‘Robust’ Prepa, LUMA deal structured to avoid failure of Prasa privatization
Private consortium sets ambitious goals to turn around troubled power utility with anticipated influx of federal aid
SAN JUAN – The public-private partnership (P3) deal between LUMA Energy LLC and the Puerto Rico Electric Power Authority (Prepa) was specifically designed to avoid the ineffectual private management and operation of the island’s water utility two decades ago, as it would allow LUMA to tap into expected billions of dollars in federal funds to permanently rebuild Prepa’s transmission and distribution (T&D) system while collecting fixed and incentive fees to fulfill its ambitious goals of turning around the utility’s services within six years, the Public-Private Partnerships Authority (P3A) chief and LUMA executives told Caribbean Business.
They acknowledged, however, that in the absence of such federal funding, LUMA would be forced to submit to the Puerto Rico Energy Bureau (PREB) a request to raise electric power service rates.
Gov. Wanda Vázquez announced on June 22 that LUMA, a U.S.-Canadian consortium, was awarded a 15-year contract to manage and operate the public utility’s T&D as well as its customer service and billing component. The deal, which was approved the previous week by PREB, requires the reorganization of Prepa into two operating companies. One is GridCo, which will retain ownership of the 18,000-mile T&D grid, and the other is GenCo, which will own the public utility’s power generation assets, “until they are otherwise disposed of,” according to the contract.
LUMA, which was incorporated locally in January, is the first private venture to directly manage and operate Prepa infrastructure since the public corporation was established 79 years ago. The company is a joint venture between ATCO Ltd., a Canadian operator of electric systems; Texas-based Quanta Services, a provider of “infrastructure solutions” for the electric power industry; and Innovative Emergency Management Inc. (IEM), a U.S. firm dedicated to securing disaster relief funding.
Avoiding the Prasa experience
The last time a P3-type of arrangement was used to fix a public utility on the island was in the late 1990s and early 2000s and it involved the Puerto Rico Aqueduct & Sewer Authority (Prasa). After then-Gov. Pedro Rosselló declared a state of emergency at the failing water utility in 1995, his administration concluded a contract with Professional Services Group (PSG), afterward known as Compañía de Aguas de Puerto Rico, a subsidiary of the French-Spanish multinational Vivendi, to manage and operate the public corporation as well as repair the utility’s aging infrastructure.
The following administration, Gov. Sila María Calderón’s, determined that the PSG contract failed to accomplish its goals and opened a new bidding process in which a $3.8 billion, 10-year contract was awarded in 2002 to French multinational Ondeo. This contract was rescinded only two years later after Ondeo requested an increase of nearly $100 million in additional fees, arguing that the system was more complex than they had assessed. The utility subsequently returned to public hands.
P3A Executive Director Fermín Fontanés Gómez said that contrary to the Ondeo deal, which involved the company making its own capital investments in the Prasa system, the $1.4 billion LUMA contract is a fixed-fee-with-incentives transaction that does not make such a requirement and relies wholly on expected billions of dollars in federal disaster and energy funds to permanently repair and make the Prepa grid more resilient to storms similar in strength to Hurricane Maria, which devastated the system and plunged the island into a months-long blackout nearly three years ago.
Fontanés stressed that the money would also be used to upgrade the system so that it can incorporate the amount of renewable energy required to meet the goals of the Puerto Rico Energy Public Policy Act of 2019, or Act 17. He admitted that in the absence of such federal funding, LUMA would be forced to request an increase in electricity rates to complete the years-long capital improvement programs needed for the utility’s T&D system (see related story).
The law mandates that the share of electricity produced from renewable sources reaches at least 20 percent by 2022, 40 percent by 2025, 60 percent by 2040, and 100 percent by 2050. Currently, about 4 percent of the electricity that is being consumed in Puerto Rico derives from either solar, wind, landfill gas or hydroelectric generator.
“The grid is not at a level that we can inject enough renewables in a sustainable way without making substantial investments. Without federal funding, the dream of renewables cannot be realized without a substantial increase in rates,” the official told Caribbean Business in a roundtable alongside LUMA executives, in which he discussed the dire state of the public utility after years of neglect and the recent blows to the system dealt by Maria and the earthquakes earlier this year. “We are where we are because we have expensive generation, and the lack of investment in the system has led to these other issues with the T&D system. The reality is that in the last couple of months Prepa has used the most expensive fuel out there until petroleum rates went down as low as they did.”
More ‘robust’ due diligence
Fontanés said that unlike the Prasa privatization contracts, the process that culminated in the P3 deal with LUMA is more “robust and in-depth” because it was conducted under both the Regulation for the Procurement, Evaluation, Selection, Negotiation and Award of Participatory Public-Private Partnership Contracts Act (Act 29 of 2009) and the Puerto Rico Electric System Transformation Act (Act 120 of 2018). He said this process included a desirability and convenience study for the P3 that incorporated “comments from the public and our other P3s.”
