexibility would extend, for example, from changing the entire method of acquisition under the plan from construction to condemnation or vice versa. Finally, it is worth noting that the key provisions of the utility establishment resolution used by the Town of Massena appear in the Appellate Division decision in the Town of Massena case cited above. Town of Massena v. Niaaara Mohawk Power Corporation, 60 A.D.2d 139, 400 N.Y.S.2d 862, 864-865 n.1 (3d Dept. 1977). This example provides a useful starting point for the drafting of an appropriate utility establishment resolution by any one or more of the East End Towns. 2. Joint Action Authorization As indicated above, there is abundant constitutional and statutory authorization for the joint exercise of the municipal utility power conferred by General Municipal Law Article 14-A by two or more municipalities. First, Article IX, Section l(c) of the New York Constitution -- part of the New York Bill of Rights for Local Government added to the Constitution in 1964 -- provides in relevant part that: Effective local self-government and intergovernmental cooperation are purposes of the people of the state. In furtherance thereof, local governments shall have the following rights, privileges and immunities in addition to those granted by other provisions of this constitution: - 11 (c) Local governments shall have the power to agree, as authorized by act of the legislature, with . one or more other governments within or without the state, to provide cooperatively, jointly or by contract any facility, service, activity or undertaking which each participating local government has the power to provide separately. Each such local government shall have the power to apportion its share of the cost thereof upon such portion of its area as may be authorized by act of the legislature. Second, Article VIII, Section 1 of the New York Constitution provides specific authority for joint action in financing by municipalities. Article VIII, Section 1 provides in relevant part that: IA]ny two or more [counties, cities, towns, villages or school districts] may join together pursuant to law in providing any municipal facility, service, activity or undertaking which each of such [town] has the power to provide separately. Each such unit may be authorized by the legislature to contract joint or several indebtedness, pledge its or their faith and credit for the payment of such indebtedness for such joint undertaking and levy real estate or other authorized taxes or impose charges therefor subject to the provisions of this constitution otherwise restricting the' power of such units to contract indebtedness or to levy taxes upon real estate. The legislature shall have power to provide by law for the manner and the proportion in which indebtedness arising out of such joint undertakings shall be incurred by such units and shall have power to provide a method by which such indebtedness shall be determined, allocated and apportioned among such units and such indebtedness treated for purposes of exclusion from applicable constitutional limitations, provided that in no event shall more than the total amount of indebtedness incurred - 12 - for such joint undertaking be included in ascertaining the power of all such participating units to incur indebtedness. Third, the general grant of authority for joint action and joint financing under Article VIII, Section 1, is specifically implemented by Article 5-G of the General Municipal Law (General Municipal Law Sections l19-m through 119-oo). In particular, General Municipal Law Section 119-o sets forth broad particular authority for the development and implementation of agreements among municipalities for the joint financing and operation of any municipal "service," including electric utility operations. Fourth, General Municipal Law Section 361(2) specifically provides for agreements among "two or more municipal corporations, authorized as provided in [General Municipal Law Article 14-A] to exercise the powers specified in [General Municipal Law Section 360] for the joint ownership, leasing, construction, acquisition, use or operation of a public utility service, within the combined territorial limits of such contracting parties. The method of operation of and the rates, rentals and charges for such service and the procedures for their collection shall be fixed by such agreements." There is no case law testing whether the general procedural requirements for utility establishment or financing by individual municipalities similarly apply to the joint exercise or. those powers by two or more municipalities. The constitutional provisions, by their terms, appear to contemplate that the procedural requirements applicable to municipalities acting individually are likewise applicable to municipalities acting jointly. Thus, it would appear that any agreements for the joint exercise of municipal utility powers are subject to the same referendum approval process as contemplated by General Municipal Law Section 360(3), (4) and (5). Joint financing activities are also apparently subject to the same procedural requirements that the Local Finance Law would impose on any municipal participant acting individually. Notwithstanding the existence of reasonably clear statutory and constitutional authority for joint action financing, joint action financing of a municipal utility serving more than one of the East End Towns may be complicated by practical considerations. This is because, under Article VIII of the New York Constitution and the Local Finance Law, municipal financing is generally required to be done on the - 13 - basis of a municipality's "faith and credit" -- i.e., general obligation financing, supported by a conditional tax, levied in connection with the relevant bond resolution, to make up any deficiency in debt service requirements that is not covered by the proceeds of utility operation. In the context of joint action financing, it is likely that lenders and bondholders would require cross-default and "step up" provisions that would obligate all non-defaulting joint action financing participants to make good on any default on financing obligations by one of the financing participants. Although these kinds of cross-coverage and step-up arrangements are permissible under Article VIII, Section 1 of the New York Constitution and General Municipal Law Section 119-o, they would inject a considerable level of complexity into a joint action utility financing because their effect on and relationship to the debt limitations applicable to participating Towns under Article VIII of the New York Constitution and the Local Finance Law is unclear as a legal matter. Thus, to the extent that the East End Towns may find it desirable in the future to contemplate the joint action financing of a municipal utility, the effects of cross- coverage and step-up requirements would have to be carefully and thoroughly evaluated in determining, as a practical matter, whether it is worthwhile to proceed with a joint action financing. B. Acquisition BV Eminent Domain General Municipal Law Section 360(6) provides that a municipal corporation may, for the purpose of establishing municipal utility service: acquire the public utility service of any public utility company operating pursuant to article four of the public service law or any other public utility service within or without its territorial limits, by purchase, or by condemnation in the manner provided by law for condemnation by such municipal corporation of private property for public use. This power to acquire utility facilities by purchase or by condemnation is one of the powers that may be exercised jointly by municipalities under General Municipal Law Section 361(2). Joint financing of any such purchase or condemnation is generally authorized under General Municipal Law Section 119-o(2) (e). 14 - It is important to bear in mind for purposes of this discussion that General Municipal Law Article 14-A permits, but does not require, a municipality seeking to establish a municipal utility to acquire facilities by condemnation. Thus, there is no general obligation on the part of such a municipality to condemn or to purchase facilities of a public utility corporation. Village of East Rochester v. Rochester Gas & Electric CorD., 289 N.Y. 391, 399-400, 46 N~E.2d 334, 339 (1943). There is no specific statutory process for condemnation of utility facilities set forth in Article 14-A of the General Municipal Law. Compare, e.g., Public Authority Law Section l199-eee(5) (specific condemnation principles applicable to the exercise of eminent domain power by the Saratoga County Water Authority against facilities of another water utility). Accordingly, the "manner provided by law for condemnation" for purposes of General Municipal Law Section 360(6) is set forth in New York's Eminent Domain Procedure Law ("EDPL"). The basic procedural framework of the EDPL is described below. II. EMINENT DOMAIN PROCEDURE LAW New York's EDPL was adopted in 1977 in order to impose a general, uniform process on the condemnation of private property for public use within the State of New York. The basic process of condemnation under the EDPL proceeds in four distinct steps: Public hearings, on specified public notice, resulting in the issuance of a "determination and findings" by the condemning authority specifying (a) the public use, benefit or purpose to be served by the proposed public project; (b) the approximate location of the project and the reasons for site selection; (c) the general effect of the project on the environment and residents of the locality; and (d) other relevant factors. The determination and findings are subject to judicial review in the Appellate Division on petition filed within 30 days of issuance (EDPL Article 2); Offer and ne=otiation, including prevesting discovery as to the value of the property to be taken. As part of this process, the condemnor is required to obtain one or more appraisals of - 15 - 3 o the property sought to be taken and to make a written offer for 100 percent of its highest approved appraisal to the party whose property is to be taken. The condemnee may reject or accept the offer, or may elect to accept the amount offered as an advance payment or deposit on full compensation and reserve the right to claim additional compensation (EDPL Article 3). Ac isition, where negotiations are unsuccessful in producing an agreement on price, is effected by court order. Proceedings must be initiated within three years of issuance of the determination and findings required under EDPL Article 2, or within three years of the entry of a final order or judgment on judicial review, whichever is later (the "final determination date") (EDPL Section 401(A)). Where the property at issue is to be acquired in stages, the determination and findings need only be made at the initial stage of acquisition. The first stage of the acquisition must be commenced within three years of the final determination date, and the last stage must be commenced within ten years of the final determination date (EDPL Section 401(C)). Vesting is accomplished by the filing of an order, on verified petition, by the Supreme Court for the county in which the property is located, determining compliance with the provisions of EDPL Articles 2 and 3, and an acquisition map, showing the property to be acquired. The Court may or may not order immediate occupancy of the property by the condemnor. Where the condemnee is permitted to occupy the property after vesting in the condemnor, the condemnee is liable to the condemnor for use and occupancy (EDPL Section 402). The condem~or may "abandon" the property acquired within ten years after acquisition, and must offer the condemnee a right of first refusal to repurchase the property (EDPL Section 406). Determination of comDensation. Within three years after vesting, the condemnee must file a claim for compensation in the Supreme Court. Compensation is thereafter determined by the Supreme Court, which - 16 - determination is thereafter subject to judicial review in the ordinary course. (EDPL, Article 5). Although the EDPL by its terms governs the condemnation of real property, EDPL Section 708 provides that "Whenever any condemnor is authorized to acquire for a public use property other than real property, the acquisition of such property shall be in the manner and procedure prescribed for the acquisition of real property under [the EDPL]." Given the specific authorization for condemnation of the "service" of a public utility corporation under General Municipal Law Section 360(6), it is clear that the process described in the EDPL will govern whether the utility facilities at issue are considered real property, personal property, fixtures or sui qeneris "utility property." As a general matter, it is worth observing that the clarity and uniformity of the EDPL imposes certain risks on the acquisition of utility assets through condemnation, particularly because the process required under the EDPL (which was enacted in 1977) has somewhat of an imperfect "fit" with the procedural requirements for establishment of a municipal utility under General Municipal Law Article 14-A (which was enacted initially in 1934 and last amended in 1965, when the former New York Condemnation Law controlled the use of the eminent domain power conferred by General Municipal Law Section 360(6)).5-/ A~ong these risks are: Potential practical tension between the requirement of General Municipal Law Section 360(3) -- that the maximum and estimated cost of the acquisition of plant and facilities be established at the outset of the formal utility formation process -- 5_/ It should be noted that the Town of Massena's condemnation cases, discussed in more detail below, proceeded under the former Condemnation Law and not under the EDPL. The principal substantive difference between the former Condemnation Law and the EDPL that is relevant to the condemnation of utility property is that Section 5-a of the former Condemnation Law required that the Public Service Commission render what amounted to an advisory opinion on the valuation of the utility assets subject to condemnation. The EDPL has no such provision. The valuation of utility assets is thus more uncertain under the EDPL. - 17 - and the foreseeably lengthy and uncertain process of finally fixing compensation (after acquisition) under the EDPL. The EDPL provides for two rounds of judicial oversight of the condemnation process: once in connection with appellate review of the initial determination and findings in the Appellate Division and the Court of Appeals, and again in connection with the fixing of compensation.6/ Given the otherwise relatively lengthy time frame envisioned by the EDPL for the completion of eminent domain proceedings, the occasions for potential judicial review under the EDPL can inject considerable elements of delay and uncertainty in the utility formation process. The negotiation and offer requirements of EDPL Article 3 (and the possibility that LILCO might accept the highest approved appraisal for its facilities as a partial payment) could result in the commitment of substantial amounts of capital with no operational benefit to condemning municipalities over what, again, could be a rather long period for carrying unproductive debt service. There may be offsetting advantages under the EDPL condemnation process as well. For example, the possibility of immediate occupancy under EDPL Section 402(B) (6) may offer the 6/ We note here that, given the structure of the EDPL, an order for the vesting of title in the condemnor under EDPL Section 402 is probably viewed as interlocutory and therefore not subject to appeal, although we have not reviewed this question in any detail. If a vesting order under EDPL is not treated as interlocutory, there may be yet a third level of judicial review. - 18 East End Towns (or any of them) the opportunity to get into the utility business more quickly -- and consequently to finance at least part of the costs of condemnation with the proceeds of utility operations -- than would be the case if occupancy of the property had to await a final condemnation award. However, this procedure has not been used in any electric utility condemnation under the EDPL and the law is therefore unclear concerning what, if any, risks may follow from using the "quick take" procedure authorized by EDPL Section 402(B) (6). In addition, there are various other cost shifting devices that the EDPL uses to discourage unjustified delay in the eminent domain process, and that may therefore result in a somewhat quicker resolution of that process than would have been the case under the former Condemnation Law. At this point in the East End Towns' consideration of the possibility of utility formation, the essential point is that condemnation is not the only means by which the Towns can get into the utility business. From the standpoint of evaluation of options, the establishment of one or more municipal utilities through the construction of self-owned facilities should definitely be considered as a viable option. This option also merits consideration because of the LIPA pre- emption issue, discussed below in Part III.D. of this memorandum. III. ANALYSIS OF SPECIFIC LEGAL ISSUES This section of the memorandum analyzes the eight specific legal issues identified at page 2 above. For s,~mmary purposes, these issues are: Generic Utility Defensive Strategies In Opposing Condemnation Proceedings; Valuation Methods Applied to Condemnation of Utility Property Under New York Law; Strategic Overview and Lessons from Town of Massena/Niagara Mohawk Municipalization; Possible Preemption of Municipal Authority Under the LIPA Act and Responsive Strategies; - 19 - Analysis of East End Towns Present Franchise Arrangements with LILCO; Implications of Energy Policy Act of 1992 7. Federal Income Taxation Issues Concerning Municipal Utility Bonds 8. Legal Issues Concerning Formation of Municipal Joint Action Agency. Each of these issues is important to any ultimate decision by the