Mayor Nutter Delivers Testimony To The Pennsylvania Public Utility Commission

Philadelphia, November 14, 2014–  Mayor Michael A. Nutter delivered testimony to the Pennsylvania Public Utility Commission during its hearing on the future of Philadelphia Gas Works (PGW).

The prepared text of Mayor Nutter’s testimony is as follows, please check against delivery:

“Mr. Chairman and Commissioners, I thank you, on behalf of The City of Philadelphia and its Gas Works, for giving me the opportunity to testify today.  Thank you also for the care the Commission has taken with PGW and the City since PGW first came under your jurisdiction in July of 2000.  We share your commitment to safe and high-quality gas distribution service at affordable rates, and your safeguarding of the interests of all customers including those who cannot afford to pay standard rates.  We know that it has sometimes been difficult for you to apply laws and regulations when PGW’s status as a “city natural gas distribution operation” – owned by the City – requires you to treat us differently from other utilities in the Commonwealth.  We appreciate your diligence and fairness, both in the past and in the future.

As you know, the City has entered into an agreement with UIL Holdings Corporation and one of its subsidiaries to sell substantially all of PGW.  (In my testimony, I’m going to refer to both the parent and the buyer together as “UIL” except where it seems important to differentiate them; and I’m going to call the sale the “Transaction.”)  The City and UIL are working with numerous civic leaders, institutions and unions to persuade City Council to introduce an authorizing ordinance and to hold hearings on the Transaction, because we are confident that both Council and the public will come to understand that this Transaction is the best long-term option for PGW and its customers and employees, as well as for the City and region.  What I would like to do in this forum, since I have not yet been able to do so in Council, is to outline the affirmative public benefits that the sale to UIL would bring and why this course of action is superior to other thinkable options.  After a brief summary of the benefits, I’m going to recite a bit of our history, including why I ultimately determined that we should sell PGW.  Then I’m going to discuss the benefits of the Transaction in a bit more detail.

SUMMARY OF BENEFITS

Here are what I see as the most important public benefits of the Transaction:

  • UIL must maintain in full all the protections and programs currently available to lower-income and senior citizens.
  • The terms of the sale require that base rates not increase before January 1, 2018, at the earliest, and promote long-term rate stability.
  • UIL must honor the current collective bargaining agreement and treat both union and exempt workers fairly.
  • UIL must maintain PGW’s operational headquarters in Philadelphia.
  • UIL Holdings Corporation must establish a second headquarters in Philadelphia for its overall business, and encourage and facilitate the engagement of its officers and employees in the charitable, governmental and community organizations of Philadelphia in a manner consistent with the level of engagement at a headquarters location.
  • After closing of the Transaction, UIL may not lay off any PGW employees for at least 3 years; any reduction in employment may occur solely through attrition; lay-offs are not permitted.
  • During the same 3-year time period, UIL-PGW must maintain an employment level of at least 1,350 employees.
  • UIL must assume responsibility for all employee benefits following the closing.  The Transaction will enable the City to fully fund pension liabilities for existing PGW retirees and employees, and to substantially reduce the unfunded portion of the City’s liability for its own employees’ pensions.
  • UIL must assume responsibility for all environmental obligations associated with PGW, both past and future, all known and unknown liabilities.

RELEVANT HISTORY AND GOALS

By way of background, the City chartered PGW as a separate business in 1835-36 and then acquired it in 1841.  It is the nation’s largest municipally-owned gas utility, serving more than 500,000 customers in Philadelphia.  PGW’s service territory is the same as our City limits, an urbanized area of 129 square miles in southeastern Pennsylvania along the Delaware River.

Since July of 2000, PGW and its rates and charges have been subject to your jurisdiction pursuant to the Natural Gas Choice and Competition Act.  As the Commission is aware, PGW faced significant financial difficulties at that time, which triggered the need for rate relief and other assistance.  In fiscal year 2000, the City extended an interest-free $45 million loan to PGW to mitigate the utility’s liquidity problems.  Although the loan was originally due in less than 3 years, PGW was unable to repay the loan until fiscal year 2008.  During this period of financial distress at PGW, the City also agreed to forgo the $18 million annual payment that the utility was obligated to pay to the City under the terms of the management agreement with the City.  Specifically, in order to shore up the utility’s finances, the City forgave the $18 million payment in fiscal year 2004 and granted back the entire annual payment to PGW in the next six fiscal years, through 2010 – a total of $126 million of support.  The extension of the loan and grant-back of the City payment strained the City’s limited resources during this period and conflicted with other municipal priorities.

