Category Archives: Business

Companies Love to Hate the PUC

BY DENNIS HOLLIER

The mood was tense in the packed Senate hearing room in December, as angry Neighbor Island businessmen, farmers and representatives from community organizations testified before the Committee on Commerce and Consumer Protection against the Public Utilities Commission. The immediate cause for the rancor was an interim decision by the PUC in September that allowed Pasha Hawaii Transport Lines to begin limited interisland cargo shipping between Honolulu and Kahului and Hilo.

Before this ruling, interisland cargo service was provided exclusively by Young Brothers – a monopoly contingent on the barge company serving not only the state’s large, profitable ports, but also the smaller, unprofitable ones, such as those on Lanai and Molokai. But the interim order imposed no such obligations on Pasha.

That’s what caused the stir. In the wake of all the discontent, Sen. Rosalyn Baker, chair of the committee, spoke testily of the need to reform the PUC, a process that this blowup may have both hastened and complicated.

     Outgoing Chair Carlito Caliboso Photo: Rae Huo

The intent of the Pasha decision, according to the previous commission chair Carlito Caliboso, was simply to find out if more competition among water carriers would help improve service and lower costs for consumers. Young Brothers, and many of its Neighbor Island customers, had a different take. They viewed the PUC’s ruling as fundamentally unfair to the highly regulated interisland barge company, and potentially lethal to the businesses that depend on its service, particularly those on Molokai and Lanai.

Even worse, they viewed the process the PUC used to reach its decision as opaque and capricious. As Baker points out, the commission held no public hearings, let alone Neighbor Island public hearings, before making its ruling. Then, one day before the Senate hearing, the commission denied a Young Brothers’ request to reconsider its decision. “I thought the commission behaved most arrogantly to the folks that came in from the Neighbor Islands to be heard,” Baker said later.

But assigning blame for the commission’s failings is more complicated than it seems.

Quasi-Judicial Agency

The PUC is a small state agency with astonishingly broad regulatory powers. According to its 2010 annual report, it is responsible for regulating electric utilities, telecommunication companies, water and sewer companies, and bus and trucking companies. In other words, a huge part of the state economy falls under its jurisdiction; yet, early last year, the agency had a staff of fewer than 40 people. For most purposes, the three PUC commissioners operate like a quasi-judicial body, with the chair presiding over lawyers, engineers, analysts and accountants who conduct research and provide technical assistance. This small cadre of professionals has to provide the expertise to regulate the diverse industries under their jurisdiction.

The Division of Consumer Advocacy is in even worse straits. In 2010, this agency, which is supposed to represent the public’s interest before the PUC (and is funded out of the PUC’s special fund), had only 11 staff positions filled. Yet, the division is responsible for much the same analytical and policy footwork as the PUC. In fact, PUC actions often can’t proceed because of delays caused by the division’s understaffing. For a while, the division simply stopped processing certification applications from telecommunications providers, according to a legislative report. Consumer Advocacy officials didn’t respond to repeated requests to comment for this story.

     Sen. Rosalyn Baker, head of the Senate’s Commerce Committee, 
     has had some run-ins with the PUC.  
     Photo: Courtesy of Senator Roselyn Baker

It’s not surprising that the most common complaint about the PUC is that it’s slow and inefficient. However, that fact has to be viewed in the context of how the agency works. Regulated companies typically bring cases, called dockets, before the commission for consideration. Dockets range from something as simple as an application to operate a motor carrier, to a petition for rate relief from a water carrier, to something as complicated as decoupling, a new policy that fundamentally changes the business model for the electric company. A docket isn’t that different than a court proceeding: There are motions, opportunities for interveners to join the docket, and periods for discovery and rebuttal. All of which take time.

And there are a lot of dockets. In 2010, 330 new dockets were filed before the PUC. In addition, there were still 271 dockets pending from 2009. Altogether, the commission completed 448 dockets over the course of the fiscal year, and left 153 pending. All those figures are improvements.

Diverse Complaints

Even though few individuals are willing to go on the record – their companies are still regulated by the commission, after all – criticism of the PUC is widespread and diverse. For example, among motor carriers, by far the largest group of companies regulated by the PUC, the standard complaint is that there isn’t enough regulation: It’s too easy to get a certificate, and there isn’t enough rate enforcement.