East Towns concerning the feasibility of establishing a municipality and the appropriate means to achieving that objective. Each of these issues is therefore analyzed below in a manner more intended to assist in that decisional process, rather than to support any specific recommendation as to whether (and if so, how) to proceed. A. Generic Utility Defensive Strategies In Opposinq MuniciDalization Efforts The specific question posed in our scope of services is to "identify obstacles and challenges that utilities have employed to seek to frustrate attempts by localities to acquire utility property." As a matter of general experience in this area, an investor-owned utility will respond to any effort to establish a municipal utility within its service territory (including the establishment of a competing municipal utility) in much the same way that it will respond to an effort actually to acquire its facilities through condemnation. There are three main components to the typical investor-owned utility's anti-municipalization strategy, each of which is directed ultimately to the erosion of the public will to create a municipal utility: 1. Attempting to make the process of utility establishment too expensive to complete. Whether or not the municipality seeks actually to acquire utility facilities through condemnation, the single most common responsive strategy of an investor- owned utility confronting the establishment of a municipal utility is to claim ,,stranded investment" -- that is, to allege that the new 20 - municipal utility has financial responsibility for the high cost generating assets that have driven rates to the point where municipalization becomes attractive. Challenging, at every possible point, the municipality's compliance with whatever procedural requirements are incumbent upon it. In New York, this would likely include challenges to: (a) the initial plan of utility establishment; (b) the municipality's legal authority to engage in the particular course of utility establishment it selects (see discussion of LIPA pre-emption, below); (c) any determination and findings made in connection with eminent domain proceedings; (d) other aspects of eminent domain proceedings; and (e) the municipality's compliance with other regulatory requirements (e.g., environmental issues). The name of the game here is both delay for its own sake, and disruption of the possibility of municipal financing of the establishment of its utility. The extensive use of propaganda (including misinformation) to dissuade popular support for municipalization. Some aspects of the predictable anti- municipalization strategy are subject to ready answers. Others have to be viewed as risks to be assessed and mitigated to the extent possible. We discuss each of these strategies in broad outline below. 1. The "Stranded Investment" Arc~ument An investor-owned utility confronting an effort to establish a municipal utility in its service territory will frequently try to defeat that effort through the assertion of a ,'stranded investment" argument. The argument originated long ago as a defense to municipal efforts to condemn utility - 21 - facilities, in the form of a claim that a municipal condemnation of electric distribution or transmission facilities necessarily deprived the investor-owned utility of the value of a proportionate share of its generating assets that, absent the condemnation, the utility would have devoted to the service of the customers proposed to be served by the municipal utility. In this context, claims for "stranded investment" were originally claims for "severance damages" or ,,consequential damages" to the property (i.e., generating assets) remaining in the hands of the utility after condemnation. See, for example, Puqet Sound Power & Liqht Co. v. City of Puyallup, 51 F.2d 688, 691-694 (9th Cir. 1931) (rejecting claim for "severance damages" to entire investor- owned utility system, including generation, resulting from appropriation of electric distribution facilities); City of Thibodaux v. Louisiana Power & LiGht Co., 225 F. Supp. 657, 661-663 (E.D. La. 1963), modified on other qrounds, 373 F.2d 870 (5th Cir. 1967), cert. denie~, 389 U.S. 975 (dictum suggesting that lessening of income producing potential of generation facilities is properly includable in condemnation damages award, actual holding is that only the value of nearby substations was affected by appropriation; case involved franchise with 64 years left to run). More recently, investor-owned utilities have attempted to claim (although not in any reported litigation) that the mere act of establishing a municipal utility, without actual condemnation, results in an actionable claim for "stranded investment" because the formation of a competing utility purportedly amounts to a governmenta% taking of property. Recently, the Federal Energy Regulatory Commission ("FERC") initiated a rulemaking proceeding (FERC Docket No. RM94-7-000) in which it attempted, without notable success, to formulate a proposed rule for dealing with "stranded investment" claims on the wholesale level. The FERC's rulemaking on the "stranded investment" issue is both ongoing and hotly contested, and the proposed rule would apply only to wholesale stranded cost issues. It therefore offers little in the way of useful guidance on the valuation of utility assets in a state law condemnation proceeding, although the ultimate rule may have some bearing on transmission pricing if the East End Towns find it necessary to seek a mandatory transmission order against LILCO under Section 211 of the Federal Power Act (see discussion at Part III.F.1. and 2. below). In addition, a number of utilities have attempted to file transmission tariffs with provisions for the recovery of "stranded investment" resulting from the formation of municipal utilities that use the host utility's transmission system. - 22 - See, e.q., Cajun Electric Power Cooperative, Inc. v. FERC, 28 F.3d 173, 176-180 (D.C. Cir. 1994) (rejecting FERC approval of "stranded investment" provision in transmission tariff). There are a number of short answers to stranded investment claims. First, and perhaps most succinctly, as the court observed in Cajun Electric Power Cooperative, Inc. v. FERC, supra, 28 F.3d at 179: IT]he concept of stranded investment has no meaning in a competitive market, since a surplus of productive capacity can always be readily eliminated simply by lowering price. That is, a price can always be found that is low enough that it increases demand sufficiently to eliminate any excess in productive capacity. Hence, there really is no such thing as stranded investment, only a failure to compete. In addition, it has been held in some cases that an offer by the condemning municipality to purchase power at wholesale from the utility that, prior to the condemnation of distribution facilities, served the municipality's citizens at retail, precludes any claim for stranded investment. Puaet Sound Power & Liqht Co. v. City of PuvalluD, 51 F.2d at 695- 697. Although the New York courts do not appear to have confronted the issue of "stranded investment" in express terms in utility condemnation, the general policies applied in valuation of utility property in cases under the former Condemnation Law tend to suggest that such a claim would be met with disfavor. See Onondaga County Water Authority v. New York Water Service CorD., 285 App. Div. 655, 662, 139 N.Y.S.2d 755, 763 (Fourth Dept. 1955) ("[S]everance damages might be proper under circumstances not present here"; valuation based on full reproduction cost of entire utility system rejected as irrelevant to the value of the plant condemned). Finally, it is well settled that there can be no valid claim for damages of any sort where a municipal utility is established in competition with, but does not condemn the physical assets, an investor-owned utility -- at least where the investor-owned utility does not hold an explicitly exclusive franchise from the municipality. ~ East Rochester v. Rochester Gas & Electric CorD., 289 N.Y. 391, , 46 N.E.2d 334, 339 (1943); Puget Sound Power & Liaht Co. v. cit of Seattle, 291 U.S. 619, 624-625 (1934) ("In conducting - 23 the business [of supplying electric light and power to consumers] by state authority, the city is exercising a part of the sovereign power of the state which the constitution has not curtailed. The decisions of this Court leave no doubt that a state may, in the public interest, constitutionally engage in a business commonly carried on by private enterprise, levy a tax to suppor~ it . . and compete with private interests engaged in a like activity"); Madera Waterworks v. city of Madera, 228 U.S. 454, 456 (1913) (Holmes, J.) ("But if, when the plaintiff built, the Constitution of the state authorized cities to build waterworks as well after works had been built there by private persons as before, the plaintiff took the risk of what might happen. An appeal to the 14th Amendment to protect property from a congenital defect must be in vain. . There is no pretense that there is any express promise to private adventurers that they shall not encounter subsequent municipal competition. We do not find any language that even encourages that hope, and the principles established in this class of cases forbid us to resort to the fiction that such a promise is implied"). 2. Other Litigation Challenges The opportunities for imposing cost and delay through litigation generally on the establishment of a municipal utility by condemnation or otherwise are as numerous as the procedural requirements involved in the establishment. Niagara Mohawk's claim that the Town of Massena "materially deviated" f~om its plan of utility establishment by deciding not to build a transmission line and thereby forfeited its right to condemn Niagara Mohawk's distribution facilities -- rejected by the Court of Appeals in Town of Massena v. Niagara Mohawk Power Corp., 45 N.Y.2d 488, 489-490, 410 N.Y.S.2d 276, 280-281 (1978) -- is illustrative, but by no means exhaustive, of utility creativity in this type of endeavor. Other examples include sponsorship (or direct initiation) of taxpayer litigation alleging that municipal activities relating to utility formation are beyond municipal powers, or fail to satisfy relevant procedural requirements. Se~, e.g., O'Flynn v. Village of East Rochester, 292 N.Y. 156, 164-165, 54 N.E.2d 343, 347 (1944), cert. denied sub nom. Despatch Shops, Inc. v. Village of East Rochester, 323 U.S. 713 (1944) (taxpayer litigation challenging municipal establishment of utility with insufficient capacity to serve large industrial customer); Cleveland Electric Illuminating Co. v. City of Cleveland, 37 Ohio St.3d 50, 524 N.E.2d 441 (1988) (taxpayer - 24 - suit challenging municipal utility financing arrangement on grounds of inconsistency with city charter). In this context, it is worth particular note that the first phase of judicial review under Eminent Domain Procedure Law Section 207 (judicial review of municipal determination and findings preliminary to condemnation) provides ample opportunity for a public utility facing condemnation to attempt to derail the process. Under EDPL Section 207(C), the Appellate Division,s review of the municipality's determination and findings is "limited to whether:" (1) the proceeding was in conformity with the federal and state constitutions, (2) the proposed acquisition in within the condemnor's statutory jurisdiction or authority, (3) the condemnor's determination and findings were made in accordance with the procedures set forth in this article [EDPL Article 2], and (4) a public use will be served by the proposed acquisition. Items 1 and 4 in particular may be interpreted with sufficient breadth to permit a creative public utility litigant to raise a host of challenges to the condemnation undertaking. Although the statute plainly contemplates a narrow standard of judicial review for the determination and findings, the language used to describe that standard is not necessarily narrow at all. Accordingly, we would expect to see a significant and thorough challenge to the dete~ination and findings at the initial stage of the condemnation process, which could serve to slow the process considerably. - 25 - 3. Pro_~9~D~anda Public utilities enjoy the right, under the First Amendment, to communicate freely with their ratepayers on matters of public concern. Pacific Gas & Electric Co v. Public Utilities Cnmmission of California, 475 U.S. 1, 11-15 (1986); Consolidated Edison Co. of New Y~rk v. Public Service Commission of New York, 447 U.S. 530, 544 (1980). It should be expected that this right will be used (and abused) to attempt to chill citizen support for any municipalization effort. B. Valuation Methods Applied to condemnation of Utility Property Under New York Law Almost everything that can be said about methods of valuing utility property in condemnation was said in 0nondaqa County Water Authority v. New York Water Service Co., 285 App. Div. 655, 662, 139 N.Y.S.2d 755, 762-763 (4th Dept. 1955) and the decision is therefore worth quoting at some length (citations'omitted): The valuation of utility properties in eminent domain presents unique problems. The absence of sales of similar property is one difficulty. For another thing, the taking includes not just the property but also the business, and the two are practically inseparable. Various tests have been employed, alone and in combination. The usual method of fixing the value of property for taking is by ascertaining market value. But there is hardly a market, in the usual sense, for a public utility, particularly a regulated utility. We must, therefore, turn to other tests of value. What we use is largely a matter of judgment and circumstance. Original cost is admissible in evidence, but is never controlling. By virtue of the vast distinction between the value for rate-making and the value of property for purchase or condemnation, this measure of value should not, and - 26 - seldom does, carry much weight in the determination of just compensation. Evidence of reproduction cost less depreciation is more widely employed as the test of value for condemnation, although by no means conclusive . Capitalization of earnings, .or the "economic" value is another method of appraisal that has met with approval in some jurisdictions, although usually rejected as the sole test. This test also has its limitations (primarily because of the speculative factors involved) but is unquestionably relevant, particularly when attempting to measure the intangibles of a public utility. Onondaqa remains good law in New York. Saratoaa Water Services, Inc. v. Saratoqa County Water Authority, 83 N.Y.2d 205, 210, 608 N.Y.S.2d 952, 954 (1994). However, its chief problem as a source of reference for valuation methodologies is that it only indicates what is not acceptable, and does not establish any particular valuation methodology as the methodology to be applied in New York. There Is Some Arguable Support For Capitalization of Earnings As A Preferred Approach to Valuation of Utility ProDert¥ in Condemnation As a matter of policy, there appears to be a slight but discernable preference among New York courts for some variation on the capitalization of earnings formula. This may be because Section 5-a of the former Condemnation Law -- providing for reference of utility condemnation cases to the Public Service Commission for certification of the rate base valuation of, and rate of return on, utility property subjected to condemnation -- expressed a preference for this methodology. Niaaara Mohawk Power CorD. V. Public Service Commission, 52 A.D.2d 388, 390, 383 N.Y.S.2d 913, 916 and n. 1 (3d Dept. 1976) (legislative findings on adoption of Condemnation Law Section 5-a concluded that condemnation awards with respect to utility property tended to be excessive, and that Section 5-a was intended "to direct the attention of the courts . to the general desirability of - 27 - the result derived by capitalizing the income which the private company could be expect to earn while subject to regulation as a private utility"). The precedential force of the legislative determinations underlying Section 5-a of the former Condemnation Law is open to question for several reasons. First, the current EDPL expresses no such preference for capitalization of earnings or any other valuation methodology (EDPL Section 512). Second, where capitalization of earnings is indicated as an advisory preference for valuation methodology in utility condemnation cases, the indication now appears only in specific enabling legislation. See, e.q., Saratoqa Water Services, Inc. v. Saratoga County Water Authority, supra, 83 N.Y.2d at 212-214, 608 N.Y.S.2d at 955- 956 (Saratoga County Water Authority's enabling legislation (Public Authorities Law Section l199-eee(5)) expresses advisory preference for capitalization of earnings methodology, but use of methodology in particular cases not mandatory). In short, it is unclear which way the old Condemnation Law precedent cuts. It could be argued that the old precedent remains good law, and that the New York Legislature simply did not see fit to specify any particular methodology in enacting the EDPL because the policy underlying Condemnation Law Section 5-a was so well established. It could also be argued, with perhaps equal persuasive force, that doing away with the general principle of Condemnation Law Section 5-a'in the EDPL, coupled with the appearance of that principle only in specific public authority enabling legislation, means that there is no longer any policy preference for capitalization of earnings as a valuation methodology. There is no precedent on either proposition at the moment. On balance, the former view seems to enjoy slightly more support (including Onondaga, which arose prior to the enactment of the former Condemnation Law), but not enough to state definitively that capitalization of earnings is the condemnation valuation method in New York. Additional Observations on Capitalization of Earninqs Subject to further emphasis of the