Special feature: What direction for rural electrics?

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FOCUS the entire state of North Dakota. “You can drive miles without even seeing a pole or lines out them,” says Williams of the Dakotas, where customer density may be as sparse as one meter per mile. Any increase in costs is a crisis for a utility serving a failing agricultural economy Williams puts it in more concrete terms: “The manager of one South Dakota electric cooperative told me, ‘I’ve done everything I can do to cut costs. We simply need a rate increase. But unless the price of wheat goes up, it won’t work.“’ As for load growth in the Midwest, Williams’ combelt counterparts say they are just as likely to lose members as they are to gain them. etween these two extremes are systems of every stripe and a wide variety of needs. There am, for example, power supply coops like Dairyland Generation and Transmission Cooperative of Lacrosse, Wisconsin. Bill Berg, general manager of Dairyland, admits his coop is one of the “haves.” Dairyland serves 28 distribution coops in four states, and owns the generating capacity to meet its 600 MW load, plus transmission capacity to market any surplus. Load growth in its four-state territory is a slow but steady 1 to 1’/2%annually At one time, the diverse group of nearly loo0 rural electric systems that have borrowed funds from the federal Rural Electrification Administration was held together by a common mission

tivesserving

SPECIALFEATURE:What

Direction for Rural Electrics?

America’sRuralElectricSystemsFace DauntingChallenges,as They Seekto ReinventThemselves andTheirMission

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he road leading into Southem Maryland Electric Cooperative’s territory from the Washington, D.C. beltway is cluttered with signs advertising deluxe housing developments with evocative names like Lakewood Estates, Gallant Green Woods, and Woodhaven Park -hardly the fields of corn and tobacco one expects entering the territory of one of America’s rural electric cooperatives. The John Deere tractor outlet here takes a low profile next to Walmart, McDonald’s, Econolodge, Circuit City and assorted shopping malls and auto dealerships. Southern Maryland (or SMBCO), the fifth largest rural electric cooperative in the country is located only 10 miles south of Washington and provides electricity to 98,000 meters. The consumer-owned utility serves part of a four-county area, bordered on the south and west by the Potomac River and on the east by the Chesapeake Bay. 16

Parts of the territory are, in fact, rural and remote. But SMECO’s healthy 26% growth in sales during the past five years is attributed primarily to the influx of capital city commuters and second home development. A recent survey found that 48% of the customers own personal computers, attesting to their affluence and sophistication. But in sharp contrast to SMECO, rural electric coops in the traditional agricultural areas of the country are dealing with a no-growth economy where the costs of distributing electricity are six times the industry average. “We in Southern Maryland can’t comprehend what it takes to get electricity in the middle of North Dakota or Iowa,” admits Jack Williams. Williams is the former board president of the National Rural Electric Cooperative Association (NRECA) and serves today on the board of SMBCO. SMECO has as many customers as the 25 rural electric coopera-

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TheElectricity Journtzl

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bringing light, convenience and economic development to rural America. When private utilities refused to extend lines to farms and ranches on the fringe of their territory, electric cooperatives filled the void, providing the most dramatic economic boost to rural America in this century But now that 99% of rural America has electricity, the rural electrics’ accomplishment brings with it new challenges and crises. The common sense of mission that once held together a vast network of rural electric cooperatives is under strain - financially and philosophically iversity and the changing character of rural America has divided the ranks. Co-ops in the upper Midwest, dependent on the sagging farm economy, face a declining customer base, rising unit costs and deteriorating infrastructure. Their challenge is survival. In the Southeast, areas once rural in character are becoming suburbanized. Businesses and homes are replacing farms. Load growth is rampant. But financing expansion of these systems within the constraints of the tightening federal purse strings is becoming more difficult. To complicate matters, all across the country, coop members their customers -alebecoming less tolerant of the historically higher retail rates of their suppliers. Now they want more than ownership and service. They want cheap electricity And if their co-ops can’t provide it,

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many in this new breed of members are willing to give up their ownership rights in exchange for lower rates from the neighboring investor-owned or municipal utility In many ways, the rural electries face the same pressures that confront investor-owned utilities. They must learn to adapt to the increased complexity of a freer, more competitive supply market, growing transmission access and rapidly multiplying environmental constraints and costs.

The common sense of mission that once held rural electric cooperatives together is under strain - financially and philosophical& ahead? “I spent my second year as president of the NRECAboard trying to convince people that change was co* that change was inevitable, that we had to cope with change,” says Williams. For every co-op, change means more aggressive cost management to stay competitive with the rest of the industry For some systems this will n?quiregiving up their long-held identity as a community-based service, instead being folded into or taken over by another coop or a private utility What lies

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To others it will mean finding new sources of funding, expanding the customer base through diversification, or enticing members back into the fold with creative capital credits strategies. Pioneers of the rural electric pmgram say it means returning to the roots of the movement: ownership, control and quality of service.

I. Roots of the Movement Rural electrification really got going in 1935, when urbanites were enjoying the first fruits of an electric economy but nine out of ten rural homes were without electricity. Private electric companies had refused to extend service to rural areas, saying that the cost of building a network to serve highly dispersed farms and ranches was unprofitable. To fill the void, farmers and ranchers themselves developed cooperative agreements to build the poles and string the wires. The Roosevelt administration institutionalized the rural electric cooperative movement in 1936 with passage of the National Rural Electrification Act and creation of the federal Rural Electrification Administration. Since that time, REA has provided a means for rural co-ops to obtain below-market funds for construction of distribution lines, which in the 1930s were being built at the extravagant cost of $1500 to $2000 per mile. The number of consumerowned co-ops has now grown from 36 to over a thousand. This unique sector of the utility indus17