Young Brothers, as we’ve seen, complains that it’s held to a different standard than its competitor – much the same complaint Hawaiian Telcom representatives make privately about its competitors.

It’s within the electric sector that we see the most complaints: that the PUC is too cautious, that the consumer advocate is too closely aligned with the utility, and that the PUC chair should be more of a vanguard. Almost all this criticism, though, comes back to those two words: slow and inefficient. Most of the complaints are justified, but that’s not the whole story.

For example, not everyone is convinced that the commission is responsible for many of these problems. Carl Freedman, an electric utility regulatory expert and frequent intervener before the commission, notes that, under the Caliboso administration, the PUC undertook an enormous number of major policy dockets. In fact, it’s largely trying to deal with those energy-policy initiatives that accounts for much of the commission’s slowness. “I think it’s a fair criticism of the PUC to say it’s not fast enough,” Freeman says. “But I don’t think that equates to criticism of (Caliboso), or even the staff. That’s a criticism of the whole state.”

Similarly, Freedman isn’t sure that slow and cautious are necessarily bad things, at least when it comes to these major policy decisions. “Some people want to see the commission be more of a vanguard. But I think cautious is certainly also one of the things we want the PUC to be.”

Caliboso also isn’t convinced that the charges of slowness and excessive caution are merited. Some of the slowness, he points out, is built into a fair and deliberative process. “You can’t really say this docket took a year, so it’s slow, for example. You really have to look at each one to see when the parties were really done with it, when was it submitted for a decision. A lot of times, it’s the parties involved in the case that slow things down, because they want time for things like review and discovery before they submit their positions and make their arguments. And all that takes time.”

Caliboso also points out that sometimes the PUC’s new responsibilities conflict with its traditional regulatory role, particularly in the complicated field of energy policy. “If you’re assuming the complaints are that we’re not moving fast enough or far enough in a particular policy direction, then you really have to look at what is the policy direction being given to the PUC from the Legislature, because we’re a creature of statute. The law says we’re supposed to be a traditional regulator. Those duties deal with trying to make sure the rates that customers pay are reasonable – so, keeping costs down. And then, we’re responsible for making sure the utilities provide reliable service and earn a reasonable rate of return. It’s all connected.

“At the same time, you’re telling the commission to try to implement these new energy policies, which should help get us off of fossil fuels, improve our energy security, reduce greenhouse emissions, improve our environment and make things more sustainable. That’s fine. I understand that task, and we’re driven to implement these policies. But those traditional regulatory responsibilities have not gone away. So, when somebody says we’re not going fast enough, maybe it’s because we still have those traditional objectives to look out for.”

Buying a Plan

The real issue is money. The PUC is mostly funded by fees collected from the utilities it regulates. This special fund should be more than adequate for the commission’s regulatory duties, but it doesn’t actually get all the money.

“In 2009, we collected $17.6 million in revenues, most of which are from the public utilities,” Caliboso says. “At the same time, our expenditures were only about $8.2 million, $2.9 million of which went to the consumer advocate. That means about $9.4 million went back to the general fund. So, the money is there. The problem, as far as money goes, is that a lot of it is being used for something other than regulatory purposes.”

Money also plays a role in another challenge facing the commission: attracting quality staff. PUC positions go unfilled for so long partly because the pay isn’t competitive with private industry. As one industry insider put it, it’s not uncommon for commission attorneys to be sitting across the table from utility attorneys making four or five times more money. This is a national problem, but, even so, according to Sen. Baker, the disparity in Hawaii is larger.

“We did a study where we looked around the country,” she says, “and other state salaries, almost without exception, are higher than ours.” Similarly, other states pillage utility commission revenues, just not so wantonly.

Utility professionals routinely complain about the underfunding of the commission. In her 2004 report on the PUC, the state auditor recommended the commission undertake serious strategic planning, pointing specifically at the agency’s deficiencies in personnel management. In 2006, the Legislature passed Act 143, which required the PUC and the consumer advocate to prepare a reorganization plan specifying their budget, resource and manpower needs. The following year, Acts 177 and 183 approved and funded most of the commission’s requests. The PUC’s reorganization plan included:

• Increasing the staff level to 62 for the PUC and 15 for the Division for Consumer Advocacy;
• Redescribing several positions to better reflect new responsibilities;
• Restructuring the agencies’ hierarchy to improve organizational effectiveness, especially by creating an Office of Policy and Research to better address highly technical policy issues; and 
• Relocating the PUC offices to accommodate the larger staff and new organization.