The P3A chief said that the proponents for the Prepa T&D contract had to review more than 18,000 documents and were posed more than 700 questions. In addition, proponents participated in more than 20 Prepa site visits, during which they conducted interviews with utility personnel and examined its operations and assets, he said.
“The LUMA team prepared themselves very well…, they essentially built a team that was set up to address what we were looking for,” the official said. “They had the operation component, the construction experience, and they also had the federal funding experience.”
Fontanés attributed Ondeo’s failure to accurately assess Prasa’s infrastructure to the fact that it is largely underground, in contrast to the power company’s above-ground T&D. He assured that LUMA is better prepared to assume the task of turning around Prepa’s complex system.
“So when you don’t do a robust due diligence process the way we performed with the proponents, they [Ondeo] really didn’t have the opportunity to get a grasp of what they were getting into. Most of the Prepa infrastructure is above ground, and the proponents to manage Prepa’s T&D had plenty of time to look into the system,” he said. “We knew this was going to come up and we ensured that we were not getting into an Ondeo situation.”
When announcing the Prepa P3 deal last month, government officials touted the apparent success of the P3 contracts involving the Aerostar operation of the Luis Muñoz Marín International Airport and the Metropistas management of the island’s toll highways. Still, Fontanés stressed that unlike the existing P3s, the LUMA deal is not a concession, noting that the revenue generated by Prepa, including from the planned wheeling program—involving independent generators servicing customers using the utility’s T&D lines—will only be managed by LUMA and not serve as compensation as in the other deals.
“Increasing the revenues of Prepa is not going to increase LUMA’s profits,” he said. “If they are more efficient managing the budget, they won’t take the remainder.”
The contract establishes that LUMA will be paid a service fee consisting of an annual fixed fee and an incentive fee. The fixed fee starts at $70 million the first year and increases to $105 million for years four through 15, while the incentive fee, which is payable upon LUMA achieving certain performance milestones, starts at $13 million on year one and increases to $20 million for years four through 15. In both cases, the amounts payable will be adjusted to inflation.
Before LUMA fully assumes management of Prepa’s T&D and services, the contract provides for a so-called front-end transition period of 320 days during which both parties will work on an initial budget and a system remediation plan. In exchange for services rendered during this period, LUMA will receive a fixed fee of $60 million as well as the reimbursement for salaries and expenses of those consortium employees and contractors or affiliates that provide certain services to Prepa.
The LUMA deal also includes a supplemental agreement that would be activated if a Prepa debt restructuring support agreement (RSA) with the utility’s bondholders has not been approved by the time the transition period ends. In this case, LUMA would be entitled to an annual fixed fee of $115 million until Prepa exits the bankruptcy process under Title III of the federal Puerto Rico Oversight, Management and Economic Stability Act (Promesa).
Fontanés acknowledged that apart from the higher fee, the bankruptcy process would also weigh down efforts by LUMA to transform the utility, given that the consortium would have to submit for approval all administrative expenses associated with operating the system to U.S. District Judge Laura Taylor Swain, who is overseeing the commonwealth’s debt restructuring process under Promesa.
“It does have an impact in terms of the flexibility that LUMA has to be an effective operator if it is tied up in court. They need that flexibility to work within their budgets and work directly with the Puerto Rico Energy Bureau,” Fontanés said. “It is more of a flexibility issue and being able to maximize what we as the government are looking for in the operator.”
Focused on rebranding
LUMA Energy CEO Wayne K. Stensby said that the consortium does not have a position on the Prepa RSA concluded with most utility bondholders last year and which is now up in the air after majority New Progressive Party lawmakers refused earlier this year to pass required legislation to enact the agreement, arguing that it would lead to substantial rate hikes. The Covid-19 crisis has put on hold negotiations between the Promesa-created Financial Oversight and Management Board (FOMB) and bondholders.
Stensby said that while the consortium “would prefer to transform a business that has emerged from bankruptcy,” the contract “provides some additional optionality as the parties work through restructuring.”
“We are really focused on our key objectives, which are to move through this transition, recruit some good employees, improve safety and customer service, and really begin what for us is a substantial transformation period,” the executive said, noting that by the end of that period Prepa would be rebranded into LUMA and customers would be receiving services directly from the company.
LUMA would be taking over infrastructure of the largest U.S. public utility by customers served, with nearly 1.5 million customers. While 91 percent of Prepa customers are residential, a large portion, 49 percent, of the public corporation’s revenue in fiscal year 2019 came from commercial clients.
Hefty challenges, ambitious goals
LUMA faces hefty challenges as it seeks to improve Prepa’s reliability, customer satisfaction and employee safety—all of which are well below U.S. industry benchmarks, according to P3A data.