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try has built 50% of the distribution line miles in the country covering some 80% of the counties in the United States, Puerto Rico, the Virgin Islands and America Samoa. Yet rural coops serve only 7% of the total electricity needs of Americans and 11% of the consumers. The typical distributioncoop to day operates much as it did 50 years ago. The consumer is also a member and an owner of the system. The members vote for a governing board of directorsand set the coop’s operating guidelines. A board-appointedmanager and staff oversee day-today operations. ln a much more immediate way than stockholders in an investorowned utility coop members have an interest in both the prudent investment of their money and in the type, cost and quality of the service provided. Indeed, consumer ownership has always been the key to rural electric coop eratives’ claim to exceptional, personal service. II. The Member Equity Conundrum “Margins,” the euphemism for profits of a non-profit cooperative, are held in reserve accounts to meet fluctuations in costs, to pay off debt, and to be allocated to members as capital credits, which represent consumer equity. Capital credits can be invested to expand or rebuild the system or returned to members as a cash refund. Finding the balance between building consumer equity in the

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system and refunding capital credits is an increasingly tricky job for coop management. Coops that are considering switching to the private sector for financing need consumer equity to improve their credit worthiness. At the same time, consumers unhappy with the typically higher cost of electricity from the cooperative may need cash refunds to remind them of the benefits of ownership. III. Increasing Rate Pressures Today,the average retail rates of most distribution co-ops remain higher than those of their neighboring utilities. For most of these the rate disparity exceeds 15%. Initially, higher coop rates were driven by the high cost of building the distribution network to sparsely populated areas. With power supply costs for coops as

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c u s high as 70 to 75% of the total operating costs, the main factor in a coop’s higher prices today is the cost of wholesale power. Most distribution co-ops purchase their power under wholesale contracts with generation and transmission (G&T) co-ops, federal power marketing agencies or investor-owned utilities (IOUs). A typical wholesale power contract is an all-requirements agreement, which leaves supply planning in the hands of the supplier. Not surprisingly co-ops did not escape unscathed from the highcost generating construction frenzy of the 1970s; during that period, many G&Ts ended up with investments in very high cost nuclear plants, many of them begun by IOUs that could see the benefit of having coops come in and help them bear the escalating ownership burden.

America’s Rural Electric+A Thumbnail Sketch There are 1000 Rural Electric Co-ops in the US. They: 0 . .

. . . .

Serve over 25 million people Own one-half of the nation’s distribution lines Serve, on average, 5 consurne~s per mile of distribution line (compared to 32 customers per mile by investor-owned utiliies and 41 customers per mile by publiir-owned utilities.) Own 5% of the nation’s generating capacity Make 7% of the nation’s electricity sales by kWh Serve 11% of the nation’s consumers Purchase 23% of their power from investor-owned power companies, 33% from federal power sources and other public agencies, and 44% from G&T co-ops

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Employ more than 57,000 people full-time

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Added new consumers at the rate of 2.8% annually in the late 1980s

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Increased kWh sales at the rate of 2.9% annually during the 1980s

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Immediately on the heels of these investments - and aggravating them -was a general downturn in consumption in the 198Os,which resulted in excess capacity for all plant owners. The new expensive plant, higher fuel costs and reduced consumption reflected in spiralling retail rates and even some bankruptcies. Although coop managers aim to keep retail prices within 15% of neighboring utilities, some have seen their prices increase to 20 or 25% higher. IV The Financing Crunch From the beginning, REAhas helped moderate costs by keeping the cost of financing to a reasonable level. If the inherent cost of service to rural areas was high, at least the cost of financing might be low. Rural electric systems, including G&Ts, may borrow from REA at the federal funds rate to build distribution, transmission, or generation facilities. Since its incep tion in the 193Os,REA continues to be the major source of funds for rural co-ops, though this is changing rapidly At first, loans were made available at or near the cost of federal funds. In 1944, legislation locked in the interest rate of RFA loans at 2%, which was then not far different from the federal funds rate. But as the cost of federal funds rose, so did the effective subsidy to the rural elect-r&s. In 1973, a revolving fund was created to supplement the 2% loan program. Principal and inter-

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est payments on the $7.9 billion in then-outstanding loans was used as seed money for the revolving fund, allowing insured loans at a 5% rate and guaranteed loans at the prevailing market interest rate. REA also could borrow additional capital from the Treasury if demand for loans exceeded the retirement of outstanding loans. The Federal Financing Bank was created within the Treasury for this purpose. FFB guurunteed Zuuns,used primarily by G&T coops, are available at the cost of money to the Treasury plus one-

eighth percent. Fifty-six percent of direct and guaranteed loans have been used for generation plants, 12% for transmission, and 32% for distribution. Since creation of the revolving fund, 5% insured loans have ranged from $83 million in fiscal year 1973 to a peak of $847 million in 1983. Depending on the coop’s financial condition, it may rf+ ceive up to 90% of its credit needs from the 5% insured loan fund. The remaining credit comes from commercial sources, primarily CoBank, which was created in the early ’70s by a consortium of cooperatively-owned financial or-

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or from the National Rural Utilities Cooperative Finance Corporation (CFC), established in 1969 by the rural co-ops themselves. CFC has become the secondary lender for most distribution coops, offering both long- and shortterm loan options by securing commercial paper, mediur&term notes and collateral trust funds for the private sector. Because of its favorable credit rating and equity funds from member coops, CFC is able to develop a portfolio of loan options at rates that are higher than the federal funds rate but generally lower than an individual co-op would be offered on its own FC works closely with REA c by necessity, since most CFC loans are concurrent with RRA loans and require a shared collateral agreement. CRC’s CEO, Chuck Gill, says that although CFC is the private sector alternative to RRA, “we aren’t trying to replace REA. Our job is to get in expensive money for coops and ifREAisthebestwaytodothatfine.” Gillbeganhis career with REA in 1961, before joining the staff at CFC in 1972. Low-cost federal funds have been a two-edged sword for co ops. Obviously, the below-market rate dollars have helped keep electric rates lower than they otherwise would have been Access to REA funds also turned out to be useful leverage to the coop movement in negotiating reasonable power contracts. The threat of coops building their own power

ganizations,

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supply with the help of federal financing sometimes dramatically decreased the wholesale cost of electricity offered by adjacent IOUs, which after all were often competitors of the coop, if only by example. But REA money hasn’t always flowed smoothly from one hand to the other. By 1990, the backlog of REA loan requests had reached $800 milIion. New borrowers found that they might have to wait as long as two years before receiving money Also, pressure mounted during the Reagan administration to wipe out REA loans altogether. eading the charge was President Reagan’s OMB director, Jim Miller, who argued that REA’s mission has been accomplished and that the cost of continued subsidies was excessive and unwarranted. On top of the subsidy issue, the deficit watchdogs were counting up the cost of loan defaults and bankruptcies, which by 1990 had mounted to $950 million. Jim Huff, REA’s most recent administrator, was appointed by President Bush in June 1992. Huff eased some of the tension over financing that existed between REA and the coops. He sees REA as a vital tool for rural coops. “If we ran just like a bank,” says Huff, “we wouldn’t be much help to some rural co-ops. We have to be both a bank and an agency that understands rural America.” But Huff sees changes coming in REAfunding. He predicts that guaranteed loans will take the place of most insured loans in the