Nothing happened as planned. In 2008, the Legislature reduced the commission’s budget again, removing nine existing positions, and not funding two new positions or the agency’s relocation. The following year, the consumer advocate lost eight positions and other new positions went unfunded. Yet, even with funding and legislative approval, the commission still can’t reorganize on its own. It needs approval from the Department of Budget and Finance to release the funds, and the Department of Human Resources and Development has to rewrite job descriptions. Both departments presented roadblocks to the PUC’s reorganization.

Finally, in the 2010 session, the Legislature relented, passing Act 130, which acknowledged that the PUC’s reorganization was essential, especially to “successfully implement meaningful energy policy reform.” Act 130 puts numbers to that, noting that the commission regulates “electric and telecommunications services worth between $3 billion and $4 billion annually.” The legislation also notes that the potential savings from appropriate regulation may save the state more than the cost of fully funding the reorganization. Put another way, a well-run PUC is good business.

Caliboso highlights the value of effective regulation differently. “Another way to think about it is to look at how much is being invested in energy,” he says. “The cost rate base for the utility – or the money they’ve invested in energy infrastructure – is almost $2 billion.” Viewed in the context of protecting that investment, the PUC budget starts to look trifling.

Similarly, Caliboso says, you can look at the state’s regulatory costs in comparison with the aims of the state’s Clean Energy Initiative. “When you think of how much we should be investing to achieve our policy goals of getting us off oil and achieving energy security, which could help both in addressing price volatility and in securing our supply of energy, the cost of (better regulation), that’s not that much more to invest.”

More of the Same?

The remarkable thing about this ebb and flow of funding is that the PUC’s reorganization isn’t controversial. “Everyone knows it should happen,” Freeman says. “Everyone agrees. Everyone is supportive.” But he acknowledges that might not be enough. After all, he points out, funding for the reorganization has been given and taken away several times. “The question is: Is the Legislature just going to wipe it out again?”

     Last month, Gov Neil Abercrombie nominated Rep. Hermina 
     Morita, as the new PUC chair.
     Photo: Courtesy of Representative Hermina Morita

Gov. Neil Abercrombie seemed to address some of these questions in February by appointing the former chair of the House Committee on Energy and Environmental Protection, Rep. Hermina Morita, to the commission, filling the seat vacated by Leslie Kondo, and replacing Caliboso as chair.

Morita had long been the most knowledgeable supporter of renewable energy in the House and a vocal advocate for increased PUC funding. Even so, it’s not clear the PUC’s reorganization will survive the legislative session. “I would like to say, ‘Yes,’ ” Morita confided, shortly before her appointment, “but I’m only confident if the other legislators fully understand that this is a critical part of our economic recovery and our economic development.” 
In fact, Morita’s appointment may add to the uncertainty surrounding the reorganization. Although she’s widely admired among PUC observers, particularly those in the energy sector, her departure from the House will deprive the commission of a powerful legislative advocate at a critical moment. She may also stir things up within the commission itself, where, as chair, Morita will have an opportunity to reshuffle PUC staff.

Some legislators simply aren’t convinced that the commission is properly structured in the first place. “I just don’t think we have the appropriate expertise on the PUC,” said Baker, shortly before Kondo’s departure. “We have two government attorneys and one private-sector attorney. We don’t have anybody with any kind of engineering expertise, accounting expertise, or financial or business expertise. We don’t even have anybody with any energy background. They don’t have to have worked for a utility, but just to understand some of the technical dynamics.”

Baker is also concerned about the PUC’s demographics. “I don’t want to impugn the background or integrity of anybody, but the commission just is not diverse. For example, there are no members from the Neighbor Islands.” She acknowledges that the addition of Morita, who is from Kauai, will alleviate some concerns, but she believes the PUC needs structural changes.

