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Wednesday, April 8, 2015

TACKA Morgan - Part Deux

The analyst currently known as (TACKA) "W.D. Morgan" has been following the various OPALCO conversations in the media, and she wanted to post a response ... but as she worked on her response, it kinda ballooned into a new post.

So here is the new post from W.D. Morgan.
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It might be worthwhile for the people buying into the “dark conspiracy” storyline of Chom & Steve Ludwig to just take a step back and look at the really big picture. A couple of people have made comments along the line of “well, if OPALCO is raising revenue over the period through 2019 to the tune of $27 million and all they have to do is buy a $15 million cable, then why can’t they just drop the rate increases to let members keep the ‘extra’ $12 million”.

Two things to consider:

First, let’s start at the 10,000 foot level: replacing the Lopez-San Juan underwater cable isn’t the only thing OPALCO has to do over the next few years. BPA power costs alone are expected to rise from $7.5 million annually in 2013 to $9.3 million annually in 2019. Spending on energy savings programs is expected to rise from $832 thousand annually in 2013 to $1.35 million annually in 2019. Depreciation was $2.7 million in 2013 and is expected to rise to $4.2 million in 2019. A word about the depreciation: first, depreciation isn’t a cash cost, it’s the recovery of a cost already spent. But, it’s indicative of the “using up” of the asset, so it’s an important number to watch; and if it’s an asset that you’ll need to replace, the depreciation must be matched by either savings or increased borrowing capacity to be able to pay for the purchase of the replacement asset.

And, oh Lord, we have a lot of assets that will need to be replaced. The biggest and most talked about it the Lopez-San Juan underwater cable. But remember, that’s just the start. Comparing our costs to the costs of mainland communities doesn’t make any sense, despite the apples to carrots comparisons that some of the “energy experts” around here like to promote. OPALCO serves a rural, not dense, service area with challenging terrain (rocks, hills, wetlands, etc. etc. etc.) THAT IS SEPARATED FROM THE SOURCE OF OUR POWER BY 5 MILES OF SALT WATER. Comparing OPALCO’s maintenance costs to some urban or suburban village on the mainland far away from salt water is pointless. All the things that make the San Juans special make it a difficult area to serve from a utility standpoint. [Want a market-based existence proof of that? Two words: Century Link.]

And, as OPALCO has noted, the marine environment is causing cable replacements to happen earlier than they originally thought. And the Lopez-San Juan cable is only the start – OPALCO has pointed out that they’ll need to replace at least 3 other underwater cables within the next 20 years. Remember – OPALCO will either need savings or borrowing capacity to fund those replacements. Oh, and the changing environmental concerns means that OPALCO can’t just leave the old cable in place – OPALCO must remove the cable being replaced. Maybe we can have a work party to take care of that – everyone bring your diving helmet!

Let’s climb a little higher to 30,000 feet and consider OPALCO’s forecasted income.  [Numbers here and above are drawn from OPALCO’s 2019 budget document, found here.]

Taking into account the new rates, here is the net margin that OPALCO is forecasting through 2019:
  • 2015          $1.098 million
  • 2016          $0.929 million
  • 2017          $2.075 million
  • 2018          $1.470 million
  • 2019          $2.101 million
So, a total of $7.673 million in budgeted net income over the next 5 years. Not increase in net income. Total net income. On a total budgeted revenue of $139.2 million for that same 5 years. So the budgeted net income amounts to 5.51% of income.

Yes, gross charges for electricity and facilities are going up. But that net income is needed to cover increases in costs and reinvestments in plant and facility over the next 5 years – and OPALCO will need to save for repairs and reinvestments for the period after that 5 years is over as well. If the savings isn’t directly spent on those capital expenditures, it will be needed to demonstrate the ability to repay loans to fund those costs. As members of the cooperative, we should be asking questions regarding what the money is getting spent on. OPALCO has provided a lot of information about that already, but it’s incumbent on every member to satisfy herself or himself that the reinvestments make sense.

My second point, and I’ll make this much briefer than the first, is that it seems like a large part of the discussion is about the breakout between electric charges and facilities charges. Emotional arguments aside, this is simply a cost allocation issue – if most of the members agree that the money OPALCO is taking in needs to be spent on specified costs, then the remaining question is how is the allocation done between the marginal cost of electricity and the cost to have access to the grid. One way or another, all of that money is going to be collected from the members.

