CNE Review – October 2021

Published on October 21, 2021 / Leer en español

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In This Issue

In the past few weeks, we have been hearing diverse opinions as to who bears responsibility for the recent rolling blackouts. Some are placing the blame on LUMA, others on the Puerto Rico Electric Power Authority (PREPA). Prompted by these discussions, we find it necessary to, once again, address the current energy crisis.

In this edition of the CNE Review, we will take a look at some of the early events that foretold the demise of Puerto Rico’s energy system, such as PREPA’s operating losses and increased levels of indebtedness, to the shortcomings of the recent agreement with LUMA for the operation and maintenance of the electric grid. We also provide recommendations as to what can be done to tackle the ongoing crisis.

Keep reading for a summary of our analysis. Click here to access the full text.

Insights + Analysis from CNE

The Demise of Puerto Rico’s Electrical System

By Sergio M. Marxuach, Policy Director

We have been hearing some rosy statements about how well the Puerto Rico Electric Power Authority (“PREPA”) used to work. it would be a mistake to romanticize the old PREPA. As we will demonstrate below, things were not all copacetic when PREPA was in charge. Puerto Rico’s energy woes were years in the making and are the direct result of PREPA’s mismanagement, negligence, and corruption.

However, PREPA’s indictment is not LUMA’s vindication. LUMA had about a year to prepare for the takeover of Puerto Rico’s electricity grid and its performance so far has been, in the best case, deficient, and in the worst, dismal. Its management, so far, has utterly failed to deliver on its promises.

Thus, it is important to keep in mind that both PREPA and LUMA bear responsibility for the recent malfunctioning of Puerto Rico’s electricity system. It is in the best interests of both companies to change their ways, for their own benefit and the wellbeing of the Puerto Rican people.

Interpreting PREPA’s last two bond offerings

The Official Statements for PREPA’s last two bond offerings, dated April 12, 2012 (the “2012 OS”) and August 15, 2013 (the “2013 OS”), respectively, contain a wealth of data and information about Puerto Rico’s electricity system.

After close scrutiny of these documents, we found that a combination of (1) low liquidity; (2) funding current spending with long-term debt; and (3) limited access to the capital markets due to increased levels of indebtedness and debt service, resulted in a significant reduction in system maintenance expenditures from $250.6 million during fiscal year 2007 to $213.9 million during fiscal year 2013, a decrease of $36.7 million, or 14.6%. (2012 OS, p. 71 and 2013 OS, p. 58)

The lack of maintenance, in turn, affected overall system performance as demonstrated by several key metrics.

Click here to read more about the three main reasons why system maintenance expenditures were reduced and the particular ways in which the system’s performance was affected.

A Series of Unfortunate Events?

While PREPA officially claimed that it suffered from a series of unfortunate events caused by a menagerie of small animals, the truth is that by the time PREPA filed for bankruptcy in May 2017 the system was already thoroughly fragile, with decreasing available capacity; increasing outage rates; and limited available reserves. And then Hurricane María hit, devastating the transmission and distribution system in September 2017.

Despite the massive effort to restore electric service after Hurricane Maria, it was always understood that it was not a permanent fix — a thorough refurbishing of the grid was necessary to bring it up to 21st century standards. PREPA estimated such refurbishing would cost north of $10 billion. Years of negotiations with FEMA followed, until an agreement was reached in December 2020. In the meantime, the patched-up grid kept acting up. On the generation side not much happened either, as evidenced by the continued dispatch of the Palo Seco generation plant.

The Arrival of LUMA

Such was the neglected state of Puerto Rico’s electricity system — an old, unreliable, fossil fuel-based generation fleet connected to a functional but fragile and unstable transmission and distribution grid — when PREPA and the government of Puerto Rico executed a long-term agreement for the operation and maintenance of the electric grid (the “O&M Agreement”) with LUMA, a Canadian/Texan consortium.

The video below (in Spanish) summarizes what LUMA and PREPA are each in charge of and the extent of coordination needed between the two entities.

That coordination is executed in accordance with the terms and conditions of another agreement among and between PREPA, LUMA, and the Puerto Rico P3 Authority (“P3”): the GridCo – GenCo Power Purchase & Operating Agreement (the “PPOA”). Click here to read some of the key terms and conditions of the PPOA.