PGW’s current financial position is stronger than in the past.  Nevertheless, PGW remains highly leveraged and vulnerable to cash crises if energy prices spike in the future or there is a local or national recession.  Given the City’s own ongoing budgetary challenges, the City believes that ownership of PGW constitutes an unacceptable risk for the City and its taxpayers.  The Transaction would give us additional security, and would put more of the risk on private investors, where we believe it belongs.

Only 4 of the 30 most populous United States cities own gas distribution utilities.  Philadelphia is the largest of these four, both in population and in number of gas customers, and is the only municipal owner in the Northeast, where the gas distribution infrastructure is the oldest.  The last several Mayors of Philadelphia considered selling PGW, but previous efforts were unsuccessful, largely due to PGW’s poor financial condition at the time.  Mayor Street in particular devoted great effort to work with PGW, our Gas Commission, and the Public Utility Commission to get PGW into position to be of net value to the City, so that it could be sold or we could pursue other appropriate options.

In July of 2010, my Administration retained Lazard Frères as a strategic alternatives advisor to assess various strategic options for PGW, including various “enhanced status quo” options under continued City ownership; entry into a management services agreement under continued City ownership; and transferring PGW to a private entity whether through a strategic sale, a public-private partnership, or an initial public offering.  We asked Lazard to assume for valuation purposes that we would maintain important public policy objectives such as stable base rates, fair treatment for PGW workers, and continuing assistance for low-income households.  Specifically, we sought to:

  • maintain the current senior citizen discount program and all PUC-mandated discount programs, including the Customer Responsibility Program and Demand Side Management (weatherization);
  • implement a rate freeze through a date certain;
  • honor PGW’s collective bargaining agreement;
  • maintain PGW headquarters in Philadelphia and/or a specified minimum number of employees in Philadelphia for at least 3 years;
  • maintain or establish dedicated trust funds for any PUC-granted rate recovery of employee benefits (i.e., health, pension, and other post-employment benefits or “OPEBs”); and
  • assume PGW-related OPEB and pension[1] liabilities (management and funding), as applicable.

Lazard Frères provided valuation, financial, analytical and technical services and made an independent assessment of the feasibility of transferring ownership and/or operation of PGW to a private entity.  After months of examination, Lazard concluded that the sale of PGW was financially feasible within certain specified economic parameters; that a strategic sale was by far the most favorable option economically; and that we could achieve important public policy objectives.

After release of the initial Lazard Report, the City selected brokers (J.P. Morgan Securities LLC and Loop Capital Markets LLC) to guide the sale process, along with other sale advisors.  The City issued a Request for Qualifications in August 2013, and more than 30 qualified parties responded with expressions of interest in the opportunity to purchase the assets comprising PGW.

After an indicative bid process, extensive due diligence, management presentations and site visits, and an opportunity for the finalists to speak with the City Council President, five bidders submitted final, binding bids on January 31, 2014.  In February 2014, the City evaluated the bids that it received, and decided to finalize a Transaction with UIL, and signed the Agreement on March 2, 2014.  UIL’s bid, without question, provided the highest price and the best terms, addressing all of the public policy goals we set out to achieve. The closing of the Transaction is contingent on City Council authorization and necessary regulatory approvals, including that of this Commission.

City Council commissioned an independent study of the Transaction, and the report concluded that the bid process was fair and competitive, and that the deal negotiated between the City and UIL met market standards.

