Rate setting mechanism flawed

Privatisation has failed to yield the expected benefits touted by the international agencies. GPL has been unable to raise matching funds for loans since 2001 and creditors are unwilling to lend because the firm’s cash flow does not put it in a position to readily repay debt.

This inability to raise matching funds, according to Lynn, is rooted in the company’s cash flow, hamstrung by the controversial rate setting mechanism.

While that mechanism guarantees a 23% return for the investor, it effectively works against the short-term interest of the company as it restricts cash flow and has failed to provide a dividend for shareholders to date.

Lynn explains that the formula as is presently configured, allows GPL to recover any shortfall in revenue for the previous year but it does not take adequate account of the spiralling increases in the cost of fuel or the cost of debt.

Diesel fuel now stands at US$50 per barrel against US$15 at the time of privatisation. While the company is allowed a fuel surcharge for rising prices, the recovery is only made in the final three quarters of the year and does not make up for the revenue lost in the first quarter or further increases during subsequent quarters.

That is, surcharges are based on prices of the previous quarters and are fixed so that increases during a quarter are collected in the next quarter, never fully closing the gap of the increased expenditure. A similar condition arises in the case of debt servicing.

Hence, Lynn argues, the formula works against the short-term interest of the firm, allowing for the constant erosion of the revenue base and leaving insufficient funds to convince a creditor that the firm can repay its obligations. The benefits attached to the formula are back-loaded but the firm needs to cash in on benefits now to be able to make the necessary investments in the operation, Lynn noted.

Lynn said changes to the formula are among the issues proposed by the Common-wealth Development Corporation (CDC), the major partner in AC Power, and are now being negotiated with the government.

Rate increases a must

The protracted nature of the negotiations between the government and CDC on restructuring GPL is also not helping the situation as GPL needs an urgent infusion of cash to be put on an even keel. The negotiations have reached a crucial point and could go either way, forcing AC Power to move to arbitration on one of the issues.

“We anticipate that the government and CDC will reach an agreement in the interests of our customers - although this will be a difficult task,” Lynn, speaking as management representative of ESBI, said on Monday. He would not elaborate saying the talks have reached a “crucial stage”. However, he sees no chances for the company’s survival in the present scheme of things unless consumers face higher rates.

“I do not think there is any future for the company if rates do not go up,” Lynn said. He insists that to keep the lights on, certain costs have to be met and the only avenue open for revenue is increased tariffs to be borne by customers.

Lynn disagrees that this is asking customers to pay for inefficiencies in the system in the higher rates, given that system losses stand at 42% instead of the 36% rate when management took over in October 1999.

System loss targets

The outgoing GPL chief executive said the business plan developed by AC Power in its bid documents was based on “flimsy” information available at the time and the level of losses now is an accurate reflection of the state of the company, despite improvements made by management.

Lynn pointed to excerpts in the Operating Standards and Performance Targets attached to GPL’s licence issued in October 1999, which pointed to uncertainties, and the business plan which cited the suspect nature of the information at hand.

According to Section two of the plan it “is based on the best available information concerning the operational status of the company, its assets and liabilities, staff etc. However, it is recognised that the available information is deficient or suspect in many respects. In the course of operations, it is anticipated that information will become available that could give rise to a need to make material changes to this framework. These issues will be identified to the GPL board of directors by the manager, with the proposed approaches to addressing the issues, as soon as practical.”

Lynn further noted that the plan and supporting documents were prepared against a background of uncertainty and future events including variation in economic growth, the level of sales growth, fuel price fluctuations, exchange rate variations, availability and timing of debt funding. The plan stated that these issues “make it difficult to predict exactly how the future development of GPL will unfold”.

AC Power also stated in that plan that the financial projections for 1999 and beyond (of US$150M) do not represent commitments by the company to incur the projected expenditures.

“Actual expenditure will be determined at the time in the context of available financing, approved annual plans and budgets and specific project proposals,” the plan said. The operating standards also commit GPL to use “best efforts” to achieve its targets and be guided by the need to maintain the balance between GPL’s growth plans and the need to preserve the company’s financial integrity.

Lynn argued that the above extracts demonstrate that the negotiators understood the complexities facing GPL and provided a flexible framework for management to operate within. He further said the rate setting mechanism carries incentives to reduce system losses as these savings go to the investor in the form of profits. He said critics have overlooked this.

Raising funds

However, he underscored that finances were necessary to improve the system and reduce the losses and these could not be acquired but not because of a lack of effort on AC Power’s part.

“It does not make any difference what contacts CDC or ESBI have, or who the new management will be, nobody lends money if they have doubts about the borrower’s ability to repay,” Lynn stated emphatically.

AC Power has been criticised for not bringing funds into the company to make the investments necessary to allow for an eventual stabilisation or lowering of tariffs. But Lynn said AC Power brought in US$20M of its equity and secured a US$10M loan. It also secured a US$20M loan from the European Investment Bank but had to raise matching financing which it could not do.

Lynn said when the managers came in October 1999 they had to arrange a transition and ascertain what needed to be done. A system development plan was developed and immediately after, the managers began preparing tenders for the supply of generation and transmission and distribution equipment.

“At the end of 2001, management was ready to issue orders for required generation... but at that time, the information available did not allow us to persuade people (creditors) that we could repay the loans. We were not raising enough money internally to repay. The tariff mechanism did not allow for that,” Lynn said.