Which brings us back to the PUC’s Pasha decision. In the wake of the flack following that ruling, Baker has proposed legislation that will further complicate the PUC reorganization. “I have a bill that tries to professionalize the staff and adds two more commissioners, so there would be a total of five,” she says. This would simplify adding a requirement that the commission include Neighbor Island representation. And, according to Baker, it would also allow PUC staff to specialize. “The bill also creates two panels,” she says. “One to deal with energy and private water systems – because that’s a big piece of what the commission does – and the other would deal with water carriers, motor carriers and warehousing. That way, you’ve got some specialization, so both the commissioners and the staff can zero in.”

It seems like a good plan. But you have to wonder if the added uncertainty introduced by the bill will kill the PUC’s reorganization in the Legislature again. That’s a fate Caliboso knows is all too possible.

“Is it a done deal, pau, don’t worry about it?” he asks. “No, they could always take it away again.”

 

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Hawaii Employee Retirement System: Underfunded by $7 Billion

BY DENNIS HOLLIER

The state got just what it was expecting in its Christmas stocking. Unfortunately, it was another lump of coal – more bad news about the state of Hawaii Employee Retirement System, which covers both state and county employees. In its five-year report, the actuary firm of Gabriel Roeder Smith & Company claims the system’s future liabilities now exceed the assets set aside to pay for them by $7.1 billion. That’s nearly $5,500 for every man, woman and child in the state.

Worse still, because of the arcane rules governing actuarial accounting, those figures don’t fully incorporate the system’s huge market losses in 2008 and 2009. Consequently, an additional $1.5 billion will be added to the state’s unfunded liability over the next two years. This means the state’s legally required contribution to the pension system will increase to more than $671 million a year by 2015.

The actuary’s findings were hardly a surprise to those familiar with the state’s pension system. In fact, Wes Machida, the conscientious new ERS administrator, spent much of the holiday season playing Grinch, briefing legislators and members of the incoming administration on what to expect in the report.

 

ERS's III, 721 members include all qualifies state and country employees

    Pension benefits for state and county workers, once earned,
are guaranteed by the state constitution; they cannot be
reduced even in a budget crisis.

 

One of the most remarkable aspects of the current shortfall is how quickly it has grown. As recently as 2000, the pension system covering government workers for the state and Hawaii’s four counties was 94 percent funded. This year, by some measures, the funding ratio has declined to less than 60 percent, and the prospects for paying down the deficit appear more and more remote.

 

There are a couple of factors behind the relentless growth of the pension liability. The first is that, like most state retirement systems, the ERS is a defined-benefit system. In other words, state and county employees are guaranteed set benefits when they retire, based on how many years they have worked and their average salaries at the time of retirement. In addition, those benefits, once earned, are guaranteed by the Hawaii Constitution; they cannot be reduced, even in response to a fiscal crisis such as the state’s recent budget shortfalls. This is typical of defined-benefit systems. In 1979, when New York City went bankrupt, it reneged on hundreds of millions of dollars owed to contractors and bondholders, but never failed to make pension payments to retirees.

 

To pay for these enormous liabilities, the ERS – again, like almost all state pension systems – is a “pre-funded plan.” In theory, enough assets are set aside and invested each year to generate income to offset future liabilities. A pension is said to be “fully funded” when current assets are projected to pay for all future liabilities. Funding comes from three sources: employee contributions, employer contributions and interest earned on the system’s assets. Each contributes to the shortfall.

 

Increase in ERS membership

      Click to enlarge image.

Digging a Hole

In Hawaii, employee contributions are set by law at around 12 percent of payroll for firefighters and police, and 6 percent for other employees. According to Machida, employee contributions amounted to $361 million in 2010, which included $187 million in one-time payments as members changed plans within the system, leaving $174 million in normal employee contributions.

The amount paid by state and county employers is also governed by statute, which prescribes an “actuarially required contribution,” or ARC, sufficient to fully fund the system within 30 years. As lifespans have increased and payrolls have expanded, the counties’ and state’s required contributions have soared: In 2000, the ARC was about $175 million; by 2010, it had reached more than $550 million – $400 million for state employers, and in excess of $150 million for the counties. Even so, the unfunded liability has grown.