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future,which will raise the cost of financing for many rural co-ops and reduce whatever subsidy may still exist in that program, given today’s prevailing low interest rates. while it may have originated in a Republican administration (which usually have been less sympathetic than Democratic ones to co-op financing needs) is likely to become a feature of the Clinton administration’s policy as well, judging from the latest budget proposal and the president’s televised economic address in late January But even with the Reagan push to eliminate REA having fallen short, many co-op managers - especially with the larger, fastergrowing systems - see the future role of REA financing as being limited, and they are concerned about it. Even the downsizing of REA may have immediate consequences for fast-growing coops like Southern Maryland Electric Cooperative. When REA funding dries up, large coops on the fringes of urban areas have to find other sources to meet their immediate and significant capital needs.

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Small co-ops don’t need large loans as urgently but the shrinkage in or elimination of REA funds may prove more damaging to them in the long run. With their slow growth and higher retail rates, they am inherently less capable of attracting private capital to replace lower-cost REA loans, should that be necessary Those that can qualify will have more difficulty than large coops in absorbing the higher interest

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ut regardless of the increased costs in financing, some co-ops am getting ready to bail out of the REA financing program. In November 1992, Congress passed legislation to allow coops to prepay their REA loans without penalty, as long as they don’t come back to the trough for the next 10 years. Cap Rock Electric Cooperative in Texas was among 26 coops that took advantage of a similar prepa ,, ent opportunity P in 1987. Steve Collier, regulatory affairs director for Cap Rock, says the payoff freed Cap Rock from the “federal red tape and delays” it =

What Consumers Think

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1992 suwey of a cross-section of American adults conducted for NRECA by the Roper Organization revealed that a signifmnt number of consumers incorrectly identified the type of electric utilii serving them and 24% had no idea what type of company provided their electricii. Although co-ops received a high rating for consumer satisfaction, the perception that co-ops provide fair and reliable setvice has declined signifkantiy since a similar survey in 1968.

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suffered in dealing with REA and saved the co-op $11 million dollars through REA’s prepayment discount. Unfortunately, says Collier, the prior window of opportunity was fraught with uncertainty over the tax treatment of the payoff, causing coops that might have taken advantage of the deal to back off. Dairyland G&T is looking at the advantages of prepayment now. ‘We want to be prepared to get out if it’s necessaq which means we have to look good to Wall Street,” says Dairyland manager Berg. SMECO board members and manager Wayne Swann already have taken the first steps toward cutting their ties with REA. fter a recent trip to New York to talk to GoldmanSachs and Moody’s Investors Service, Swann feels confident that SMECO could receive an A or AA rating without any changes in its current operations. He expects the board to approve the $25,000 to $50,000 cost of securing a credit rating so the co-op will be ready to approach investment bankers should the need arise. Standard and Poor’s currently rates only a handful of rural coops -sixteen -but generally these have fared better than the median rating for private utilities. S&F’s kinder treatment of most co;ops is attributable to lack of heavy regulatory oversight. Coops and private utilities that are subject to state regulatory authority over rates are viewed as having less operating flexibility and therefore lower credit worthiness,

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according to an S&l? “Special Report” on rural co-ops published in June 1991. Rating agencies are, however, more concerned about other factors that affect co-ops -the same factors that keep coop managers on the edge of their seats: a declining rural economy territorial integrity, and above all, competitiveness and retail rates. Unless a co-op manager is confident that these issues are not going to be negative baggage, it won’t be worth the high fees associated with securing a credit rating.

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NRECA’s executive vice president Bob Bergland admits that, after years of trying to protect REA funding from budget slashing “more and more money is going to come from the private sector.” But that doesn’t mean NRECA is going to give up its efforts to pl’eserve subsidized REA loans. “REA serves as a fire insurance company You may not need it today, but you’re not about to cut the lifeline. That’s like canceling the fire insurance because you haven’t had a fire,” says Bergland. Chuck Gill says CFC would have no problems meeting the needs of the distribution co-ops if

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REA funds dry up. CFC currently provides about 30% of total direct long-term loans to distribution coops, but Gill predicts CFC will become the primary lender for coops in the future. “If G&Ts start building the way they were in the ‘SOS,that’s a different scenario,ll says Gill. “But I don’t think they will. Future construction is going to be in smaller increments.” L biggest challenge over the next 10 years will be trying to keep all louo coops together,” says Gill. “If SMECO and the other larger coops choose to go to the private sector on their own and we’re left with the financing needs of only the small coops, we won’t be able to do the best job in securing lowcost rates. We need to convince all the co-ops it is better to remain with us in the long run rather than jumping back and forth based on who has the best rates at any particular time.” To meet the challenge, Gill says CFC will have to offer a full range of financing options that are relevant to alI different sized coops short-term lines of credit, variable rates, loans for diversification ventures, as well as the traditional long-term fixed loans and guaranteed loans. . CFC already has one competitive advantage over investment banks: “value-added services.” CFC offers an educational fund to member coops to promote the concept of cooperative ownership; it provides regulatory assistance and administers the Integrity Fund, financial assistance to

