Indiana Utility Regulatory Commission and Citizens Energy Group and Sewer and Energy & Environment and Water and Utilities

Smooth utility deal carries potential bonus for city

August 21, 2010

Lost amid the roiling debate over whether the city should sell its water and sewer utilities to Citizens Energy is a little detail that could increase—or decrease—proceeds of the deal by $25 million.

It might not seem like much in the context of the $1.9 billion sale approved by the City-County Council last month, but $25 million is about half of the city’s anticipated budget deficit next year. And it’s what the Indiana Pacers have asked for in capital improvements to Conseco Fieldhouse.

Citizens Energy deal fact boxIt’s also the amount the city can hang onto if Citizens can successfully manage and mitigate the city’s lingering legal and contractual obligations involving the utilities over the next two years.

Key among them: successfully renegotiating operating agreements with Veolia Water and United Water. The two private firms now manage the water and sewer utilities for the city. United’s contract is set to expire in 2018, Veolia’s in 2022.

To cover claims the two utility operators could potentially file stemming from the sale, and to indemnify Citizens from other claims it could inherit, the city plans to put $40 million into an escrow account at the closing of the deal.

Such escrow accounts are not uncommon in major asset sales and could cover any breach by the city “of any representation, warranty or covenant.” Other potential liabilities include lingering health care and retirement obligations or some environmental issues that originated under city ownership.

According to sale documents, the city’s obligations are effectively capped at $40 million; any legal obligations above that amount are Citizens’ problem.

The ideal scenario is that Citizens never need tap the $40 million for legal claims. If so, two years after the sale closing, Citizens would get $15 million and the city would keep the other $25 million of the unused escrow amount.

The $15 million is to serve as an incentive for Citizens to manage the transition cost-effectively.

“That’s absolutely our hope,” said Chris Cotterill, Mayor Greg Ballard’s chief of staff.

Contract talks

Under that ideal scenario, the total proceeds the city could reap from the sale could be $459.7 million. But if the escrow is exhausted, the city expects to collect $434.7 million—$25 million less.

Or, the amount of proceeds could land somewhere in the middle. If Citizens draws down part of the $40 million in escrow, it would, after two years, keep 37.5 percent of the remaining escrow—somewhat less than the $15 million maximum.

The city would get the remainder.

“It’s not necessarily all $15 million. They don’t get all $15 million unless they have the full amount of the escrow left,” Cotterill said.

Citizens, which operates the city’s gas, steam and chilled water utilities, won’t elaborate on the progress of talks with Veolia and United. Nor will it say to what extent it plans to engage them going forward.

“Citizens is continuing to negotiate with Veolia and United for new long-term contracts that will ensure the most efficient and effective utility services” for ratepayers, Citizens spokesman Dan Considine said in a prepared statement run through a gauntlet of lawyers working on the deal.

On Aug. 11, the city and Citizens filed a case with the Indiana Utility Regulatory Commission seeking state approval of the sale. The IURC’s approval is all that’s still needed to close the deal.

Already, public comments are trickling in to the commission. They range from concerns about whether Citizens would meet minority contracting goals to a regurgitation of the unsuccessful argument opponents used in testimony before the City-County Council.

For instance, Larry W. Williams of Indianapolis told the commission the deal amounts to a hidden tax increase and urges the IURC to reject it.

“Where do you think this money comes from? It comes from ratepayers,” Williams reasons. “This is not free money that just fell from the sky. Citizens did not just pull [the purchase price] out of their back pocket. We, the ratepayers/taxpayers, are not off the hook; we will have to pay it back.”

Savings projections rosier

Citizens said it will retain all union employees at the water and sewer utilities and plans to use attrition to adjust staffing of back-office operations. Citizens is considering a wide range of efficiency moves, such as joint purchasing, a single customer service center, improved debt collection and the use of more conservative debt management practices at the water utility.

When the City-County Council approved the sale, Citizens estimated it could achieve annual savings of $43 million. That might have been conservative.

“A more thorough analysis now indicates that combining the … utilities may yield annual savings of up to $60 million after a three-year integration period,” Considine said, saying executives upped the estimate after getting their hands on more data during due diligence.

The city’s recent filing with the commission mentions the plan to put the $40 million in escrow. The amount wasn’t outlined in a memorandum of understanding released last year when Mayor Greg Ballard proposed selling the utilities.

Rather, the memorandum said the acquisition price would be subject to a “downward adjustment” of up to $15 million to the extent Citizens assumed certain obligations.

The adjustment would be based on a “mutually agreed cost-sharing, indemnity and escrow arrangement” to be included in the definitive agreement, later, it said.

The $15 million “is an incentive to Citizens to work with Veolia and United to ensure their continued involvement with the utilities, and to preserve Veolia and United jobs as well as minimize any costs associated with the renegotiation of their contracts,” Baker & Daniels attorney Nate Feltman said in a memo to Cotterill in late June.

Nearly nine years ago, when the city bought the water utility for $515 million from Merrillville-based NiSource Inc., a $35 million escrow was set aside to protect the city from lingering obligations, Cotterill said.

In any case, last month, the City-County Council approved the $40 million escrow plan when it OK’d the sale. That agreement shields Citizens from some liabilities, however, including some environmental penalties assessed by regulators, and some so-called Barrett Law claims stemming from sewer connection fees.

The $40 million escrow is the largest of the city’s list of costs in the deal, which is expected to generate $504.4 million for the city before deducting any costs.

Other deal costs

Out of another $15.9 million in costs, about $9 million is to be paid to attorneys, bankers, engineers and public relations firms. Big firms hired by the city, besides Baker & Daniels, include CitiGroup and Crowe Horwath.

City officials expect the sale and restructuring under Citizens will reduce rates at least 25 percent. But ratepayers still face “substantial” annual rate increases in coming years due to a 2006 consent decree the city reached with the Environmental Protection Agency to reduce combined storm and wastewater overflows.

Sewer upgrades, including a 20-mile catchment tunnel to be burrowed deep beneath the city, are anticipated to cost at least $1.7 billion by 2025.

The city expects to pocket $262.6 million in cash from the sale. It will fetch another $154 million in bond proceeds secured by payments in lieu of taxes the new owner of the utilities will pay the city. Originally expected to be $140 million, the proceeds from the bond are now $153.8 million, Ballard said recently, crediting the city’s AAA credit rating.

Citizens is also absorbing debt from the utilities, including $916 million from the water operations.

The city’s $153.8 million in bond proceeds is to be used in a first round of road, bridge and sidewalk projects. How the rest of the money coming from the deal will be spent is subject to City-County Council oversight.•

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