The system’s investment earnings scenario isn’t any rosier. Here, too, state law predominates, setting the pension fund’s anticipated rate of return on its investments at a robust 8 percent. But this number has little bearing on the system’s actual earnings. In the past 10 years, returns only reached as high as 8 percent four times. In fact, the system’s market earnings over the past decade have averaged only 2.8 percent, not even keeping pace with inflation. With such inflated earnings expectations, not only is income overestimated, but future liabilities are underestimated.

Assuming Liability

Employer contribution in millions

     Click to enlarge image.

There are, in fact, a slew of other actuarial assumptions that affect the size of the pension system’s liability. For example, Machida notes, the system assumes an average life expectancy of 83 years. Every year, though, actual life expectancy increases. “The average life span of a female schoolteacher is over 90 years,” Machida says.
Other assumptions are more financial. “For example, there were more promotions than expected,” Machida says. “Salary increases were projected at 3 percent or 4 percent; but professors, for example, at one point were given a 9 percent to 11 percent raise. Police officers were getting a 9 percent raise.” Similarly, more benefits were added to the pension system without consideration for how we would pay for them. It will be hard to get back these costs.

Distressingly, most strategies to address the system’s weaknesses hinge on manipulating some of these manini-seeming assumptions: extending the age of retirement; changing the definition of “base pay”; changing the way cost-of-living allowances are calculated. Because the benefits of retirees and existing employees are protected by the state constitution, any changes can probably only apply to new hires. That means the cost of addressing the system’s long-term liability will have to be spread over a small pool of members.

Annual pension payments in millions

     Click to enlarge image.

 

Machida says these assumptions aren’t the main reason the state’s unfunded liability has grown so dramatically. He ascribes most of the increase to an old rule that allowed legislators to seize any annual earnings over 8 percent and apply them to the state’s ARC. In 2001, the worst year, the state used approximately $150 million of these “excess” earnings to help balance the budget. Between 1999 and 2003, according to Machida, more than $350 million in excess earnings were diverted from the pension system. “In 2004, with the assistance of (then) Governor Lingle, we introduced legislation to take that away,” Machida says. But the damage has been done. “If that money had not been taken,” he says, “the system today would be almost fully funded.”

Whatever the proximate causes of the pension-system shortfalls, the effect is a vicious circle: When current income and contributions aren’t enough to pay current benefits – a condition that began in 2006 and is projected to accelerate rapidly for the next five or six years – the only option is to sell off portfolio assets to cover the difference. In 2011, the ERS is projected to cannibalize nearly $200 million in portfolio assets; by 2020, that figure could reach $600 million a year. That’s the opposite of a “pre-paid pension fund.”

How to Fix It

Fixing this problem is going to take time. The formula, according to Machida, is straightforward. C+I=B: contributions plus investment earnings must equal benefits paid. To make that equation balance, each variable will have to be tweaked. First, the employer’s contribution must increase. “This isn’t an option,” it’s a necessity, Machida says. Failure to comply with state law would have disastrous effects on state and county bond ratings.

The scale of the increases necessary will be painful. The recent actuarial report by Gabriel Roeder Smith already raises the ARC to 19.7 percent of payroll for firefighters and police, and 15 percent for general employees, which should yield $671 million a year by 2015. Even that won’t be sufficient. To generate the extra $182 million needed, the actuaries recommend increasing those figures to 27.3 percent and 18.8 percent, respectively, which will yield an additional $43 million. The ARC already constitutes about 10 percent of the state’s general fund budget; it’s hard to see where the additional revenue will come from to pay for the increase.

Dollars contributed to the plan in FY 2010

The interest variable in the pension equation also comes into play in the actuaries’ calculation. By assuming an additional 1 percent yield on the system’s investments, they add another $117 million to the pot. (Although they don’t mention it in their report, raising the assumed rate of return also lowers the current unfunded liability.) But, as Machida points out, raising the targeted investment return comes with higher levels of risk, which further could jeopardize ERS assets.

In fact, making up the state’s unfunded liability on the left side of the pension equation is probably impossible in the long term. That means legislators are left with the politically difficult option of reducing retiree benefits. Machida outlines the possibilities:

• Raise the retirement age;
• Increase the number of years it takes employees to become vested;
• Change how final salaries are calculated; and
• Constrain future payroll growth.

Some version of all of these reductions will likely be necessary, but can the Legislature make them happen?