BENEFITS OF THE TRANSACTION FOR PGW EMPLOYEES

UIL has made a number of commitments regarding the PGW workforce, both inside and out of its Agreement with the City.  UIL will make offers of employment in Philadelphia, effective at closing, to each and every person employed by PGW immediately prior to closing.  Compared to compensation with PGW, each employee’s base pay must be at the same level or higher.  Benefits, together with wages, must in the aggregate be substantially equivalent to aggregate benefits and wages in effect for the employee immediately prior to closing.

In addition to its promises in the Agreement, UIL made a number of promises to all PGW employees in a letter dated September 17, 2014, which I have attached to my written testimony.  UIL has offered the following to all PGW non-union employees and has indicated that it is prepared to offer the following to union employees through the collective bargaining process:

  • unchanged medical benefits in 2015
  • unchanged medical benefits in retirement to anyone eligible to retire as of January 2015, irrespective of the actual date of their ultimate retirement
  • phased in cost sharing for medical benefits beginning in 2016 (except for those eligible to retire as of January 2015)
  • unchanged practices in 2015 relating to sick leave and vacation balances
  • unchanged pension plan benefits
  • a 401(k) plan to replace PGW’s existing 457 plan, with at least equivalent benefits
  • no change to PGW’s current life insurance benefit

Moreover, UIL will not lay off any PGW employees for at least three years after closing.  Any workforce reductions during that time will come solely through attrition, and even then UIL will ensure a workforce level of at least 1,350 employees.  Over time, we expect that many employees will see an increase in their total compensation as a result of UIL’s philosophy of market-based, competitive compensation.

UIL will assume the collective bargaining agreement in place at closing through the end of the term of that agreement, and may extend it pending negotiations.  The City expects UIL to continue its historical practice of building strong labor relations.   UIL will require highly skilled employees to maintain and operate the gas company, to ensure that the system continues to deliver gas safely to customers, and to improve the gas infrastructure.  Like PGW, UIL has strong relationships with the Utility Workers Union of America.  UIL has a highly diversified workforce and reaches out to minority- and woman-owned businesses in order to enhance competition and promote diverse participation among its vendors.

The City will maintain responsibility for PGW pensions attributable to service through the closing of the Transaction.  The City will fully fund the PGW pension out of the sale proceeds, and under a separate agreement will fully fund the PGW pension going forward.  UIL will assume full responsibility for other post-employment benefits for current and future retirees and for management of the existing OPEB trust in accordance with its terms.  UIL will establish its own pension programs for employees going forward, initially through a plan mirroring PGW’s existing plan.

In sum, PGW’s employees will be no worse off, and in many cases better off, if we consummate the Transaction.

BENEFITS OF THE TRANSACTION FOR PGW CUSTOMERS AND THE COMMUNITY

The City expects the Transaction to benefit PGW customers in several ways.  In the first instance, UIL has committed to accelerating cast-iron main replacement significantly more than PGW could do in the City’s hands.  We recognize and share the Commission’s concern for safety, and believe this is one of the more important reasons why the Transaction will serve the public interest.

Secondly, UIL is committed not to increase base rates until at least 2018.  This is important to City residents, who pay the highest rates in the Commonwealth, and to the City, the School District of Philadelphia, and other area authorities that receive gas service from PGW.

Third, the City and UIL will ask the Commission to require UIL to maintain PGW’s existing customer support programs.  This will include such programs as discounts for low-income households, demand-side management programs, and the senior citizen discount in its current form.

Fourth, we expect additional long-term rate benefits as UIL operates PGW more efficiently and as the utility pursues new regulated business opportunities, realizing increased revenues inuring to the benefit of all gas customers.  In general, the Transaction will eliminate restrictions on business and partnering opportunities connected with the constitutional limitations on the City’s involvement in private business, and should assist in creating an energy hub in Philadelphia.  This should make UIL more nimble and flexible as compared to PGW’s current multiple layers of governance, and should also shift responsibility for the business to private investors in the context of PUC regulation.

All of the above benefits should increase the number of well-paying jobs among other workforces as well as PGW’s.  They should also improve safety and service, to the benefit of the entire community.

Serving the community has historically been the central objective of PGW’s management.  UIL has agreed to continue this tradition by its commitments summarized above.   UIL is also committed to establishing a second corporate headquarters in Philadelphia and to become a leading corporate citizen of Philadelphia, both through its utility business and through its charitable foundation.

