Where LIPA's money went: Billions spent to get power; not enough spent to protect it

No matter how hot it got on summer's hottest day, with all of the Island's air conditioners at full blast, the Long Island Power Authority wanted to have more than enough electricity to deliver to its customers.

And it did just that -- even if it meant spending billions of ratepayer dollars on questionable deals, Newsday has found.

LIPA agreed to a 20-year, $914 million contract for the right to buy power that it can use only in rare circumstances. In another deal, flawed planning for power the authority didn't need cost in excess of $100 million. And more than $20 million went for a failed research project to turn natural gas into electricity.

As LIPA faces state investigations and intense criticism for its response to superstorm Sandy, it's the authority's failure to spend more money to protect its transmission and distribution system that might cause the death of the utility as it now exists.

Although LIPA pledged in 2006 to allocate $20 million annually over the next five years to reinforce its system, officials instead spent an average of $12.5 million, according to a 2012 state report that LIPA disputes. The same study said LIPA was not meeting industry standards for trimming trees and that it had abandoned a program to inspect and replace old utility poles.

Downed trees and poles have been cited by LIPA as a significant reason that 90 percent of its customers lost power after Sandy.

LIPA officials blamed the authority's $7 billion debt obligation for not spending more to protect Long Island from extended post-storm outages.

"Frankly, we would like to spend more on making the whole system more resilient," LIPA board member Neal Lewis said after Sandy. "But it's kind of like having a second mortgage on your house and then trying to get a home-improvement loan."

Newsday spoke with 10 energy industry experts and reviewed hundreds of LIPA contracts, reports and bond documents submitted to investors. That examination found that the authority hasn't let debt prevent it from a relentless pursuit of new power sources, or from investing millions of dollars on risky research and development ventures.

In addition, multimillion-dollar deals LIPA has been stuck with would likely be abandoned if it were a private company and not a public authority with state-appointed directors, experts said. LIPA property tax payments subsidize almost half of Port Jefferson's entire $38 million schools budget, for example, even though the authority has been using a minimal amount of power generated by the local plant.

"Should we be paying for plants we don't use?" asked former LIPA trustee Sheldon Sackstein, chairman of the business advocacy group Action Long Island. "It doesn't make sense."

Keeping the lights on

Balancing the costs of power purchases, energy efficiency programs and grid maintenance is difficult. As Long Island's economy grew in the first part of the past decade, LIPA focused on building its power capacity, including new generating plants and underwater cables to potentially cheaper electricity sources outside the Island.

If the authority had underestimated its need for electricity each year, Long Islanders would likely have been inconvenienced and infuriated if summer blackouts and brownouts occurred.

Former LIPA chief executive Richard Kessel pushed for many of the most expensive power deals and defended the initiatives.

"We added resources to keep the lights on," Kessel said in a recent interview. "And just like after Sandy, if you don't build and the lights go out, you're blamed for it. And I think Long Island is in better shape than almost every part of the state because of the resources that we added."

Aside from a few questions answered by departing LIPA chief operating officer Michael Hervey, officials of the utility declined requests to be interviewed for this story. Kevin Law, who succeeded Kessel as chief executive, did not comment.

Hervey emailed a statement to Newsday on Wednesday that read, in part: "Newsday's reporting is inaccurate and rehashes issues that LIPA has fully addressed numerous times over the last decade. LIPA has saved its customers millions of dollars and invested wisely with respect to rebuilding and maintaining an electrical system that was neglected by" its predecessor, the Long Island Lighting Co.

During a Thursday night hearing of the Moreland Commission, which was created by Gov. Andrew M. Cuomo to investigate how utilities dealt with Sandy and its aftermath, Hervey defended LIPA's performance and said the authority had made a $500 million investment in hardening the system for storms.

Benjamin Lawsky, a Moreland Commission co-chairman, called LIPA's response to superstorm Sandy an "epic failure."

Repeating past mistakes

A utility's plan for the future centers on those few hours when electricity usage is at its peak. In New York, that peak demand dictates the energy requirement for the next year under rules set by the New York State Reliability Council (NYSRC), an administrative nonprofit composed mostly of local energy insiders.

The council requires utilities to have access to more power than they're expected to use. The total amount of power available is called the utility's capacity.