point that there is no single, controlling valuation methodology for utility property that has been accepted by the courts of New York (or any other state), there are some mechanical elements of the capitalization of earnings approach that may be worth further - 28 - consideration in this context. These elements do not advance the search for concrete guidance on a dollar amount that the East End Towns could expect to pay for whatever LILCO assets (if any) they might determine to acquire by condemnation. However, they furnish some conceptual background on how this methodology might work in practice. First, from an economic and engineering perspective, although not necessarily from a legal perspective, a capitalization of earnings approach tends to drive the valuation of utility property toward a value approximating original cost less depreciation, plus severance damages. The qualification "plus severance damages" is an important one for our purposes, and will be revisited later in this discussion. The rationale for the basic observation that capitalization of earnings tends to drive the valuation of utility property toward original cost less depreciation (also known as "book value") is straightforward. The capitalized earnings of a utility on specific property are simply the present value of a stream of future earnings associated with that property. The earnings of a regulated utility for a given year are based on an approved rate of return applied to the then-current net book value of the facilities, i.e., their original cost, less depreciation accumulated to that point. In broad and theoretical terms, the allowable rate of return and the appropriate discount rate to be used in the present value determination are approximately equivalent and the net result of the discounting exercise should yield approximately book value. Second, it is by no means clear what earnings get capitalized where part, but not all, of a utility's facilities are acquired in condemnation. As a matter of logic, but not necessarily of law, capitalization of earnings ought to be applied only to the specific property acquired. The OnondaGa case, discussed above, suggests -- but stops far short of establishing for all purposes -- that this ought to be the case. See Onondaqa County Water Authority v. New York Water Serve, 285 App. Div. 655, 662-665, 139 N.Y.S.2d 755, 764-765 (4th Dept. 1955) ("[S]everance damages might be proper under circumstances not present here"; valuation based on full reproduction cost of entire utility system rejected as irrelevant to the value of the plant condemned). Third, and perhaps most importantly, there is the question of what "plus severance damages" means in this context. As suggested in Part III.A.1. above, LILCO would very likely argue that severance damages include its "stranded - 29 - investment" -- i.e., that condemnation damages should include its carrying costs, over a certain period, of generation assets that would have been dedicated to serving electric demand in the condemning municipality had the condemnation not occurred. The arguments against this kind of claim are also outlined in Part III.A.1 above, but it is simply not possible to predict with any certainty at this point how the courts of New York would ultimately resolve the issue in the context of a condemnation. Additional Observations on Market Value and Comparable Sales Although the New York case law does not express a clear preference for one valuation theory over another, there is an observation in Onondaqa (later confirmed in Saratoqa) to the effect that comparable sales represent the best evidence of the value of property in any condemnation context -- including condemnations of utility property. There are two examples that furnish some limited evidence of the "market" value of utility property in New York that may be of some value in fixing a price for LILCO's assets in condemnation. There is also a detailed statement of the New York Legislature's views on appropriate valuation methodologies specifically for LtLCO's facilities in the LIPA Act (Public Authorities Law Section 1020-h(1) (f) through (m), which tends to suggest -- assuming that municipal condemnation were not otherwise pre-empted (see discussion in Part III.D. below) -- that the legislature favors (or favored) original cost less depreciation as a valuation methodology for LILCO's assets. Because the LIPA Act presents a distinct set of problems, we focus here on the other available evidence of "market value" for utility property. The first evidence of "market" valuation appears inferentially in a case in which LILCO attempted to condemn certain utility easements on railroad right of way belonging to the Long Island Rail Road (LIRR). Although the ultimate disposition of that case was that LILCO was not entitled to condemnation of LIRR property, the factual discussion in the reported decision offers some insight into the negotiation process used to value utility rights-of-way. Lon I 1 nd Rail Road Co. v. Lonq Island Liahtin~ Co., 103 A.D.2d 156, 157-159, 479 N.Y.S.2d 355, 357-358 (2d Dept. 1984). The second, and probably more useful, example is the voluntary sale of the electric distribution facilities of Kenwood Power & Light Co. (a wholly-owned subsidiary'of Oneida - 30 - Silver Corp.) to the Town of Sherrill, New York in 1977. We understand, from information supplied to us by Sherrill's counsel in the acquisition, that the valuation of utility assets for the purpose of this sale was at net book value, or original cost less depreciation. The Sherrill-Kenwood sale furnishes at least one example of a "comparable" sale of utility assets that is generally regarded as the most compelling evidence of market value. Finally, it should be noted that the Commissioners of Appraisal in the Town of Massena condemnation case (discussed in the following section of this memorandum) arrived at a valuation of Niagara Mohawk Power Corp.'s facilities that appears to have been based on the reproduction cost new less depreciation (RCNLD) methodology discussed in the portion of the Onondaaa decision quoted above. Although the Massena condemnation thus provides an example of the use of RCNLD as a valuation methodology, the valuation recommendation of the Commissioners of Appraisal never received judicial approval because the case was settled. Thus, the valuation in Massena (which was reached under the former Condemnation Law rather than the EDPL) has no precedential effect. Ce Strategic Overview and Lessons from Town of Ma~sena/Niaqara Mohawk Municipalization The one fundamental lesson to be learned from the Town of Massena municipalization is that a high level of enduring public commitment to the formation of a municipal utility is probably the single most indispensable ingredient in that process. It should be anticipated that investor-owned utility opposition to the municipalization will be tenacious and, in all likelihood, considerably better funded than the municipalization effort itself. The other principal lesson of the Massena municipalization is that -- given an economically viable alternative source of power supply -- the long-term, high intensity public commitment required to complete the creation of a municipal utility will ultimately result in substantial benefits to the community that undertakes the commitment. We set forth in Attachment A a chronological s~mmary of events in the Massena municipalization~/ This s,~mmary is based on the testimony of Edward J. Kaneb, then-Chairman of the Massena Electric Utility Board in FERC Docket No. EL86-24-000 -- Municipal Electric Utilities (continued...) 31 - Some statistical background is also informative. The electric demand in the Town of Massena was approximately 15 MW during the period when Massena was establishing its system. Massena had originally predicted a maximum cost of $4.5 million for acquisition of facilities. The Commissioners of Appraisal appointed in the condemnation proceedings (under the former Condemnation Law) determined the value of the physical facilities that Massena sought to condemn as being $4,214,000, and the costs of severing that system from NIMO's system and reconnecting NIMO's system to be an additional $537,000. After the Commissioners of Appraisal issued their valuation decision, Massena and NIMO agreed that Massena would acquire an expanded distribution system (including facilities in four neighboring communities) for a purchase price of approximately $8 million. Between the initiation of its opposition to the Massena municipalization effort in December 1973 and September 22, 1981 -- when the fighting finally stopped for good -- NIMO spent approximately $4.2 million opposing the Massena municipalization. Net savings to Massena's citizens resulting from the municipalization equalled the initial purchase price of Massena's utility facilities by May 1986 -- about five years after operations commenced. According to the U.S Department of Energy, Energy Information Administration (EIA Form 861) and the Federal Energy Regulatory Commission (FERC Form 1 for NIMO), 1992 rates (the most recent available data) compare as follows: Niagara Mohawk Avq. Revenue/kWh Town of Massena Av . Rev nue kwh Residential $.106 $.047 Commercial .100 .052 Industrial .055 .037 On average, Massena's citizens save approximately 50 percent over what they would have paid if they had remained Niagara Mohawk customers as a result of their municipalization. ~/(...continued) Association of New York State v. Power Authority of the State of New York (filed October 20, 1986), and the various reported court and administrative decisions. - 32 - What the citizens of Massena had that citizens of other communities -- Toledo and New Orleans, to give two reasonably current examples -- have lacked is the enduring commitment to the goal of municipalization that enabled them to withstand a relentless barrage of propaganda and litigation designed to frustrate their political will to establish a municipal utility. Obviously, it did not hurt Massena's cause to have engaged the services of first rate engineers and attorneys to assist them in their efforts. Should the East End Towns expect a similar fight if they decide to pursue the formation of a municipal utility? Certain aspects of the process will certainly be different. The enactment of Section 211 of the Federal Power Act as part of the Energy Policy Act of 1992 (see discussion in Part III.F. below) will make the process of obtaining transmission rights a good deal quicker and more certain than it was in Massena's case. In addition, many of the specific legal issues that Massena had to confront were resolved in its favor and therefore likely will not confront the East End Towns in precisely the same form. However, vociferous utility opposition, both in the marketplace of ideas and in the courts, is a fact of the municipal utility formation process, and no one should expect that process to be easy. De Possible Preemption of Municipal Acquisition Authority Under the LIPA Act and Possible ResDonsive Strateaies The question of whether to acquire LILCO's facilities within any or all of the East End Towns (whether by condemnation or by voluntary purchase), or whether to proceed with construction of the Towns' own electric facilities, must be examined in the light of two recent New York State court decisions. The basic issue here is whether the enabling legislation for the Long Island Power Authority (Public Authorities Law Section 1020 through 1020-b_h (the "LIPA Act") pre-empts the authority of municipalities in LILCO's service territory to acquire LILCO's assets by purchase or condemnation. LILCO would undoubtedly argue that two court decisions establish this proposition: citizens for an Orderly Enerc~ Policy v. Cuomo, 78 N.Y.2d 398, 576 N.Y.S.2d 185, 582 N.E.2d 568 (1991) (hereafter "COEP v. Cuomo") and ~ Liqhtinq co. v. County of Suffolk, 119 A.D.2d 128, 505 N.Y.S.2d 956 (2d Dept. 1986), aDDeal denied, 506 N.Y.S.2d 1031 (1986) (hereafter "LILCO v. Suffolk"). In order to understand the "LIPA pre-emption" issue, and to evaluate the feasibility - 33 - and desirability of possible approaches to the issue, it is first necessary to appreciate how and why the issue arises. 1. The LIPA Act On July 24, 1986, the LIPA Act became law. In very brief summary, the LIPA Act is the response of the New York Legislature to what it perceived as the threat to the continued viability of LILCO's electric service on Long Island, growing out of the regulatory and financial disaster that LILCO's efforts to construct its Shoreham Nuclear Power Plant ultimately became. Several provisions of the LIPA Act -- the legislative findings and declarations in Public Authorities Law Section 1020-a, the general powers vested in LIPA under Public Authorities Law Sections 1020-g and 1020-h, and the rules of statutory construction in Sections 1020-ff and 1020-gg -- are central to the LIPA pre-emption issue. The legislative findings and declarations underlying the LIPA Act (Public Authorities Law Section 1020-a) list six related consequences of LILCO's development of the Shoreham Nuclear Power Plant which the Legislature finds create situation threatening the economy, health and safety in [LILCO's] service area." These include: (1) rapidly escalating and excessive costs of electricity in LILCO's service area, which pose a "serious threat to the economic well-being, health and safety of the residents and the commerce and industry in the service area"; (2) lack of confidence in LILCO's ability to meet the electric service needs of its customers; (3) deterrence of development of new commerce and industry in LILCO's service area as a result of escalating and excessive electric rates; (4) the imprudence of LILCO in initiating and continuing the Shoreham project; (5) general economic strain caused by present LILCO rate levels due to Shoreham, and anticipated future increases; and - 34 - (6) uncertainty as to whether Shoreham would ever go into commercial operation, and uncertainty as to the safety and reliability of its operation if it did enter commercial operation. The Legislature "expressly determined" in Public Authorities Law Section 1020-a that the problems arising from LILCO's pursuit of the Shoreham project were "matters of state concern within the meaning of" Article IX, Section 3(a) (3) of the New York Constitution,~/ (i.e., matters as to which municipalities do not have Constitutionally protected exclusive authority) and that "these matters of state concern best can be dealt with by replacing such investor owned utility [i.e., LILCO] with a publicly owned power authority." The remainder of the LIPA Act sets up a comprehensive structure for the establishment and operation of LIPA as a "corporate municipal instrumentality of the state which shall be a body corporate and politic and a ~o~i~ical subdivision of the state, exercising essential governmental and public powers." Public Authorities Law Section 1020-c. Among the "essential governmental and public powers" that the Legislature vested in LIPA were the powers (1) to acquire LILCO's stock through tender offer or otherwise, and (2) to acquire some or all of LILCO's stock or physical assets through eminent domain. Public Authorities Law Section 1020-h. Moreover, Public Authorities Law Section 1020-g(n) provides for the assumption of all LILCO service rights and obligations by LIPA, as follows: (n) After the establishment of Long Island Power Authority (LIPA) and the commencement of its Article IX, Section 3(a) (3) of the New York Constitution provides in relevant part that: (a) Except as expressly provided, nothing in this article shall restrict or impair any power of the legislature in relation to: (3) Matters other than the property, affairs or government of a local government. - 35 - function as a utility, LIPA shall acquire from LILC0 all franchise and utility service responsibilities for all ultimate consumers of gas and electricity within LILCO's former service territory, including the responsibility to provide safe and adequate service. Insofar as relevant to this discussion, Public Authorities Law Section 1020-h establishes a detailed, and rather extraordinary, regime for LIPA's acquisition of LILCO's physical assets, including: detailed principles of property valuation to be applied in fixing compensation for any taking (Public Authorities Law Section 1020-h(1) (f) through (m));9/ a requirement that LIPA's board of trustees determine, prior to initiating any eminent domain proceedings against LILCO's assets, "that the rates to be charged after 9/ Certain of these detailed valuation principles are plainly specific to a LIPA acquisition of Shoreham, and are not likely to be accepted by a court as legislative findings generally~ applicable to a condemnation of LILCO's facilities -- assuming that condemnation of those facilities is otherwise available. See, e.g., Public Authorities Law Section 1020-h(1) (g),(h) and (k) (iii). In other instances, most notably the Legislature's repeated finding that LILCO's economic viability is "dependent upon extraordinary financial stability adjustments granted by the public service commission" (Public Authorities Law Section 1020- h(1) (k) (i) and (ii), (m)) may properly be subject to judicial notice in a condemnation initiated by an entity other than LIPA. In any event, it should be pointed out that the Legislature may not direct that specific ualuation principles control the determination of condemnation damages. Rather, consistently with the constitutional requirement that "just compensation" for a taking of property be determined by the courts, the Legislature may only suggest that certain principles be considered in the valuation process. See, e.q., Saratoqa Water Services, Inc. v. Saratoqa County Water Authority, suDra, 83 N.Y.2d at 212- 214, 608 N.Y.S.2d at 955-956. - 36 - such acquisition and for such reasonable period of time as the board may determine will not be higher than the rates projected to be charged by LILCO during such period if such acquisition had not occurred" (Public Authorities Law Section 1020- h(2)); detailed procedures for condemnation of LILCO's assets at significant variance from those procedures set forth in the EDPL (Public Authorities Law Section 1020-h(6)); and e a requirement that, upon acquisition of LILCO's stock or physical assets, LIPA will make payments in lieu of taxes ("PILOTS") both to the state (in consideration of gross receipts taxes that would otherwise have been payable by LILCO) and to municipalities and school districts (in consideration of property taxes that would otherwise have been payable by LILCO) (Public Authorities Law Section 1020-q(1) and (2)). Finally, Section 1020-fl of the Public Authorities Law states that the LIPA Act is to be "liberally construed to effect [its] purposes," and Section 1020-gg states that the provisions of the LIPA Act shall control over the provisions of any other law with which they may be inconsistent. Against this very basic background on the LIPA Act, it is possible to assess the effect of the LIPA Act and court decisions construing it on the ability of the East End Towns to acquire LILCO's facilities within their territorial jurisdictions using their own eminent domain authority under General Municipal Law Section 360(6). As discussed immediately below, unless altered by legislative action or judicial action or both, the foregoing provisions of the LIPA Act and the court decisions construing those provisions could pose a significant obstacle to condemnation of LILCO's facilities within the East End Towns. - 37 - 2. The Pre-Emption Problem a. LILCO v. Suffolk At approximately the same time that the LIPA Act became law, the Suffolk County Legislature adopted a resolution establishing the Consumer Electric Corporation of Long Island ("CEC") as a not-for-profit corporation with the purposes of acquiring LILCO's stock or assets and closing and decommissioning Shoreham. LILCO immediately sought and obtained an injunction against the implementation of Suffolk County's CEC resolution, and Suffolk County appealed. On appeal, the Second Department of the Supreme Court Appellate Division, found that the Suffolk County CEC resolution was invalid both because it was pre-empted by the "detailed, highly comprehensive enactment" of the LIPA Act and because it was inconsistent with the method which the State had chosen for dealing with the problems posed by LILCO's Shoreham debacle. LILCO v. Suffolk, 119 A.D.2d 128, 132-134, 505 N.Y.S.2d 956, 959-960 (1986), appeal denied~. 