Municipal growth and rural utility rates at stake in SD electricity squabble

A long, simmering battle between electricity providers in South Dakota is coming to a head as the 2020 legislative session winds down, and at stake is the potential for faster economic growth in some cities versus the possibility of higher electric rates for rural residents.

The debate is raging between municipalities that provide electricity to residents and rural electric cooperatives that serve customers living outside of South Dakota’s major cities, and it is one of the quietest but potentially highest-impact issues now being considered in Pierre.

Rural electric cooperatives are angered by what they say is the unfair loss of tens of millions of dollars’ worth of potential revenue due to the unilateral taking of parts of their service territories and customers by growing cities that annex new lands and homes — a process now legal under state law.

The rural providers are backing legislation that would add new hurdles to the process by which municipal electric utilities take over a co-op’s service territory and begin collecting utility payments from customers within the territory. The bill under consideration this session is the second attempt at a change in the law in the past two years and follows the failure of a 2019 legislative study committee to reach a compromise between the co-ops and the municipal utilities.

Leaders from several cities that own their own electric utilities have been fighting against any attempt to curtail their ability to take electric service territory when they grow. Some city and municipal utility leaders argue that restricting city-owned utilities from taking territory when needed will slow economic development and harm the state’s overall growth in the long run.

The rural electric co-ops this session are pushing House Bill 1262, introduced by Rep. David Anderson, R-Hudson. The bill would force city-owned electric utilities to meet in-person with the electric utility provider whose territory is being taken before a takeover can happen. The bill would also give co-ops the ability to demand a court hearing to contest a service territory takeover they think was fraudulent or an abuse of discretion.

The bill is scheduled for a hearing in the Senate Commerce and Energy Committee at 10 a.m. on March 5. If the bill passes out of committee, it would move to the Senate floor either later that day or on March 9.

The conflict between electric co-ops and municipal utilities stems from a law known as the Territorial Act of 1975. During the 1970s, there was a nationwide public policy movement aimed at making the build-out of electrical infrastructure more efficient by giving various types of electric utility providers exclusive rights to serve pre-defined pieces of territory. That essentially created state-approved electric service monopolies for rural electric cooperatives, municipal utility departments and investor-owned utilities. The thinking was that by giving each electric utility a monopoly over their service territory, there would be less duplication of expensive infrastructure, which would keep rates down for end users.

“If we didn’t have service territories and any company could build anywhere, you can imagine a residential city block and you have three electric companies running lines, poles and wires into a residential area each hoping to serve customers in that area, you can imagine how inefficient and, probably even from a safety perspective, hazardous it would be,” said Chris Nelson, one of South Dakota’s three public utilities commissioners.

But not all monopolies are treated equally under the 1975 law. City-owned electric utilities, in particular, were given a powerful tool — the ability to take over neighboring service territory whenever they deem it necessary for a city’s growth. Of the three types of electric utility providers in South Dakota, municipal electric departments are the only ones allowed to take territory without first coming to an agreement with the provider from which they are taking territory.

“As those municipalities, over the years, have continued to grow and continue to take territory from my member systems, the economic impacts have continued to elevate and it hurts. It stings,” said Ed Anderson, general manager of the South Dakota Rural Electric Association.

There have been 18 takings of territory from rural electric cooperatives since 2010, Anderson said. Several of the takings included infrastructure and customers and most were done without the expressed consent of the co-op whose territory was being taken, he said.

City leaders in communities such as Brookings, Watertown, Vermilion and Volga say the bill would create new and unnecessary hurdles to their economic development efforts. Uncertainty and delays due to red tape, they say, can kill a city’s bid to bring in a new factory or ethanol plant, for example.

“They want to know who’s going to serve them and what’s the cost going to be,” said Steve Lehner, general manager of Watertown Municipal Utilities. “And if I can’t tell them that, because the (co-op) can challenge in court for who has the right to serve, or challenge in court the cost that we’re gonna pay, then that company is going to go look for another community.”