New York power administrators this year required utilities, including LIPA, to have a capacity equal to 116 percent of the year's forecast peak, an amount based on the previous year's peak usage. The goal is to keep power supply droughts to one day per decade at most, said NYSRC consultant Alan Adamson.

NYSRC's rules regulate only whether a utility has enough power to meet demand and do not regulate distribution to homes and businesses. Those rules are set by the state Public Service Commission, which oversees every private utility company in New York, but not LIPA, a nonprofit public power authority created by the State Legislature.

The authority's failures after Sandy invite comparisons to LILCO, the utility LIPA replaced in 1998. LILCO had a dismal reputation with customers for many reasons, including the billions wasted on the unused Shoreham Nuclear Power Plant, a poor response to Hurricane Gloria in 1985 and electricity rates that were among the highest in the country.

LIPA was created to reverse that. By statute, the authority exists to save ratepayers money.

Instead, LIPA has repeated some of its predecessor's missteps.

After adjusting for inflation, LIPA's rates are essentially the same as LILCO's final rates, according to a Newsday analysis of U.S. Energy Information Administration data. And in some years, they've been higher. LIPA customers last year paid the second-highest rates among U.S. utilities with at least 500,000 customers, trailing only Con Edison, a for-profit enterprise.

By the authority's own math, every $36 million it spends annually represents 1 percent of a customer's power bill. The following expenditures are among those of questionable value to Long Island residents:

$914 MILLION FOR A HARD TO USE RESOURCE

LIPA agreed to a $914 million, 20-year contract for power that came with a crucial, but largely unknown, catch: It can almost never be used.

The authority is allowed to tap into its second largest source of power, Pennsylvania's Marcus Hook plant, only if two different regional power systems declare emergencies. That hasn't happened since the contract began in 2010, Newsday found.

Five energy experts interviewed by Newsday said they had never heard of a restriction like it.

The deal came about because LIPA needed a dedicated source of power for its $2.7 billion Neptune project, in which two underwater cables stretch from Long Island to New Jersey. LIPA has said Neptune would be a money-saving venture because it gives the authority access to cheaper power it can buy as needed from power plants in more than a dozen states.

But as the cable was coming online in 2007, LIPA found itself under fire from Matthew Cordaro, a frequent critic who is currently co-chairman of the Suffolk County Legislature's LIPA Oversight Committee. Without a power plant under contract on the other side of the cable, Cordaro said Neptune would lose money for LIPA in the long run.

LIPA's solution was the contract with Marcus Hook, a gas-fired plant in a tiny town alongside the Delaware River.

Like many LIPA power agreements, the roughly $45 million LIPA spends on the deal each year buys only the promise that the plant's electricity will be available if LIPA wants it. The power itself is an additional charge.

To get electricity from Marcus Hook to Long Island, "system emergencies" must be simultaneously declared by the New York Independent System Operator, which runs New York's power market, and PJM, which plays the same role in New Jersey, Pennsylvania and other states. Both declare emergencies when there is a danger that there is not enough power to meet demand.

The two groups have not once declared system emergencies at the same time since the Marcus Hook deal took effect June 1, 2010. Data provided by the two agencies shows NYISO invoked a system emergency on eight days since that date, and PJM said its last system emergency was in August 2008. PJM reported nine near-misses dating to 2007, none of which happened on the same day as a NYISO emergency.

Howard Axelrod, president of Albany-based utility consultant Energy Strategies Inc., said he had never heard of an agreement like it during his 30 years of consulting.

"Would they have better used those $45 million to improve their storm restoration?" Axelrod asked. "Could it have benefited customers more using it there than the once-every-10-year extended outage under multi-regional situations? Those are all good questions."

Other experts expressed similar confusion over the deal.

"If they have to meet some sort of a reserve requirement, and that power is interruptible power, how does that satisfy the requirement?" former LIPA trustee Sheldon Sackstein asked. "I'm not so sure that as a resident of Long Island that it actually does anything for me."

"It's not a conventional thing," said Alan Adamson, the NYSRC consultant, who previously worked for LILCO and the New York Power Pool, NYISO's predecessor. "I've never heard of that."

Tying the Neptune cables to a mostly-unusable power supply was not a good solution, said Cordaro, a former president of the Midwest ISO, one of the largest regional power grids in America.

"It's very hard to justify," said Cordaro, who more recently has sought top jobs with LIPA. "It just doesn't make sense."