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co-ops that face threats of takeover or annexation CFC’s effective interest rates are also lower than the nominal rates because participating members receive capital credit refunds out of the operating margins on a 6-year rotation. In fiscal year ‘92, CFC retired $31.4 million in capital credits to its members based on their interest paid on outstanding loans. Gill thinks the impact of higher interest rates on coops is minimal, with or without REA. “A 2% change in load factor is better than cheap money” for most coops, says Gill. “Interest is a small part of their total cost - only about four and a half cents out of every dollar Even doubling interest rates over time may not be that significant.” And he sees a silver lining in decreased relianceon REA. ‘The presence of REAallows us the luxury of thinking that perhaps we are insulatedfrom the market forces we need to react to,” says Gill. V. Diversity and Disaffection The major problems facing NRECA and rural co-ops across the country go beyond the scaling

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back of federally subsidized loans or the cost pressures of the 30s. The more ominous threat to the rural electrification system is its growing diversity and disaffection splintering, many could say NRECA can no longer speak for the “average” cooperative in rural America because the average coop is too unrepresentative of the species, and because the average co-op is not the one with the most pressing needs, The co-ops facing the biggest challenges are at opposite ends of the spectrum, and their problems ate dissimilar. The increasing divergence between the large, fast-growing coop and the small, declining agriculturalbased coop is making NRECA, their trade association, schizophrenic. Understandably, it is leading to resentment between the two extremes over how resources are being divided. Another rift has developed be tween the distribution and G&T coops. “G&Ts have a different perspective from the rest of the industry,” says Bob Thornton, CEO for Northeast Oklahoma Electric Coop. ‘Their customers are coops, not the little old lady who

How CFC Stacks Up l

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CFC’stotalloansoutstandingin FY 92: $5,X0,666. CFCk cmdii ratingfor collateraltrustbondsand medium-termnotes: AA- and A+ In FY ‘92,47% of CFC loan dollarswent to G&Tsand 46% to distributionmops. Todaysmarket: CFC’s7-year loan rate is 7.126% comparedto 7-year TreasuryBondrate of about5.6%

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can’t pay her biu - the person that comes through my door every day They are not as sensitive to cost control as we have to be.” But the most damaging disaffection may be the one that is undercutting the loyalty of the members of the distribution coop. “Old members were part of the movement,” says Thornton, “But new membership has no kinship with you. The new generation wants to know, What are you going to do for me tomorrow?“’ Without the defining mission of the movement, coop members are becoming more concerned about the bottom line - the price of electricity hen co-op members are no longer enamored with the fact of consumer ownership and community-based control in the face of higher prices, price competition with neighboring utilities becomes a much more serious threat. “The conventional wisdom among co-ops is that you can overcome a 20% differential in price with impeccable service,” says Steve Collier of Cap Rock Electric Co-op. “But beyond that, something is going to break.” When prices get too far out of line, co-op managers may find little resistance from members/consumers to takeovers by IOUs or annexations by municipal utilities. In some cases, members or . the board of directors may initiate such a sellout themselves. As a case in point, Collier cites Bossier Rural Electric Manage ment Cooperative in Louisiana,

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where the board sought and is considering a buyout offer from Southwestern Electric Power Company (SWEPCO). Bossier’s board president, Donny Hood, and its manager, Joe Caplis, who promoted the idea in 1991, argued that the sellout could lower the coop’s rates by 40%. Bossier is bound by an all-requirements contract with Cajun G&T, which is heavily invested in excess power and was pushed close to bankruptcy in 1990. At the announcement of negotiations, Bossier’s manager said the co-op’s residential rates were running about $.03 per kWH higher than SWEPCo’s. “There’s no way to compete with SWEPCO’s rates,” Caplis was quoted as saying. Negotiations are still in progress. here have been other sellouts to IOUs where members have taken matters into their own hands. In January of this year, after a massive storm-related outage resulted in up to 10 days’ loss of power for the members of United Electric Cooperative in DuBois, Pennsylvania, the members organized and announced plans to petition for a recall of the board of directors. Already frustrated by a severe rate differential with the neighboring investorowned utility the members are calling for a new board of directors dedicated to selling the co-op to Pennsylvania Electric Co. Members of Northern Electric Coop Association in Virginia,Minne sota are responding to a substantial rate dift&ntial with a neighboring IOU (36% for customers using loo0

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kWh per month, for example) with a similar approach. In February members petitioned the board to reconsider its earlier rejection of a buyout offer from Minnesota Power and Light VI. The Takeover Threat Dick Pence, special programs administrator for NRECA, heads a team of lawyers, management consultants and public relations experts that is ready to provide advice and assistance in both unwanted takeovers or sellouts driven by member dissatisfaction, which Pence describes with irony

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as “severe outbreaks of democracy.” Pence says there are basitally two factors leading to a private utility’s interest in a rural electric coop: rapid growth in the co-op’s territory or the potential for growth later. As SWEPCO observed in the pending negotiations to take over Bossier, even though the private utility would have to absorb some losses in the short term, the company’s interest is based on the strong potential for economic development in Bossier’s territory Private utilities didn’t show much interest in rural coops dur-

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ing the 1970s or before. Utility managers everywhere were preoccupied with construction programs and had little or no surplus cash with which to expand. But as new plants came on line (or were cancelled) and utilities became cash-rich again, they started eyeing co-ops as possible growth investment opportunities and as a way to shelter otherwise taxable dollars. of the most high profile takeovers came in 1986. Pacific Power and Light Company of Portland, Oregon targeted two Wyoming rural electric coops for takeover. The members of one coop, Shoshone River Electric Co-op in Cody, supported the sell-out, but T&State G&T, which supplied Shoshone under an all-requirements contract, challenged the takeover in court. The case ended in settlement. PP&L held on to Shoshone but had to compensate T&State for lost revenues under its all-require ments contract. The message from the U.S. Justice Department overseeing the settlement set a new tone for future takeovers: “The agreement reached in this decision . . . should serve as a warning to investor-owned utilities and others. The United States will take whatever steps necessary to protect the security that ensures repayment of the billions of taxpayer dollars supporting the rural electrification program.” The results convinced PP&L to abandon further pursuit of the