Cause for conflict

For several decades, the monopoly system created in 1975 worked pretty well. Power lines, substations and electric generation capacity expanded to serve most every customer that needed it. Rural electrical cooperatives worked closely with many of the state’s 35 municipal electric utilities to build transmission lines and even provided emergency maintenance services.

But as the pace of growth sped up in cities such as Watertown and Brookings, two of the largest cities with their own electric utilities, the cities ran into the edges of their own defined service territories and started taking territory from neighboring rural electric co-ops. Those city-edge territories often became home to large, industrial customers who can generate a lot of money for the utility that sells them electricity. For cities, successfully recruiting such customers means more jobs and an increased tax base.

One recent example is the Bel Brands cheese plant in Brookings. The plant started construction in 2012 on land annexed into the city. The city’s annexation included a takeover of electric service territory belonging to the Sioux Valley Energy co-op. At the time of annexation, there was no electric infrastructure on the ground, said Al Heuton, executive director of the Brookings Economic Development Corporation.

“The standard practice for industrial development has been for Brookings to acquire the land, and between the city of Brookings and Brookings municipal utilities, they install all the infrastructure,” he said. “They’re basically fronting the development costs.”

Promising to take over electric service on the land slated for the Bel Brands plant allowed Heuton and other city leaders to guarantee to the company that electrical infrastructure would be in place and what rates for service would be. The certainty and potential for cost savings were critical to Brookings’ successful bid for the plant, Heuton said.

“If we can’t provide that here, then they’re going to go somewhere else,” Heuton said.

Building power lines and substations is expensive, but providing electricity is the easiest utility service from which to turn a profit and provides revenue municipal utilities need to cover their costs, Heuton said. Selling electricity has been especially lucrative for Brookings. The municipal utility company annually returns about $2 million to the city’s general fund, city budget documents show.

While cities such as Brookings have been able to expand their service territories and boost their revenues, rural electric co-op members have been forced to pay higher rates as a result, said Carrie Vugteveen, director of communications and government relations for Sioux Valley Energy.

Sioux Valley Energy, one of South Dakota’s largest rural electricity cooperatives, estimates it has missed out on about $21.5 million in revenue over the past 20 years that could have been generated on territory taken by city-owned utilities. The estimate is based on rates that could have been charged to businesses and residents in the lost territory, Vugteveen said.

Co-ops were created specifically to give rural residents a way to provide themselves with electricity. Co-ops are owned by the people they serve and their biggest interest is in getting and providing electricity as inexpensively as possible. Adding large industrial members to a co-op means fixed costs for maintenance or new infrastructure can be spread over more kilowatt hours, which in turn can reduce the rate each member (including residential customers) pays for each kilowatt hour they use.

There is no guarantee, however, that co-ops would end up serving large consumers such as Bel Brands even if municipal utilities’ ability to take territory was restricted. A provision in the 1975 law allows consumers who contract to use at least two megawatts of electricity — more than double the average U.S. household’s monthly usage — to choose who will provide their electricity.

Rural electric co-ops have won several large customers over the years by submitting bids, said Chris Studer, chief member and public relations officer for East River Electric, a cooperative that builds electricity transmission lines and substations for other co-ops. In recent years, the Blunt, S.D.-based Oahe Electric Cooperative won the right to serve the new Ringneck Energy ethanol plant in Onida, despite the plant being located within the city’s municipal utility service territory.

Still, rural co-ops are often at a disadvantage when bidding against municipal utility departments. On average, the state’s co-ops serve 2.5 members per mile of power line. Municipal utilities, meanwhile, serve roughly 42 customers per mile of line. Because they tend to serve members dispersed over large, rural areas, South Dakota electric co-ops have had to spend more on construction and maintenance of everything from power lines to power plants.

The result is that co-op members tend to pay slightly higher rates than municipal utility customers. Usually the difference winds up being a few cents per kilowatt hour, which can add up to several dollars on monthly bills.

“There’s this misnomer out there that electric co-ops have much higher rates and that’s just not the case, it just isn’t,” Vugteveen said. “We have bid on loads and we have won some of those loads. We can be competitive; we are competitive.”