506 N.Y.S.2d 1031 (1986). The basic principle here, as in any pre-emption case under New York law, is that local governments have, for the most part, only that authority which they derive from the state through legislation (such as Article 14A of the General Municipal Law), and they are pre-empted from regulating in areas where a State law "indicates a purpose to occupy an entire field of regulation" (505 N.Y.S.2d at 959, citation omitted). The court in LILCO v. Suffolk found that the LIPA Act, which established LIPA for the purpose of acquiring all or part of the stock or assets of LILCO, decommissioning the Shoreham nuclear plant and replacing LILCO as the electric and gas utility serving most of Long Island, pre-empted Suffolk County from establishing CEC to do essentially the same thing. Moreover, the court ruled that the intent of the legislature to pre-empt local government action in this field could be inferred from the LIPA Act. It relied on the following observation by the Court of Appeals in Consolidated Edison Co. of New York v. Town of Red Hook, 60 N.Y.2d 99, 106, 468 N.Y.S.2d 596, 599 (1983) (citations omitted): The intent to pre-empt need not be express. It is enough that the Legislature has impliedly evinced its - 38 - intention to do so . . . A desire to pre-empt may be implied from a declaration of State policy by the Legislature. . or from the fact that the Legislature has enacted a comprehensive and detailed regulatory scheme in a particular area.10/ Because (a) the LIPA Act contains a declaration of legislative policy that the issues it addresses are "matters of state concern" on which the state retains supreme legislative authority by virtue of Article IX, Section 3(a) (3) of the New York Constitution; and (b) the LIPA Act itself is a ,'comprehensive and detailed regulatory scheme" governing the public acquisition of LILCO's shares or assets, Suffolk County's attempt to exercise local authority in this area was held pre-empted. LILCO v. Suffolk, sumra, 505 N.Y.S.2d at 959-960. The court also held that Suffolk County's CEC Resolution was barred because (1) "Suffolk County's 'authority to enact local laws under the Constitution or the Municipal Home Rule Law is conditioned on the exercise of such authority not being inconsistent with any State enactment' ([citing Town of Red Hook])" (505 N.Y.S.2d at 959); and (2) "the differing treatment accorded these significant issues [(i.e., taxes and preference power)] by [the LIPA Act] and the county resolution represents a marked inconsistency in important areas of substantive policy" (505 N.Y.S.2d at 959). lO/: Essentially the same formulation of the issue can be found in a number of cases. See, e.q, PeoDle v. DeJesus, 54 N.Y. 2d 465, 469, 446 N.Y.S.2d 207, 430 N.E.2d 1260 (1981); Robin v. Incorporated Villaqe of HemDstead, 30 N.Y.2d 347, 350- 351, 334 N.Y.S.2d 129, 285 N.E.2d 285 (1972) (once state policy is expressed, "a village or other municipality lacks authority to deal with the matter unless it is specifically empowered to do so by terms clear and explicit"); Dou a~. County of Suffolk, 102 A.D.2d 531, 532, 477 N.Y.S.2d 381, 382 (2d Dept. 1984) (pre-emption of county regulation of "drug paraphernalia"); Matter of Ames v. Smoot, 98 A.D.2d 216, 218, 471 N.Y.S.2d 128, 130 (2d Dept. 1983) (village not required to file environmental impact statement prior to repeal of local regulation on use of pesticides because local regulation was pre-empted by state law and therefore invalid). - 39 - Read narrowly, LILCO v. Suffolk holds only that a municipality may not legislate a takeover of LILCO when (a) the State has enacted comprehensive LILCO takeover legislation, or (b) the municipal "legislation" is inconsistent with State legislation. If the East End Towns were to attempt to condemn facilities of LILCO for the purpose of establishing municipal electric systems, LILCO would surely assert that the LIPA Act, as interpreted in this case, precludes any exercise of the East End Towns' eminent domain powers against LILCO's facilities, on grounds of pre-emption and inconsistency. This would raise the following two questions: (1) Does the LIPA Act pre-empt towns from exercising their eminent domain powers under pre-existing legislation against LILCO facilities? (2) Is condemnation of LILCO facilities within the town boundaries for municipalization purposes inconsistent with the LIPA Act and therefore barred? Those issues have not previously been addressed by a New York court. The only case concerning the LIPA Act decided by the Court of Appeals of New York is citizens for an Orderly Enerc~ Policy v. Cuomo, discussed in the next section. b. COEP v. Cuomo Several parties brought a court challenge to the validity of the 1989 Settlement Agreement among LILCO, LIPA and the State of New York providing for the transfer of Shoreham to LIPA for $1 and its subsequent decommissioning or conversion to a fossil fuel generating facility. (The State Legislaturehad voted not to ratify the substantially identical 1988 Settlement Agreement, and although the 1989 Settlement Agreement did not require ratification, the Legislature refused to pass the requested legislative approval thought to be necessary for performance of the agreement.)ll/ Among other things, the challengers argued that the 1989 Settlement Agreement violated the LIPA Act and exceeded the authority of the Executive Branch. By a tenuous 4-3 margin, and over a stinging dissent, the Court of Appeals upheld the validity of the 1989 Settlement Agreement in citizens for an Orderly Enerq7 Policy v. Cuomo~ 78 N.Y.2d 398, 1_~1/ citizens for an Orderly Enerq¥ Policy v. Cuomo, 576 N.Y.S.2d 185, 199 (dissent) (Ct. App. 1991). - 40 - 576 N.Y.S.2d 185, 582 N.E.2d 568 (1991) ("COEP v. Cuomo").12/ The Court held that LIPA and the Executive Branch had discretionary authority under the LIPA Act to acquire Shoreham from LILCO without LIPA replacing LILCO as the electric service provider in LILCO's service territory. The New York Court of Appeals also concluded that the closure of Shoreham was not necessarily the end of LIPA's statutory mission. Thus, the Court found in COEP v. Cuomo, 78 N.Y.2d 398, 414, 576 N.Y.S.2d 185, 192., 582 N.E.2d 568 (1991) that (citations omitted, emphasis in original): Further, under the terms of the Agreement, LIPA did not permanently forego the exercise at some time of its delegated power to acquire and supplant LILCO should it decide in its "sole discretion" that doing so would accomplish the Act's objective of controlling utility costs to LILCO's customers. The Agreement is not structured to expressly prohibit acquisition by LIPA of any part of LILCO other than Shoreham, as the Agreement in no way precludes LIPA from exercising its full range of statutory choices under the LIPA Act depending on the time and circumstances, including market conditions and the State's fiscal situation. Rather, the Agreement plainly accomplished an u~gent objective of the Act: the prevention of further rate increases attributable to the Shoreham enterprise. LILCO would argue that L_~LCO v. Suffolk and COEP v. Cuomo, read together, frustrate any possible exercise of municipal eminent domain powers against LILCO's facilities. On the one hand, the State has "occupied the field" of possible public acquisition of all or any part of LILCO's facilities -- thereby leaving no room for individual municipal action in this area (LILCO v. Suffolk). On the other hand, the State having accomplished its principal objective under the LIPA Act of stopping Shoreham, it nonetheless continues to 12/ Judge Hancock wrote a strong dissent, joined by two other judges. The swing vote in the case was provided for the majority by Chief Judge Wachtler, who is no longer on the Court of Appeals. - 41 - Occupy the field to the exclusion of municipal acquisition activities -- even though it has no discernable present intention to do anything further under the LIPA Act (COEP v. Cuomo). However, no court has construed the LIPA Act or the two court decisions interpreting it in the context of a limited, municipal condemnation of LILCO facilities. The flexible approach to implementation of the LIPA Act en~lorsed by the slim Court of Appeals majority in COEP v. Cuom~ may in fact have weakened the precedential effect of the Appellate Division's holding in LILCO v. Suffolk. We discuss below a number of possible approaches to the LIPA pre-emption issue that ought to be considered as part of an analysis of the feasibility of establishing a municipal utility by the East End Towns. 3. Possible Approaches We have identified four possible approaches to the LIPA pre-emption issue: (a) seeking a declaratory judgment, prior to the initiation of condemnation proceedings, that the LIPA Act does not bar municipal condemnation of LILCO assets; (b) entering into an arrangement with LIPA under which LIPA would either (i) condemn facilities and transfer them to the East End Towns, or (ii) authorize the East End Towns to exercise their own eminent domain authority, or (iii) some combination of the foregoing; (c) seeking one or more legislative alterations of the LIPA Act; and (d) establishing a competing'municipal utility without condemning LILCO assets. Depending on local will and the wherewithal to proceed, any of these options could conceivably result in the elimination or neutralization of the LIPA pre-emption issue. a. Declaratorv Judc~ment The East End Towns could consider, as a prelude to individual condemnation proceedings, jointly petitioning the Supreme Court of Suffolk County for a declaratory judgment that the LIPA Act does not pre-empt municipal condemnation of LILCO facilities within the Towns' borders and that such condemnation would not be inconsistent with the LIPA Act. For one thing, the Towns could argue that a local, municipal condemnation under longstanding legislation is distinguishable from a county's overreaching attempt to compete with the State in taking over all of LILCO within and without the county's borders. After all, the mere fact that a local law touches upon the same matters as State legislation does not, in and of - 42 - itself, render it invalid on pre-emption grounds. People v. New York Trap Rock Corp., 57 N.Y.2d 371, 378, 456 N.Y.S.2d 711, 442 N.E.2d 1222 (1979). Indeed, since nothing in the LIPA Act even remotely purports to limit the right of municipalities to build their own utilities to compete with LILCO (as discussed below), thereby potentially rendering LILCO's local facilities valueless, then arguably it would be anomalous to find that the LIPA Act pre-empts municipal condemnation of LILCO Facilities, which would protect other LILCO ratepayers by requiring payment to LILCO of fair value as compensation. Municipal condemnation of limited pieces of the LILCO system is also not necessarily inconsistent with the LIPA Act. It would merely reduce the size of the LILCO system available for eventual takeover by LIPA. Moreover, if necessary, LIPA could acquire the municipalized portions of the system back from the Towns by contract or condemnation under Sections 1020-g and 1020-h of the Public Authorities Law. In addition, there are certain constitutional arguments that the East End Towns could advance. For example, Article IX, Section l(e) of the New York Constitution guarantees municipalities the "power to take by eminent domain private property within their boundaries for public use" subject only to legislative regulation of eminent domain proceedings against property outside of municipal boundaries. Thus, a condemnation effort limited in territorial scope to within municipal boundaries of the East End Towns, or any of them, coul~ be argued to be constitutionally protected and not subject to state pre-emption. Furthermore, facts such as (1) the consummation of the 1989 Settlement Agreement among LIPA, the State and LILCO, (2) the passage of eight years without acquisition of LILCO by LIPA and (3) the current Executive inclination in New York effectively to "defund" LIPA, establish that whatever the legislative intent to occupy the field of acquisition of LILCO's assets may once have been, that intent has plainly been abandoned as a practical matter. These arguments appear persuasive, but would have to be tested in court. It may be possible to obtain a declaratory judgment on motion for s,~mmary judgment, thereby avoiding time-consuming and costly discovery battles, but this cannot be guaranteed. Any decision would be appealable to both the Appellate Division and the Court of Appeals, but LILCO may not want to risk losing an appeal of a decision 43 - favorable to the Towns. These are risks to be weighed in making a strategy decision. b. Cooperative Action with LIPA Various provisions of the LIPA Act itself may offer a way around the LIPA pre-emption impasse through joint action among the East End Towns and LIPA. First, LIPA is generally authorized by Public Authorities Law Section 1020-f(h) "to make and execute agreements, contracts and other instruments necessary and convenient in the exercise of the powers and functions of the authority under this title, including contracts with any . · municipality in accordance with the provisions of section one hundred three of the general municipal law, and . all municipalities are hereby authorized to enter into and do all things necessary to perform any such agreement with the authority." Second, LIPA is specifically authorized by Public Authorities Law Section 1020-f(t) "to transfer any asset of the authority to one or more (ii) municipal gas or electric agency established pursuant to article 14-A of the general municipal law, for such consideration and upon such terms as the authority may determine to be in best interest of gas and electric ratepayers in the service area." Another possibility is for LIPA simply to conclude, in the exercise of its discretion as to how best to achieve whatever remains of its statutory mission, that the exercise of eminent domain authority by the East End Towns is an appropriate'means of implementing the objectives of the LIPA Act. The principal issue in pursuing this possibility is that LIPA's discretion under Public Authorities Law Section 1020- h(2) appears to be limited to the use of its own acquisition authority, and not applicable to the authorization of the acquisition through purchase or eminent domain of LILCO's facilities by others. There are three issues that may make cooperative activity with LIPA problematic. Although none of these issues conclusively rules out cooperative action with LIPA, all of them counsel in favor of careful consideration before attempting to proceed further. First, as a condition prior to exercising LIPA's own eminent domain powers, the LIPA board is obligated to determine that LIPA's rates after the acquisition will be at worst no higher than LILCO'S rates would have been if LIPA had not undertaken the particular acquisition under consideration. (Public Authorities Law Section 1020-h(2)). Second, where LIPA exercises its acquisition authority, it is - 44 obligated both to the state and to local municipalities for PILOTS for gross receipts and property taxes, respectively. (Public Authority L. Sec. 1020-q.) Thus, any arrangement for joint action with LIPA would have to factor in some mechanism for paying PILOTS (and obviously for determining in advance how the allocation of the obligation to pay PILOTS affected the feasibility of the undertaking). Finally, LIPA's Settlement Agreement with LILCO provides that, in the event that LIPA ever does determine to exercise its acquisition authority over any LILCO asset other than Shoreham, LILCO is entitled to resume its federal court challenge to the constitutionality of the LIPA Act. COEP v. Cuomo, 78 N.Y.2d at 409, 576 N.Y.S.2d at 188, referrinq to Lona Island Liahtin~ Co. v. Cuomo, 666 F. Supp. 370 (N.D.N.Y. 1987), anneal dismissed and iudc~ment vacated, 888 F.2d 230 (2d Cir. 1989). It is unclear at this point whether or to what extent any of these considerations may deter LIPA from cooperating with the East End Towns, or whether any of these considerations make it more worthwhile for the East End Towns to attempt to proceed without LIPA's cooperation. Nonetheless, cooperation with LIPA represents a potentially viable way around the LIPA pre-emption issue and the possible benefits of its cooperation (or obstacles to that cooperation) are clearly worth exploring and evaluating further. c. Le=islative Amendment The most direct and obvious solution to the LIPA pre-emption, issue is to persuade the New York Legislature to adopt an amendment to the LIPA Act which eliminates the pre- emption problem. There are a number of variations on this theme, which might be worth pursuing depending on the East End Towns' perception of the political climate. The first and simplest option would be legislation adding a Section 1020-h(12) to the Public Authorities Law which would read: Nothing in this title shall be construed as pre-empting, or otherwise limiting, the rights of any municipality located in whole or in part in the service area from exercising any power or authority granted to it by article 14-A of the general municipal law, including the right to acquire facilities through eminent domain as set forth in subsection six of section - 45 - three hundred sixty of the general municipal law. It is, of course, possible to add other options. One that might be helpful to the East End Towns would be to add Public Authorities Law Section 1020-h(13), to read: In connection with the exercise of the power of eminent domain specifically reserved to municipalities located in whole or in part in the service area, the legislative findings with respect to the appropriate valuation of LILCO's property, as set forth in subsection one (f) through (m) of section ten hundred twenty-h of the public authorities law, shall be considered by the court in establishing just compensation for any property taken by any such municipality. Finally, it may prove possible to obtain an entirely new enabling statute for a new power authority -- say, the ,,Peconic Power Authority" having its own title under the Public Authorities Law, and provided with a specific preferred valuation methodology similar to that made available to various county water authorities. See, e.