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From Rural Electrics, page 23

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thinks the more insidious prob-

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A federal district court judge in

lem is municipal annexation of ru-

Louisiana has ruled that the Rural

second co-op, Garland Light and

ral co-op territory, which he says

Electrification Administration

Power Company in Powell, Wyo-

threatens to “nibble co-ops to

can, pursuant to the Rural Electri-

ming.

death rather than crunch them all

fication Act and the supremacy

at once.” Since 1985, rural electric

clause of the U.S. Constitution,

A Chilling Effect

systems have lost nearly $8 mil-

prevent a municipality from an-

lion annually in revenues because

nexing territory now served by an

had a chilling effect on sub-

of annexation, and NRECA pro-

REA borrower.

sequent takeovers in other parts

jects additional losses of $26 mil-

of the country

lion through 1995. And munici-

Pence thinks the IT&L case has

It also served as a

trigger for NRECA to take a more

pal annexations may be more

acti1.e role. After the W&L take-

difficult to fight, since the will of

over, NRECA and CFC estab-

An REA Veto? The decision in City @Morgan

City v. South Louisiana Electric Cooperative Association, handed

lished the Integrity Fund. On a

down by Judge Rebecca Doherty

voluntary basis, co-ops may desig-

on February 23, rejected the argu-

nate a portion of their capital cred-

ments of a formidable set of mu-

its annually to the fund. Co-ops

nicipal intervenors -

can request money to help pay for

the National League of Cities, Na-

engineering, legal or public rela-

tional Institute of Municipal Law

tions support in the event of an

Officers and the American Public

unwanted takeover attempt.

Power Association -

including

that REA

may not exercise veto power over

Even uninvited takeovers can be successful if the membership

a municipality’s right to condemn

can be persuaded of the benefits

REA-financed property in areas

of lower prices over ownership.

annexed into city limits. The central issue in the case,

So the task of the NRECA team is

said Judge Doherty, is whether

much “like a political campaign to get someone elected. You have

the members may be secondary to

section 907 of the Rural Electrifica-

to convince members to vote it

state law sanctioning them. Al-

tion Act empowers the REA ad-

down,” says Pence. Where there

though NRECA is aggressively

ministrator to preempt a city’s

are high retail rates and member

pursuing legislative protection

power of expropriation.

disaffection with community-

against annexation in states like

held that state law is preempted

based ownership there are serious

Minnesota, Illinois and Louisiana,

by federal law even if there is no

Doherty

Pence says it’s a frustrating battle.

express preemptive language,

But note that the co-ops may have

and even if the area preempted is

overs is that out of 70 takeover at-

won a big victory with a recent

traditionally regulated by states,

tempts since 1945, only 14-20%

U.S. District Court decision in

“if their operational effect is to

have been successful.

Louisiana, whem the supremacy

‘disturb’ or ‘interfere with’ a fed-

198Os, when hostile takeover activ-

clause of the U.S. Constitution

eral program or activity regulated

ity increased dramatically, only

was invoked to permit REA to

by federal statute.”

two of 11 attempts were success-

overcome a municipal utility’s at-

ful.

tempt to annex an REA bor-

that the federal court decision in

rower’s territory against the fed-

Louisiana was especially disap-

eral agencfs

pointing to public power interests

threats to winning that campaign. Perhaps the bottom line on take-

In the

While IOU takeover attempts are expected to persist, Pence May 1993

objection.

APPA’s Alan Richardson noted

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in light of a recent Minnesota

it’s going to get increasingly

and Maintenance, Administrative

state court decision that REA may

harder to make a statement as a

and General, and Consumer Ac-

protect the financial interest of the

group. There’s too much friction

counts twice that of the largest

federal government in any volun-

between the co-ops in their goals.”

tary disposition of REA-financed

systems. The increase in these expenses is continuing to increase as

Collier is not convinced that

the system size decreases.

property but not in the case of an

high rates and member dissatis-

involuntary disposition, such as

faction can be overcome with pub-

Consolidation could have dra-

under a municipal condemnation.

Boiling Waters e territorial waters will con-

lic relations campaigns. A self-de-

matic benefits for the smallest co-

scribed “voice in the wilderness,”

ops, coops like those that merged

Collier spends part of his time

to form Iowa Lakes Electric Coop-

training coop executives and con-

erative.

T” tinue to boil, however, The

sulting with individual coopera-

federal government has appealed the Minnesota decision to the

tives on the virtues of a more aggressive business strategy. And

The Merger Option n 1984, Iowa was in the midst of

state court of appeals and it is

I a major farm crisis. The co-ops

likely that Morgan City will seek

in the most rural areas of Iowa

review of the Louisiana decision

served 2.5 customers per mile of

by the U.S. Circuit Court of Appeals. In general, co-ops have less protection against territorial piracy than private or municipal utilities. Co-ops serve less well-defined rural areas that often did not receive official regulatory recognition.

As

‘The little guys that are not viable will go away Co-ops have to stop operating like a costplus industy ” -Sew

long as the co-op is slow-growing

collie

distribution line (compared to an average of five consumers for coops in other parts of the country and 40 consumers per mile for the typical IOU). As the number of farms continued to diminish across the rural midwest, the Iowa coops knew cost-cutting measures were essential. Three distribution coop boards

or competitively priced, territorial

in Iowa -

raids are less of a threat. But mu-

Buena Vista (3,600

nicipal and private utilities are

he doesn’t mince words. “The lit-

members), Pocahontas (2,600),

likely to fight legislative protec-

tle guys that are not viable will go

and DEK (3,600) -

sat down to

tion if they consider co-ops to be

away Co-ops have to stop operat-

discuss the possibility of a merger.

lucrative expansion prospects.

ing like a cost-plus industry”

Bruce Bosworth, then general

At the top of his list of remedies

manager for DEK Electric Coop-

are mergers and consolidations of

erative, recalls that the initial ef-

coops to achieve a critical mass

fort faltered at first over staffing is-

that will give them more control

sues.Though it sounds trivial,

over their costs. USDA’s 1991 Statistical Report

staffing changes can have a major economic impact in rural areas

on Rural Electric Borrowers presents some very convincing num-

where the co-op is the primary

ests and membership disaffection, this may not be realistic.

bers to support the cost savings of

worth.

