Why Cuomo backed off on LIPA privatization

4. LIPA CEDES CONTROL TO PSEG - After 4. LIPA CEDES CONTROL TO PSEG - After questions were raised about LIPA's management, finances and response time after superstorm Sandy, Gov. Andrew M. Cuomo proposed a plan that gave PSEG, a New Jersey utility company, nearly complete control of the Long Island power grid, replacing the LIPA brand with a new entity, PSEG-LI. On Oct. 3, LIPA trustees approved Cuomo's effort to reform the utility. Read the full story Photo Credit: Steve Pfost

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The Cuomo administration backed away from months of pushing for the privatization of LIPA after the New York Power Authority and an outside consultant in May challenged the projected cost savings, according to state documents.

Two confidential reports obtained by Newsday through Freedom of Information filings -- one by NYPA and the original by Lazard Ltd. that recommended privatization of the Long Island Power Authority -- shed light on the behind-the-scenes analyses that led the Cuomo administration to shift gears.

In its 21-page report, NYPA said another consulting firm, Booz & Company, found that Lazard had overestimated the projected savings from privatization and failed to account for hundreds of millions of dollars in costs required to achieve those savings.

Lazard, meanwhile, in its report said the hybrid approach ultimately settled on by the Cuomo administration would cost ratepayers hundreds of millions of dollars, and recommended it only as a "contingency."

NYPA, after initially defending privatization, eventually found it "carries with it some significant risks," including that LIPA would no longer be eligible for federal reimbursement for storm damage, its report said. LIPA expects to receive 90 percent federal reimbursement for the $800 million-plus tab of superstorm Sandy costs.

One Cuomo official said the administration believed the loss of federal reimbursement for storm damage "was too significant to ignore."

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In the end, according to another Cuomo administration official who worked on the analysis, "we just felt uncomfortable with some of those [Lazard] forecasts." Still, he praised Lazard as one of the "best and the brightest" firms to conduct the analyses.

More power to PSEG

NYPA and Gov. Andrew M. Cuomo ultimately decided on an enhanced version of an already planned transition to PSEG of New Jersey. The new plan, which gives PSEG near-total control of the electric system, was presented to the State Legislature in late May, passed in June and signed into law by Cuomo last month.

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Assemb. Robert Sweeney (D-Lindenhurst), the Assembly sponsor of Cuomo's bill, said that while he still believes LIPA was originally intended to be a fully municipal utility, it is better off under the new law. "It's an improvement," he said.

NYPA's report said Lazard had projected annual savings from privatization as high as $330 million. However, Booz's forecast was more conservative, projecting savings of $189 million a year, at best.

Booz said Lazard didn't take into account the cost of achieving the savings; Booz estimated that outlay at $185 million to $271 million, the report said. Such "synergy" savings often entail costs such as contract termination fees and severance obligations. The NYPA analysis doesn't specify those costs, but Lazard by comparison showed zero costs to achieve.

Lazard spokeswoman Judi Mackey declined to comment.

Larry Waldman, LIPA's chairman, said he had not seen the Lazard report and declined to comment on the final recommendations. "I'd love to see it," he said, noting that LIPA trustees had already picked PSEG to run the system. "We picked a company of great reputation."

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NYPA and administration officials also differed with Lazard over whether all LIPA debt would have to be refinanced if PSEG took over the contract. Lazard believed such a deal would trigger a full refinancing and PSC review, while administration officials settled on refinancing only around a third to half of LIPA's $7 billion in debt.

The Lazard analysis also found the "fully outsourced model," a version of which has been put in place with PSEG, would result in an "inability to capture [cost-saving] synergies," contractor profits that were "higher than expected," higher debt costs and large transition costs.

Now banking on it

A version of that idea is something the Cuomo administration is now banking on.

"We said we can redesign the contract and find synergy savings that could be significant," and contribute to a freeze in LIPA's delivery charge, the administration official said.

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The 145-page Lazard report also reveals the extent to which the financial consulting firm, which has a history of analyzing options for LIPA, reviewed a range of future structures, including a Chapter 9 bankruptcy filing to restructure the agency's $7 billion in debt.

Under a Chapter 9 filing, "bondholders could be forced to absorb some of the Shoreham debt costs, while a "transfer of LIPA's ratemaking authority to the PSC could serve as the bankruptcy/default triggering event," the report said.

The analysis found that such a filing would be "similar to privatization from an organizational perspective, with ownership transferred to creditors, rather than an investor-owned utility." It could "relieve rate pressure," while avoiding bond defeasance costs that would be required to remove debt as a liability on the balance sheet, the study found.

In the end, Lazard recommended against a bankruptcy filing. It cited "likely adverse effects on other New York State tax-exempt issues" -- because other state agencies could conceivably suffer a bond downgrade -- and a "complex/lengthy legal process."

One Cuomo administration official added, "We didn't really believe bankruptcy would be sustainable in a court," because LIPA could always turn to ratepayers to cover its costs.

While some criticized the governor and Lazard for stressing only privatization beginning in January, after an interim Moreland Commission report recommended it, the Lazard report shows it also examined making LIPA a fully public utility, as well as an expansion of the public-private partnership.

Least beneficial

The Lazard analysis said a fully public LIPA would be the least beneficial of three primary alternatives it studied. It expected it would cost ratepayers a cumulative $745 million over 10 years, and that it would be a "burden on the state budget."

Lazard found privatization to be the alternative with the greatest costs savings while giving LIPA ratepayers greater accountability through full PSC regulation. All operating risks, it found, would be transferred to a private entity, while decision-making would be streamlined.

The Lazard report cites four other consulting firms with which it worked to reach its conclusions: Hawkins, PFM, Orrick and Booz & Company. The costs of hiring those firms isn't listed, but Newsday has previously reported that Lazard's November to March 2012 contract was valued at just under $1 million, according to another Freedom of Information filing.

Lazard didn't envision the need for LIPA to lower property taxes on the four major generating plants that ultimately became a point of contention in negotiations for the legislation. As part of the final legislation, LIPA has offered settlements to districts that host the plants, including Port Jefferson and Northport, that forgive hundreds of millions in past payments, but cut future taxes by around half over 10 years. Districts were given four months to accept the proposals.

Assemb. Steven Englebright (D-Setauket), who co-sponsored the bill, called the Lazard analysis "off base and tone deaf," and said the "very first thing I said to the Lazard gathering back in the early part of the year was that the FEMA reimbursement was extremely important and that they weren't factoring it in."

Englebright praised Cuomo. "That the governor went in a different direction suggests that he was not tone deaf and that he was interested in predictability and had a firmer grasp of the dynamic of interest rates," he said.

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