~., Public Authorities Law Section l199-eee(5) (legislative pronouncement on capitalization of earnings method for valuing property condemned by Saratoga County Water Authority). d. Establishin~ a Com~etinq Utility Each of the foregoing options assumes to some extent that the East End Towns would be willing to confront the LIPA pre-emption issue directly. We believe, in addition, that the establishment of a competing municipal utility by any or all of the East End Towns, without acquiring any LILCO assets, does not run the risk of being invalidated by pre-emptive effect of the LIPA Act. First, it is clear that the central objectives of the LIPA Act are (1) the takeover of LILCO if necessary, and (2) the closure of Shoreham at all costs. Neither of these objectives has any relationship to the establishment of a municipal utility that does not seek to acquire LILCO's assets. The mere fact that a local law touches upon the same matters as State legislation does not, in and of itself, render it invalid on pre-emption grounds. People v. New York - 46 - TraD Rock CorD., 57 N.Y.2d 371, 378, 456 N.Y.S.2d 711, 442 N.E.2d 1222 (1979). Second, in enacting the LIPA Act, the Legislature was expressly operating under A~ticle IX, Section 3(a) (3) of the Constitution (Public Authorities Law Section 1020-a). Article IX, Section (3) (b) of the Constitution states that: "The provisions of this article shall not affect any existing valid provisions of acts of the legislature ." Thus, it would appear that whatever the effect of the LIPA Act on the specific field of activity it undertakes to regulate -- the acquisition of LILCO's stock or assets -- the LIPA Act could not constitutionally restrict pre-existing municipal powers under General Municipal Law Article 14-A which are outside that field. Thus, we believe that the East End Towns could create a municipal utility that competes with LILCO without running afoul of the pre-emption issue, provided that they do not seek to acquire any of LILCO's assets. Ew Analysis of East End Towns Present Franchise ArranGements with LILCO We have reviewed franchises either granted to, or passing through merger or asset acquisition to, LILCO from the following municipalities among or within the East End Towns: 1. Town of Southampton a. Village of Southampton b. Village of Sag Harbor 2. Town of Riverhead 3. Town of Southold 4. Town of East Hampton 5. Town of Shelter Island at Village of Dering Harbor (Shelter Island Heights) The key historical and contractual elements of the various franchises are s~marized in the Table appearing on the following page. For the reasons s,,mmarized below, none of the franchises poses an obstacle to the formation of a municipal utility by any one or more of the East End Towns. 47 - The franchises granted by the Villages of Southampton, Sag Harbor and Dering Harbor may pose certain service territory issues involving the New York Public Service Commission, if those villages are not part of the municipalization effort. A few general observations about the nature of franchises under New York law are pertinent to this discussion. First, a franchise is a property right under New York law, and is thus generally protected from curtailment or taking without just compensation. 60 New York Jurisprudence 2d (Franchises), Sections 2 and 3, pages 373-374. Although a franchise is regarded as property and may not be "taken" in a constitutional sense without just compensation, it is equally well settled that no "taking" occurs where a municipality establishes a competing utility -- at least where the municipality has not granted an exclusive franchise. Villaqe of East Rochester v. Rochester Gas & Electric CorD., 289 N.Y. 391, 399-400, 46 N.E.2d 334, 339 (1943). Second, exclusive franchises do not arise by implication under New York law. Monopoly is not an essential element of the franchise. Milhau v. Sharp, 27 N.Y. 611 (1963). Thus, "except where a grant is by its terms exclusive, the grantor reserves the power to grant a subsequent franchise competitive with it, no matter how injurious the competition; and such a subsequent grant is not violative of the constitutional provision against impairing the obligation of contracts." 60 N.Y. Jur. 2d (Franchises) Section 9, p. 383. Indeed, because the New York Legislature may not grant exclusive franchises by private or local bill under Article III, Section 17 of the New York Constitution, it is difficult to see how it could have delegated a power it did not have to towns under Section 64(7) of the Town Law, or to villages under Sectio~ 414-2(1) of the Village Law -- the relevant enabling statutes for the municipal grant of franchises in this instance. Third, the~e is no necessary exclusivity of utility service areas under ~ew York law. The right of a utility to serve in a particular locality depends (a) on the grant of a franchise, and (b) the subsequent certification by the Public Service Commission under Public Service Law Section 68 that the exercise of the franchise is in the public convenience and necessity. Finally, several of the franchises we examined were of indefinite duration. Under New York law, the grant of a franchise without a definite term is treated as a perpetual - 48 - grant. PeoDle v. O'Brien, lll N.Y. 1, (1888); Brauer v. Iroquois Gas CorD., N.Y.S.2d 166, 168 (Sup. Niagara 1975). 38-55, 18 N.E. 692, 85 Misc.2d 936, 381 None of the franchises that we reviewed are by their terms exclusive (see Table). Accordingly, none of the franchise reviewed presents an obstacle to the establishment of a competing municipal utility. In the event that one or more of the East End Towns determines to proceed by condemnation, the franchise may be assigned some value in condemnation -- although how much value is very much open to question. Village of East Rochester v. Rochester Gas & Electric Cor., 289 N.Y. 391, 399, 46 N.E.2d 334, 338 (1943). A couple of fine points are worth noting. Franchises exist from both towns and villages within the towns. This may counsel in favor of getting the villages on board; otherwise, the extension of service to the villages would (a) require their consent, and (b) require approval of the NYPSC under General Municipal Law Section 361(1) and Public Service Law Section 68. To the extent that we have franchises granted by different levels of governmental bodies, the foregoing administrative issue exists and will need to be resolved at some point. However, it is not an impediment to proceeding with municipalization. F. Implications of Enerqy Policy Act of 1992 The most significant feature of the Energy Policy Act of 1992, for purposes of this discussion is the authority given to FERC to order mandatory transmission service under Section 211 and 212 of the Federal Power Act (16 U.S.C. §§ 824j, 824k). In short, Section 211 provides a reasonably certain means for the East End Towns to require LILCO to transmit power from other utilities to them -- a means of acquiring power supply that is likely to prove considerably more cost effective than constructing submarine cables. Prior to the enactment of these provisions, it was typically held that the FERC had no general authority to require electric utilities to transmit (or "wheel") electric power, although it could do so in particular circumstances (e.g. as a condition to authorization of a utility merger, in order to remedy antitrust problems). Under Section 211, the FERC now indisputably has such general wheeling authority. We discuss below (1) the general requirements and operation of Sections 211 and 212 of the Federal Power Act, and (2) a potential application of those provisions in the context of a APPENDIX B Estimated Operating and Maintenance Expensem Operating and Town Maintenance Expenses Southampton $6,850,000 East Hampton 3,750,000 Riverhead 2,500,000 $outhold 2,300,000 Shelter Island 600,000 TOTAL $16,000,000 Joint-System $15,250,000 (*) - (Includes an Allowance For Administrative and General Expenses but does not include Power Cost, In-Lieu Property Tax Payments, Debt Service on Borrowed Funds and Depreciation) B-18 East End Municipalization ACQUISITION OF ~ECTRIC PROPERTIES OPERATING AND MAINTENANCE EXPENSES We have reviewed the on-going annual operating and maintenance expenses of operating murticipal electric departments in New York, as well as others for which we have information, and have developed a preliminary estimate for the annual operating and maintenance cost each of the Towns could be expected to pay for this expense. The cost we have estimated does not include power supply expenses, in-lieu-of-tax payments, depreciation expense or debt service on the funds which will be needed to purchase the properties and set-up operation. The power supply cost will need to be developed separately and the other expenses are dependent on the cost of the properties acquired as well as the current level of taxes paid by LILCO. It is assumed that each Town would plan to pay in-lieu tax payments equal to the amount of taxes LILCO is now paying on the pr6perty to be acquired. The expenses developed does however consider all other annual cost each utility will incur. In reviewing the annual cost of other operating municipal utilities, it was appaient that the operating and maintenance cost varies substantially between utilities based on the conditions in the particular municipal service area and the general operation policies of the managing board. The new Town municipal electric departments will have the same leeway in establishing the operation policies of the new utilities. Based upon the information available at this time, we have developed the following preliminary estimate of each utliity's operation and maintenance cost. s.~'our~Mp~ R.W. Beck B-17 APPENDIX B Initial Set-up Town Cost Southampton $3,250,000 East Hampton 2,250,000 Riverhead 1,800,000 Southold 1,675,000 Shelter Island 850,000 TOTAL $9,825,000 Joint-System $5,300,000 In addition to the materials and supplies required to initially set up the departments; a working capital fund is needed to pay operating and maintenance expenses during the period between acquiring of the properties and the time revenues are first received from the sale of elect:ricity (i.e., until the new electric customers have paid the initial round of electric bills). For the purpose of this Study, we have assumed an amount equal to approximately 45 days of operating and maintenance expenses, excluding power purchase expense, would be required as the working capital fund. This results in the following estimated working capital fund for each Town. Working Town Capital Fund Southampton $1,000,000 East Hampton 500,000 Riverhead 400,000 Southold 400,000 Shelter Island 100,000 TOTAL 2,400,000 Joint-System !,250,000 B-16 East End Municipalization ACQUISITION OF-~-~.ECTRIC PROPERTIES Preliminary Estimated Engineering Costs Five Separate One Joint- One Town Town System System Systems Phase I $600,000 $500,000 $1,500,000 Phase II 250,000 250,000 1,250,000 Phase III 500,000 400,000 1,750,000 TOTAL $1,350,000 $1,150,000 . $4,500,000 UTILITY OPERATIONS AND START-UP COST The ,amount of cost ultimately expended to initially establish the operation of a municipally-owned electric system in each of the Towns or as a single system to serve all the Towns, will depend on the particular procedure which each Town, or group of Towns, follows. For the purpose of estimating the comparative cost of start-up on an individual Town basis versus a joint-system basis, we have assumed each Town and the joint-system would establish, equip and organize a municipal electric department comparable to the municipal light departments other towns in New York have established and currently operate. The start-up cost for a new electric department is primarily associated with providing office and garage space, acquiring office equipment, transportation vehicles and work equipment, purchasing an inventory of maintenance and replacement materials and setting up a working capital account. The amount each Town will be required to spend on start-up costs is also related to the size of the electric system the new department must maintain, and the cash flow estimate of the individual electric system. We have assumed each new utility would initially lease office and garage space. We recommend this approach because it both reduces the initial capital requirement and gives the Towns time to plan for the type of facility that would best fulfill the needs of the new electric department. Based upon a review of the materials and equipment other municipal departments maintain and the above considerations, we estimate each of the Towns and the joint-system would expend the following amounts to initially establish and equip their new electric departments. s.~-.ou,.~., R.W. Beck B-15 APPENDIX B Preliminary layout and cost estimate for separation and reconnection plan Preliminary organization and operation plan for utilities (or utility) Engineering and economic study of potential severance damages LILCO may claim Engineering assistance to legal council and Towns in evaluating and responding to questions raised by LILCO and Town. Prepare exhibits and testimony to be used in eminent domain proceedings The second phase (Phase II), eminent domain proceedings, are expected to take several months and the effort required during this period could involve a large number of engineering hours to assist the legal counsel in evaluating claims made by LILCO and preparing rebuttal testimony. The final phase (Phase III) activities will be based on the final rulings of the court and/or negotiations with LILCO. It would address the separation and reconnection plan, the method of separating the new distribution system(s) from LILCO system would be finalized, and construction contracts would be awarded. During this time, the organization and operation plan would be finalized and staffing would be undertaken. The amount of effort required to complete the engineering tasks in each of the above phases, and therefore the costs, will be dependant on a number of factors, the most important of which, is the amount of information LILCO cooperatively provides and the effort required to obtain it from LILCO or from other sources. We do not estimate that there would be a major difference in the engineering cost between proceeding with a eminent domain proceeding for either: (1) one Town, or (2) for all the Towns to form a joint-system to supply all the Towns. The difference in this case is estimated to be in the range of 10 percent to 15 percent. However, if each Town elected to establish its own independent system and each had to go through the total eminent domain proceeding on their own, we estimate the engineering cost on a total basis would be much higher. Our preliminary estimate of the engineering cost for each of the above phases is as follows. B~14 East End Municipalization ACQUISITION OF .,LECTRIC PROPERTIES Distribution System Modify Separation and Power Supply Reconnection Facilities Southampton $1,250,000 $1,000,000 East Hampton 1,000,000 1,000,000 Riverhead 500,000 3,500,000 Southold 150~000 1,000,000 Shelter Island 150,000 3,500,000 TOTAL $3,050,000 $9,500,000 Joint-System $5,000,000 $45,000,000 ENGINEERING EXPENSES It is unknown at this time how willing LILCO will be to negotiate the sale of its electric properties in each Town. If they oppose the acquisition by the Towns, it can be anticipated that significant funding will be needed to support the legal and engineering effort required to determine the value of the properties as well as the negotiation and litigation related to certain subsequent contractual obligations. The amount that will be required for legal and engineering expenses could also vary substantially depending upon the whether each Town proceeds independently with litigation or litigation is undertaken as a group. Chapter 360 of the New York General Municipal Law sets forth the procedure that all municipals must follow to set up and acquire an electric system. The process to be followed prior to commencing the eminent domain proceeding could take up to one year. The engineering work that is anticipated as necessary during this initial phase (Phase I) includes the following. 