VII. Mergers & Consolidations NRECA keeps looking for a common theme to pull the nation’s rural cooperative network together, but with diverging inter-

“We can’t speak with one voice

larger size:

non-farm employer, says BosOne year later, however, the

anymore,” says the Cap Rock Co-

The smallest systems, in terms

merger idea was raised again, this

op’s Steve Collier. “We’re going to

of consumers served, had per con-

time involving the whole board at

see continued segregation, and

sumer expenses for Operations

each coop.

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Bosworth says the de-

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Electric Cooperative is a prime ex-

raised retail rates one percent, but

plan and how it would be pre-

ample of a larger co-op that has

we identified savings over the

sented to the membership were

used mergers as a strategy not to

next five years, some of which

made almost overnight.

cut costs, but to enhance its mar-

have already materialized.”

cisions on headquarters, game-

ket position. Cap Rock serves an

The message to the member-

Collier says cost savings are

ship was simple, says Bosworth:

area in west Texas that has a

only a minor reason to promote

“We’re going to do the same thing

strong agricultural base of cotton

mergers. Mergers are more valu-

we’ve been doing, but we’re go-

farming and ginning, with ap-

able as a marketing strategy

ing to cut the work force by 20%.

proximately five customers to

Larger co-ops can provide better

We need to remain competitive.”

every mile of distribution line.

service, take advantage of an un-

The consolidation was over-

Unlike most rural co-ops, how-

dervalued asset, gain a strategic

whelmingly approved, creating

ever, industrial and commercial

advantage through transmission

Iowa Lakes Electric Cooperative.

customers make up 65% of Cap

acquisition, or simply get rid of a

Rock’s load.

competitor.

Sharing Merger Benefits

Market Synergies

n 1985, Cherokee Rural Electric

I Cooperative approached Iowa Lakes about another merger.

A

nearby IOU was nipping at the heels of Cherokee because their rates were high. “We could help them more than they could help us, but there were some mutual benefits,” says Bosworth. “Seven years later, Iowa Lakes has reduced its costs by almost

F

or instance, the consolidation

Cost savings are on/y a minor reason to promote mergers. Mergers are more valuable as a marketing strategy

with Hunt-Collin gave Cap

Rock some market diversity combining their existing industrial and commercial load with a new urban residential market. Collier also attributes the consolidation with Cap Rock’s successful negotiation of a lower-cost supply contract with Texas Utilities Electric

twice what we projected, “says

Company (TUEC) for the Hunt-

Bosworth, “with savings of $4.8

Collin territory

million. We also got indirect sav-

[Hunt-Collin] would have done it

In 1990, Cap Rock first merged

“I don’t think

on their own,” says Collier.

ings from improvement in staff.

with Lone Wolf Electric Coopera-

Now we have an engineer, a direc-

tive, a contiguous co-op to the

tor of finance with a CPA, an eco-

northwest. The second merger

without complications.

nomic development specialist and

came in 1991 with Hunt-Co&n

asked the state Commission to

a legislative liaison.” The experi-

Electric Cooperative, located

deny the merger on the grounds

ence of Iowa Lakes has made Bos-

across the state on the outskirts of

that Cap Rock didn’t have the

worth a strong advocate of merg-

the Dallas/Fort Worth metropoli-

supply options to support Hunt-

ers for other coops. He argues that instead of the 47 distribution

tan region. Both co-ops ap-

Collin. Using what Collier de-

proached Cap Rock with the idea

scribes as “typical monopoly tac-

co-ops and three G&Ts in Iowa,

and both were only 10% of its

tics,” TUEC refused to wheel any

consumers would be better

size.

power through its territory to

served with 9 or 10 distribution co-ops and one G&T. Mergers are not just for small co-

“In the short term, it cost us

TUEC

Hunt-Co&n and refused to serve

money,” says Collier. “It’s like re-

it directly except under its own

financing. You need to pay up

terms

ops and not just for cost savings,

front for savings in the future.

according to Collier. Cap Rock

The initial impact may have

May 2993

The Cap Rock mergers were not

Although the merger was eventually consummated,

Collier 83

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sive marketing strategy can re-

ices and employees,” says Collier. “The co-ops should keep their

receive power through all-requirements contracts with its distribu-

quire this type of messy battle,

names and board members. If you

tion coop buyers with G&T co-

points out that taking an aggres-

end up with 22 board members, it

ops or investor-owned utilities.

won’t take long before the board

In fact, all-requirements contracts

Boudreaux agrees with Collier

itself realizes they can’t operate a

are now a condition imposed by

that the benefits of consolidation

business efficiently that way”

REA on any G&T receiving fed-

and most co-ops aren’t up for it. NRECA strategic planner Greg

go beyond dollars, but for differ-

“Besides,” he argues, “from

eral loan guarantees to build new generation.

ent reasons. “Improvements in

every dollar a distribution coop

staffing can allow a co-op to be-

collects, 60 to 70 cents goes for

come more involved in commu-

power supply, 20 cents for O&M

nity development activities,

and interest on the debt. So even

face few supply options if they

achieve greater levels of specialization and deal with new issues,”

if a manager fires all the employ-

lack direct transmission access to

ees, the coop saves only 5%. To

lower-cost suppliers. The typical

E

ven coops not bound by all-

requirements contracts may

have a major impact on costs, the

rural electric coop owns only the

he limited number of merg-

distribution co-ops need to make

transmission network within its

ers or consolidations over re-

themselves better businesses, and

territory and is frequently sur-

cent years indicates that mergers

they need to gain more leverage

rounded on all sides by investor-

are not easy to accomplish.

in negotiating supply costs.”

owned or municipal-owned

says Boudreaux.

