Urban Politics #172: Council Considers City Light Subsidy For Local Steel Mill


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By City Councilmember Nick Licata.

With assistance from my L. A. Lisa Herbold on this issue

Urban Politics (UP) blends my insights and information on current public policy developments and personal experiences with the intent of helping citizens shape Seattle’s future.

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CONTENTS:

  • Council Considers City Light Subsidy For Local Steel Mill
  • History Of Steel Mill’S Reduced Rate
  • Current Proposed Legislation
  • The Possible Loss Of Jobs
  • Cash To The City
  • The Value Of Interruptible Power
  • A Reasonable Approach


Council Considers City Light Subsidy For Local Steel Mill

The City Council will consider legislation proposed by the Mayor for Seattle City Light to sign new electricity service contracts between it and Nucor Steel Corporation, City Light’s largest customer. This legislation is controversial because it significantly reduces the company’s financial obligation to SCL. Councilmember Jean Godden’s Energy Committee will be briefed at its meeting this coming Friday on the proposal, with a possible vote.

To understand the new proposal it is necessary to review the history of this contract, the rationale behind the new contracts and finally the Council’s options, including one I propose.

History Of Steel Mill’S Reduced Rate

In 2001 Birmingham Steel had been hit hard by escalating power costs. They approached the City to develop “a partnership that would benefit both parties” as Birmingham’s General Manager Eddie Lehner explained in a memo written toÊ Councilmember Heidi Wills in October 2001. The steel company was having difficulty reaching an agreement with City Light to reduce its electrical bill and was seeking assistance from the City Council. After much wrangling with the Paul Schell administration, the Mayor presented a proposed electrical contract between SCL and Birmingham, much like Mayor Greg Nickels is doing now.

The final contract that was agreed upon by both the Mayor and the City Council reduced Birmingham’s electrical rates during 2002 and 2003. Instead of paying $55.40 MWh (per megawatt hour) like City Light’s other industrial customers, they would pay only $38.89 per megawatt hour. They had originally threatened to close the plant down if they did not get $35 MWh. This worked out to them saving roughly $12 million and paying back about $13.5 million over the subsequent five years, beginning this year. The additional $1.5 million roughly captured the interest costs associated with ‘paying back’ the savings over time.

In negotiating with Birmingham City Light maintained, according to the Superintendent and the Mayor, the basic principle that any new rate must not provide a direct subsidy to the company. Any short-term rate relief must be balanced against an increase in future rates that will have the effect of leaving City Light financially whole. There was a concern that the other major industrial producers could also make a similar request for lower rates.

As part of the rationale for providing these lower rates City Light obtained the right to interrupt the company’s electrical supply if the price of electricity reached a certain trigger price. Consequently a new electrical rate category was created for the steel mill. In a SCL issues brief memo that predated the agreement, SCL staff concluded that it was unlikely that the utility would ever benefit from this provision. In fact the “interruptibility” clause has never been used by City Light.

Even before the agreement was signed, SCL had financially helped the steel mill operate efficiently and keep its utility bills low. They had given the company over $1.1 million in conservation incentives in 2001. In addition during the 2000-2001 energy crisis, City Light paid Birmingham a total of $4 million to not operate the mill (which reduced their effective energy costs by almost 40%, even though their total operating hours were not significantly reduced).

One final note on Birmingham; they went bankrupt in 2003 and NUCOR bought the plant along with the ongoing rate agreement with SCL, and therefore assumed both its lower rates and its obligation to pay back those deferred savings.

Current Proposed Legislation

An ordinance submitted by Mayor Greg Nickels does a number of things. It accepts a one time immediate payment of $9 million instead of receiving the $13 million over 5 years. It continues and expands the “interruptibility” provisions that are intended to strengthen the utility’s ability to capture revenues, at a cost to SCL of at least an additional $2 million. The steel mill would pay $3 more per MWh bringing their cost to $42 per MWh for 2004 but they might adjust it up to $49 a MWh, after the year is over depending on what SCL’s 2005 rate is determined to be in late 2004. I believe this just an invitation to come back and ask the City for a third time to provide lower rates.

The Mayor’s initial press release lists three major benefits to Seattle: preservation of about 300 family-wage jobs in Seattle, an immediate payment of $9 million to City Light; and new interruptibility provisions that strengthen the utility’s ability to capture revenues. Below I look at each of these three assertions and try to determine to what extent are they public benefits or public costs.

