AG accused CUC of ‘gold-plating’

Former Auditor General Nigel Esdaile found ‘strong and persuasive evidence’ that Caribbean Utilities Company had undertaken excessive capital investment in order to increase electricity rates and investor returns.

The findings were part of a Special Report of the Auditor General on Caribbean Utilities Company Ltd, which was completed in October 2003 just prior to Mr. Esdaile’s leaving the post, but only tabled in the Legislative Assembly last Wednesday.

Mr. Esdaile said the issues raised in the report indicated CUC’s non-compliance with its licence agreement over a protracted period of time.

‘Specifically, there is solid evidence, supported by our independent consultants, of excessive and/or unjustified investment – ‘gold-plating’ – in both generating plant and transmission and distribution assets.

‘These investments have had a significant impact on the Rate Base and have driven up tariffs more than is reasonable and necessary,’ Mr. Esdaile stated, adding that he recommended the matter be referred to the Government’s Legal Department for review.

The report was never made public until last week for a variety of reasons, partially because it was feared it would prejudice CUC’s licence renewal negotiations with the Cayman Islands Government. Those negotiations began in November 2003 and did not conclude until April, 2008.

The Auditor General’s report on CUC was requested in 2002 by former Minister of Works Linford Pierson. Former Electricity Regulatory Authority Chairman Cline Glidden Jr. said Thursday the findings of the report influenced the 2001-2005 UDP administration’s stance on CUC.

‘It was the foundation on which we based our position,’ he said, adding that the pressure the UDP brought to bear on CUC in October 2004 to ‘roll-back’ a three-per cent price increase that took effect 1 August, 2004, came after Mr. Esdaile’s report was circulated to Members of the Legislative Assembly.

The report was particularly critical of CUC’s 15-per cent rate of return at the time, something that was changed when the electricity producer signed the new licence agreement last year.

‘The 15-per cent rate of return was probably reasonable when it was introduced in 1979, when global interest rates were much higher,’ the report stated. ‘In my opinion, it is now excessive.’

Because there was what Mr. Esdaile called light-handed regulatory control over CUC, he said there was no effective participation of government in the corporate decision-making process from a public interest perspective,

‘Specifically, there has been no oversight and few restrictions on the scale and nature of CUC’s capital investment,’ the report stated. ‘Tariff increases are driven by investment, not efficiency or productivity.’

The report stated that even though the fully allocated cost of the production and distribution of electricity had ‘remained remarkably constant over the past 15 years’, electricity rates had increased over 30 per cent over the same period.

The report highlighted several cases of what Mr. Esdaile called excessive, gold-plating capital investment, including cases where new generating capacity was installed in advance of need or justification.

‘Two 10.3 MW units commissioned in 1987 and 1989 were substantially too large for the system and affected system reliability,’ the report stated. ‘A 7.59 MW generator installed in 1992 was not actually required until 1996. More recently, a 12.25 MW unit commissioned in 2001 took generating capacity well over the maximum stipulated in the licence.’

The former Auditor General also found fault with CUC’s investments in its transmission and distribution system. The report said the decision to lay the 14-mile, US$8.6 million submarine cable across North South could have been deferred for five years with only a minor impact on reliability.

Audit consultants also found that if CUC had done a proper analysis of alternative options before replacing the old North Sound substation, which they said had substantial residual life, it might have resulted in cost savings of up to US$15 million.

More significantly, the report stated the consultants were not shown any documentation to justify investment in almost US$200 in transmission and distribution assets projected from 1996 to 2010.

‘They concluded there is strong evidence of system over-build,’ the report stated.

CUC disagreed

The former Auditor General noted that CUC’s management disagreed with most of conclusions and findings contained in the report. The utility company’s comments were included at the end of the report to provide balance.

With regard to investment in electricity infrastructure, CUC said it was necessary for ‘reliable, world-class service’.

‘The… report appears to take the early position that CUC is over-investing for the exclusive benefit of shareholders at the expense of consumers,’ CUC stated.

‘CUC consumers have grown to expect world-class reliability and this requires CUC invest in new technology, reliable assets with long lives and maintain a sufficient reserve.’

CUC stated that the Auditor General’s report downplayed the importance of reliability.

‘The report concludes that CUC has excessive generating capacity for Rate Base reasons, yet finds its reserve margins comparable to other utilities in the Caribbean. It also concludes that countries with lower reserve margins can experience ongoing power outages.’

CUC argued that the risk factors of investment in a small island exposed to a substantial hurricane risk should be considered when discussing appropriate returns for the shareholders of the company. It also noted that the government earned more through fees and duties from CUC between 1991 and 2002 than its shareholders did.

The company stated its use of debt in its capital structure was prudent.

‘When analysing the debt-to-equity ratio of CUC, it can be concluded that the company maintains a healthy level of equity, which has been the key to its financial strength.’

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