T

Even

the staunchest proponents of consolidation admit that there is a lot of resistance. Identity and ownership are the cornerstone of co-ops, and mergers threaten that. “The dilemma in most cases stems from directors who don’t want to jeopardize their control,” says Bosworth, of Iowa Lakes. Gary Williamson, general manager of Central Power, a transmission and

trans-

mission facilities. Without the

VIII. Comgetitive Power SUPPlY

cooperation of the transmission

Gaining control over supply costs may be one of the toughest challenges facing rural electric cooperatives in the next ten years. Aggressive management of supply costs is not a familiar role for distribution coop managers and boards. Most distribution co-ops

owners, most of whom have a financial interest in supplying the coop directly, lower-cost supply remains inaccessible. Cap Rock Electric Cooperative faces both the constraints of an allrequirements contract and transmission isolation. Cap Rock receives all its power from TUEC

wholesale supply coop in North Dakota, pinpoints another prob-

What’s a ‘G&T’

lem. “Most mergers are painful in rural co-ops because it means loss of jobs. Co-ops contribute significantly through wages to the job

G&Tcoop is organized by member distribution co-ops to provide transmission

Aa

ndlor supply servfces. The G&Tmay build its own generation and transmission

base in the community” Collier recognizes the potential

or procure it from IOUsor federally owned power projects such as WA’s hydro-electric system. Rural coops enjoy the right of first refusal of power from low-cost federal

obstacles and recommends that

power projects under a public doctrine known as the preference clause, which has

co-ops that are considering merg-

proved an invaluable competitive advantage for some coops.

Faced with waning

ers do it without undercutting the

loyalty of distribution coops to the rising supply costs of the ’80s REA now requires

individual co-op’s identities and

that G&Ts have an all-requirements contract for the sale of power from a federally fi-

without pressing for a reduction

nanced power plant.

in staff and services. “No one will support it if it means cutting serv-

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and is surrounded by the utility’s

high-risk strategies, drastic re-

its only remaining generating

transmission network. Two years

structuring of the cooperative net-

plant. Every three years SMECO

ago, Cap Rock gave TUEC notice

work, and alienation between co-

renegotiates its rates with PEPCO,

that it planned to transfer some or

ops with different goals and

but the coop is locked into the all-

all of its power supply needs to

agendas.

requirements arrangement for lO-

lower cost Western Texas Utilities. TUEC took the case to court

Cobb is the fourth largest rural coop in the country with 107,000

year windows to facilitate PEPCO’s long-term planning.

and won, at least on the issue of

consumers and a growth rate of

timing, arguing that Cap Rock

4% in 1992. Cobb receives its

ager, says he is quite satisfied with

must give longer notice under the

power from Oglethorpe G&T,

the current wholesale costs of 4.4

terms of the most-recently negoti-

along with 38 other much smaller

cents per kWh and the congenial

ated all-requirements

rural cooperatives in Georgia.

relationship the co-op has devel-

contract.

TUEC also threatens to use its

Although Cobb EMC provides

Wayne Swarm, SMECO’s man-

oped with the utility Swarm

transmission control to prevent

the bulk of Oglethorpe’s reve-

points to a recent joint venture

the co-op from wheeling power

nues, it has only one vote when it

with PEPCO to illustrate their

from cheaper sources.

unique partnership.

B

ut there may be new hope

for transmission-locked

In 1989, the

coop built a combustion turbine

ru-

and then leased it backed to

ral co-ops in the 1992 National En-

PEPCO under a shared savings ar-

ergy Policy Act. “With the Na-

rangement.

The turbine became

tional Energy Policy Act we

part of PEPCO’s dispatchable sup-

finally have a slam dunk chance

ply and was integrated into the re-

to force wheeling,” says Collier,

gional power pool. Swarm esti-

whose co-op decided to challenge

mates the arrangement is saving

TUEC’s wheeling policies under

SMECO about $700,000 a year

the Energy Policy Act provisions

and is providing PEPCO with

that allow the FERC to order

new capacity built at less than its

wheeling to promote wholesale

comes to setting policy for the

competition or remedy discrimi-

G&T. The smaller co-ops main-

natory practices.

tain a voting plurality and can

For many cooperatives, getting control over supply costs may prove even more rocky Without

own cost of money

W

hen asked if the co-op was concerned about PEPCO

control supply decisions and pric-

taking a more aggressive interest

ing creating a triangle of tensions.

in the lucrative SMECO territory,

“I’m not advocating that Cobb

Swarm admits that expansion by

a provision in the contract allow-

break its contract,” says Collier,

acquisition probably has crossed

ing a co-op to escape its all-re-

‘but in some cases, that seems to

PEPCO’s corporate mind. “I’m

quirements commitment over

be the only option.” Breaking tra-

sure they’d love to have our terri-

time, a co-op’s only option may

ditional supply relationships is

tory, but now they’re getting $100

be to threaten to break the con-

drastic medicine and not every co-

million a year in power supply

tract, thus risking a court battle

op is unhappy with its supply ar-

costs from us.”

and possibly bankruptcy

rangements.

Collier uses Cobb EMC to illus-

Southern Maryland Electric Co-

SMECO stays on top of its competition despite the “neighborly”

trate his point that regaining con-

operative has been an all-require-

relationship.

trol over supply costs -

jority of SMECO consumers mov-

jor component of a cooperative’s

ments customer of Potomac Electric Power Company (PEPCO)

rates -

since 1953, when SMECO closed

moving out of PEPCO’s service

the ma-

may require aggressive

May 2993

Swann says the ma-

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very important to us, so we do

a completely unrelated business

NRECA’s Bob Bergland says diversification is “very much a com-

monthly rate comparisons.

that helps balance out the market

ing thing,” but his sights are on

yearly basis our residential rates

fluctuations, is the most challeng-

community services like garbage

On a

Business diversification, buying

are a little higher than PEPCO’s -

ing concept for rural electric coop-

collection, fire protection, cable

about eight to ten percent higher.”

eratives, but may offer the great-

m, water and sewer. Bergland

Like Collier, Swarm says, “Service

est benefits. Cap Rock Electric

sees this type of product diversifi-

makes up some of the difference,

Coop is pursuing diversification

cation as a natural complement to

but you can only go so far.”

into the competing market of

the cooperative’s traditional role

natural gas.

to aid rural economic develop-

IX. Diversifying Services The majority of coops lack the

“It makes a lot of sense if natu-

ment. “Rural residents have been

ral gas is going to be the fuel of

excluded from privileges that are

interest or the will to tackle dras-

the future,” says Collier. “The co-

taken for granted within city lim-

tic changes in supply arrange-

op manager needs to get light and

its. Co-ops come under heavy

ments. For these, Collier still has

heat to customers at the least cost,

pressure to take up the slack as

some advice for survival in the

so natural gas may be the best

part of their mission.”