Estimated yields based on actual and market value of assets

     Although, by statute, the ERS assumes its portfolio will earn 8
percent annually, its actual performance has been erratic at best.
Since 2001, market earnings have averaged only 2.8 percent.
 Click to enlarge image.

To begin with, as Machida points out, the benefits of existing employees are protected by the state Constitution. That means new hires will likely bear the brunt of any changes in benefits. Calvin Say, the longtime Speaker of the House, acknowledges the challenges faced by the Legislature. “I’ve introduced a number of bills to deal with the unfunded liability,” he says. “One that I had was to increase the retirement age from 55 to 60 so you can contribute to the trust fund longer. But you can’t address these changes with present employees. You can’t change this for the current retirees. It’s all going to be based on new employees.”

Kalbert Young, the Abercrombie administration’s incoming director of the state Department of Budget and Finance, makes much the same point. “I would say that the governor is interested in looking at what are the available means for resolving the liability issue,” he says. “Admittedly, though, it’s a very big number; and given the condition and depth of the problem, our timeline for resolving it may not be in the near term.” In other words, future state and county employees will be paying the tab for generations.

EUTF fond in even worse

That’s assuming today’s politicians can enact the necessary changes. Machida points out that, because they will likely only affect new hires, any prospective reduction in employee benefits are probably not subject to collective bargaining. Nevertheless, it’s difficult to envision the Legislature enacting major reductions without at least the tacit support of the public unions, by no means a sure thing. House Speaker Calvin Say remarks on how difficult it’s been trying to make these kinds of changes in the past: “For me, it’s been a sincere effort to try to control both the employers’ and the employees’ contributions,” he says. “But present employees do not understand that. They don’t want Calvin Say to force them to pay more for their pension contribution. But something’s got to give.”

Say remains optimistic. “Overall, I feel very confident, because, at the end of the day, the state government is obligated to fulfill its responsibility. So, yes, we’ll address that unfunded liability one way or the other. It will probably be through the guise of taxation.”

The Big Picture

“But time is of the essence,” says Machida. That’s because, as glum as the Gabriel Roeder Smith report seems, it may still understate the size of the problem. To understand why, it helps to put Hawaii’s retirement system in a national context. Since 2000, the number of states with fully funded pension systems has declined from 26 to four, according to a recent report by the Pew Center on the States. Hawaii is in the bottom quartile, one of 19 states described as having “serious concerns.” Remarkably, Pew data do not even include the effects of the Great Recession of 2008. Once those losses are incorporated into the picture, the perspective will be much worse.

Despite its baleful conclusions, the Pew report is squarely in the mainstream of actuary standards. It relies on the states’ own analyses and draws its conclusions using normal actuarial accounting procedures. There is a growing number of analysts, though, who believe that traditional actuarial accounting and its assumptions are part of the problem and help mask the true scale of the states’ pension crises. The most inflammatory of these is Joshua Rauh, a researcher at Northwestern University’s Kellogg School of Management, whose 2010 report suggests the states’ total unfunded liability may be several times larger than the findings in the Pew report. For example, he predicts Hawaii’s ERS will go broke in 2020.

Not surprisingly, Rauh’s conclusions have been largely discounted in the public pension community. “Among public pension actuaries,” says Keith Brainard, executive director of the National Association of State Retirement Agencies, “I think you would find the overwhelming perspective that Joshua Rauh’s findings and recommendations are inappropriate.” Even ERS administrator Machida – by no means an apologist for the status quo – downplays Rauh’s conclusions: “The ERS is not going to run out of money in 2020.”

But Rauh isn’t alone in raising questions about the size of the unfunded liabilities facing state pensions. For example, Andrew Biggs, of the American Enterprise Institute, uses a standard financial process called “options pricing” to reach much higher figures. In the case of the Illinois State Employees’ Retirement System, his analysis more than doubles the state’s total liability, from $23.8 billion to $47.3 billion.

