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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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Sao Paulo's Power Grid Nears Breaking Point

  • Sao Paolo is facing blackouts and experts are warning that its grid may collapse if no action is taken soon.
  • Enel Distribuiç?o São Paulo (still “Eletropaulo” to many consumers) became an indirect subsidiary of the Italian, state-controlled, giant Enel in 2018.
  • The shortfall of capital spending at Eletropaulo and asset stripping at Thames were not one off events or accidents but rather the result of a change in utility culture.
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Dark days ahead in São Paulo, the industrial and commercial hub of Brazil. They noticed last month, after a three day blackout hit the city’s center and its poorer neighborhoods, although a previous power outage in November was a portent of things to come. Consultants contend that the electric company has underinvested for years and that the city’s grid will collapse within three years unless corrective action is taken—which sounds a lot like Thames Water. The electric company declared that it was in “full compliance with all contractual and regulatory obligations.” (That comment reminds us of the inevitable reply when one says to a nursing home operator that there are not enough nurses and aides around to care for the patient, which is, “We are complying with all regulations.” Note, not that there are enough nurses and aides, just that they are complying with the letter of the law. That is a great way of shifting responsibility.)

Enel Distribuiç?o São Paulo (still “Eletropaulo” to many consumers) became an indirect subsidiary of the Italian, state-controlled, giant Enel in 2018. Enel, which operates in 30 countries, may be the largest electric company in the world. This situation resembles that of Thames Water which was once a government agency, then a company owned by British investors, then a company owned by a German utility, after which it fell into the hands of an Australian infrastructure investor, and finally various pension and investment funds. Thames Water’s managers have been accused of loading the company with too much debt, paying excessive dividends, and spending inadequately on major water quality capital programs, in effect, draining the company of cash resources to the point that it has literally begun to default on several fixed income obligations. Related: What Does Renationalizing Thames Water Mean?

Way back in the early days of the late nineteenth century, local business people or municipalities set up the electric utility. Then several decades later the holding companies took over, not to achieve economies of scale, but to exploit leverage and complex financial structure to extract profits from a large number of local operating utility companies. When the holding companies collapsed, (battered first by depression and then regulated by the ‘34 act), the component parts re-emerged as independent companies or as government agencies, and the focus returned to the local level. The surviving holding companies operated contiguous subsidiaries and the local utility became a booster and synonymous with the local economy. Utility executives were part of the local establishment and would find it embarrassing if they had to explain why the lights kept going out to their friends and neighbors at the country club. (Ditto for the British electricity boards with their local advisory boards.) By the 1990s, however, governments had gotten tired of regulating. The U.S. government enforced the Public Utility Holding Co. Act of 1934 in the most cursory fashion and finally dumped it in 2005. After the British privatized the electric companies, their government showed no interest in who owned the nation's vital infrastructure. The new utility mandate was simply —just follow the rules. Nothing else. Financiers, national champions, and empire builders got to work re-building new financially predatory holding companies. They did not do it to improve electricity service, for sure. But whatever the reason, the relationship between the utility and those served became purely contractual and all residual notions of the public interest were cast aside. And, as many of you realize, well paid insiders know more than government staffers, so the public may end up on the losing side of those arrangements.

So, we argue, that the shortfall of capital spending at Eletropaulo and asset stripping at Thames were not one off events or accidents but rather the result of a change in utility culture. Utility managers went from trying to serve a local public interest to instead serving the purely financial interests of international holding companies that could easily be headquartered in Abu Dhabi or Beijing. For the public, the new managers do no more than is required by the regulators who really do not understand the capabilities of the regulated entity. For the holding company shareholders, the utility managers extract the maximum cash from the utility even if doing so affects service now or in the future—or at least until something breaks. All of which is aided and abetted by light-handed regulators.

But in the end, the utilities have less leverage than their comments about meeting requirements would indicate. Unlike other internationally owned businesses, they cannot move their assets or their customers elsewhere. Utilities serve a geographically specific place however they’re owned. Foreign owners will argue that punitive actions taken against them by regulators will affect the country’s reputation among investors. But protecting foreign investors who provide substandard service is not a winning election ploy for politicians. Even in bankruptcy or other forms of financial reorganization, utility assets continue to provide service. So why rescue them? Equity shareholders in sprawling holding companies might have to get used to the idea that they have to provide a service, not just take out the dough. 

By Leonard Hyman and William Tilles for Oilprice.com

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