April 6, 2010

By Tracy Idell Hamilton and Anton Caputo
San Antonio Express-News

Editor’s note: This story originally appeared Sunday, April 4, exclusively in the print edition of the San Antonio Express-News.

Mayor Phil Hardberger always was privately skeptical of the rosy outlook CPS Energy executives painted as they pushed for the expansion of the South Texas Project nuclear plant.

He said he wasn’t outright opposed to the construction of two new reactors, but he was wary of cost estimates that always were lower than those for similar projects across the country.

Back in 2007, the CPS Board of Trustees was getting the hard sell from executives who warned that San Antonio could run short of power as early as 2016.

"We felt a lot of pressure to keep moving forward at all times," he said recently.

But Hardberger, an ex-officio CPS board member, saw potential trouble on the horizon, financially and politically – and he had an idea about how to limit dam? age on both fronts.

Sitting in a board meeting that fall, Hardberger wrote his idea on a yellow legal pad. He tore off the sheet and slid it over to CPS CEO Milton Lee.

The message was simple: As it pursued the nuclear expansion, the utility must promise San Antonio that it would limit electricity rate increases to 5 percent a year every other year.

Doing so, Hardberger reasoned, could give future City Council members political cover if they judged the expansion worth pursuing, while setting a limit that most San Antonians could afford.

That language was incorporated into a board resolution that, as much as anything, set the community’s expectation about the cost of the nuclear project.

So, last year, when CPS pushed for a 9.5 percent increase, not 5 percent, just two weeks before the council was set to vote for $400 million more for the project, the switch angered council members and the public.

CPS officials tried to explain. While the rate boost would be 9.5 percent, once savings from the Spruce 2 coal plant came online sometime in 2010, the overall bill impact would be just 5 percent, they said.

That explanation did little to mollify the council or ratepayers, and CPS executives’ apparent inability to understand their outrage typified the utility’s tin ear when it came to navigating the politics surrounding the hotly debated project.

The revelation in October that a $12 billion construction cost estimate had been kept from the CPS board – and the ensuing uproar – may have been the precipitating event that blew up the deal with NRG Energy a few months later. But CPS’ failure to get the politics right was one of several factors that undermined the utility’s efforts to stay in the project.

Others included a leadership vacuum at CPS that allowed a cadre of true believers – the utility’s nuclear development executives – to continue pushing the deal, even as the economic ground shifted beneath their feet.

By 2009, the country was wallowing in a recession that had altered the energy landscape: San Antonio’s power needs had diminished, natural gas prices were dropping and the imminent threat of carbon-emissions legislation was receding.

But it wasn’t until San Antonio elected a new mayor in May that the CPS board gained a skeptical voice questioning the assumptions of the deal. Before then, there seemed to be few checks by the board as the project moved forward, even during the bouts of heartburn brought on by CPS’ partner in the deal, NRG.

The merchant power company based in New Jersey had long nursed concerns over CPS’ ability to get public approval and pay for the equal ownership share of the project the utility insisted on, resulting in periodic friction between the partners.

CPS executives’ decision not to reveal the high cost estimate to the board amped up that friction, since NRG planned to share it with analysts at a quarterly meeting. But during that meeting, Steve Winn, CEO of Nuclear Innovation North America, a partnership between NRG and contractor Toshiba, went further.

He told Wall Street analysts that San Antonio might not be able to afford the project, a move that infuriated CPS.

Rumblings that NRG was working against the utility’s interests intensified.

Working to be first

NRG CEO David Crane defended his company’s actions.

NRG didn’t want CPS out of the deal, he said. Whatever level of investment San Antonio could support was fine with NRG, but the utility needed to decide. The uncertainty was damaging the project’s reputation, he contended.

Crane, a former Lehman Brothers investment banker, had international business contacts that helped NRG forge agreements with Japanese firms like Tokyo Electric Power Co., which signed on as a consultant in 2007, and Toshiba, which ordered from Japanese Steel the massive reactor parts no American company could make. NRG also looked to the Japanese government for loan guarantees.

With the STP expansion, NRG was reaching for a goal no less ambitious than reigniting the U.S. nuclear industry, which had stalled in the 1970s.

But with passage of the 2005 Energy Act, incentives became available for companies willing to take the risk.

In 2007, NRG became the first company in decades to file an application with the Nuclear Regulatory Commission. STP’s already-available land, water and transmission lines made it one of the most favorable sites in the country.

Still, NRG sought to reduce its risk further – an effort that led to one of the most controversial developments of the project, from CPS’ perspective.

In March 2008, without telling CPS in advance, NRG signed a deal with Toshiba to create NINA, to market and build nuclear projects throughout the U.S.

Toshiba paid NRG for the right to act as contractor on future NINA nuclear projects and for a 6 percent share of the STP expansion.

Crane said the partnership had an added benefit: As a co-owner, the contractor would have an interest in trying to keep the project’s costs in check.

The view of the deal from Navarro Street, though, was one of suspicion.

CPS Trustee Steven Hennigan, who survived Castro’s call to step down last fall, was uncomfortable with NRG, so the partnership deal with Toshiba put him on high alert.