Many LIPA documents, including official disclosures to bond investors, explain the emergency-only provision in a footnote or ignore it entirely. It is so little-known that LIPA's departing chief operating officer, Michael Hervey, said he was unaware of it.

"I don't know the details," Hervey said when asked about the contract. It was signed before he took over LIPA in 2010, though he was the authority's vice president of operations at the time.

The Marcus Hook deal is as expensive as some standard power contracts, and LIPA is counting the power it can deliver toward the 116 percent reserve required by state power administrators.

A NYISO spokesman declined to explain why the organization allowed Marcus Hook's potential power to be counted toward LIPA's capacity requirements, citing "confidential market information."

LIPA is still able to use Neptune to purchase power on PJM's spot market, though that's been problematic as well.

From May to June, the cables went out of commission after Neptune's transformers failed. One transformer is still out, cutting the line's capacity in half.

The inoperative lines forced LIPA to draw power from more expensive sources, costing the authority at least $2 million more per month than anticipated. New transformers cost another $10 million, though some of that expense might be covered by insurance.

Because the cable was out for most of the summer peak, NYISO limited how much of Neptune's capacity will count toward LIPA's requirement next year.

As a result, LIPA's ratepayers could pay millions more for capacity from other sources.

$102 MILLION PAID TO CAITHNESS ENERGY TO DELAY PLANT'S OPENING

The power industry is driven by a fear of customer backlash from summer brownouts or blackouts. And predicting electricity needs is tough for any utility, especially one like LIPA, which faces the uncommon challenge of bringing power to a heavily populated island.

"They're in the business of predicting the future, and there's a built-in bias to err on the side of adding too many resources than too little," Gordian Raacke, executive director of the nonprofit advocacy group Renewable Energy Long Island, said of utilities in general.

Starting around 2001, LIPA went on a power supply buying binge as then-chief executive Richard Kessel warned of an "ever-growing need for electricity" on Long Island.

Kessel approved contracts for privately-owned low-capacity power plants called peakers. LIPA arranged $1.7 billion in such contracts from 2001 to 2004. Though common in the industry, peakers are switched on only when regional consumption spikes and are considered one of the more expensive ways to generate power.

LIPA spent the next several years arranging $6 billion worth of additional projects to shore up power supply even as the economy began to slow, contracts show. Power over-budgeting during a recession is "not abnormal" in the industry, said energy consultant Axelrod.

"One of the biggest sources of uncertainty is your load growth," Axelrod said. "Especially if you look at the time frame leading up to the recession."

LIPA committed $330 million to lease the Cross Sound Cable, which connects Connecticut to Long Island in Shoreham. It signed a 15-year, $924 million deal to buy power from the Bear Swamp hydro-energy plant in Massachusetts. And $2.7 billion would go to the Neptune cables linking LIPA to electricity sources through New Jersey.

But LIPA's projections called for even more power.

The authority made a $1.49 billion deal with Caithness Energy to build a state-of-the-art power plant in Yaphank. It pushed ahead over the objections of residents who didn't want the facility in their neighborhood and critics who said the utility could save money by revamping existing plants.

By 2007, LIPA had developed such a glut of purchased power that it had no immediate use for the plant.

In exchange for delaying the opening for a year, LIPA agreed to compensate Caithness Energy for lost revenue by paying an extra $102 million over 20 years.

Former LIPA trustee Sheldon Sackstein said that the costly mistake is a symptom of a more fundamental problem: LIPA chooses long-term power contracts rather than owning its own plants. The utility only finances the construction of the plants, and then buys the power from private entities.

"A 20-year supply agreement doesn't make LIPA better," Sackstein said. "LIPA's planning is a sham, but we have to pay for it."

In early 2010, with the economy still weak, LIPA forecast that it would not need any new major power sources until 2020.

That date has since crept forward. Before Sandy, LIPA was weighing proposals for a new plant in 2018, again to be owned by a private entity.

Under consideration: Caithness II, a facility in the Yaphank shadow of the still-operating Caithness, with twice the output of its predecessor. The potential price tag has not been disclosed.

Departing LIPA chief operating officer Hervey said in an interview that the utility's estimates for power may become more conservative -- especially in light of Sandy's economic impact. Regarding the stated need for another big power source, LIPA's board has directed executives to "go back and relook at the forecast," Hervey said.