He said management advised the directors of the company of the situation as well as the prospect of the firm getting into cash flow difficulties but most of 2002 was spent debating this issue at the board level.

Asked if the US$23.45M in equity (with US$3.45M now in limbo) had been injected all at once whether this would not have allowed for improvements in the system to curb losses and create efficiency savings, Lynn said the staged flow of the equity (over four years) allowed for a lifeline for GPL as some of the equity was used to subsidise the operating costs of the company. He said if that equity had been invested up front, the financial troubles would have shown up long before as the firm would not have had that “lifeline”. He holds to the view that the decision to spread the investment was a valid one.

He also said the US$23.45M would not have been sufficient to make a significant impact on technical losses which stand at 18%. He said these losses would have only come down by a few percentage points. The company, he said, has made some inroads in commercial losses in the case of large customers but it would require an investment of about US$24M to tackle the problems posed by small residential customers. These problems include electricity thefts and defective metering as the old metering system facilitated thefts and leakage. The investment would work out to an average of US$200 per household.

Investment required

To get GPL to an acceptable standard may require a total investment of US$50M-60M over the next five years, Lynn estimates. However, he noted that it would be a question of affordability for Guyana. The firm’s initial business plan had projected that almost US$150M would be necessary to fix the system.

The firm is still to secure matching funds for the EIB loan and US$1M for the US$32M unserved areas electrification programme.

The company’s financial situation was also made worse by the withholding of the US$3.45M final tranche by AC Power because of the PUC $1.3B compensation order last year. One of the conditions for the release of the tranche is for economic rates to be effectively implemented and the PUC compensation order (challenged in court) provided for consumers to get credit from GPL. The final tranche is now subject to arbitration proceedings by AC Power, having twice been postponed because of the negotiations between the shareholders.

CDC is proposing to invest a further US$4.5M in equity if agreement is reached on restructuring the power company. But this would not solve the problems of the company, which needs to be able to survive on its cash flow and Lynn insists rates would need to be raised.

Prime Minister Sam Hinds last Friday said consumers would not be asked to pay for the inefficiencies in the operations of GPL. The system losses carry up the cost of operations for GPL with more fuel required to over-generate current to allow for a full load to consumers. Consumers are billed for the entire production cost.

Blame

The government and consumers have been blaming management for the state of affairs of the company. Hinds said AC Power had failed to raise funding and introduce a reliable billing collection service at GPL, which had resulted in an unacceptably high level of technical and commercial losses.

Asked to comment on this statement, Lynn said Hinds’ statement is consistent with previous government statements, which sought to blame AC Power and the managers for the problem.

While not wishing to make detailed comments in response, Lynn said the present situation developed during the reign of the current management, board and shareholders. He said all the parties did their best to improve GPL and many successes have been had even if the parties fell short of people’s expectations and their own targets. He said the main issue is to make the situation better but the board and its directors are ultimately responsible for running the business.

Management, he said, proposed to bow out of GPL voluntarily to help the government and CDC to reach agreement on the issues. ESBI, he added, is not willing to invest more money into the operation as it has not yielded any returns to date on the US$4M injected into GPL. ESBI has settled its obligations with CDC and is willing to stay on until the transition takes place subject to being compensated. Management had originally expected to stay until June, and at the latest, September, to effect the transition, subject to agreement between the two sides by the end of January.

There has been no agreement and Lynn said the managers are willing to leave earlier now.

“It is easy now to take shots at us as we are about to leave,” Lynn stated.

He said his team would stay on to ensure a smooth transition and minimal disruption to services and will leave when requested to.

But he said it is crucial that GPL be put on a footing that enables it to develop successfully and urged that it is essential that people’s expectations for the future are realistic. He also called for a cultural change regarding the payment of bills and theft of electricity. He further advised that public commentators must develop an understanding of the complexities of business and the particular challenges that face an electric utility in a developing country.

He also insists that the tariffs are economic tariffs, even though they cover inefficiencies in GPL’s operating systems. Lynn said the residential rates are within the range of other Caribbean utilities. He said compared with Canada, 52,000 customers pay less here for power than residents using less than 51 kilowatt hours per month in Ontario.

Improvements

Lynn said improvements in the system achieved by the managers include: improved electricity supply with less interruptions, shorter interruptions and improved voltage to many areas; improved care for the environment with the introduction of an environmental management system; the application of international utility technical standards; introduction of new metering and installation standards; meeting targets on collection of accounts, payment of suppliers and the level of bad debt; producing audited accounts within three months of the year’s end; improving conditions of service for both customers and employees; reducing the number of estimated meter readings from 25% to 15%; introducing a regular billing cycle and improving accuracy as well as identifying and reducing commercial losses in large customer installation. Here 25% of the large customers base, which accounts for 45% use of electricity were targeted. Some customers have since left the grid in favour of self-generation.

Lynn said in evaluating GPL’s performance, the whole picture needed to be taken into account.

In the case of technical targets, Lynn said some of the targets were not met in the area of generation, transmission and distribution and commercial loss reduction. These included connecting Sophia to Onverwagt at 69 KV, installing a 69 KV substation at Eccles and one at Leonora and Coldingen.

However, the targets met include the refurbishing of production equipment; installing 10 megawatts of mobile generation; rehabilitation of the 69 KV lines from Onverwagt to Canefield; initiating a commercial loss reduction plan and preparing for 50 HZ to 60 HZ conversion; assessing rural electrification needs and initiating one or two programmes; and initiating rehabilitation of the Georgetown network.