[ public works ]
In 2007, the massive Texas utility company TXU was sold to a private-equity firm, on the advice of George Bilicic of mega-firm Lazard. It was the biggest leveraged buyout in history. Lazard made a tidy $13.5 million fee; Bilicic went on to work for the bankers who bought the utility. As for the utility itself? Energy Future Holdings (as TXU is now called) is now spiraling into debt so deep that Warren Buffett recently apologized for investing in it.
Now the same consultant (Bilicic) at the same company (Lazard) is advising Mayor Michael Nutter on a plan for a similar sale, this time of Philadelphia Gas Works (PGW), the city-owned utility. Potential conflicts of interest aside, consumer advocates contend a sale could hurt ratepayers and the 109,000 poor and elderly that rely on subsidized gas heat. But Nutter, citing a report by Lazard, says it could free the city from major financial liabilities, including costly pensions.
"We're moving forward in the process to sell PGW," says city budget director Rebecca Rhynhart. "But it doesn't mean that we can't pull back if the pricing doesn't come in as we want," or if conditions to maintain social subsidies for poor residents are not met.
Yet Community Legal Services attorney and ratepayer advocate Phil Bertocci worries customers could "pay much more than they would pay if PGW remains under city ownership."
Others share his concerns. "For someone to be able to capture a profit, they're going to have to do it through rate increases and slashing employees," says City Controller Alan Butkovitz. A private company might be able to invest in much-needed infrastructure repairs of thousands of miles of decrepit cast-iron pipelines. But Philadelphians could end up funding that via higher rates.
"The more you spend on capital repairs [as a privately owned utility], you get a guaranteed return," says Butkovitz. A private PGW would be a regulated monopoly. "It's not like the free market."
Those concerns make City Council approval uncertain. Councilwoman Maria Quiñones-Sánchez thinks a private company would cut subsidies. "I don't see how they would ever convince me to go along with it," she tells CP.
Indeed, those subsidies are the main reason PGW rates are so extraordinarily high. Unlike New Jersey, Pennsylvania does not share the cost of subsidies statewide. In 2010, Philadelphians paid nearly eight times more than our suburban neighbors — an average of $200.58 apiece — to support PGW's programs for the poor. The city insists it would require a private company to maintain the programs, but future owners could petition the state Public Utilities Commission to reduce benefits.
The Lazard study concludes that gas utilities, when merged with private companies, are able to realize efficiencies through economies of scale. But a 1999 study by Public Financial Management found that to sell at a profit, PGW would have to inflict "significant" layoffs and "essentially eliminate" social programs.
But the PGW of the late 1990s was a different company: Mismanagement and heavy debt forced the city to issue a $45 million loan in 2000. That debt has since been repaid, and PGW has trimmed personnel by nearly 40 percent since 1988 and boosted collections to more than 98 percent. PGW is still laden with $1.142 billion in long-term debt. But it is no longer paying it off with new debt, and the company has resumed delivering its $18 million franchise payment to the city.
Most everyone compliments PGW's current management — which is precisely what perplexes gas workers. "We're against the sale," says Keith Holmes, president of Gas Workers Local 686, which represents 1,138 PGW employees. He says the city's proposed conditions for a sale, which require a new owner to honor the current collective bargaining agreement, do not promise much: The contract expires in May 2015. He's angry that workers made concessions to rebuild the company only to see it potentially sold out from under them.
Privatizing PGW is a perennial City Hall thought experiment, and the current budget crises makes a sell-off especially attractive. In July 2010, Nutter quietly spent $200,000 of ratepayer funds to commission the Lazard study. While Rhynhart says the city will hold out for a profit, the study's conclusions are cautious, suggesting the city could "exit its PGW ownership and operating requirements at little or no cost (and potentially at a profit)."
To discover the actual price, the city will hire a financial consultant to manage the sale. While the city hasn't yet decided on a pay structure for such a consultant, Rhynhart notes that, often, consultants are paid only if a sale goes through. That poses a potential conflict of interest.
Indeed, Lazard might stand to profit from their recommendations: potentially drawing a fee for managing the sale and later profiting from investments in a privatized PGW. First, Lazard tells CP it does hope to manage the sale. Second, Lazard proposed, among other possibilities, PGW's sale to an infrastructure fund; Lazard happens to have a strategic relationship with such a fund, the Lazard Global Listed Infrastructure Portfolio. Finally, two of the six potential buyers Lazard interviewed for the PGW study were Lazard clients.
Bilicic denies any conflicts. And William Cohan, a financial journalist and former Lazard banker, says the arrangement is normal for Wall Street.
"It may be offensive on the street level, but that's not unusual," Cohan says. "What would be unusual is if at the end of that process the fund that Lazard controlled ended up buying that utility."
But Bart Naylor of the watchdog Public Citizen calls that Wall Street status quo wrong. "It's certainly a conflict to say, 'How would you like to assess a proposal whereby some investment bank will make a big fee and it might be you?'" he tells CP.
Though Cohan says they have long since cleaned house, Lazard has given cities horrible advice in the past. In 1995, the firm and Merrill Lynch paid a $3.64 million settlement to Washington, D.C., after allegations of an undisclosed conflict of interest, recommending the city buy interest-rate swaps while marketing those same swaps for Merrill. Lazard and Merrill also paid $24 million in fines for alleged fraud perpetrated against government entities. In 1998, Lazard paid $9 million to the Los Angeles Metropolitan Transportation Agency to settle allegations of fraud in the municipal-bond market.
The proposal to sell PGW comes amid a nationwide wave of privatizations by cash-strapped local governments. While privatization can make cities money in the short term, contracts often have clauses that can cost money and work against the public good down the line.
Chicago's 2009 privatization of parking meters prompted meter increases and a potential $10 billion in lost revenue over the 75-year life of the contract. The city must also compensate private owners when they close a street for maintenance or a parade. Likewise, so-called "noncompete clauses" for privatized highways have blocked governments from making improvements on "competing" public roads. Former Gov. Ed Rendell came under fire for his failed proposal to privatize the Pennsylvania Turnpike because Morgan Stanley, contracted to manage the process, was to be paid only if a sale went through.
Bilicic says it's unlikely a noncompete clause would be included in a contract to privatize PGW. But Penn State law professor Ellen Dannin says it is possible that the city's future support for alternative energy, or subsidies to winterize and decrease gas use, could violate a contract provision.
"People who have an uneasy feeling," Dannin says, "are right to feel that way."