$21 MILLION LOST TO FAILED FUEL CELL PROGRAM

Even as LIPA neglected basic maintenance like tree trimming and utility pole inspections, the authority spent at least $54 million on research and development in the 10 years after taking over Long Island's power grid and shelved a multimillion-dollar energy-savings program.

LIPA has cut back on research and development spending in recent years, down to $3.6 million in 2011 compared with $6.3 million six years earlier, according to the authority's budgets. The reductions came after LIPA invested in failed efforts to turn natural gas into electricity and bring electric buses to Long Island, and granted millions for solar panels to a local business.

It's not unusual for private utilities to spend a small fraction of their revenue on R&D. But for a debt-saddled public authority to devote any resources to such ventures shows that LIPA has confused its mandate to provide ratepayers with cheap and reliable electricity, said Martin Cantor, a Melville economic development adviser and former LIPA consultant on energy efficiency programs.

"Why are they having learning experiences on the ratepayer's dollar?" Cantor asked. "They're not operating as a business. When a business makes an investment, there always has to be a return."

The utility has also fumbled in the area of energy savings, where at least one of LIPA's key initiatives could have been considered a quantifiable success -- if LIPA officials had not determined that they didn't want to use it.

Since 2001, the utility has committed at least $44 million to LIPAedge. The program put upward of 36,000 Internet-connected thermostats in participating residences and businesses, allowing LIPA technicians to slightly lower power settings during heat waves.

Besides avoiding brownouts and blackouts, the thermostats could potentially reduce LIPA's peak energy usage by an estimated 50 megawatts annually, an amount greater than the utility's 2011 goal for all of its other energy efficiency programs combined.

Cutting that peak would also reduce the amount of power needed the following year, lowering ratepayers' bills.

But from at least August 2009 through August 2011, LIPA never activated the thermostats, even during July 2011's record heat wave.

Hervey, LIPA's outgoing chief operating officer, said last year that the utility didn't use LIPAedge because it had more than enough power to spare, even on its peak days.

"I don't think we're in the business of trying to ration electricity on peak periods," he said.

The program is now being used again, although it's unclear how frequently. Hervey estimated the authority had used it "a couple of times this year."

Other LIPA investments never came close to delivering on their promise.

In 2003, LIPA donated $4.1 million in a grant for solar panels to a Melville-based company called FALA Direct Marketing. Within five years, the firm abandoned its local offices and cut 200 employees when it was bought by a Minnesota company.

As critics pointed out at the time, LIPA had no recourse to demand a reimbursement.

"To give such a sweetheart deal without requiring a claw-back promise is mind-boggling," then-state Assemb. Marc Alessi (D-Manor Park) said.

One of the authority's biggest failures was a partnership with a Latham-based company called Plug Power. The program was touted in LIPA news releases as a first-of-its-kind effort to transform natural gas into electricity using fuel cells.

From 1999 to 2008, LIPA spent $21 million on a fuel cell initiative, including $15.5 million that went to Plug Power.

According to an internal report LIPA commissioned in 2007, those fuel cell programs were millions over budget each year and marred by production delays and technical problems. LIPA eventually shelved the program.

At the time, then-chief executive Law acknowledged that the fuel cell program was a flop.

"We are charged with oversight and monitoring, and we failed to do a good job," Law said.

Such admissions are rare from LIPA, which tends to portray even apparent failures as worthwhile ventures.

After spending $93,000 on a demonstration for a backup fuel cell system which then had to be shut down because of a power malfunction, LIPA said in a 2009 R&D report that the "series of reports and operating experiance [sic]" was worth twice what it had paid.

And when LIPA scrapped plans to introduce electric buses to local public fleets, the utility still called the project a "qualified success."

LIPA spent $507,000 on the electric bus concept before a partnering company -- bus powertrain manufacturer Odyne -- suspended operations.

Because Odyne ultimately sold the technology to a trucking technology company, LIPA concluded that the project "proved invaluable to advancing medium-duty plug-in hybrid technology."

LIPA claimed in 2009 that in theory, those advances "could lead to a benefit for LI ratepayers of over $2,000,000."

RATEPAYERS COVER SCHOOL BUDGETS

LIPA customers spend millions of dollars each year to pay property taxes on aging, inefficient power plants that produce less and less energy.

A state energy task force this year urged that the plants be modernized. LIPA has raised the prospect of retiring them.

But local schools and governments have become dependent on the tax payments, which must be paid regardless of how much power the plants produce.