1. Mapping of all primary distribution lines 2. Inventory of all properties to be acquired 3. Valuation of properties to be acquired ~soum,~,~ R.W. Beck B-13 APPENDIX B The 69 kV lines that cross the western border of Riverhead supply local load in Riverhead as well as extending westward into Brookhaven. We anticipate LILCO wanting to retain this 69 kV transmission line, therefore, we have added to the overall cost of the work required along this border, the cost of constructing a new 69 kV line from LILCO's Riverhead substation to connect with the Grumman Plant and a second line to Wildwood. We have also identified several potential locations along the western borders of Riverhead and Southampton where separation and reconnection work may be required on the lower voltage distribution lines. We have provided an allowance of $5,000,000 to do this reconnection work and construct the new 69 kV lines discussed in the preceding paragraph. Another cost we anticipate that the joint-system plan would incur that the separate-system plan would not, is the cost of acquiring the 69 kV transmission line that loops through the five Towns. The jointly-owned system's ownership of this portion of the 69 kV transmission system and the 69 kV substations would allow the joint-system to establish a single delivery point at LILCO's 138 kV Riverhead Substation and take advantage of coincidental metering of the group's peak kW demand. Based on a very preliminary estimate of the Reproduction Cost New of this tine tess an allowance for depreciation, we have estimated a cost of $45,000,000 for the purchase of the 69 kV transmission lines and stepdown substations in the five Towns. This cost does not include the cost of the 69 kV lines that extend from the Riverhead Substation to the west which we have assumed would not be acquired. It represents the incremental cost of properties obtained for a jointly-owned system that are over and above the properties which the individual Towns would individually acquire for stand-alone systems. While we have added in the cost of acquiring the 69 kV loop in this Preliminary Study, it is important to note that this 69 kV line is also tied to several small generating stations that LILCO operates. We believe these stations are used to maintain stable voltage conditions during high load periods as well as provide capadty to serve LILCO's overall load. It is our preliminary opinion that LILCO can and should continue to own and operate these small generating stations, and in fact, will need to operate these stations to deliver stable power to the joint-town system and LILCO's other customers on Long Island. This issue should receive future study if the Towns continue developing a joint-system. COMPARISON OF SEPARATION AND RECONNECTION COSTS A comparison of the amounts we have estimated to fund the separation and reconnection cost and for making modifications to power deliver facilities for each Town on a separate-system basis and for the combined Towns on ,a joint- system basis is shown below. B-12 East End Municipalization ACQUISITION OF, .ECTRIC PROPERTIES Shelter Island is bordered on all sides by the shoreline of the island. This natural boundary eliminates the need to consider severance damages along the border. The only points where disconnection and reconnection work is assume to be required is where the lines come on to the island. We have estimated an allowance of $150,000 for the disconnection and recormection work to be done to the distribution lines both inside and outside the town for the points the distribution lines enter the island. Power is delivered into Shelter Island through a 69 kV transmission line that extends through the town and circles ~rough the other Towns included in this Study. LILCO's reports do not indicate that there is any stepdown substation on the island, therefore, we have assumed that if a separate electric system were established on the island a 69 kV substation would need to be constructed and connected to the existing distribution system. We have estimated a cost of $3,000,000 to construct a new substation and reconnection of the distribution lines. SEPARATION AND RECONNECTION UNDER JOINT-SYSTEM If the five Towns proceeded to establish one jointly-owned system to serve the power needs of all the Towns, we believe it is reasonable to assume the power requirements would justify the Towns ioint-system taking power at the 69 kV level at the Riverhead Substation. The combined number of customers and customer energy usage in the five Towns based upon the information obtained from LILCO is as follows. Customers Energy Sales (MWh) 85,335 903,664 From the information provided, we have estimated the five Towns' total annual peak kilowatt demand for electridty is approximately 200,000 kW and the annual kilowatt hour energy requirements, including system losses, is approximately 961,000 MWh. Assuming the five Towns establish a single operating system, it will result in a substantial reduction in the separation and reconnecfion work required by eliminating that work along the borders between the five Towns. The only border where work would be required would be the western border of the area. The lines that would be affected along this border are the 69 kV transmission lines and the lower voltage distribution lines. s.~sou~-~, R.W. Beck B-Il APPENDIX B The western border of Southold joins the Town of Riverhead which is also included in this Study and is currently supplied retail electric service by LILCO. If separate utilities are established in each Town, we have identified several potential locations of separation and recormection work which may be required. We have estimated a cost of $150,000 for the disconnection and reconnection work to be done to the distribution fines both inside and outside the town along the borders. Power is delivered into Southold through a 69 kV transmission line that extends through the town and circles through the other Towns included in this Study. LILCO's reports indicate LILCO reduces the voltage to 23 kV at a 69 kV stepdown substation and extends the 23 kV line through the town. The 23 kV line appears to be the primary source of electric power for the town. The existing substations in Southold appear to have adequate capacity to supply electric requirements of the town, therefore, the power supply plan would be to continue to receive power delivery through these LILCO-owned substations. Some reconnection of the lines leaving the substations is anticipated. We have provided an allowance of $1,000,000 to fund necessary modifications to the substations and reconnection of the distribution lines. The esiimated purchase price of the 23 kV distribution line and substation would be included in the purchase price of the properties in the town for both a separate- or jointly-owned electric system. LILCO also maintains a 14 MW generating station in Southold. We have assumed LILCO would continue to own and operate this generating station. SHELTER ISLAND LILCO reported the entire Town of Shelter Island had the following number of customers and customer energy usage. Customers Energy Sales (MWh) 2,493 20,141 From the information provided, we have estimated the Shelter Island's total annual peak kilowatt demand for electridty is approximately 5,000 kW and the annual kilowatt hour energy requirements, including system losses, is approximately 21,000 MWh. B-lO East End Municipaiization ACQUISITION OF, ..ECTRIC PROPERTIES We have estimated a cost of $500,000 for the disconnection and reconnection work to be done on the distribution lines both inside and outside the town along all the borders. Power is delivered into the general area of Riverhead through 138 kV transmission lines and a 138 kV stepdown substation (Riverhead Substation) which is located just across the border of the town in the Town of Southold. From this substation, 69 kV transmission lines extend through the town and circle through the other Towns included in this Study. A 23 kV subtransmission line also extends across the town from the Riverhead Substation. LILCO's reports indicate that LILCO has three 69 kV stepdown substations in the Town. The primary source of electric power for the town appears to be 13.8 kV distribution lines from the Riverhead Substation, the 69 kV substations and the 23 kV lines passing through the town. The existing distribution substations in Riverhead do not appear to have adequate capadty to supply all of the electric requirements of the town, therefore, for the town to establish a separate electric system, the power supply plan would potentially have to include a new 69 kV stepdown substation to supplement the power it would continue to receive through the existing LILCO-owned substations in the town. In addition to the substation, some reconnection of lines leaving both substations is anticipated. We have estimated a cost of $3,500,000 to fund necessary construction of a new substation and make modifications to the existing substations and reconnecfion of the distribution lines. SOUTHOLD LILCO r.eported the Town of Southold had the following number of customers and customer energy usage. Customers Energy Sales (MWh) 11,928 108,330 From the information provided, we have estimated the Southold's total annual peak kilowatt demand for electricity is approximately 25,000 kW and the annual kilowatt hour energy requirements, including system losses, is approximately 115,000 MWh. Southold is bordered on the north, east and south by the shoreline of Long Island identified by Long Island Sound, Gardiners Bay, and Great and Little Peconic Bays. These natural boundaries eliminate the need to consider severance damages along the north, east, and south borders of the town. ~sou~M~ R.W. Beck B-9 APPENDIX B anticipated. We have estimated an allowance of $1,000,000 to fund necessary modifications to the substations and reconnection of the distribution lines. The estimated purchase price of the 23 kV distribution line and substation is included in the allowance we have provided to purchase LILCO's distribution properties. LILCO also maintains a two generating stations in the town. One generating station is located near the eastern border and the other is located near the western border of the town. The eastern station contains 6 MW of diesel generation and the western station contains a combination of diesel and combustion turbine generation totaling 28 MW. We have assumed LILCO would continue to own and operate these generating stations. RIVERHEAD LILCO reported the Town of Riverhead had the following number of customers and customer energy usage. Customers Energy Sales (MWh) 13,143 173,137 From the information provided we have estimated Riverhead's total annual peak kilowatt demand for electricity is approximately 38,000 kW and the annual kilowatt hou~ energy requirements, including system losses, is approximately 184,000 MWh. Riverhead is bordered on the north by the shoreline of Long Island Sound and on the south by FIanders Bay and the Peconic River. The area south of the Peconic River is within the Towns of Southampton and Brookhaven. Southampton is one of the other Towns included in the Study. While the river serves as a natural boundary, there are several points where line reconnection work is required. The eastern border of Riverhead adjoins the Town of Southold which is also included in this Study and is currently supplied retail electric service by LILCO. If separate utilities are established in each Town, we have identified several potential locations where separation and reconnection work may be required. The western border joins the Town of Brookhaven which is also supplied retail power by LILCO. We have identified several potential locations along this border where separation and reconnection work may be required. B-8 East End Municipalization ACQUISITION Or- ;LECTRIC PROPERTIES LILCO also maintains a 11.5 ,MW combustion turbine generating station in Southampton. We have assumed LtLCO would continue to own and operate this generating station. EAST HAMPTON LILCO reported the entire Town of East Hampton had the following number of customers and customer energy usage. Customers 19,787 Energy Sales (MWh) 186,217 From the information provided, we have estimated East Hampton's total annual peak kilowatt demand for electricity is approximately 44,000 kW and the annual kilowatt hour energy requirements, including system losses, is approximately 198,000 MWh. East Hampton is bordered on the north, east and south by the shoreline of Long Island, identified by Gardiners Bay, Block Island Sound and the Atlantic Ocean. These natural boundaries eliminate the need to consider severance damages along the north, east, and south borders of the town. The western border of the town is defined by Town Line Road which divides the town from the Town of South Hampton. South Hampton which is also include,d in this Study is currently supplied retail electric service by LILCO. If separate utilities are established in each Town, we have assumed both utilities would construct a new distribution line along the full length of this border. We have estimated a cost of $1,000,000 for the disconnection and recormection work to be done to the distribution lines both inside and outside the town along the borders. Power is delivered into East Hampton through a 69 kV transmission line that extends through the town and circles through the other Towns included in this Study. LILCO's reports indicate LILCO reduces the voltage to 23 kV at a 69 kV stepdown substation and extends a 23 kV line through the town. The 23 kV line appears to be the primary source of electric power for East Hampton. The existing substations in East Hampton appear to have adequate capacity to supply electric requirements of the town, therefore, the power supply plan would be to continue to receive power delivery through these LILCO-owned substations. Some recormection of the lines leaving the substations is s.~'our,,*,~,~, R.W. Beck B-7 APPENDIX B From the information provided, we have estimated that Southampton's total annual peak kilowatt demand for electridty is approximately 97,000 kW and the annual kilowatt hour energy requirements, including system losses, is approximately 442,000 MWh. Southampton is, with minor exception, bordered on the north and south by the shoreline of Long Island identified by Great Peconic and othe~ bays on the north and the Atlantic Ocean on the south. These natural boundaries eliminate the need to consider severance damages along the north and south borders of the town. The eastern border of Southampton is defined by Town Line Road which divides Southampton from the Town of East Hampton. East Hampton which is also included in this Study is currently supplied retail electric service by LILCO. If separate ulilities are established in each Town, we have assumed each utility would need to construct their own new, completely separate distribution line along the full length of this border. A short section of the northwest border of Southampton abuts the Town of Riverhead which is also included in this Study. This portion of the border follows the Peconic River, The remainder of the western border of the town is over land and adjoins the Town of Brookhaven. It is assumed that the new munidpal utility will need to isolate its newly formed distribution system from LILCO's distribution system which will continue to serve Brookhaven. We have identified ten potential locations along these borders where some separation and reconnection work may be required. We have estimated a cost of $1,250,000 for the disconnection and reconnection work to be done to the distribution lines both inside and outside Southampton along all the borders. Power is delivered into the general area of Southampton through 138 kV transmission lines and a 138 kV stepdown substation (Riverhead Substation) which is located in the northwest corner of the town. From ttUS substation, 69 kV transmission lines extend through the town and circle through the other Towns included in this Study. LILCO's reports indicate that LILCO has six 69 kV stepdown substations in the town. These 69 kV substations appear to be the primary source of electric power for the town. The existing distribution substations in Southampton appear to have adequate capacity to supply electric requirements of the town, therefore, the power supply plan would be to continue to receive power delivery through these LILCO-owned substations. Some reconnection of the lines leaving the substations is anticipated. We have estimated an allowance of $1,000,000 to fund necessary modifications to the substations and reconnection of the distribution lines. B-6 East End Municipalization ACQUISITION OF..ECTRIC PROPERTIES general plan for serving each municipal area independently is discussed in the following subsections. SEPARATION AND RECONNECTION UNDER SEPARATE-SYSTEMS The establishment of a separate Town-owned electric system in each of the municipalities has been assumed to require the complete separation of the electric system distribution properties in that Town from the electric distribution system outside of that munidpality. In order to estimate the cost of disconnecting and then reconnecting the systems of the electric company outside the Town as well as the electric distribution system inside each municipality, we have used maps of each of the Towns and the adjoining areas. Based on these maps, we have developed a basic plan of supplying power to the electric distribution system in each of the Towns and the reconnection work required to establish each of the independent Town-owned electric systems. It was assumed that if each of the Towns established their own individual distribution system, they would not acquire any of the properties operating above the 23 kV voltage level. However, if the Towns joined together to form one utility they would, as a group, also acquire the 69 kV transmission line that passes through the Towns and the 69 kV stepdown substations that are used to supply the Towns. Cost were included in each plan for construction and/or modifications to the existing substation and/or subtransmlssion lines to provide a point of power supply. LILCO has small generating stations located throughout the Towns which appear to be used both to provide LILCO with capacity and energy, and also to stabih~ze the voltage to all area customers. Since LILCO's transmission system will continue to be the method of power delivery to the Towns, and as such, they will continue be responsible for voltage stability, we have assumed that LILCO would retain all of its existing generation. Therefore, the cost of acquiring the electric system does not include the cost of this existing generation. A description of the power supply and separation plan, as well as, estimated severance cost for each Town is set forth in the following paragraphs. SOUTHAMPTON LILCO reported the entire Town of Southampton (including the five villages) had the following number of customers and customer energy usage. Customers Energy Sales (MWh) 37,984 415,839 s~soun.