Bell Burnett & Atwater has developed a report that provides a framework for public power utilities in California to utilize when they evaluate large load opportunities.
BB&A is a California-based management consulting firm serving public sector infrastructure clients in the energy, water, wastewater, and transportation sectors and is an associate partner of the California Municipal Utilities Association.
The authors of the report are R. Alexander Burnett, a Principal at BB&A, where he leads the firm's energy and infrastructure development practice, and Drew Atwater, a Principal at BB&A, where he leads the firm's infrastructure finance and rate design practice.
The report says that five factors set California publicly owned utilities apart from Investor-Owned Utilities (IOUs) in evaluating data center projects.
“Some of these factors go across state boundaries, but each effect how risk should be allocated and underline why having a thoughtful and articulated development strategy upfront is so important,” the report said.
The five factors are:
• Capital structure
• Balance sheet size and concentration
• No shareholder cushion
• Public accountability
• The California regulatory environment
In the report, BB&A notes that in its work, it generally organizes the risks of large-load service into six categories:
• Counterparty credit risk
• Pre-commercial-operation stranded asset risk
• Post-commercial-operation stranded asset risk
• Forecast and demand risk
• Technological obsolescence risk
• Reliability and grid integration risk
“If any of these risks materialize without being properly structured, managed, and allocated, the risk is that they fall on existing POU ratepayers,” the report said.
“The failure mode is cross subsidization: the residential customer, school district, or local manufacturer paying for infrastructure built to serve a data center that did not perform as promised. The project need not fail outright; sustained underutilization of contracted capacity shifts costs onto those same customers just as surely as a default.”
Protecting against this risk “is paramount to developing a successful project,” the report said. “It is at the heart of the promise and compact with the community – that the data center project will not only pay for itself but will not expose the community and ratepayers to incremental risk.”
Avoiding cross subsidization
BB&A argues that avoiding cross subsidization is the single most important concern for an elected official and the community evaluating these transactions.
“It is a legal obligation in many cases through municipal bond covenants and charter language, a fiduciary obligation in others, and uniformly a political reality. The point is not to refuse data center load. Serving large load with a properly structured business deal can produce contracted community benefit. The point is to ensure the deal is structured so the data center is a demonstrated benefit to the community, including existing customers, rather than a hidden tax or burden, whether financial or environmental, on them.”
Details on the Framework
The framework rests on five principles, which are detailed in the report.
"Cross subsidization is the failure mode to avoid at all costs. Information and informed decision making are the cheapest mitigant. Risk should be allocated to the party best positioned to manage it. Standardization and standard market practices, without sweetheart deals, enables speed. Building the right project in the right way with the right protections is paramount to success," the report said.
Applied to the six risks, the framework produces a set of default allocations, the report said.
Practical Sequencing
"Three practical steps stand out based on our experience, recognizing the fact that not all projects or developers are created equal," the authors wrote.
Before the inquiry arrives, a utility should develop its positions on will serve letters, credit, collateral, take-or-pay structure, ownership, infrastructure development, cost allocation, and termination rights, among others. "Codify them in council- or board-adopted policy where appropriate. Apply them uniformly."
The most common misstep the report's authors see in California POU negotiations "is not technical but procedural: a utility receiving a serious inquiry, assembling a small team, and negotiating against a developer-supplied term sheet without first establishing what the utility's own positions are. That sequence cedes the framing of the negotiation to the developer before the utility has decided what it needs or requires."
The starting point should be from the utility side not the developer, the report said.
"When the inquiry arrives, standardized intake screens out inquiries that are not serious enough to merit project-team attention. A reservation fee that converts to a security deposit at Energy Services Agreement (ESA) execution is a useful structure: it has a screening effect, demonstrates customer seriousness, and protects the utility's planning resources. It will screen the quality and capability of the developer to deliver a project."
The letter of intent stage is also the stage to address departing load implications, including regulatory charges if the customer is currently served by an IOU or otherwise looking to interconnect to an IOU in connection with the project.
Throughout the contract term, the ESA is the operational document, the report noted.
After commercial operation, monthly review of contracted versus actual demand and quarterly review of utilization trends should feed back into the utility's planning posture for additional inquiries, including the contractual ability to claw back power and contract obligations if not used, the report said.
