Back in August 2020, CNE published a report that analyzed important aspects of the agreement between the Puerto Rico Electric Power Authority (“PREPA”) and LUMA Energy and offered specific recommendations to improve it. Given the recent public debate regarding this transaction, we are republishing a summary of our findings in this Weekly Review.
On June 22, 2020, the Puerto Rico Electric Power Authority (“PREPA”) and the Puerto Rico Public-Private Partnerships Authority (the “P3A” or “Administrator”) entered into an agreement for the Operation and Maintenance (“O&M” Agreement) of PREPA’s Transmission and Distribution System (“T&D System”) with LUMA Energy, LLC, (“ManagementCo”) and LUMA Energy Servco, LLC (“ServCo”, and together with ManagementCo, the “Operator”).
The Operator, in turn, is a consortium formed by ATCO Ltd., a Canadian operator of electric systems, and Quanta Services, Inc., a Texas-based provider of “infrastructure solutions” for the electric power industry.
The O&M Agreement grants the Operator the right to operate and manage PREPA’s T&D System for fifteen years, while PREPA retains the ownership of the T&D System. In consideration for managing the T&D System in accordance with the O&M Agreement, the Operator is entitled to receive a Service Fee consisting of:
- An Annual Fixed Fee that starts at $70 million on year 1 and increases to $105 million for each of years 4 through 15, and
- An Incentive Fee that is payable upon the Operator achieving certain performance benchmarks. This Incentive Fee starts at $13 million on year 1 and increases up to $20 million for each of years 4 through 15.
In both cases, the amounts payable on account of the Fixed Fee and the Incentive Fee, if any, will be adjusted for inflation. The agreement also includes a “Front-End Transition Period” and a “Back-End Transition Period” during which the fees are different from the Service Fee stated above.
We summarize below some aspects of the agreement that in our opinion raise important concerns, as well as CNE’s recommendations on how to approach them.
PREPA will be split into two operating companies: GridCo, which retains ownership of the T&D system and GenCo, which retains ownership of the generation assets. Both are required to enter into a power purchase and operating agreement (the “GridCo-GenCo PPOA”) with the Operator acting as an agent of GridCo, providing for expense reimbursement, power delivery, and other services related to the generation, sale, and purchase of power and electricity from PREPA’s generation assets.
Now, the notion that two PREPA subsidiaries will enter into a bonafide, arm’s length agreement is frankly naïve, not to say outright preposterous, and in our opinion raises some serious concerns.
First, under the proposed terms for the GridCo-GenCo PPOA, GenCo will be responsible for procuring fuel for GenCo’s generation units but it will be GridCo who “shall pay for all fuel purchases after GenCo certifies receipt and quality, and authorizes payment.” Furthermore, pursuant to Section 2.5 of Exhibit H to the O&M Agreement, “GridCo shall have no obligation to verify any invoice submitted by GenCo.” The failure to require even a minimum amount of due diligence from GridCo prior to paying any invoice, including fuel invoices, is baffling to us, given the nefarious history of PREPA’s fuel procurement practices. The PPOA should require such diligence from GridCo, even if it is minimal.
Second, the terms and conditions of the proposed PPOA will govern GridCo’s purchases of energy generated by GenCo. And while Section 3.1 of Exhibit H states that “if the cost of the Energy from the Generating Facilities becomes more costly on an incremental basis than other sources available to GridCo, the output from the Generating Facilities shall be reduced to zero, if GridCo so requests…”, the concept of “costs” for this analysis is not defined. It is important then that the final PPOA include a detailed definition of “costs” attributable to the generation of electricity to minimize consumer rates and avoid the cross-subsidization of GenCo’s inefficient generation units by GridCo.
Power Supply Dispatch and Management
The O&M Agreement requires the Operator to use “economic dispatch” to run the T&D System, but that term is ambiguously defined. The combination of an ambiguous definition of “economic dispatch” and an oligopolistic market structure means that strategic interactions among and between market players, including price-fixing via market signals, could take place and result in rent-seeking behavior and the extraction of rents.
Therefore, the Puerto Rico Energy Bureau (“PREB”) should clarify, by regulation if necessary, the meaning of “economic dispatch” in the Puerto Rico power market, and develop a process to investigate allegations of price-fixing or market collusion.
To receive payment of the annual Incentive Fee, the Operator has to achieve certain performance benchmarks. But a significant number of the benchmarks have not been determined yet and are subject to further negotiation among the parties. In addition, almost all of the benchmarks are set against PREPA’s prior performance, which sets the bar too low to justify the transaction.
In our opinion, the performance metrics should be developed in consultation with the PREB and the P3A using best practices and benchmarks from similarly situated utilities.
In the final analysis, we cannot advocate in favor of maintaining an environmentally harmful and economically unsustainable government-owned enterprise in charge of our power system.
Yet, while we strongly favor the thorough transformation of PREPA, the proposed O&M Agreement is critically deficient in several key areas. If that agreement cannot be corrected in a timely manner, then we can only recommend the parties return to the negotiating table. And try again.