~,~M~, R.W. Beck B-5 APPENDIX B EXISTING ELECTRIC PROPERTIES The basic electric properties existing in each of the Towns is assumed to consist of open wire primary voltage distribution lines supported by wood poles that extend alongside the streets in each community. The majority of these open wire lines are supported by wood crossarms; however, it is also assumed that LILCO has used some amount of spacer cable-type construction, as generally found in other utility service areas. The facilities included with these distribution properties include transformers, secondary (lower voltage) conductors, service drops to customers, and meters. Other facilities included along the distribution lines include switching devices, capacitors, risers that extend underground electric service to some customers. In addition the above basic electric distribution properties, a 69 kV transmission line extends in a "looping" fashion from a 138 kV substation in Riverhead through each of the Towns and then back to Riverhead. We have assumed the Towns would not acquire any of the 138 kV or 69 kV transmission properties if they formed individual electric system but we have assumed that they would acquire the 69 kV transmission line i_f the Towns established one jointly-owned electric svstem. While the potential acquisition of the 69 kV transmission will increase t~e acquisition price significantly, there are associated benefits for including the 69 kV loop in the acquired fadlities. The cost of wheeling in purchased power is generally lower if receipt is taken at a higher voltage, and acquisition of the 69 kV systems would allow the combined mu/ti-town utility to benefit through metering of their combined load at a single delivery point and the subsequent lower peak demand due to load diversity (i.e., the coincident peak demand of the Towns 'will be lower than the sum of the five Towns' individual non-coincident peak loads). There are also several small generating stations in the Towns, as discussed later, we have assumed LILCO would retain ownership of these generating stations. Review of the border area around each of the Towns established that, with limited exceptions, the Town border is the shoreline of Long Island. This aspect results in there being a small number of points that need to be separated and reconnected, and consequently results in generally low reconnection cost. While in the case of five independent new utilities, we have assumed that the Towns would not acquire any of the high voltage (138 kV or 69 kV) transmission lines or high voltage stepdown substations used to supply power to service areas outside the Towns, we did assume that every new service area established would have to pay for some type of power delivery facility. The B-4 · East End Municipalization ACQUISITION OF ~.ECTRIC PROPERTIES sum of the five individual peak demands, which would equate to corresponding savings in annual wholesale energy costs of about $2.2 million; (3) other economy-of-scale operating cost reductions for a single system could easily more than make up the remaining difference. The actual costs and benefits cannot be estimated or assessed without further study. BASIC COST OF ELECTRIC SERVICE A basic component of the cost charged to customers for the electric service they receive is the annual cost incurred by the utility assodated with the ownership of the properties used to serve these customers. In this Study, we have not developed an estimate of this annual cost because the scope of the Study did not include estimating the cost of acquiring the existing electric properties within each Town. We have, however, estimated all the other cost of setting up an operating utility based upon both the separate-system plan and the joint-system plan. The annual cost of this difference in setup cost and differences estimated for the other operating cost under both the separate-system plan and joint-system plan are discussed in the report. A description of the existing electric system properties in each of the Towns and the basic plan we have assumed for setting up a town-owned electric system in each area, together with the basis for estimating each of the above costs, is contained in the following subsections. COSTING METHODS The estimated amount that would have to be paid to acquire the existing electric distribution properties within the Towns will either be based upon the amount negotiated between LILCO and the Towns or, if negotiations prove to be unsuccessful, the amount ultimately determined as the result of a condemnation proceeding. The purchase amounts determined appropriate for past condemnation proceedings of which we are aware, have ranged from: (1) the recorded book cost to initially construct the properties, less an allowance for depreciation, to (2) the cost to reconstruct the properties new, less an allowance for depreciation, which is generally referred to as the Reproduction Cost New Less Depreciation ("RCNLD"). For the purposes of a Preliminary Feasibility Study, we believe it appropriately conservative to assume that the amount that would have to be paid for the properties would approach the RCNLD amount, which is the higher of the two valuation approaches. Therefore, the approach we would recommend in subsequent studies would be to develop an estimate of this RCNLD amount for the properties in each of the Towns. s.~,,~our~M~,., R.W. Beck B-3 APPENDIX B Estimate of Partial Costs to Establish Electric Systems ($000) Disconnection and Modify Power $~rt- Working Reconnection of Delivery Engineering up Capital To~al Syetem Facilities Coats Coats Costs Costs Southampton E. Hampton Riverhead Southold Shelter' Island Total Joint System $1,250 $1,000 $1,1S0 $3,250 $1,000 $ 7,650 $1,000 $1,000 $1,1S0 $2,250 $ 500 $ 5,900 $ 500 $3,500 $1,150 $1,800 $ 400 $7,350 $ 1SO $ 1,0(]0 $1,ISO $1,67S $ 400 $ 4,37S $ 150 S 3tO00 $Ir150 S 850 S 100 $$5,250 $3,050 $ 9,500 $4,500c~ $9,825 $3,400 S:9,~ $3,0~0 $45,000 $1,350 $5,300 $L2S0 $37,900 TI~ total for five separate individual ublllty systems reflects the potential for some economy gained by simultaneous, parallel efforts by the individual Towns. At first blush, the summary table above appears to indicate that a single, joint system is sibrgtificantly less economic that the case where the five individual Towns go it alone. This is not necessarily the case. While the above table addresses a portion of the up-front costs necessary to get into business, the more telling information is the differences in the on-going annual operating costs for the newly formed utility. The up-front capital requirements translate into a portion of the on-going annual operating costs of the new utility, through the mechanism of the annual debt service associated with the long- term financing of the initial capital requirements. As discussed in the body of this Appendix, formation of the single joint electric system may need to entail acquiring an additional portion of the LILCO distribution system (the 69 kV transmission line which loops through the five Towns) at an estimated additional costs of about $45,000,000 as indicated in the s~ummary table above. Acquiring the 69 kV line has some associated economic benefits which will serve to at least partially offset the economic impact of the increased capital cost. The benefits will be in the form of: (1) reduced transmission wheeling costs paid to LILCO to deliver the Town's wholesale power due to the higher 69 kV delivery voltage; and (2) lower peak demand (which equates to lower wholesale power costs) as a result of metering the total combined electric requirements of the five Towns on a coincident basis at a single delivery point. Until the economic benefits resulting from the 69 kV line are quantified in the form of their impact upon the annual operating costs, it will not be dear whether or not they fully offset the added up-front capital costs. The potential offset effect can be illustrated with a hypothetical example, assume that: (1) the difference in up-front capital costs is as shown in the summary table, at about $30 million, which equates to an increase in annual debt service on the order of about $2.6 million per year; (2) the resulting peak demand of the five Towns when metered coincidently turns out to be, say 20% lower than the B-2 East End Municipalization APPENDIX B PRELIMINARY ENGINEERING COST ANALYSIS: ACQUISITION OF ELECTRIC PROPERTIES EXECUTIVE SUMMARY As discussed in Appendix A to this report, New York General Law (Section 360) sets forth the procedures that a municipal corporation must follow to establish an operating municipal electric department. The municipal corporation may establish its utility by either purchase or condemnation of the existing electric properties within its geographic area, or by construction of its own electric facilities. Should the Towns elect to form their own community-owned electric utility(s), they have the option of either creating their own individual electric system or to band together and create on jointly-owned electric system which serves the combined electric needs of the five towns. In our analysis, we have explored the projected economic ramifications associated with the choice between these two options. In this Appendix we present a general description of LILCO's existing electric properties within each Town, and identify the portion of these properties we suggest the Towns acquire if each establishes a separate utility system, as well as the properties to be acquired if one jointly-owned system were established. We also develop a preliminary estimate of the allowance of funds proposed as necessary to disconnect and reconnect the electric systems from the remaining portion of LILCO's electric distribution system under both the separate-system plan and the joint-system plan. While the scope of this Study does not include estimating the cost of acquiring all LILCO's distribution properties in the Towns, we have developed a preliminary estimate of the cost of the differences in the properties which would be acquired under the joint-system plan as compared to the separate- system plan so that we could show the total difference in acquisition and setup cost associated with each plan. Provided betow is a table illustrating the estimated costs for certain of the tasks associated with the establishment of electric systems for the Towns. Please note that the major cost component related to acquisition which is not addressed below is the cost to acquire the LILCO's electric distribution infrastructure itself. Table of Contents APPENDIX B PRELIMINARY ENGINEERING COST ANALYSIS: ACQUISITION OF ELECTRIC PROPERTIES EXECUTIVE SUMMARY ........................................................................................... B- 1 BASIC COST OF ELECTRIC SERVICE ..................................................................... B-3 Costing Methods ....................................................................................................... B-3 Existing Electric Properties ....................................................................................... B-4 SEPARATION AND RECONNECTION UNDER SEPARATE-SYSTEMS .................... B-5 Southampton ............................................................................................................. B-5 East Hampton ............................................................................................................ B-7 Riverhead .................................................................................................................. B-8 Southhold .................................................................................................................. B-9 Shelter Island ........................................................................................................... SEPARATION AND RECONNECTION UNDER JOINT-SYSTEM .......................... B- I l COMPARISON OF SEPARATION AND RECONNECTION COSTS ......................... B-12 ENGINEERING EXPENSES ................................................................................ B- l 3 UTILITY OPERATIONS AND START-UP COST ................................................. B-15 OPERATING AND MAINTENANCE EXPENSES .................................................. 13-17 Appendix B Preliminary Engineering Cost Analysis: Acquisition of Electric Properties TABLE FRANCHISE HISTORY AND DESCRIPTION EAST END TOWNS - 60 - municipal joint action in utility formation, financing and even in eminent domain processes. There are a number of pragmatic administrative issues that will likely need to be addressed as and when the East End Towns decide in general terms on what municipal joint action structure best fits their needs. Such issues as may arise later in the utility formation process appear likely to revolve around specific and concrete practical situations that are beyond the scope of this study and that cannot be addressed informatively at this point in any event. The formulation of agreements for joint governance, allocations of costs and rate formulae, and the integration of whatever limitations may exist on the individual and collective abilities of the East End Towns to finance are examples. However, in each case, these kinds of issues can only be informatively addressed on the basis of concrete concerns and concrete data which are simply not available to us at this point in the evaluation process. - 59 - by a nongovernmental entity, such as an investor-owned utility. Such bonds are called "private activity bonds" for purposes of Section 141. In short, municipal bonds used to finance the condemnation of utility assets will generally be taxable. As is true of many provisions of the Internal Revenue Code, there are exceptions to the general rule of Section 141. Specifically, there are four exceptions to the taxability of interest on "private activity bonds," only one of which has any possible definitional relevance to the East End Towns. Bonds used to finance acquisition of utility property may be subject to favorable tax treatment if they qualify as "exempt private activity bonds." There are eleven criteria that have to be met to achieve this qualification -- typically the most difficult of which is for the issuer to obtain an allocation of the relevant state's "volume cap" under Section 146 of the Code -- which may or may not be applicable depending on the structure of financing ultimately selected by any one or more of the East End Towns for the acquisition of LILCO's assets. Discussion of these eleven criteria for achieving "exempt private activity bond" status is beyond the scope of this study, and is in any event premature until one or more of the East End Towns reach a decision as to the mode of facility acquisition that they propose to pursue. Interest on "exempt private activity bonds" is subject to the "alternative minimum tax" or "AMT," but is not subject to full taxation as ordinary income. For purposes of the present level of inquiry, two basic assumptions should be kept in mind. First, if bonds are used to finance the condemnation of utility assets, interest on those bonds should be presumed (for planning purposes) to be taxable as ordinary income under Section 141 of the Code. Second, if the bonds are used instead to finance the construction of new municipal facilities, interest on them will continue to enjoy exemption from taxation under Section 103 of the Code. Legal Issues Concerning Formation of MuniciDal Joint Action Aaencv As outlined in Part I.A.2 of this memorandum, New York law offers more than ample support for municipal joint action structures, and no obvious impediments to their use in the utility formation process. Articles VIII and IX of the New York Constitution and General Municipal Law Sections 119-o and 361(2) provide both general and specific support for - 58 - its customers which might be affected by the municipalization and in franchise agreements should be reviewed in light of the FERC's Stranded Investment NOPR. Given the Commission's relatively aggressive reading of the statute generally, it is likely that an aggregator such as a municipality may enjoy the benefits of access to the wholesale markets afforded by the Energy Policy Act with out having to endure the c~mbersome process of acquiring an entire transmission or distribution system. Just how many