The authority is managing legal disputes with local entities, including the Town of Huntington, as it tries to reduce the tax payments. LIPA contends that the plants have been assessed unfairly because they have lost commercial value.

If LIPA were a private company that answered to shareholders, the situation might be less complicated. Instead it must deal with local political interests as it tries to unburden ratepayers, an awkward spot that a private utility wouldn't find itself in, said Cantor, the Melville economic development adviser and former LIPA consultant.

"Rather than providing the best power at the lowest cost, LIPA is obligated to pass on to ratepayers property taxes on inefficient plants just to satisfy the financial needs of local governments," Cantor said.

LIPA is an administrative agency that contracts with a private company, National Grid, to handle utility operations. Since it acquired the Island's electric network in 1998, the authority has been bound by agreement to cover the property tax obligation on power plants owned by its private partner.

LIPA estimated that it made $194 million in such payments in 2011, and that money was passed directly to customers. The total cost of the tax payments has increased from $169 million in 2008.

But even as the property tax payments grow, the amount of power LIPA draws from the older plants has diminished because the authority can turn to cheaper, cleaner alternatives.

LIPA is paying Huntington $74 million for a plant in Northport that opened in 1967 and has been operating at 27 percent of capacity, according to the authority. The money is shared by several taxing districts in town, with $49 million going to the Northport-East Northport School District -- just less than one-third of the district's $154 million budget.

John Gross, the district's attorney, said losing the money would result in "a parade of horribles" so severe that the state and other parties would likely be forced to intervene.

LIPA's plant in the Village of Port Jefferson, which opened in 1958, has also seen a decline in use.

It has been operating at 13 percent capacity, LIPA said, yet Brookhaven Town collects $25 million in property taxes for the plant. Of that, the Port Jefferson School District gets $16 million, which is 42 percent of the district's budget.

In addition, LIPA is paying the Village of Port Jefferson $2.5 million in taxes for the plant this year, or 27 percent of the village's budget.

Village Mayor Margot Garant and others in the community have pushed LIPA to modernize the plant and return it to full operation. According to a village consultant, that plan would bring long-term savings to ratepayers.

And it would keep the tax dollars coming.

Garant said if the plant revenue evaporated, the village would need to double its property tax levy.

Thomas Bjurlof, a member of the Mayor's Energy Task Force who is paid by the village to consult on the issue, said the standoff between LIPA and local governments over tax dollars can be blamed on LIPA's power supply monopoly and the absence of political will to reach a resolution.

"It never should have happened," he said. "Everyone got addicted to the money coming from the power plants. It's a political problem. It needs a political solution. It has nothing to do with the energy industry."

LIPA'S FUTURE IN DOUBT

In October 2011 -- one year before Sandy -- a consulting firm offered recommendations to revamp LIPA's organizational strategy and make its spending more transparent.

The utility's officials had spent the previous month under fire for a slow response to another storm, Irene.

"LIPA's board of trustees and customers are acutely aware that LIPA's retail electric rates are among the highest in the country, and that customer satisfaction with LIPA is low," wrote consultants for the Massachusetts-based Brattle Group, which LIPA paid $1.1 million.

In its 182-page report, the Brattle Group weighed privatizing LIPA, an option made prohibitively expensive by the authority's huge debt. The consultant proposed a less drastic plan in which the utility would take more direct control over the cost of operations handled by PSE&G, which will take over management responsibilities from National Grid in 2014.

LIPA trustees approved the plan, set to be implemented that year, and billed it as a revolutionary change. This year, LIPA announced plans to spend billions more on a new plant in Yaphank or Shoreham and to begin overhauling decades-old steam plants.

The initiatives come even as LIPA has acknowledged that customer energy usage has dropped unexpectedly.

Since Sandy, all of LIPA's existing plans are in question.

The utility's repair costs from the storm are estimated to hit $950 million -- a figure that approaches the cost of a new power plant. LIPA officials hope to receive 100 percent reimbursement from the federal government for Sandy-related damage.

Gov. Andrew M. Cuomo has been outspoken about dissolving the utility, and Moody's Investors Service said it may downgrade LIPA's credit rating.

LIPA might not get the shot at redemption that had the board so enthused one year ago.

"There is a new LIPA on the way," chairman Howard Steinberg said in a news release after the Brattle Group released its report.

Steinberg resigned in November.