We live in a complicated and oftentimes confusing world. Faced with that reality, it is only to be expected that people will oversimplify complex problems. We then divide solutions to economic, political, or social problems into two groups and with a heavy sigh of relief we declare ourselves decidedly in favor of this set of solutions and most definitely against that other set of proposals. While that simplicity may help us feel better, this kind of binary thinking is not helpful in advancing real solutions to difficult problems. What usually happens is that the public discourse degrades into a screaming contest between those ferociously in favor of one “solution” and those rabidly against it. As the opposing groups talk past each other little thinking and even less analysis about the underlying problem gets done.
This is precisely the situation with respect to the public-private agreement between the government of Puerto Rico and LUMA. In recent days, the public debate on this issue has devolved into a silly shouting match between those who support LUMA and those who oppose it. But to paraphrase Pope Francis, who knows a thing or two about hard-nosed negotiations, reducing complex reality to simple binaries is the result of mediocre thinking and when faced with such a reductive, partial mental scheme we must try to transcend it and see the world as it really is, in all its wonderful and confusing complexity.
In the case of the agreement between LUMA and the Puerto Rico Electric Power Authority (“PREPA”) after 15 months of operation it is clear that LUMA is not measuring up to expectations. Both the Puerto Rico Energy Bureau (“PREB”) and the Puerto Rico Public-Private Partnerships Authority (“P3 Authority”) have been critical of various aspects of LUMA’s performance. So far LUMA: has incurred in budget overruns; has failed to meet key performance metrics regarding the duration and frequency of outages; is behind schedule in meeting certain maintenance goals (for example, controlling vegetation growth around important lines); and has shown little evidence that it is achieving the savings it represented it would generate from a more efficient management of the transmission and distribution system (“T&D System”). It is up to the government of Puerto Rico, then, to defend the interests of the Puerto Rican people.
However, this is not the whole story. While we fully sympathize with and support the demands for affordable and more reliable electric service in Puerto Rico, the objective reality is that all of our electric power troubles cannot be blamed on LUMA. The T&D System, while functional, has been in a fragile state since the emergency repairs related to the damage caused by Hurricane Maria were finalized in 2018.
In addition, PREPA’s generation fleet, with the exception of a handful of units that have been retrofitted to burn natural gas, has not been modernized. It still relies mostly on oil and diesel fuel for the generation of electricity. This means that Puerto Rico is at the mercy of oil and natural gas markets, which have been roiled recently by the unexpectedly rapid economic recovery from the COVID-19 pandemic, the strong post-pandemic shift towards the consumption of manufactured goods (instead of services), other constraints on energy supply, and the invasion of Ukraine by Russia.
Therefore, a share of the outages, at least those related to the patched-up state of the grid, and the rate increases, which are mostly, if not wholly, a function of increases in fuel costs, cannot be properly charged to LUMA.
Given this complicated reality the government of Puerto Rico has several options, some of which we explore and explain in the accompanying Policy Brief. To make a long story short, the answer to those who ask whether the operation agreement with LUMA can be terminated is yes. The contract provides several ways for doing so.
Perhaps the easiest course of action, in procedural terms, would be not to seek the extension of the interim operation period that ends on November 30. The Supplemental Agreement currently in effect provides for the automatic termination of both agreements (the Operation and Maintenance Agreement (“O&M Agreement”) as well as the Supplemental Agreement) on that date, unless the government of Puerto Rico seeks to extend its effectiveness.
However, each proposed solution carries with it some consequences that must be analyzed beforehand to avoid mistakes or making an already difficult situation even worse. In the case of the scenario we just described, the automatic termination of the agreements would trigger the occurrence of several events.
First, pursuant to Section 7.2(c)(i) of the Supplemental Agreement, PREPA would be required to pay LUMA a termination fee, which in this case would be equal to the Interim Period Service Fee (see Section 4.2(d) of the Supplemental Agreement). This fee would amount to $115,000,000 in 2020 dollars, adjusted for inflation.
Second, the termination of both agreements would trigger the clock on the Back-End Transition period, which could last up to twelve months and during which LUMA would wind up its operations and transfer them to a successor operator. PREPA would be responsible for paying a Back-End Transition Fee to cover the cost of LUMA’s operations during this period.
The problem with this and any other termination scenario is that it appears there are no candidates to be a successor operator in the event of termination. That is, there appears to be no Plan B. Who will then be in charge of Puerto Rico’s transmission and distribution system?
Devolving the operation of the T&D System to PREPA, a criminally corrupt and extremely inefficient corporation, would be a regression, instead of progress towards meeting Puerto Rico’s energy objectives. In addition, most of PREPA’s employees with experience in transmission and distribution have either retired or moved on to other government agencies. Thus, even if it were desirable to return the operation of the grid to PREPA it may be unable to do so.
In the alternative, seeking a new operator pursuant to the Puerto Rico P3 law would be a cumbersome process that could take up to two years. Given the experience with LUMA, it seems highly unlikely to us that many world-class companies will be lining up to take up its place as operator under the same terms and conditions granted to LUMA. If anything, any such interested company would probably seek even more favorable terms than the ones currently set forth in the agreement with LUMA. There is also the risk that a hastily put together fly-by-night operator with political connections may obtain the new contract, leaving Puerto Rico with the worst of both worlds: a fragile transmission and distribution system and an incompetent, corrupt operator. A scenario that would be absurd in almost any other country, but which cannot be categorically ruled out in Puerto Rico today.
In addition, we have to take into account the impact that terminating the O&M Agreement now could have on the disbursement of the FEMA and CDBG-DR funds allocated for the reconstruction of the grid. The likely scenario is that both agencies would adopt a wait-and-see attitude with respect to such disbursement as legal and operational wrinkles are worked out. This means that the reconstruction of the grid would take even longer than the currently projected 10 years.
Therefore, it appears to us that the best case scenario would be to make the agreement between LUMA and the P3 Authority work. The current public debate is a sideshow because both sides are wrong: it is just as irresponsible to grant LUMA a blank check as it is to terminate the Operation and Maintenance Agreement without identifying a viable successor operator. In our view, the key questions are (1) why has LUMA been unable to meet basic performance objectives during the past 15 months?; (2) what is the government of Puerto Rico willing and able to do about it?; (3) what are the consequences of terminating the current agreement?; and (4) what are the viable alternatives to LUMA, that is what is Plan B? These are the questions we are asking and analyzing.
Going forward, we recommend, at a minimum, that the P3 Authority hire an independent world-class firm of engineers, preferably from the United States or from Europe, with no business or political connections to Puerto Rico, to relentlessly and unwaveringly supervise LUMA’s performance of its obligations pursuant to its agreement with the P3 Authority.
Finally, we warn our readers against believing those who are already peddling easy fixes and trafficking in false hopes with the expectation of financial or political gains, or both. There are no effortless solutions to Puerto Rico’s energy problems. It will take several years of steadfast hard work to rebuild the system and to decrease energy rates. There are no shortcuts, no easy answers, no straightforward ways out. The only option is to work through it. Otherwise, we face the unpleasant prospect of several more years of economic decline and the social stagnation that would entail.