transmission or distribution facilities the aggregator must own is still an open question. It is likely, however, and may be plausibly argued that an aggregator will not have to own all of the transmission or distribution facilities over which all of the energy it delivers to its customers flows because Congress used the word "all" only to qualify the energy delivered, not the facilities owned. If so, the electricity markets will become even more competitive and all consumers will be eligible to enjoy the benefits of emerging competition in the electric power industry. Federal Income Taxation Issues Concerning Municipal Bonds Used To Finance Condemnation of Utility Facilities As part of the omnibus Budget Reconciliation Act of 1987, congress amended Section 141 of the Internal Revenue Code (26 U.S.C. Section 141) so as to restrict severely the ability of municipal utilities to use tax exempt financing to acquire the operating assets of investor-owned utilities.20./ The general rule under Section 141 of the Code is that interest on any municipal bonds is taxable as ordinary income if the lesser of five percent or $5,a00,000 of the proceeds of such bonds are used to acquire utility "output facilities" -- including electrical transmission, substation and distribution facilities -- previously used or held for use 20/ Some cynics have suggested that there may be a relationship between the fact that the city of Chicago was evaluating a possible municipal condemnation of the distribution facilities of Commonwealth Edison Company during 1985 and 1986, and that the fact that then- Chairman of the House Ways and Means Committee, Rep. Daniel Rostenkowski, was the original sponsor of this legislation. In fact, Internal Revenue Code Section 141 was known in the trade press for a while as the ,,Rostenkowski Amendment." - 57 - point of delivery to a lawful reseller, as well as all necessary associated services to accomplish such delivery in a reliable manner. The Commission further noted (id. at footnote 36 (emphasis in original))lS/: The fact, therefor, that transmission services may encompass the use of facilities that in other contexts would be classified as distribution facilities has no effect on the Commission's authority to order transmission services under section 211. In its recent Stranded Investment NOPR19/, the FERC indicated that it expects some new municipal electric utilities to be formed for the purpose of providing electric service to major industrial customers of franchised electric utilities. Other statements in the NOPR suggest that the FERC may be liberal in allowing jurisdictional utilities to recover for so-called "stranded investment" in rates for transmission and ancillary services for the benefit of former retail requirements customers during a three-year transition period as a trade-off for liberally interpreting the exception to the prohibition against retail wheeling (i.e., in favor of newly- formed municipal electric utilities). The stranded investment provisions,'if any, in existing contracts of the utility with 18/ Former Ohio regulator Ashley Brown addressed the question of where the line between transmission and distribution lies in provocative terms in a recent address to NARUC. He is reported to have said, "'No one knows for sure,' but 'imperialists on the Federal Energy Regulatory Commission staff,' believe that transmission - and hence, the FERC's jurisdiction - goes right up to the meter. They concede, he said, 'that somewhere in the meter, there is state jurisdiction.'" The Electricity Daily, Vol 4, No. 40, March 1, 1995. Notice of Public Rulemaking on Recovery of Stranded Investment Costs by Public Utilities and Transmitting Utilities (the "Stranded Investment NOPR"), Docket No. RM94-7-000, FERC Statutes and Regulations ~ 32,507 at pp. 32,864 n.18, 32,865 n.27. - 56 - Sufficiency of Ownership of Transmission or Distribution Facilities The most aggressive reading of the term ,,transmission or distribution facilities" would start with the FERC's long held positionl7/ that, under Section 201(b) of the Federal Power Act, an entity's accounts, books, records and contracts used for transmission, or sales for resale, of electric power in interstate commerce, constitute jurisdictional "facilities." However, since "transmission or distribution facilities" is used in Section 212(h) of the Federal Power Act to condition an exception to the general prohibition against retail wheeling, it will likely be narrowly construed to require a municipality to own m~re than just books and records to qualify as a facility owner even though books and records are part and parcel of facility ownership. The FERC's pronouncements so far on the subj~ect of facilities are contained in its response to an attempt by Texas Utilities Electric Company ("TU") to fend off a wheeling request by Tex-La Cooperative in 1994. FERC rejected TU's suggestions that because "local distribution facilities" were involved in a Section 211 wheeling application, the Commission lacked jurisdiction to issue a wheeling order (Tex-La Electric Cooperative of Texas, linc, 67 FERC 461,019 (1994) at 61,056): ... [W]e believe that we may order transmission services under Section 211 even when they involve the use of "local distribution" and "generation" facilities that are otherwise non- jurisdictional. The Commission reasoned that (id. (emphasis in original)): ... [W]e believe that Congress, by the use of the term "transmission services," intended the Commission to be able to order delivery of the electric energy from the point of receipt of such energy on the transmitting utility's system to the 17/ E.q., citizens Ene~q"f Corporation, 35 FERC ~ 61,198 at pp. 61,452-3 (1986); Hartford Electric Liqht Co. vt Federal ~ower C__o~_~ission, 131 F.2d 953, 961 (2d Cir. 1942). - 55 - to deliver a11[16/] such electric enerq¥ to such electric consumer. Nothing in this subsection shall affect any authority of any State or local government under State law concerning the transmission of electric energy directly to an ultimate consumer. (Emphasis added.) This restriction will prohibit a municipality from obtaining a wheeling order in order to import electricity for supplying its customers unless the municipality meets the 2- part test (A and B in the quoted text above) for avoiding the prohibition on sham transactions. By definition, a properly constituted municipal utility will meet the first part of the test because it will be a political subdivision of a state. Regarding the second part of the test, because a municipality in circumstances under consideration here will likely not be providing electric service on the date of enactment of subsection 212(h), it can meet the test only if it "would utilize transmission or distribution facilities that it owns or controls to deliver all such electric enerow to such electric consumer." As indicated below, the FERC has made only limited pronouncements on the nature or amount of facilities which an entity must own or control and use to 'deliver electric power wheeled pursuant to a Section 211 order as a prerequisite for eligibility for such an order. 16/ The use of the word "all" will be key to whether the FERC allows a municipality to overcome the retail wheeling/sham transaction prohibition to obtaining a wheeling order. Congress specifically required that "all" of the electric energy flowing to a municipality's electric consumers must flow over the "transmission or distribution facilities that it owns," but did not use the word "all" earlier in the sentence to qualify the words "transmission or distribution facilities." Thus, it is logical to conclude that a municipality need not own all of the transmission or distribution facilities serving its consumers but only that all of the power it provides to its consumers must flow over what ever transmission or distribution facilities it does O~. - 54 - NO order issued under this Act shall be conditioned upon or require the transmission of electric energy: (1) (2) directly to an ultimate consumer, or to or for the benefit of ~ if such electric enerq¥ would be sold by such entity directly to an ultimate consumer, unless: (A) such entity is...a State or any political sub-division of a State (or an agency, authority, or instrumentality of a State or a political subdivision)...[a ~ which is or has been financed by REA]...a erson havin an obli~ arising under State or local law (exclusive of an obligations arising solely from a contract entered into by such person) to Drovide electric service to the public...; and ~uch e t__~ was providing electric service to such ultimate consumer on the date of enactment of this subsection or would utilize transmission or distribution facilities that it owns or controls - 53 - In Florida Municipal Power Aqenc¥ v. Florida Power & Liqht Company [65 FERC ~ 61,125 at 61,165 (1993)] the Commission determined that, as a general matter, the availability of transmission service enhances competition in power markets by increasing power supply options of buyers and power sales options of sellers. The Commission added that, if a transmission customer determines that transmission service will allow it to serve its customers more efficiently, the public interest will be served by requiring that the service be provided so long as the transmitting utility is fully and fairly compensated and there is no unreasonable impairment of reliability. Thus stated, the "public interest" test does not present any insuperable obstacle to a municipal electric utility obtaining a wheeling order from the FERC. be Avoiding The Retail Wheeling and Sham Transaction Prohibitions The main impediment to a wheeling order which municipalities attempting to escape constructing their own power delivery facilities will have to overcome is the prohibition on retail wheeling and sham wholesale transactions in Section 212(h) of the Federal Power Act. For purposes of this discussion, we will assume that the municipal utility will own the very minimal facilities which might only include retail customer metersl5/, possibly combined with service drops. Section 212(h) provides, in pertinent part, as follows: 15/ According to the chief spokesperson for Imatran Voima Oy, the Finnish State Utility, meter technology has developed to the point where they now can permit customers to choose their suppliers on virtually an hourly basis. "Right now, it costs [approximately $1,000] to buy one...But if the rate of technological development is as fast as it has been for, say, mobile phones, the [electric power] market will be completely different in just a few years." Electric Utility Week, February 20, 1995 at 16. - 52 - is included within the definition of "electric utility." As discussed in Part F.2.c. below, any "electric utility" is eligible to apply to the FERC for and obtain a wheeling order under Section 211(a) of the Federal Power Act and, if necessary, an interconnection order under Section 210(a) (1) of the Act. Thus, while the full implications of this law are still unfolding, a municipal electric utility, once established, would be eligible to apply for and obtain both interconnection and wheeling orders from the FERC. a. Section 211 Access Revisited Under Section 211 of the Federal Power Act, the FERC may issue a wheeling order if certain conditions are met, but is not obligated to do so. Section 211 establishes two conditions which must be met before the FERC is authorized to issue a wheeling order. First, the order must meet the requirements of Section 212 of the Federal Power Act. Section 212: establishes parameters for the terms and conditions, including price, of mandatory transmission service under Section 211 wheeling orders; establishes procedural requirements, including mandatory settlement negotiations; prohibits inconsistency with State laws on retail marketing areas; prohibits mandatory retail wheeling and sham wholesale transactions; and contains certain limitations which apply only to specified Federal transmission systems (eq., Bonneville Power Administration and certain Texas utilities). Second, the FERC must find that the proposed wheeling order "would otherwise be in the public interest." Regarding the public interest requirement, the FERC has stated (Old Dominion Electric CooDerative, Inc. v. Delm~rva Power & Li ht Com an , 68 FEI~C ~ 61,169, 1994 FERC LEXIS 1656 at 31 (1994)): - 51 desirable option to consider. Such an option appears to be feasible under the Energy Policy Act of 1992. As discussed in the preceding section, in the Energy Policy Act, Congress declared that with few exceptions, all transmission-owning utilities would henceforth be common carriers vis-a-vis each other. This has introduced dramatically enhanced transmission access and with it, increasing competition in the wholesale generation market. Since the cost of generation typically comprises 70% of the cost of electricity delivered to the consumer, anyone who can aggregate sufficient load to "shop" the wholesale generation markets can theoretically realize huge savings in the delivered cost of power but only if they can somehow maintain the current cost of delivering that power. The possibility of municipalities creating their own electric utilities and benefiting from the emerging competition in the wholesale power market without having to bear the burden of uneconomical power delivery costs attendant to condemning or duplicating the existing power delivery services is a legally untested, but intriguing hypothesis. The point of view taken here will be that of a municipality which does not want to acquire or operate significant power delivery facilities. Instead, the municipality wishes to: aggregate and "shop" the load of some or all of its residents in the wholesale generation market where competition plays the biggest role, and escape the daunting burden and cost of acquiring the necessary power delivery facilities through condemnation or construction of new, duplicate facilities. Such a municipality faces one key legal problem. Assuming it can establish a municipal electric system, how can that system access the newly competitive wholesale generation market? Accessing the wholesale generation market is a matter of federal law. Once a municipality establishes a municipal electric utility, it then constitutes a "municipality" under Section 3(7) of the Federal Power Act. Under Section 3(22) of the Federal Power Act, a municipality - 50 - promote the economically efficient generation and transmission of electricity; be just and reasonable and not unduly discriminatory; and d. ensure to the extent practicable that costs incurred in providing the transmission service and properly allocable to providing it are charged to the party requesting the service and not to the transmitting utility's customers. Section 212(h) also bans mandatory retail wheeling, and forbids the FERC to order transmission service directly to an ultimate customer, or through an entity to an ultimate consumer unless the entity (for our purposes) is a poilitical subdivision of a state and such entity would use transmission or distribution facilities that it owns or controls to deliver electric energy to the consumer. In general, the FERC has been fairly vigorous in exercising its Section 211 authority and has been quick to expand the availability of transmission service where that authority has been inUoked. See, e.q., Florida Municipal Power A~enc¥ v. Florida Power & Light Co., 65 FERC ~ 61,125, reh'q dismissed, 65 F!ERC ~ 61,372 (1993), final order., 67 FERC ~ 61,167 (~994). In iparticular, the FERC has indicated in rather strong terms that it does not intend to be deterred in exercising this autharity by unsupported claims of technical difficulties. E1 PaSo Electric Co. v. Southwestern publiq service co., 68 FERC ¶ 61,182 at p. 61,938 (1994). Thus, we would not expect tha~ the East End Towns would confront the same kinds of delays that the Town of Massena encountered in obtaining transmission rights for its municipal utility system, because Section 211 now offers a reasonably quick and certain way to resolve transmission disputes. 2. "Muni Lite" Given the high cost, both politically and financially, of acquiring an investor-owned electric utility's facilities serving a municipality, creation of a municipally- owned utility withou~ undertaking the burden of acquiring significant transmission or distribution facilities is a - 49 - municipalization effort by any one or more of the East End Towns. 1. Overview of Section 211 Section 211 establishes basic requirements for a FERC order for mandatory transmission service. It seems likely that, in the event that any one or more of the East End Towns determines to proceed with the establishment of a municipal utility, they will be able to satisfy the criteria for a Section 211 order. Under Section 211, "any electric utility[13/] · may apply to the Commission for an order under this subsection requiring a transmitting utility[14/] to provide transmission services (including any enlargement of transmission capacity necessary to provide such services)." The Commission may grant the order if it finds (1) that the order meets the requirements of Section 212, and (2) that the order is otherwise in the public interest. The requirements of Section 212 are that the rates terms and conditions imposed by the Commission must: permit the recovery of all costs incurred by the transmitting utility in providing the service, including (i) an appropriate share of legitimate, verifiable and economic costs, (ii) taking into account any benefits of providing the service, and (iii) the costs of any enlargement of transmission facilities required for providing the service; 13/ An "electric utility" is defined by Section 3(22) of the Federal Power Act as "any person or State agency (including any municipality) which sells electric energy[.]" 14/ A "transmitting utility" is defined by Section 3(23) of the Federal Power Act as "any electric utility which owns or operates electric power transmission facilities which are used for the sale of electric energy at wholesale[.]"