Repowering Puerto Rico’s Future
PREPA: A Case of Bad Governance
Hurricane Maria put a punctuation mark on a classic case of bad governance. For decades, the Puerto Rico Electric Power Authority (PREPA), the state-run utility, operated as a “monopoly that regulates itself; sets its own rates without actual oversight; incurs operational, managerial, and administrative deficiencies whose actual cost, at the end of the day, is borne directly by customers; and whose governance lacks transparency and citizen participation.” Favoritism and foul play were the norm.
In 2014, Puerto Rico established an energy commission to oversee the severely underperforming PREPA. However, PREPA’s reliability worsened after 2014 – marked by severe system reliability problems at all infrastructure levels – while its debt ballooned to $9 billion. Synapse Energy Associates found PREPA in dire need of monetary, intellectual and human capital infusion. Despite clear problems, corrective regulatory actions that would adversely affect PREPA were politically difficult to enact. PREPA declared bankruptcy right before Maria hit.
Good governance must be the theme of repowering Puerto Rico. That spans basics like enforcing property rights – electricity theft is a major problem in Puerto Rico – to mechanisms for transparency and accountability, like independent audits, political independence and ethics rules. It also requires an economic paradigm capable of attracting capital and putting it to its most productive use.
Puerto Rico at a Crossroads
Post-restoration, Puerto Rico doesn’t need to be told what infrastructure to invest in. Rather, it would benefit from guidance on how countries have built modern energy institutions that achieve reliable service at an affordable rate. If the economic paradigm is solid, efficient investment decisions based on economic fundamentals, not political preferences, will follow.
The electric industry’s options include the market model – where government facilitates competition – or a centrally-planned approach, where government owns the resources or regulates a private monopoly to substitute for competition. The market model requires sophisticated institutions to design and competently administer markets. To pursue this option, Puerto Rico would require extensive institutional upgrades, a prerequisite that appears unattainable in the next five years. Thus, in the short-term, the economic paradigm will have to adjust to something more simplistic, i.e., central planning.
The commission took a step towards improved central planning by requiring PREPA to develop an integrated resource plan (IRP). IRP is a central planning process for determining what resources will meet peak demand at the lowest reasonable cost. It emerged in the states in the 1980s in response to poor planning by monopoly utilities.
Indeed, in many ways, Puerto Rico is struggling to catch-up to where states were 30 years ago. As it does so, the island will encounter the same challenges that states with a regulated monopoly model face today.
In recent years, monopolies have struggled to plan for declining demand and rising distributed resource value, both of which exist in Puerto Rico. In response to these issues, the energy commission opened a proceeding in October seeking suggestions on how to use distributed resources and microgrids. This could challenge PREPA’s monopoly on electric service. This underscores the importance of using competitive mechanisms within the monopoly paradigm.
While a degree of central planning is necessary, Puerto Rico should not wed itself to monopoly ownership of assets. To inject some degree of competition into the mix, the planning process should identify needs and hold competitive auctions to procure least-cost investments. Third-party procurement through contractual agreements reduces the likelihood and consumer consequences of mismanagement in project development. That seems particularly valuable in the case of PREPA. The cost of competitive procurement will reflect investor confidence. To attract private capital, the commission must enact a sufficient rate scheme to keep the utility financially sound in order to provide confidence for investors.
The Path to Good Governance
As such, near-term goals for Puerto Rico include good governance basics, an efficient and sufficient ratemaking process, and use of best practices in integrated resource planning and competitive procurement. Puerto Rico should consider privatizing PREPA if sufficient political appetite exists. If institutional integrity and sophistication advance, the opportunity to entertain more advanced market mechanisms may unfold down the road.
Simply put, the state of economic development reflects the quality of institutions and policies. The electric industry is more sensitive to these factors than most. The more Puerto Rico embraces good governance, the better its economy’s outlook.