Let me break this subdiscussion down into two separate conversations: first – what is the reasonable way to charge for facilities costs vs the actual electrons people use. Second, what, if anything, should be done to assist those members most in need – Chom and others want to combine those into a single discussion, but they’re really separate issues.

What is the true cost to have a meter on your house? Well, the utility is paying the same costs to hang your meter, you’re using the same distribution lines, the maintenance gals and guys are maintaining the entire system and your meter is hooked up to the same underwater cable as everyone else. That’s true even if you have solar pre-heated water, even if you have a solar array on your roof, even if you have a windmill, even if you turn the switch off on your power cords, even if you have LED lights instead of compact fluorescents, and on and on. The costs to maintain and install the system and line up to your meter are the same irrespective of whether you only use the system on the coldest days in the winter or whether you leave your doors and windows open and the a/c on all year. Maintenance and repair on the system isn’t caused by the number of electrons running through your meter, it’s caused by weather, the marine environment, the passage of time AND THAT WE LIVE 5 MILES ACROSS AN OPEN OCEAN FROM OUR POWER SOURCE. Sorry, it just is what it is. Discussing a reasonable facility charge in the San Juans by reference to how a utility in Southern California does it, where their electricity distribution lines run a short way from the source ACROSS OPEN SAND, is pointless.

Lastly, the members need to have a discussion about what, if anything, it is reasonable to do to help our least fortunate members afford electricity. To conflate this conversation with the determination of what the facility charge should be is wrong-headed, but if your goal is to confuse members, it’s a good way to inflame the discussion. But we do need to talk about who should be assisted, what the income cutoffs should be, what the form of that assistance should be and what measures should be in place to ensure that no member is gaming the system. And we should have that conversation bearing in mind that OPALCO is a cooperative – WE are the utility, so every dollar someone doesn’t pay is a dollar that must be collected from someone else.

-- W.D. Morgan

Monday, April 6, 2015

Guest Column - The Straight Story on OPALCO

Utility costs are increasing, but TH doesn't believe the local press/blogs have adequately summarized all the moving parts related to OPALCO's current situation ... maybe because no one wants to ... or maybe because no one has done the research. That's why TH is publishing the following analysis by someone who has carefully analyzed the finances and plans of OPALCO. We have no dog in this hunt. This is just a straight-up analysis from a financial expert who is also a keen watcher of local dynamics. You can call her (or him) W.D. Morgan.

Enjoy!
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There is an ancient belief that the gods love the obscure and hate the obvious. Without benefit of divinity, some of the self-described community activists here in the San Juans, like the gods, are trying to confuse OPALCO members. To what end is not clear, they just “want to ask questions” and “start a conversation”. No one here at the Trojan Heron is opposed to conversations or questions, we just like to make sure that the conversation isn’t premised on confusing correlation with causality, and other fun logic flaws. Then we can get back to arguing with and disliking each other for more concrete reasons.

First, no one here at Trojan Heron works at OPALCO, does any consulting for OPALCO or has any other connection other than as members of the cooperative. We’re not advocating for or against anyone running for the OPALCO board.

Our agenda? As always: question everything. Even question the self-proclaimed experts (because experts have done some of the dumbest, or most disastrous, things imaginable). Especially ask questions of the people who say they don’t have an agenda but simply want to ask questions themselves and have a conversation. Seems to me that we should have a community conversation about all the people (usually the same people over and over again) who want to have community conversations.

The OPALCO topic of the week seems to be their 2014 financial statements, their 2015 budget and, lastly, their proposed rate increases through 2019. Witness the article in the Island Guardian by Chom Greacen, a resident of the Lopez Community Land Trust and "founder of Palang Thai, a nongovernmental organization that conducts public-interest research and works for fair, sustainable, and democratic development of the energy sector".

While the lead-in to Greacen’s article in the Island Guardan promises “what’s behind the rising rate is worse” than the rate increases, you’re never let in on the secret. Only questions. More questions. And a supposition that there’s a dark conspiracy at OPALCO to bury the costs of a broadband build-out in your electric rates. The “proof” of that? Why ... it's the “curious patterns”. Patterns of increasing costs. Mysterious words are used: “grid control backbone”, “underground cable replacement” “computers/servers/software”. There are no conclusions, mind you. More questions. Words like “perhaps”. More questions.

Never mind that the answers to those questions are largely found in a single document.

