PGW's long and troubled history

In 2009, a delegation of state regulators visited Mayor Nutter after granting Philadelphia Gas Works an unprecedented emergency rate increase that kept the utility afloat through another financial crisis.

The missionaries from the Pennsylvania Public Utility Commission, headed by then-Chairman James H. Cawley, urged Nutter to sell the precarious city-owned utility before another financial disaster struck - or worse.

From the PUC's perspective, the utility's outlook was negative: PGW suffered from declining sales, its growth prospects were limited by the city's borders and its unwieldy public governance structure, it needed to accelerate replacement of its aging cast-iron gas mains, and its impoverished customer base was tapped out and could not pay more.

The PUC believed private investors, unshackled of political ownership, could reduce operating costs, inject outside capital, and assume PGW's risks from taxpayers.

"It's my view that a sale would be beneficial even if the city does not profit," Cawley advised.

Nutter set in motion a series of events that led Philadelphia to where it is today: Weighing an offer from UIL Holdings Corp. of New Haven, Conn., to buy PGW for $1.86 billion.

The proposed sale, now hanging by a thread, will reach a pivotal juncture in the coming days. Without City Council approval, the deal will expire at the end of December.

For sale advocates, UIL's offer provides the city a rare opportunity: Government could liberate itself from PGW's liabilities, private investors could dramatically speed replacement of brittle gas mains, and the city could inject a half-billion dollars of profit from the sale into its underfunded pension plan, providing budget relief for years to come.

Adding to the offer's urgency is the growing movement among regional political, business, and labor leaders to promote Philadelphia as an "energy hub." They say a private PGW could play a bigger role in developing industries tied to the booming Marcellus Shale natural gas field.

Nutter, entering the last of eight years in office, has been unable to persuade Council to endorse the sale.

Council President Darrell L. Clarke declined to introduce the mayor's legislation authorizing the sale, saying Council had "no appetite" for the proposed deal. Efforts are underway to rewrite the proposal to address Council's concerns.

No sweeteners will overcome those Council members who are flat-out opposed to privatization. They view the sale process as a power grab by business and Harrisburg interests that could leave vulnerable low-income customers to the mercy of an insensitive private utility.

Marian B. Tasco, the Council member leading the opposition, said PGW was doing well now and decried Nutter's efforts to "permanently divest ourselves of a very valuable city asset."

Clarke, a potential mayoral candidate next year, has stated a preference for exploring a less ambitious "public-private partnership" for PGW to build side businesses that might boost revenue. Those projects, such as manufacturing new fuels, also could contribute to the energy-hub efforts.

"At the end of the day, we have to take advantage of this very important energy opportunity," said Clarke, the linchpin of any decision.

That the city is even having this discussion now would have been unimaginable five years ago, when PGW was widely regarded as having no net value because it was so laden with debt and its own unfunded pension and post-retirement obligations.

Under the stewardship of new management appointed by then-Mayor John F. Street, PGW's finances improved significantly. PGW's unionized labor helped by agreeing to concessions. The PUC granted a series of favorable rate increases.

PGW was put up for sale at an opportune moment, when utilities are valued at a premium and interest rates are low. Thirty-three entities submitted bids.

A wild card unforeseen in 2009 added to its value: The dramatic growth of gas production from the Marcellus Shale field. Nearly a quarter of the nation's natural gas is now produced a few hours' drive from Philadelphia, and the brokers marketing PGW emphasized the utility's proximity to shale opportunities.

Econsult Solutions, which reviewed the proposed sale on behalf of the Mechanical Trades Council of Delaware Valley, said the UIL sale "could represent a once-in-a-lifetime opportunity" to stimulate industrial development.

Sale foes say the same factors bolster their arguments.

Councilman W. Wilson Goode Jr., at a Nov. 13 hearing examining alternatives to selling the utility, wondered whether a sale would provide only a one-time infusion to the city treasury.

"When we give up the asset, we give up control of long-term economic opportunities," he said.

Nutter and the PUC say that despite PGW's improved financial condition, the utility's fundamental weaknesses are unchanged.

If anything, the PUC's interest in getting the city to sell are only stronger today than they were five years ago. Over five months in 2010-11, PGW, as well as gas utilities in Allentown and San Bruno, Calif., had fatal explosions, adding pressure on regulators to force gas-distribution companies to address aging infrastructure.

"If you ask us what keeps us up at night of the 8,000 entities that we have oversight for, I'd say PGW was No. 1," said Robert F. Powelson, the PUC's chairman.

PGW's current problems are chronic and can't be easily addressed by a municipal ownership structure, supporters of a sale contend.

Since 1981, PGW's sales volumes have declined 35 percent. The typical residential customer now uses 830 units of gas, down from 1,290 three decades ago.

"PGW's sales volume has dramatically decreased due to lost population, less industry, warmer weather, and energy-efficient appliances," the utility's chief executive, Craig White, told the PUC at a hearing Nov. 14. Each time a customer replaces an old furnace or water heater with new, efficient equipment, gas sales decline further.

PGW can either cut costs or increase revenue to avert a projected $40 million rate increase in 2018, he said.

PGW's payroll has already contracted from 2,825 employees to 1,630 in recent decades. But until its aging infrastructure is replaced - half of the 3,000-mile system is obsolete cast-iron mains - it will need a large workforce to respond to the high volume of leak complaints, White said.

PGW would need to borrow more money to ramp up its gas-main replacements or to invest in new growth ventures, such as expanding production of liquefied natural gas at its Port Richmond plant to respond to a growing market for LNG fuel.

But PGW has struggled with efforts to reduce its debt in recent years from 83 percent of equity to 70 percent (investor-owned utilities typically aim for a 50-50 debt-to-equity ratio). Increasing PGW's debt also puts city government's creditworthiness into question.

"There's sort of a vicious cycle there," White told the PUC. "The more debt we issue, the more that influences Wall Street and the rating agencies, the next thing you know, your bond rating drops, your interest rates go up, and you're back at the commission for a rate increase."

PGW is also limited in the type of ventures it can engage in that might generate new revenue.

"As a municipal, we have no shareholders, and risky ventures are not exactly in the DNA of governments," White said. The risk-averse approach makes it "very difficult for us to react nimbly and timely when market opportunities present themselves."

Pressed by the PUC, White said a privately owned PGW would have more flexibility to develop the kinds of ventures envisioned in an energy hub: pipelines, gas-to-liquid plants, LNG manufacturing, or power production.

"I'm certain that an investor-owned PGW would play a much larger role in the development of an energy hub than a municipal PGW will," White said. "That's just a fact."

The Nutter administration has tried to diminish the growing sentiment on Council favoring a public-private partnership.

Most of the partnership conversations have focused on expanding LNG production. But Shelley R. Smith, the city solicitor, says a partnership poses insurmountable legal issues and would jeopardize the tax-exempt revenue bonds the city used to finance the LNG operation.

Nutter says a partnership would also do nothing for the city's beleaguered pension plan or to relieve the city of PGW's liabilities.

A sale would generate net proceeds of $417 million to $628 million for the city's underfunded pension. The infusion would reduce the city's annual minimum pension payment by $41 million, to $62 million, more than offsetting the loss of $18 million that PGW now pays the city.

215-854-2947 @maykuth