The Transaction will clearly provide very substantial benefits for customers and the community.

BENEFITS TO THE ECONOMY

As I have already mentioned, the City expects the Transaction to benefit the region’s economy.  At present, PGW operates as a municipal utility within the boundaries of the City, and is constrained from growing its business to its full potential.  Under our ownership, PGW cannot invest in private companies or enter into joint venture agreements that would leave it with financial risk.  This prohibition under the Pennsylvania constitution prevents municipalities from bankrupting themselves on risky business ventures.  We might be able to fund expansion of PGW’s Liquefied Natural Gas facilities through taxable bonds, but we could not easily partner with someone else to do it.  UIL, by contrast, could undertake any sort of normal financing or business transaction – subject to this Commission’s regulatory oversight – for the benefit of customers and the economy.

Because a private owner has more options and because UIL would be a good owner, the Transaction is likely to generate expanded natural gas opportunities and a broader customer base – for example, manufacturers, shipping and transportation companies – in connection with the positioning of Philadelphia as a regional energy hub.  It will also allow for additional critical infrastructure upgrades (such as incremental cast iron main replacement) and should also create new jobs for our building trades and members of the Gas Works Employees Union of Philadelphia, Local 686, Utility Workers Union of America AFL-CIO.  All of these changes should improve the regional economy.  The establishment of a second headquarters of UIL Holdings Corporation in Philadelphia demonstrates UIL’s commitment to the City and its local and regional economy.

BENEFITS TO THE CITY

We also expect the Transaction to provide real and substantial benefits to the City, both in the near and longer term.  In the near term, selling PGW will protect the stability of the City’s and PGW’s finances.  After paying off all of PGW’s bond obligations and putting aside funds for other liabilities, including fully funding the PGW pension plan and prudently reserving for residual risks, the City expects to have between $417 million and $628 million remaining, based on current markets and reasonable assumptions.

The Transaction is the only possible option for the City to generate this kind of money from PGW.  And because it is a one-time opportunity, we intend to use the bulk of net proceeds not to fill a budget hole or to cut taxes, but rather to address a structural problem in the City’s finances, namely, the crisis in our employee pension plan.  On an actuarial basis, our Pension Fund is less than 50% funded; a Boston College study ranks ours among the twelve worst funded of the 150 largest funds.

State law requires us to deposit hundreds of millions of dollars a year into the Pension Fund as a Minimal Maintenance Obligation or “MMO” so that we will eventually be fully funded by the year 2039.  We intend to deposit the bulk of net proceeds of the Transaction into our Pension Fund.  That alone will save us between $41 million and $62 million a year to start in MMO payments.  That will save us hundreds of millions of dollars more over time, perhaps a billion or more overall, even after subtracting out our loss of the $18 million payment that PGW is obligated to make to the City every year.

We don’t intend to stop there.  If City Council is willing, and as we have proposed in the draft ordinance, we also intend to enter into an additional agreement requiring the City to deposit the MMO “dividend” – beginning with the $41 million or more minus $18 million – into the Pension Fund every year until we are at least 85% funded.  This deposit will increase the MMO “dividend” as well, eventually itself to over $100 million a year.

Clearly, this is a once-in-a-generation opportunity for the City.  If we do not take it, there are no comparable alternatives.  Future Administrations and Councils may be forced to make drastic cuts to services, wages, or benefits, or to raise taxes, or both to address the significantly underfunded pension fund.  By contrast, the Transaction should enable the City to maintain and improve services, reduce tax burdens, or both.

I see one additional benefit to the City.  PGW is important to us, but it is not part of our core business as a city.  By divesting ourselves of PGW, I believe that the Transaction will facilitate the more effective delivery of municipal services while allowing the utility to operate more efficiently and expand its opportunities under private ownership.  Taking this into account together with the numerous benefits to customers, employees, the regional economy, and local economic and charitable activities, the City believes that the negotiated terms of the Transaction are truly outstanding and that the sale of PGW will benefit all stakeholders.  The Transaction is in the public interest.”

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