In a nutshell, PREPA is responsible for the operation and maintenance of the generation fleet, while LUMA is in charge of funding PREPA’s operations on a monthly basis and dispatching load into the grid. Given the complicated character of this relationship, we suspect that the recent rolling blackouts are as much a function of (1) a decrepit generation fleet and an unstable transmission and distribution grid as of (2) a series of coordination failures between PREPA and LUMA.

What can we expect moving forward and what can we do?

Given this state of affairs, this is what we can expect…

  • It will take about 10 years to upgrade the transmission and distribution system, with or without LUMA. This task is exceedingly complex and expensive. And there are no shortcuts.
  • The modernization of the generation fleet will also take several years, be it with additional natural gas capacity, increased generation from renewable sources, or a combination of both.
  • The above means that in the short term electric service in Puerto Rico will continue to be unreliable and expensive.
  • Rising fossil fuel prices (including natural gas), the unavailability of several low-cost generation units to meet base load due to unforeseen breakdowns, and the obligation to eventually start paying debt service on PREPA’s restructured indebtedness, will be the main drivers of the cost of electricity in Puerto Rico.

…and what we hope can be done:

  • Nonetheless, some remedial measures could be implemented in the short term to stabilize the transmission and distribution system and to reduce the dependence on the use of high-cost peaking units. It is up to both PREPA and LUMA to identify those “quick wins” and execute them.
  • In addition, the transition to renewable generation must continue. The generation of electricity using renewable sources protects both the environment, by lowering emissions of greenhouse gases, and consumers, by stabilizing the price of electricity. It is not true that electricity from renewable sources is always more expensive than electricity generated with traditional fuels. The technology for solar and/or wind generation in combination with battery storage has developed significantly during the last few years, in some cases approaching the costs of natural gas generation.
  • Furthermore, in order to properly compare costs between one kind of generation and another, it is necessary to add the cost of the environmental and health damages caused by fossil fuel generation. Adding in the costs of these negative externalities almost always reveals that fossil generation is costlier than initially thought. The imposition of a carbon tax is one of several policy alternatives to force polluters to internalize the cost of these negative externalities they impose on society at large.
  • Finally, it is imperative that the government agencies in charge of implementing energy policy in Puerto Rico have the necessary resources to execute their respective missions: (1) the PREB to regulate rates and promote long-term planning for the system; (2) the P3 Authority to effectively monitor and robustly enforce the O&M Agreement with LUMA; and (3) PREPA to adequately coordinate the day-to-day operation of the generation system.

Want to learn more?

On Our Radar...

Climate Change – This fall, from October 31 through November 12, the 26th gathering of the Conference of the Parties to the United Nations Framework on Climate Change, or COP26 for short, will take place in Glasgow. According to a recent paper published by Chatham House, if emissions of greenhouse gases follow the current trajectory “there is a less than five per cent chance of keeping temperatures well below 2°C above pre-industrial levels, and less than one per cent chance of reaching the 1.5°C target set by the 2015 Paris Agreement”…and “many of the climate change impacts described in this research paper are likely to be locked in by 2040, and become so severe they go beyond the limits of what nations can adapt to.”

How Democracies Die – The breakdown of democratic regimes has been studied for decades by historians, sociologists, and political scientists. What is different now, is that many of those analyses focus on the United States, including this thought-provoking essay published in The Atlantic by Eliot A. Cohen, where he concludes that if the U.S. “succumbs to its internal divisions, to its preoccupation with partisan feuding and its desire to withdraw from international politics, the world order, such as it is, will crumble.”

The Future of Work – In this interesting op-ed for the New York Times, Jonathan Malesic writes that “work sits at the heart of Americans’ vision of human flourishing. It’s much more than how we earn a living. It’s how we earn dignity: the right to count in society and enjoy its benefits. It’s how we prove our moral character. And it’s where we seek meaning and purpose, which many of us interpret in spiritual terms…But work often doesn’t live up to these ideals. In our dissent from this vision and our creation of a better one, we ought to begin with the idea that each one of us has dignity whether we work or not. Your job, or lack of one, doesn’t define your human worth.”