And when, more than a year after NINA was formed, Winn and Mike Kotara, a senior member of CPS’ nuclear development team, came up with a plan to change the partners’ ownership terms from 50-50 to 60 percent for NINA and 40 percent for CPS, Hennigan’s alarm bells really went off.

But the genesis of that proposal stemmed not from NINA, but from CPS’ own financial woes, Kotara said.

In May 2008, after spending about $200 million on the project, CPS asked the City Council for a 5 percent rate increase, about a third of which would go for the expansion. But even after intense lobbying by Hardberger, the City Council approved just 3.5 percent, specifically asking that none of the increase go to the nuclear project.

"So we had another six months of drift," Winn said. "That’s when Kotara and I started talking about a 60-40 split."

That would have put some money in CPS’ pocket, but the CPS board rejected the offer, wanting to maintain its equal footing with NRG, even though the utility was dealing with almost unprecedented financial difficulties.

The world changes

For years, CPS’ finances had been strong. It didn’t need to raise rates and it had the highest credit rating of any municipally owned utility in the nation. It operated for decades with little oversight, dutifully shipping hundreds of millions of dollars every year to City Hall – enough to make up almost a third of the city’s general fund – while offering some of the lowest power rates in the country.

CPS was accustomed to the public praise of elected officials.

And while Hardberger largely had kept his reservations about the proposed nuclear expansion to himself, Castro began questioning the deal almost immediately after taking office in June.

His concerns were bolstered by the work of Councilman Reed Williams, a retired refinery executive who ran the numbers on the nuclear deal and didn’t like what he saw. Compared with the cost of natural gas, nuclear power had just a slight edge, Williams concluded, but carried more risk than he thought a city utility ought to take.

Castro’s apprehensions about CPS created an opening for NRG to court the new mayor. It saw Castro as the key decision-maker in San Antonio on the nuclear issue.

But while the mayor’s private meetings with NRG were viewed with suspicion by CPS, they weren’t always doing what NRG hoped. Indeed, Robbie Greenblum, Castro’s chief of staff, ultimately soured on the company during a late-August meeting with Winn and Crane.

But his suspicions about NRG took a back seat to the news that then-interim General Manager Steve Bartley hadn’t shared the higher cost estimate with the board. With a construction estimate from Toshiba $4 billion higher than expected, the total project cost could top $18 billion – $5 billion more than CPS had told the public.

That estimate was a negotiating tactic on Toshiba’s part, Bartley insisted at the time, and the utility never would have agreed to move forward at that price.

In hindsight, some people close to the deal believe that if the board had been properly briefed about the estimate, it might not have become the crisis that led to CPS ending its partnership with NRG.

But so much had changed from 2007 to 2009, it seems unlikely that CPS would have been able to remain a full partner in the project, even if Bartley had handled the estimate better.

The utility’s revenues were dropping from reduced power use, lower natural gas prices and shrinking off-system sales, even as it was burning through $1 million a day on the nuclear project.

CPS executives conceded they couldn’t keep rate increases to 9.5 percent every other year and still pay for the nuclear expansion and upcoming capital expenses.

At the same time, developments in the natural gas industry were making the price of that fuel less volatile and more cost-effective.

Selling more of CPS’ stake in the project – one way to reduce the utility’s costs and risks – was dependent on finding a buyer, not a sure bet, according to people familiar with the market.

"The world changed on them," Williams said recently. "And they weren’t continuing to check their assumptions."

By early December, CPS’ role in the nuclear deal was no longer tenable. The utility had lost credibility, Bartley and another executive had been forced out, Castro wanted new people on the board and relations with NRG had grown cold.

The crisis ended, for the most part, by CPS’ success in the courtroom, where it prevailed at a critical stage of its lawsuit against NRG and NINA to exit the deal. In the end the parties negotiated a settlement that, assuming the plant is built, gives CPS 200 megawatts from it, enough to power about 40,000 homes.

For its almost $400 million investment, CPS says the agreement is worth $1 billion.

Some of the credit for the settlement goes to Charles Foster, the retired AT&T executive who replaced Aurora Geis as board chair after Castro sought her resignation.

Foster inserted himself in the stalled negotiations with NRG, and along with acting General Manager Jelynne LeBlanc-Burley, helped hammer out the deal.

LeBlanc-Burley, the human-resources vice president promoted after Bartley’s departure, then helped persuade a still-skeptical City Council to pass the rate increase it needed, a move that shored up credit rating agencies’ confidence. Moody’s, which had downgraded CPS’ outlook to negative, bumped it back up to stable after the vote.

CPS is on the mend, Foster said. Its financials are strong, he said, and the utility is headed in the right direction. The search for a new CEO should be complete by June.

He acknowledged the utility still has work to do, chiefly to repair lingering perceptions that it’s not an open, trustworthy organization.

And challenges remain as the utility embarks on a period of high capital investment in aging coal and gas plants, which means convincing the public that regular rate increases will be necessary.

Williams worked unsuccessfully to get CPS to change its rate structure in a way that would reward efficiency and hopes to tackle the subject again.

He thinks the utility needs to stay focused on its core mission.

"As long as they recognize that they’re a public service company,” he said, “I think they’ll be fine."