Applying the same formula to Hawaii’s total liability swells our unfunded liability from $7.1 billion to more than $14 billion. Of course, the calculation isn’t that simple. It’s worth noting, though, that even pension actuaries are beginning to look at other ways of measuring pension liabilities. All of these suggest that our total liability is higher than the $18.8 billion actuarial valuation in the Gabriel Roeder Smith report. Rauh, basing his discounting rate on 30-year Treasury notes, calculated Hawaii’s total liability at $24.2 billion. The state’s own actuaries calculated a total liability of $21.5 billion when they used the market value of assets instead of the traditional actuarial method. Pessimism is clearly becoming part of the mainstream.

In fact, the actuary’s report to the ERS board in December included some startling language. Under the heading, “What does this all mean?” the report states: “If the assumptions are met for all years beginning July 1, 2010, and the current contribution policies remain, the system is not expected to run out of money. But it is very close.” (Italics added.) Worse still is how long the actuary says it will take to fully fund the system, given the same set of assumptions: never.

Pension Benefits

In FY 2010:

$925 million was paid by the plan to about 39,000 retirees and beneficiaries.

 

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Marketing Hawaii to the World

BY DENNIS HOLLIER

      The Hawaii Tourism Authority’s VP for Brand Management, 
      David Uchiyama, is a numbers man. Under his leadership, 
      the state’s international marketing strategy has been 
      increasingly driven by good data.
      Photo: Irwin Wong

Tokyo, Japan —

High on the stage of the Hawaii booth, overlooking the hubbub of Japan’s biggest travel fair, the musical group Manoa DNA launches into “Aloha You, Aloha Me.” It’s a catchy tune, sung mostly in Japanese, that has become the band’s signature song here in Japan, and the smiling, enthusiastic crowd gathered at the foot of the stage seems to know all the words.

The group’s performance brings business at the neighboring booths to a standstill. At the Canada booth, instead of watching videos of Nova Scotia on giant plasma screens, visitors swivel 180 degrees to watch the band and clap to the music. The Japanese women hosting the Las Vegas booth set down their brochures to dance and sing along. They cheer and flash shaka signs when the song ends. This might be Japan, but there’s a great deal of Hawaii at the Japan Association of Travel Agents Congress and World Travel Fair.

That makes Japan an excellent place to start talking about how Hawaii sells itself to the world. Japan, after all, is our most lucrative foreign market, and three of the most important players in that marketing effort are at the event. On the edge of the crowd is Takashi Ichikura, dapper in an aloha shirt and blazer. Ichikura-san, as he’s known to almost everyone here, is the director and principal owner of Hawaii Tourism Japan, HTJ, the state’s marketing partner in Japan, and the person most responsible for organizing Hawaii’s presence at the JATA fair. At the back of the crowd are the two key players from Hawaii: Hawaii Tourism Authority president and CEO Mike McCartney and his right-hand man, VP for brand management David Uchiyama. 

They’re an odd couple: McCartney, the sensitive, soft-talking former politician; and Uchiyama, the taciturn numbers man and marketing guru. The industry consensus is that their good cop/bad cop routine, the mix of political sensitivity and strategic planning, has been one of the keys to reviving Hawaii’s battered tourism economy. Here’s how they’re doing it.
 

      More than 111,000 people attended the JATA World Travel 
      Fair in Tokyo in September. HTA president and CEO Mike. 
      Photo: Irwin Wong

Old-School Marketing

Even in the digital era, marketing is sometimes just about getting in front of as many people as possible, and the JATA World Travel Fair is one of the largest tourism expositions in the world. This year, 71,740 consumers attended and, more important, so did 39,492 travel agents, tour operators, media and others in the travel industry. That makes the fair an extraordinary marketing opportunity, which is why HTJ invests so much time and money on its booth every year. It still works.

For example, HTJ used a contest at the fair to persuade nearly 5,000 consumers to complete surveys about how they choose a destination. Employing QR codes, the survey provided consumers with a link to HTJ’s new mobile website, resulting in 74,199 hits and 23,712 unique visitors, a 33 percent increase over the previous month. Exposure at the fair also boosted hits to HTJ’s regular website by 69 percent to 1,387,079 during the month. And, of course, tens of thousands of brochures were handed out at the booth, each offering a specific call to action. 

Beyond the raw numbers, the fair also generated the kind of good will that marketers love, even if they can’t measure it. All those people singing along to Raiatea Helm and Manoa DNA are priceless.