Some of the things in Greacen's article simply aren’t accurate. For example the article states that a $7.5 million loan to the broadband subsidiary has “pushed OPALCO financially close the brink”. And what would make her think that? That OPALCO as of 12/31/14 needed to negotiate an exception to a loan covenant as to its TIER requirement (see below for more about TIER). Hmmm ... as long as we’re posing questions: how did a loan that hadn’t been made as of 12/31/14 and won’t be made per OPALCO’s own schedules until the years 2015 through 2019 (in the link, see page 12 of 20, explanation for line 30, debt) ... how did the as-yet-to-be-incurred debt push OPALCO “close to the brink” on 12/31/14? It must have involved a time machine. Or maybe it didn’t push OPALCO “close to the brink”. Or maybe OPALCO wasn’t “close to the brink” at 12/31/14 – for support see discussion of financial ratios below.

But, back to the cost of the broadband subsidiary.  Board minutes indicate that the start-up costs will be that $7.5 million amount, but the only out-of-pocket costs for members will be paid at $3/member/month for 24 months, beginning in 2015. The rest is either directly paid from cash flow from the new broadband business or indirectly from the cash flow of the new business as it pays down the intercompany loan from the parent.  The board minutes also specifically reflect that the costs of the new entity “are not included in the new rate structure”.

You’re encouraged in Greacen's article to find scheduled rate increases “alarming” ... 41% by 2019. You’re not pointed to the detail. It’s here - it’s a 12% increase in 2015, followed by estimated increases of 6% annually thereafter. And the explanation? It’s right here - and, hey, guess what – it’s consistent with what OPALCO has been saying for months. Electricity cost and electricity infrastructure costs are driving OPALCO rates upward.

The author pretty much accuses OPALCO of fraud when she goes into more detail about the “curious patterns” where she wants you to conclude that increases in headquarter facility costs, computers/servers/software and even underground cable replacement are really hidden broadband costs. Actually, you don’t have to look further than here to see that all the costs related to Island Fiber are shown separately from OPALCO operations down in “non-operating margins” where the revenue from and costs associated with “NewCo” (really Island Fiber/Rock Island) are shown.

And what about those patterns? It’s worthwhile remembering that correlation doesn’t mean causation. That when two numbers both increase, it doesn’t mean there’s a connection. It’s something that even people with graduate degrees forget or don’t notice, but it’s important. You can end up with graphs that show that suicides are "caused" by US science spending. Likewise, you can also end up thinking broadband is driving up OPALCO's rates, when there is precious little evidence to support that connection.

Greacen makes much of OPALCO’s TIER ratio, without explaining what it is. But it’s name dropped. And it’s “alarming”. What else would you need to know?

It’s useful to understand what a “TIER” calculation is (and isn’t) before discussing its relevance. TIER stands for “times interest earned ratio,” you’ll also see it commonly referred to in financial literature as the “interest coverage ratio”. It’s a leverage ratio designed to measure the amount of earnings a business has available to make interest payments on its debt obligations. The formula for the calculation is: earnings before interest and taxes divided by interest expense.

“Earnings before interest and taxes”, sometimes called “profit before interest and taxes”, is, just as it implies, the net earnings of a business before payment of interest and non-operating taxes. It’s the amount of money available to make the payments on the debt the business owes. “Interest expense” is just that – the interest on all debt, long and short-term, of the business.

What kinds of things affect a TIER calculation? Decreases in operating margins – as perhaps might be caused by relatively flat revenue caused by warmer winters while at the same time operating expenses increased because of BPA pushing through rate increases on purchased electricity? Yep. That's what happened. Also, having to pay to replace existing underground cable? Yep. That happened too.

It’s reasonable to expect OPALCO to explain their TIER calculations and the changes over the years, but to accuse them of financial fraud without acknowledging the answers they've already given ... or perhaps not even knowing that answers had been given to those questions ... is an overreach.