The Possible Loss Of Jobs

The first benefit is an economic benefit to the entire community and certainly the possible loss of any jobs to Seattle is a serious concern. The NUCOR steel mill has 285 employees. But such a possible loss must take into account the probability of NUCOR closing the plant.

The threat that NUCOR would shift work to one of their other two west coast steel mills has been raised. They have one in Utah and another in Arizona. The Utah plant is operating at full capacity so it is unlikely expand production without significant and costly new plant investments.

The Arizona plant on the other hand was closed as of the end of last year. NUCOR has said they may need only two plants so the assumption is that they could close the Seattle plant and reopen the Arizona one. However that plant has a troubled past, and never operated at full capacity due to its inability to obtain a long-term power contract. In fact its prior owner, North Star, could not operate the plant at a profit. So North Star closed the plant and sold it to NUCOR for $35 million, although the plant was built in 1996 for about $175 million.

Daniel DiMicco, NUCOR’s CEO, noted in Metal American Market (March 26, 2003) that the Arizona’s plant is not of the latest design and hadn’t worked successfully at that location. In other words there is no comparison between Seattle’s plant, which is one of the most efficient steel mills in the nation and the Arizona one. Our central staff concluded that the Arizona facility does not appear to be a viable option in the short-run, and definitely not without some plant upgrades and a new power contract. In sum, NUCOR does not have the leverage they imply with this plant.

Cash To The City

Part of the attraction of the Mayor’s proposal is for the City to receive a significant amount of cash upfront, however the $9 million lump-sum payment is equivalent to the $13 million paid out over roughly 4 years, if one assumes s over a 14% rate of discount. City Light’s costs of borrowing is at most 5%. At that rate, an $11+ million lump-sum payment is equivalent to the $13 million paid over time. However, given that City Light faces the risk of NUCOR ceasing operation and receiving no further payments over time, a discount rate somewhat higher than the 5% can be justified in economic terms but going to over 14% fails the straight face test.

The Value Of Interruptible Power

Electricity service would still be interruptible, but the energy price trigger would be reduced from $55 to $49 per megawatt-hour. If City Light were to interrupt service, the utility would realize more revenue because it would no longer be required to share its gains with NUCOR.

However, it is unlikely that this value amounts to the approximate $6/MWh ‘discount’ NUCOR would receive if they paid only $49/MWh in 2004 vs. $55/MWh which other industrial users would be paying. Given that it is possible that their rate might be less than $49/MWh when they lobby the City during the next rate setting process the gap would be even greater.

An initial analysis suggests that a ‘discount’ of $2/MWh would probably better reflect the actual economic benefits to City Light. When combined with a potential rate reduction in 2005 of an additional $2/MWh – $3/MWh which City Light might be considering, this implies a long-term energy rate for NUCOR of roughly $50/MWh. (A base of 55/Mwh minus a reduction of 3/Mwh plus the ‘discount’ of $2/MWh SCL’s right to interrupt NUCOR’s energy flow.)

A Reasonable Approach

After reviewing the material, I believe a reasonable approach recognizes NUCOR’s value as a major employer and balances it against their contractual obligation to pay back the discounted rates they have been receiving. When I do the numbers I conclude that they should make a single payment of $10 million to the City rather than $9 million. This figure is based on a 10% discount rate, which takes into account both the City’s costs of borrowing and the risk factor of the steel plant shutting down.

They should also pay a rate of no less than $50/MWh for 2004. Since the City Light Rate Advisory Committee will be reviewing and making recommendations for all 2005 City Light rates, NUCOR and other industrial users’ rates may be subject to a reduction at that time.

This approach avoids a direct subsidy to a particular company, which was one of the key principles identified by City Light and the Council when the previous agreement was established. And it maintains the City Light’s commercial/industrial rates being charged on a cost-of-service analysis, not on an ‘ability-to-pay’ basis.Ê

* This a short but technical explanation on why the $50/MWh is a fair rate. Our central staff suggest that a ‘discount’ of $2/MWh would probably better reflect the actual economic benefits to City Light of having the right to interrupt the company’s electrical supply. When that $2 discount is combined with an expected City Light rate reduction in 2005 of an additional $3/MWh, a net of $50/MWh is reached after being deducted from the $55/MWh that NUCOR would be expected to pay.

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