Friends of Mill Valley

Posted from the public record of letters sent to the City of Mill Valley City Council: 2-23-10

To: Mill Valley City Council
From: Kevin Ferrell
Date: February 22, 2010

I write to add my name to the rapidly growing list of well informed citizens of Mill Valley including eleven of its former mayors calling for you to opt Mill Valley out of the Marin Clean Energy (MCE) project and to withdraw Mill Valley from the Marin Energy Agency (MEA) as soon as possible.

Approximately one third of my thirty plus year career in banking and finance was spent as an energy banker. I headed the energy banking units of both Bank of America and Bankers Trust. In that capacity, I personally negotiated dozens of transactions and contracts with all of the major energy companies including Exxon, Chevron, Shell and British Petroleum. I was personally involved in the evaluation and financing of scores of energy production, processing, transportation and distribution projects. Projects under $1 billion were small, most were multi-billion dollar projects. While at Bankers Trust, I also headed the unit which provided fee based risk management advisory services to clients, particularly financial institutions and energy companies. For three consecutive years that unit was recognized as the best in the world by a major financial publication. Shell North America was one of our largest clients and I personally negotiated a multi-million dollar, multi-year contract with Shell involving the placement of risk management personnel directly in their Houston offices where the MCE contract was negotiated. I have spent many hours on Shell North America’s trading floor where I would expect the MCE contract was structured. Additionally, as domestic treasurer of Bank of America, I was the second largest issuer of debt securities in the United States and as President of Seafirst Bank, I led the largest public/municipal finance unit in the state of Washington. Consequently, I think it is fair to say that I have expertise and experience particularly apposite to MCE, both with respect to its contract with Shell and its longer term plan to finance, construct and operate energy production facilities.

Given the extremely regrettable propensity of MCE’s advocates to attack it’s critics’ motivations, lack of knowledge or understanding, etc, rather than adequately address their many legitimate concerns and objections, I would also like to state that I am certainly no shill for PG&E, the company was never a client of mine, and, in the interest of doing our family’s part in the fight against climate change, we long ago installed solar panels on our house and generate 100% of our own electricity, among other measures. When it comes to “green” and renewable, we put our actions and money where our mouth is.

That said, I strongly concur with the many compelling arguments made by the eleven former Mill Valley mayors in support of their conclusion that “it is imperative that the City withdraw from both the MCE plan and the Marin Energy Agency itself if the Agency persists in its contract with Shell.” Like the eleven mayors, I have also carefully studied the MCE plan, and based on my extensive knowledge and expertise in the energy markets, risk management, and financing the construction of energy projects, I add the following observations.

With respect to MCE/Shell contract:

The MCE/Shell contract does not add value to Mill Valley/Marin County ratepayers in any dimension; it destroys value economically, in terms of renewable power it adds minimal, if any, benefit, and it makes no contribution to countering climate change and global warming.

The assertion that the MCE/Shell contract will provide power to Mill Valley and its citizens at the same or better rates than PG&E is just not true. As has been more than amply shown by many informed parties, MCE involves numerous, significant, material risks. What has not been explicitly pointed out is that risks have costs. In fact, risks can be expressed in terms of incremental costs. With the appropriate financial and economic data (which MCE has so far not provided) and statistical techniques, risk managers can calculate the estimated costs of these risks. These costs must be added to the rates that MCE says it will charge to reflect MCE’s true costs. Clearly, when the costs of MCE’s risks are added to its stated rates, MCE’s real rates are much higher than PG&E’s rates.

As an analogy, let’s say you want to fly from San Francisco to New York and there are two airlines offering service at the same fare. However, one of the airlines has a significantly worse record in terms of risk—more overbookings, delays, lost baggage, mechanical failures, less qualified personnel, even crashes, etc than the other. Clearly, when you add in the “costs” of these risks, you choose the less risky airline, (especially so if both have the same “greenness,” “carbon footprint,” etc.). By choosing to join and remain a member of MEA/MCE, Mill Valley’s City Council is essentially booking the City and, by virtue of MCE’s mandatory conversion, its resident ratepayers and taxpayers (without their express permission) on the risky airline without any offsetting benefit.

In addition to the introduction of numerous significant risks, the only other substantive thing that the MCE/Shell contract does is to insert two middlemen, MCE and Shell, their costs and in the case of Shell, its profits, between Mill Valley/Marin County ratepayers and the source of power. These are all negative inputs. No value is added, no real benefit is gained. No new power, particularly renewable power comes online. Power is fungible and, as high volume buyers and sellers of power, both Shell and PG&E operate in the same power market, buying from and selling into the same pool. In fact, it is quite conceivable that in the normal course of business the MCE/Shell contract could involve the sale of power to Marin ratepayers that was purchased from PG&E. When Enron manipulated power prices and orchestrated brownouts in California ten years ago, it routinely bought from and then sold back the same power at higher prices to PG&E and other California utilities.

All the MCE/Shell contract really does is undemocratically buy Marin County ratepayers to the front of the line for the 25% of the contract that supposedly would come from existing renewable sources. A dirty little, but nonetheless open secret in the power industry is that more renewable energy is sold that is actually produced. Given the incentives and the aforementioned fungibilty of power and how the power markets work this is not surprising. But hey, who’s keeping track? How does an unsophisticated end user even audit the path of an electron generated by a solar panel or a wind turbine to an electrical outlet in Marin? And exactly how will MCE direct a “green” electron through PG&E’s wires to a ratepayer who did not opt out of MCE, but not to his/her next door neighbor who did. Given these realities, it is very reasonable to question how much incremental renewable power the MCE/Shell contract would really even deliver to Mill Valley/Marin County.

