CUC surcharge clause necessary

A clause in the Agreement in Principle signed last week between the Cayman Islands Government and Caribbean Utilities Company will allow CUC to implement a temporary surcharge in the event a catastrophic event causes significant losses to the company.

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CUC President and CEO Richard Hew said the provisions of the clause are standard in the electricity industry and he explained why they were necessary.

‘Investors and lenders won’t come on our side unless the major risks are covered,’ he said.

Although CUC and insure its generation assets such as its plant and generators, it is very difficult if not impossible to insure transmission and distribution assets.

Insuring transmission and distribution assets changed after Hurricane Andrew cut a devastating swath through the northern Bahamas, Florida and Louisiana in August 1992, Mr. Hew said.

‘The insurance providers… decided T&D insurance was way too much exposure and they were not going to carry it,’ he said.

Since then, T&D insurance has been available from time to time, but it is difficult to find and very expensive, with premiums that start around 12 per cent of the insured value. Mr. Hew said some companies will place a certain amount of T&D insurance on the market on an inconsistent basis, almost as gamble.

‘But you don’t have standard programmes like you do in other property assets,’ he said.

Based on the high price and difficulty in obtaining coverage, CUC made the decision that T&D insurance was not cost effective.

Had it decided to pay the price, however, it would have just added to the company’s expenses, which would have ultimately been paid for by the consumer through higher rates.

CUC has investigated the possibility of joining a self-insurance plan proposed by the regional electricity companies, but Mr. Hew said the rates only seemed beneficial to countries on the periphery of the hurricane zone.

‘I did not see any benefit from it for CUC,’ Mr. Hew said, adding that none of the Caribbean countries considering the programme went ahead with it.

Without insurance, CUC was faced with a choice on how to deal with a catastrophic loss; either charge an up-front fee to customers to set aside for the disaster contingency or to collect fees after the fact though a cost recovery surcharge. The latter was done after Hurricane Ivan caused millions of dollars of damage to CUC assets in September 2004.

Mr. Hew pointed out that many private sector businesses did the same thing, only it wasn’t called a cost recovery surcharge.

‘Other businesses that weren’t regulated… if they had costs to recover, they raised prices to do so. The prices on a lot of things went up after [Hurricane] Ivan.’

CUC suffered about US$20 million of uninsured T&D losses as a result of Hurricane Ivan. The depreciated value of those assets was about US$14 million, Mr. Hew said. Ultimately, the company agreed to accept US$13.4 million in the form of a three-year 4.7 per cent cost recovery surcharge that was added to electricity bills.

As part of the licence renewal agreement, however, CUC will cease collecting the cost recovery surcharge after this month. Electricity Regulatory Authority Managing Director Phil Thomas said last Thursday CUC was ‘basically walking away from CI$2.2 million in cost recovery surcharges.’

Mr. Hew spoke about the reasons for doing that.

‘It wasn’t that we weren’t entitled to collect the full amount, or that it wasn’t fair and just,’ Mr. Hew said. ‘This was a concession we made in our negotiations for our new 20-year licence.’

Although CUC will not obtain insurance for its T&D assets, it is doing other things to protect those assets. As part of an effort to mitigate the effects of any future hurricane hit on the island, CUC is doing things like putting its substations indoors and building more concrete poles, said the company’s Corporate Secretary Douglas Murray.

‘By continuing our hardening of the T&D assets, we’re doing everything we can to prevent costs,’ he said.

The Cayman Islands Government might also help reduce or lessen any cost recovery surcharge that might become necessary to impose in the future.

Leader of Government Business Kurt Tibbetts said in the past that the government was willing to look at the possibility of sharing some of the risk of CUC’s uninsured assets as a way of keeping electricity costs down to the consumer.

Last Friday, he said the government was still investigating whether Cayman could insure separately the CUC’s T&D assets through one of the regional catastrophic insurance programmes.

Mr. Tibbetts said he agreed with the approach of the Agreement in Principle whereby CUC would only charge a cost recovery surcharge after a catastrophic event.

‘Why have to pay for it in advance when it’s something that might not happen,’ he said.

In the event CUC would have to impose another cost recovery surge after a catastrophe, the company would work with the Electricity Regulatory Authority to determine the surcharge that would be required to take CUC back into its target return on rate base of 11 to 13 per cent.

Because CUC would use its credit rating to borrow the cash it needs to repair any damage it sustains in a catastrophe – and thus restore power as quickly as possible – the timeliness of cost recovery would be important so CUC did not experience any liquidity problems, Mr. Hew said, adding as an example that CUC couldn’t wait 20 years to recover a $20 million outlay.

‘We will look at the impact on the consumer… and their ability to pay our bills, too,’ Mr. Hew said.