However, if municipal utilities continue to siphon away co-op customers, rates for rural residents could rise well above what they are now.

No common ground

As far as municipal utilities are concerned, there is no problem with the current system of defined service territories. Any service territory takings that included customers and infrastructure have been or are being paid for. Municipal electric utilities are required to compensate co-ops and investor owned utilities when they take service territory. According to a formula included in the Territorial Act of 1975, when a municipal utility takes territory from another utility, it must pay a quarter of the gross revenue generated in the territory for seven of the first 11 years after the territory is taken.

Such compensation is fair and allows cities to grow and actively compete for to bring new employers to their communities and the state, said Heuton, the Brookings development official.

“For our purposes, it would be much better if nothing were to change,” he said.

The problem, as co-ops see it, is that the compensation is both too little and too temporary, while territory takings are permanent.

“These are lost forever. It’s not just, ‘Oh we got it and now it’s ours for the time being.’ It is lost revenue until that business goes away or to the end of time,” Studer said.

Since the year 2000, Sioux Valley Energy has received about $2.1 million in compensation for territory takings that around Brookings alone have covered 2,600 acres of land, 1,600 homes and 81 businesses, Vugteveen said.

“We have fixed service territories, the investor owned utilities have fixed territories. But municipal electric utilities don’t. That’s where we see the inequity and the unfairness,” she said.

That perceived unfairness has driven efforts by rural co-ops over the past two years to change state law. During the 2019 legislative session, Sen. Brock Greenfield, R-Clark, introduced a co-op-backed bill that would have prevented municipal utilities from arbitrarily taking any territory from another utility. Greenfield’s 2019 bill ignited a furious debate before being gutted and re-written to create a 9-member legislative summer study committee aimed at finding a compromise between co-ops and municipal utilities.

During the summer and fall of 2019, the study committee members spent more than 15 hours over three meetings listening to experts and lobbyists from co-ops and municipal utilities, as well as discussing the issue themselves. Ultimately, the 2019 study committee failed to find a workable compromise.

“The committee was set up to fail for the municipalities,” said Lehner, the Watertown utility manager.

The committee was stacked so heavily in favor of co-ops, Lehner said, that he and other municipal officials complained to the Legislature’s executive board. Many of the committee members had actually been co-sponsors of the original 2019 legislation, he said. And despite the many hours of testimony and discussion, the proposals that did arise from the committee’s work weren’t acceptable to municipal utilities.

Co-ops, though, helped write and found a sponsor this session for what became House Bill 1262, which they call a compromise. If the bill becomes law, it would force municipal utilities to give notice up to one year prior to taking service territory from another utility, to give co-ops a chance to negotiate for a better deal prior to territory being taken, and to give co-ops the option to challenge a territory taking in court. The co-ops see the legislation as necessary in order to level the playing field and protect their most vulnerable and remote customers from paying excessively high electricity rates.

Co-op officials also say they don’t agree with municipality arguments that taking service territory is critical to recruiting new businesses.

Sioux Falls is a great example of how all types of utility providers can work together to boost a city’s growth, Vugteveen said. There are two co-ops — Sioux Valley and Southeastern Electric — serving members on the expanding edges of the city. Xcel Energy, an investor-owned utility, provides service to much of Sioux Falls and the city itself owns a small electric utility serving part of the city center and the airport. Sioux Falls hasn’t had any problem growing despite the variety of electricity providers serving the area, Vugteveen said.

“We all work in concert with each other. This is how it can work,” she said.

Lehner said the window to respond to requests for proposals from companies looking for a new location can close within days of the city receiving notification. If cities can say quickly and with certainty that it will be able to provide everything a business needs, the odds of winning the bid get much better, Lehner said. He vowed to keep fighting HB1262 even if the bill becomes law.

“Quite frankly, every business I lose because I can’t tell them what their costs are going to be because of 1262, I’m going to make sure that people know about that. That’s going to get into our press,” Lehner said.