With respect to the financing, construction and operation of power facilities:

Marin Energy Authority asserts that within five years it will begin to build and own renewable energy facilities producing up to approximately 240 megawatts, borrowing $400- 500 million to do so. It is currently promising to begin producing renewable energy for provision to Marin ratepayers by 2016. Such a plan is fraught with very real risks: completion delays, cost overruns, the risks of an unproven management/operator, market risk, technology risks, just to name the most obvious. Given these risks, it is my judgment that no lender or bond investor would provide financing for such facilities without explicit guarantees provided by the county and member cities including Mill Valley if it were to continue as a member of MEA. In reality, such guarantees translate into individual guarantees provided by Mill Valley/Marin County ratepayers, and most alarmingly for those Mill Valley/Marin County ratepayers who opt out of MCE, Mill Valley/Marin County taxpayers. That’s right, even if you opt out you would still be on the hook! After all, what security does a lender really have if the guarantees only come from ratepayers who, according to MCE, “can opt out at any time”?

As of this date, MCE has not announced the procurement of any site or sites in or out of Marin County for the location of its proposed power facilities, nor settled on a renewable power technology, i.e., solar, wind, etc, or mix of technologies. Marin County leaders who have lived in the county their entire lives and are extremely familiar with the county’s limits and restrictions on the construction of large projects and the hurdles such projects must overcome—political and otherwise, have opined that MEA’s timeline is highly doubtful at best, questioning whether such facilities could ever even be built in Marin County. Why should other counties be any easier? Lenders do not take these kinds of risks without guarantees on which to fall back. Major energy and utility companies who are more experienced in constructing energy projects than any other organizations, who are staffed with thousands of extremely well trained and experienced project managers and engineers, who have longstanding, very valuable relationships with contractors, who have far more resources than MEA, and who have completed literally hundreds of energy and power projects over their histories nonetheless routinely experience completion delays and cost overruns on new projects. Such cost overruns are often 50-100% over the initial estimates. It is totally unrealistic to think that MCE would not be subject to the same risks, in fact, it would be much more subject to such risks. One does not just call up a contractor and say “please build me a 100 megawatt solar panel or wind turbine farm.” Anyone who has ever hired a contractor just to redo their kitchen knows all the things that can go wrong. Lenders do not accept contractor, completion or cost overrun risks.

MEA/MCE is obviously unproven as a manager/operator of energy production facilities. The fiascos, failures, performance shortfalls, and poor results of other Marin County entities including the Marin Municipal Water District which is currently raising rates even as Marin County residents have reduced water consumption, SMART which is desperately casting around for $155 million in funding and/or a federal bailout due to massive cost overruns and erroneous revenue assumptions, and the various Marin sanitary districts who frequently dump raw sewage into the Bay do not inspire confidence that MEA/MCE is likely to be up to the task of managing the financing, construction or operation of complex energy facilities. Lenders do not bet on unproven managers/operators.

When financing the construction of a power project, lenders and bond investors typically demand at least “two ways home” to get repaid. That means there must be at least two separate and distinct sources of funds to repay the loan and service the interest payments. Typically, the first source is cash flow which arises from the sale of power produced by the project, and usually such cash flow must be a multiple of the debt service obligations to provide a margin of safety. However, such cash flow is naturally subject to many risks, project delay or failure, interruptions in operation, lower prices, less demand, higher costs, and so on. None of these are risks that lenders are willing to bear. Accordingly, they look to a second source—cash held in escrow, the cash flows of other projects, the sale of other assets, or guarantees of other entities. Since MEA/MCE does not have the first three, it would have to find guarantors to back up any loans to finance its proposed energy projects. This means that Marin County and its taxpayers would be on the hook for literally hundreds of millions of dollars in principle and interest, and Mill Valley and its citizens for at least tens of millions of dollars. Likely more, with delays and cost overruns.

Bottom line, when you clear away all the rhetoric, all the tortured rationalizations, all the uninformed, misleading and false claims, the “greenwashing,” etc, cut to the chase and get to the heart of the matter, MCE exposes Mill Valley, Marin County and its citizens to very real and significant financial risks and costs, without adding any substantive value in any dimension, and doing nothing to counter climate change or global warming which is the whole point of the exercise. There are many other compelling arguments against MCE, most notably the highly objectionable mandatory conversion without permission of all Mill Valley ratepayers to MCE. Overarching all however, is that taking on real costs and significant risks for no real benefit just makes no sense and must not be imposed on the citizens of Mill Valley or Marin County by its elected representatives. Accordingly, I ask you to carefully consider the expertise and experience I bring to this matter and the points that I have made. Certainly, I will be happy to discuss the subject further with the Council and/or its members. In closing, in the interests of our town and its citizens, I again strongly urge the Council to opt Mill Valley out of the Marin Clean Energy project and to withdraw Mill Valley from the Marin Energy Agency as soon as possible.

Sincerely,
Kevin Ferrell