’90s: “Co-ops need to embrace

Though less daring than Collier,

competitive opportunities by di-

Northeast Oklahoma manager

versifying and capturing a larger

Bob Thornton is another advocate

customer base.” Collier identifies three kinds of diversification:

product diversifi-

cation, market diversification and business diversification.

Product

diversification, simply expanding into related products or services like cellular phones, demand-side

The majority of co-ops lack the interest or the will to tackle drastic changes in supply arrangements.

management and cable m, is al-

of diversification.

“We should

have created service co-ops, not electric and telephone coops, in the early ’30s and ‘~OS,”he says. “The type of service could vary across the country depending on what people wanted -

water dis-

tricts, security systems, whatever.” X. Where Is the Future?

ready an accepted marketing strat-

The next decade for rural elec-

egy among distribution coopera-

fuel in some cases. Or I might

tives. As Collier sees it, product

want to get in natural gas as a

tric cooperatives will undoubt-

diversification can make the pri-

hedge to reduce my costs in sell-

edly require change, as President

mary product -

ing electricity or to take advan-

Clinton’s economic message sig-

more valuable to the consumers

tage of new markets like natural

nalled, but some of the forces of

because it comes with additional

gas vehicles.”

change are only beginning to

electricity -

services the competition may not

Business diversification isn’t for

emerge now: more flexible trans-

offer.

everyone, admits Collier. “Most

mission access, more competition

Market diversification, according to Collier, means finding new

co-ops are niche boutiques that

in power supply, and broadening

are used to operating as a cost-

environmental regulations cover-

markets that have strategic advan-

plus business with no competi-

ing everything from electromag-

tages like improving the co-op’s

tion. Managers and boards are

netic fields to carbon emissions

load factor. It may require draw-

not prepared to buy competitive

from power plant smokestacks.

ing in new businesses to the terri-

businesses.

tory or consolidating with an-

pariah among co-ops. Welre not

viate the disadvantages of the

other seller.

like the little co-ops.”

“have-not” co-ops. Deregulation

86

Cap Rock is sort of a

Some of the changes could alle-

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SMECO, for instance, recently

of supply and open transmission

been staying on top of this on-

access could mean more flexibility

slaught of new problems and pos-

voted to change its capital credits

in power supply helping co-ops

sibilities. He describes his basic

policy to allow refunds to new

fight their historic cost disadvan-

message to rural co-ops this way:

members that traditionally had to

tages. Transmission access also

“We live in a chaotic world that is

wait five years to capture the fi-

could be a lifesaver for some

redefining the industry, and you

nancial benefits of ownership.

transmission-locked

need to respond.”

The hope is that this strategy will

co-ops with

But Boudreaux doesn’t believe

serve as a reminder of the unique

mission may exacerbate the threat

draconian measures are needed to

advantages of cooperative mem-

to co-ops’ territorial integrity, by

ensure that co-ops maintain their

bership and counterbalance its

allowing other utilities and even

unique place in the industry

price differential with PEPCO.

independent power firms better

argues that co-ops need to return

access to high growth areas.

to their roots: “Boards ought not

excess capacity

1

T

But open trans-

He

S

MECo’s manager also

he 1990 Clean Air Act

to manage [just] on the bottom

thinks coops need to place more emphasis on reliability -

Amendments will mean

line, but make the co-op recog-

getting customers back on line im-

nized as a unique quality service

mediately after an outage, reduc-

even higher costs for many co-’ ops, but managers believe the

ing the aggravation of momen-

new regulations will not exacer-

tary power interruptions common

bate the cost differences with

in rural areas, and improving the

other coal-based utilities. G&Ts own 6% of the coal-based generating capacity in the country but most is newer capacity that was built to cleaner standards. Dairyland G&T’s manager Bill Berg thinks his co-op will weather the Clean Air Act well for a utility that is heavily invested in coal

“We should have created service co-ops, nof elecfric and telephone co-ops, in the early 30s and ’40s.” --Ebb Thornton, N.E.Okkhma HeciticCo-q

high voltage network for back-up reliability. Bob Thornton, manager for Northeast Oklahoma Electric Coop, agrees that reliability and member responsiveness are critical. “We claim price is the root of our problem, but I don’t think so. We need to satisfy the needs of

power plants. Because Wisconsin

the people. We need to build a

was ahead of the Clean Air Act in

reputation for excellent and per-

tightening emission standards,

that will compensate for higher

Berg says they have already be-

rates. The coop should be seen

gun phasing in costly changes

by the members as a valued com-

human nature to want to take con-

that will hit other utilities in the

munity partner.”

trol is stronger than the obsession

next few years. But he is still concerned about

Boudreaux acknowledges that

sonal service.” If he’s right and the tendency in

with the bottom line, then the

this could be particularly challeng-

same force that is an obstacle to

what might be coming down the

ing with the new breed of mem-

consolidation -

pike. “A carbon tax would hit us

bership. “New, seasonal and ur-

tity and ownership -

harder than most utilities. And

banite members may require

key for many rural co-ops to re-

heavy metals, even though it’s a

special effort to educate them.

main viable participants in their

minute problem with coal plants,

But one way to meet their con-

communities’ growth.

would require us to install scrub-

cerns about the bottom line is

bers,” he says.

with innovative distribution of

As a strategic planner for NRECA, Greg Boudreaux has

May 2993

-

a sense of idenmay be the

n

Catherine A. Morris

capital credits to emphasize benefits of ownership.”

87