In terms of reliability, Prepa’s average annual outage time per customer is nearly seven times the industry benchmark, while the average annual number of outages per customer is nearly five times the industry standard—even well below that of the Hawaiian Electric Co. In terms of service, Prepa takes an average 13 minutes to answer customer calls compared with the industry standard of less than one minute.
Prepa workers are more likely to suffer accidents than their stateside counterparts. The average number of “safety-related incidents per year, scaled to workforce size,” at Prepa is 12 times the industry benchmark, while the average number of “safety-related incidents resulting in lost workdays per year” was nearly 26 times the industry standard.
At the same time, local electricity consumption has decreased by 22 percent between 2007 and 2019, as the island’s economy deteriorated and its population dropped. Similarly, the number of Prepa employees has been reduced from more than 9,000 in 2012 to fewer than 6,000 in 2019, with the biggest decline among T&D workers.
LUMA has already outlined several ambitious benchmarks for Prepa in the next six years. The consortium plans to reduce operating and management costs by 20 percent, or a net decrease of $100 million a year, by 2026 compared to the 2019 Fiscal Plan. The company has also stated that it will cut “technical and non-technical” energy losses by $150 million a year. This would make for cumulative net operations and management costs savings totaling $323 million by 2027, exceeding the $141 million fee it would collect on that year, the company claims.
Moreover, LUMA plans to slash outage time by 59 percent by 2025, as well as improving employee safety by cutting accidents by 40 percent by 2025. It also seeks to improve customer service response time by 81 percent.
Stensby acknowledged that to meet these goals the makeup of the Prepa workforce will likely change, although he stressed that the company would be adding jobs, not eliminating them. He said that many new jobs would require “large project management-type of skill sets,” adding that “there probably will be more technology opportunities as we roll out better customer programs.”
“If you take those benchmarks and the idea of substantial amounts of federal funding, I honestly think we are going to have opportunities for employees here that will not exist anywhere else in the world. There is no utility that will have this amount of capital investment over this extended period of time. I think it’s going to be fantastic,” he said. “I get really excited over the opportunity to recruit as many people as want to join us, and, honestly, one of our challenges will be finding enough people.”
Deal sparks controversy
Nevertheless, the Irrigation & Electrical Workers Union (Utier by its Spanish acronym) filed a lawsuit last week at the Puerto Rico Court of Appeals seeking to overturn PREB’s approval of the LUMA deal. The largest labor union at Prepa alleges a lack of public participation from stakeholders in the decision, as well as a conflict of interest involving PREB Chairman Edison Avilés, who served on the government P3 committee that selected LUMA and, afterward, participated in the PREB process that granted the certificate of compliance to the consortium.
The consumer representative on Prepa’s governing board, Tomás J. Torres Placa, has also criticized the lack of public participation in the process.
Still, Fontanés defended the legality of the process, noting that the public hearings related to Aerostar’s takeover of the island’s main airport had to do with Federal Aviation Administration licensing and not the P3 contract itself.
“The selection process is never public because we have public utility companies that are participating and the law establishes it that way. That is the way P3s are done,” he said.
In a legal analysis written by Utier attorney Rolando Emmanuelli, the union also alleges that the P3 contract is “null and void” because it fails to protect utility workers’ and retirees’ acquired rights and collective bargaining agreements under Act 120. Gov. Vázquez met with union leaders last week and pledged to review the analysis to “clarify all of these doubts” with LUMA and make the corresponding amendments to the contract as needed.
Fontanés countered this charge, saying that the deal “provides Prepa employees with options.”
“They make the determination if they want to move with LUMA. We all agree that it is best for everybody for LUMA to hire these employees because they need this expertise,” he said. “Compared to other transactions, there is a specific quality and knowledge that Prepa employees have and are needed by LUMA. LUMA will make its offers and the employees will decide. If employees decide not to accept, then they can stay with Prepa and Genco, or within the government of Puerto Rico. The same flexibility applies to their existing pensions.”
Fontanés assured that under Act 120 Prepa employees get to retain their rights under existing collective bargaining under the new management.
“So if they want to keep those rights and take them with them to LUMA, they can, and if they like what LUMA offers, it’s their choice,” the official said, noting that the consortium includes the largest employer of union and non-union line workers in North America.
Quanta President & CEO Duke Austin said that his company, which has worked on the island since 2018, has hired many Puerto Ricans to work at its stateside operations involving construction and engineering. He said the LUMA deal will allow many of these workers to move back to the island “because they are excited about the stability and what they can do as part of the grid.”
“What we see and understand is that [Prepa] has a very good group that we can work with to transform the culture as well as the physical infrastructure, which will allow for a modern workforce with a career path as well as to establish a modern grid,” Austin said. “It’s a personal thing for us and the way we feel about it, because we can do something great with the grid of Puerto Rico.”