What other sort of analysis might be done on OPALCO’s financial statements. Let’s take a look at a couple of widely used ratios:
  • Liquidity Ratio – measures the ability of the business to pay off current liabilities. A business’s Liquidity Ratio is calculated as: Current Assets/Current Liabilities = Liquidity Ratio. Usually, a business with a liquidity ratio of less than 1.5 is considered to be in financial distress. OPALCO’s liquidity ratio at 12/31/14 was $9,883,829/$3,438,051, or 2.87 (or if you work for CNBC, about 3). 
  • Leverage Ratio – measures how much the business relies on debt. The Leverage Ratio is calculated as: Equity/Total Assets = Leverage Ratio. A business with a Leverage Ratio lower than .3 might be considered to be overly leveraged and in financial trouble. OPALCO’s leverage ratio at 12/31/14 was $40,662,189/69,270,631 or .59 – note that the leverage ratio cannot be higher than 1.0. At the December 2014 board meeting, the OPALCO board adopted a resolution requiring that the company maintain an equity-to-capital ratio, another label for leverage ratio, of at least 40% on an annualized basis.
  • Quick Ratio – measures a business’s ability to meet short-term obligations and is calculated as: (Cash & Cash Equivalents + Marketable Securities +· Accounts Receivable)/Current Liabilities. OPALCO’s quick ratio at 12/31/14 was ($3,534,091 + $0 + 3,036,986)/$3,438,051, or 1.91. The industry averages for electric utilities is a quick ratio of between .85 and 1.0 – meaning OPALCO’s ability to meet short-term obligations is better than average.
  • Long-Term Debt percentage – measures the proportion of a business’s total assets that was financed by long-term debt (technically, this is the remainder of the Leverage Ratio calculation, there will be a small difference in the two calculations related to current liabilities). OPALCO’s long-term debt percentage at 12/31/14 was $24,987,266/$69,270,631, or 36%. OPALCO’s long-term debt percentage is somewhat better (i.e., lower) than other electric utilities.
  • Percentage of Cash and Short-term Investments – measures the percentage of total assets made up of cash and short-term investments; this, like the Quick Ratio, reflects the ability of the business to fund operations. OPALCO’s percentage of Cash and Short-term Investments at the end of 2014 was ($2,254,475 + $1,279,616)/$69,270,631, or 5.1%.
Is all of this still confusing? Maybe read through this ... it’s the budget document that OPALCO put together to explain the 2015 – 2019 activity and it covers not just the budgets but has narrative explanations of most things. If you just want the highlights, they’re covered in the first few pages and then you can drill down into whatever excruciating detail you’d like.

Actually, if OPALCO can be criticized for anything, it’s probably that they put out so much information. Monthly board packages often run 50 pages or more. Sometimes well over that. One worthwhile suggestion would be that members need to have someone at OPALCO curate the information, telling the members where to look to find executive summaries of information and where to look if they want to drill down into the detail.

Here’s the executive summary: by all appearances, OPALCO isn’t “close to the brink”. On the contrary, it’s healthy compared to others in the electric utility industry. Sure it’s reasonable to “ask questions and demand straight answers from the board and management” of OPALCO. It’s also reasonable to ask members to refrain from insinuating dark conspiracies as a community organizing strategy. Alleging fraud on the part of the management and board of the co-op where your only “proof” is various questions that have largely been answered is simply irresponsible.

OPALCO is a cooperative – when we talk about the “company” we’re talking about “us”. Where management isn’t perfect, we, the owners, should require them to improve. And management has to remember that perfect consensus will never be achieved – what they owe the members is that conversations are fully fleshed out and then the elected board decides what to do. Keeping in mind that not everyone will be happy.

Worthwhile conversations to have amongst the members would be to talk about relative merits of differing ways to try and equitably allocate costs, or to hear OPALCO’s ideas about what happens to its business model over time as more users switch to solar generation, or to talk about what we as members can do to assist those members most in need.

Those conversations aren’t helped when the opening position is accusing management of fraud. If I want dark conspiracies, I’ll watch The X Files on Netflix. Or I would if my broadband were fast enough. 

-- W.D. Morgan  

Monday, March 9, 2015

Three Strikes And They're Not Out ...

As commenters have noted, the county was sued today (again). This time the issue is misuse of government funds ... permit fees specifically. In short, the suit alleges that the County has violated state law by misusing the monies collected for building permits by using them to subsidize general government. For example, building permit fees have been used to pay part of Sam Gibboney's salary even though she has not been directly involved in reviewing or approving building plans. The suit alleges that the misuse and diversion of funds has amounted to as much as $1.2 million over the past three years (statute of limitations).

Reportedly, this same general issue has been brought up repeatedly by the Building Advisory Council to no avail. It also was the impetus for the recent whistleblower claim by Building Official John Geniuch.

CD&P seems to be generating a lot of lawsuits for the County these days. In addition to this lawsuit, there is the OPMA lawsuit and the Friends/CSA lawsuit regarding the CAO ... all related in one way or another to alleged CD&P mismanagement, overreach, and bungling (and not counting ongoing as-applied lawsuits related to specific parcels/permits).

Three current lawsuits ... and counting ...