By City Council member Nick Licata

Ed. Note: This editorial originally appeared in Licata's "Urban Politics" newsletter.

No one likes higher utility rates, but one is certain to come next year.

Given that Seattle City Light is in a budget crisis, it will run out of cash early next year and will need to issue a significant amount of debt ($200 million) to fund its capital program.

The Seattle City Council must decide this week what their rates will be for 2010.

Below, I provide a brief and hopefully understandable explanation of what the situation is. I have not touched on all possible elements that could affect the utility’s rates, but I’ve tried to hit on what seems to be the most important in meeting this critical challenge.

First off, a bit of context: City Light’s rates are significantly lower than the nearest comparable electrical utilities, Puget Sound Energy and Tacoma Light and the Snohomish Public Utility District, even after the mayor’s proposed 8.8 percent increase is included.

Office buildings, big-box retail with grocery, medium sized industrial manufacturer and small manufacturer serviced by City Light all have utility bills ranging from 16 percent to 64 percent below these other three utilities.

Seattle City Light’s rates will be increasing, that is certain. The question is by how much? The council is currently trying to decide if the mayor’s proposed 8.8 percent increase is the right amount.

The debate right now, in the most general terms, is to determine how to keep City Light’s bond rating from either falling or falling so far as to harm the utility’s ability to raise funds that it needs to operate.

City Light has an annual budget of just over $1 billion, yet less than $300 million is really discretionary; the rest is committed to debt service, capital projects and contractual obligations.

So when proposals are made to cut their budget instead of raising rates to cover their revenue gap, the question of where to cut without harming direct service to rate payers becomes tricky. Even under the mayor’s proposed budget, cuts were proposed to the tune of $11 million, including $1 million in conservation projects.

There are several moving parts to this puzzle. The first is the existing gap between revenue and budget, which is currently pegged at $140 million. Half
of that amount is a long-term structural issue due to rates not keeping up
with expenses.

The council and the mayor decreased City Light rates in 2007, and overall rates have declined 25 percent since 2003 when inflation is taken into account, and for medium, large and high-demand customers, the rate decrease comes out even greater, to 40 percent.

The other $70 million in revenue shortfall is due to the rapid decline in
natural gas prices that has driven down the price of electricity that City
Light sells on the open market, known as surplus energy sales.

These sales compete with natural gas for buyers of energy. Given the national economic climate with a 10 percent unemployment rate, this relationship is not predicted to change in 2010.

Consequently City Light lowered its projected sale for surplus energy to $120 million in 2010. Even this lower estimate may represent a recurring tendency for City Light to overestimate revenue it expects to receive for its surplus energy; in five of the last seven such projections, City Light has overestimated revenue.

The second moving part of this puzzle is determining how the bond market
will rate City Light’s financial condition. Standard and Poor is a credit rating agency that rates the financial strength of utilities on a number of conditions, one of the most important being their debt service coverage (DSC).

The DSC is the amount of revenue available to the utility to pay debt service, after paying all other costs. Under current city policy, which was set by the council, City Light should set retail rates to generate at least twice as much revenue as needed for debt service (referred to as 2.0 coverage).

Unfortunately, today City Light’s actual DSC is about 1.3. At 1.25, bond covenants on certain outstanding bonds would prevent City Light from issuing more bonds.

The council is currently trying to determine what the minimal DSC can be to
sustain a financially healthy utility. City Light is currently rated AA- by Standard and Poor. City Light is one of the highest rated utilities, allowing it to borrow at a low rate.

If we do not meet the 2.0 DSC, we will most likely see a rating decrease. Once a rating decrease takes place, the lower rating remains for a number of years; the last time City Light’s financial rating was decreased, it took more than seven years to get back to our previous higher rating.

The closer we get to 2.0, the lower the drop in our rating. A one-grade decrease to A+ would result in $1 million a year for 20 years in higher bond costs for a $200 million bond. City Light goes out to the bond market about every two years with bond packages as high as this amount.

In addition, a lower rating loses us the opportunity to take advantage of the low bond market rates to re-finance current bonds that we are paying a higher interest rate on. This saving could easily amount to a one time savings of more than $20 million.

The mayor’s proposal would have adopted a 1.6 DSC, after increasing rates by
8.8 percent, and require setting up an automatic rate adjustment mechanism that would use future quarterly rate increases to compensate City Light for
shortfalls in surplus energy sales.

This mechanism, known as a PRAM, was opposed by our citizen oversight group, the City Light Rates Advisory Committee. In addition, rates would also be planned in 2011 and in 2012, for a total of at least a 22 percent increase over three years.

The council is considering two alternatives to the mayor’s proposal. One
would increase City Light’s rate by 13.8 percent to achieve a DSC of 1.8, thereby keeping the financial rating of City Light as close as possible to our
written policy of having a 2.0 DSC.

The other alternative is to go with a rate lower than 8.8 percent and accept a lower bond rating and consequently lock in higher financing costs for years into the future.

Future rate increases and further budget cuts are possible with both options, although a double-digit rate increase is almost certain next year if the lower rate hike is taken now.

Each option has strengths and weaknesses. Given the weak economy, many
businesses that are struggling would feel the impact of a rate increase. That concern is balanced against allowing City Light to cut maintenance on its huge power generating investments and reduce service to its ratepayers.

I believe that path could jeopardize Seattle’s greatest public asset, our
publicly owned electrical utility, which delivers electricity lower than any
nearby private utility.

Whatever option is chosen, it is absolutely necessary for the council to adopt the recommendation of City Light’s Rate Advisory Committee to unify strategic planning, budgeting and rate-setting in order to achieve a sustainable and healthy City Light.

We must begin to control City Light’s operating budget first and then establish rates to meet that budget, rather than setting the rates to meet City Light’s budget. That would be the only sure way to provide reliable, dependable, fair and predictable rates capable of weathering economic downturns such as what we are currently experiencing.

The council will vote on an increase in City Light’s rates Nov. 12 in the Budget Committee.

Nick Licata can be contacted at nick.licata@seattle.gov.

To subscribe to "Urban Politics," send a message to urbanpolitics-subscribe@speakeasy.net.