Like almost all HTJ programs, the fair also offered marketing opportunities for the state’s travel partners – hotels, wholesalers and attractions that depend on tourism. In fact, six Hawaii-based travel partners paid a nominal fee – helping offset the cost of the event – to have a table at the Hawaii booth. These included the Kaanapali Beach Hotel, Hilton Hawaiian Village and Kualoa Ranch. Travel professionals and consumers file past their tables collecting brochures and listening to the company pitch. HTJ also provides free brochure hosting for companies that can’t come to the fair.

Marketing partners like HTJ provide other essential services, like training and educating travel agents and wholesalers. HTJ, for instance, offers extensive destination training, both online and through seminars it conducts around Japan. Last October, HTJ collaborated with numerous Hawaii hotels and attractions to bring more than 200 Japanese travel agents to the Islands on a familiarization trip – or megafam. It’s much easier to sell a place when you’ve been there yourself. Similarly, in November, the Hawaii Visitor and Convention Bureau, HTJ’s North American equivalent, hosted a small group of travel writers on a trip to Oahu.

 

      Photo: Irwin Wong

The JATA travel fair in Japan is also a good opportunity to see the competition. This year, more than 1,000 delegates from 90 countries gathered at nearly 900 exhibition booths. A stroll through the exhibition hall reveals that Hawaii doesn’t have a monopoly on good marketing ideas.

The Croatian booth, for example, is a collaborative affair, with Croatia’s equivalent to HTA lauding the country as a tourism destination, and its version of DBEDT wooing Japanese investors. (The fair’s organizers awarded the Croatian representatives “best destination marketer” for 2010.) In the Yemen booth, visitors can change into Bedouin garb and pose for photos in an ersatz harem. Mexico, one of Hawaii’s most important tourism competitors, has a spectacular booth with multiple flat-screen displays showing videos of Chiapas, Oaxaca and the Yucatan. Not to be outdone by Hawaii’s performers, Mexico employed a full mariachi band, replete with balladeers and brass.

 Big exhibitions like JATA highlight one of the great challenges facing Hawaii: As a small, island state, we don’t have the financial resources to compete with entire countries such as Mexico or Australia, or large states like Florida or California. Even some cities, such as Las Vegas or Macau, have larger marketing budgets than Hawaii. Industry observers estimate Mexico’s tourism marketing budget at $200 million to $250 million a year. Florida’s destination marketing – split among many agencies – probably totals more than $150 million.

In contrast, the total marketing budget for the state of Hawaii in 2010 was $65 million, which had to filter through HTA, to the marketing partners such as HTJ and the Hawaii Visitors and Convention Bureau, down to the individual island chapters. Most insiders say this simply isn’t enough money. “We ought to be spending about $150 million a year instead of $60 million,” says Outrigger president and CEO David Carey.

Big events like the JATA fair aren’t cheap. It cost HTJ $48,326 just to rent the floor space in the exhibition hall for three days. Building and manning the booth, including the stage and the sound system, cost $111,657. Transportation, accommodations and nominal per diem for the performers ran another $41,350, even though HTJ was fortunate that much of the talent was already in Japan. Roll in HTJ’s staff time to plan for the event and to support the HTA visit, and the tab for JATA approaches a quarter of a million dollars. That doesn’t include the money spent by the travel industry partners or the cost of flying in the HTA board members and staff. There’s no way around it: Big-time marketing is expensive.
 

 

      McCartney spoke at a JATA symposium on how to increase 
      global travel among Japanese people who live outside the 
      Tokyo area.
      Photo: Irwin Wong

 

 

Although Japan is an important market for Hawaii tourism, it’s dwarfed by North America, particularly the U.S. West, which contributed about 2.8 million arrivals to Hawaii last year, more than twice as many as Japan. So, in 2009, when plummeting visitor counts threatened a crisis in Hawaii’s largest industry, it’s not surprising that the marketers looked to the West Coast. In the wake of the loss of Aloha Airlines and ATA, the question for the Hawaii Visitor and Convention Bureau seemed to be: How do we preserve and grow airlift? And from the marketer’s perspective, how do we do that and still maintain the integrity of the Hawaii brand? As HVCB president and CEO John Monahan points out, “We didn’t want to dilute its value, built over decades, by putting ‘Hawaii on Sale.’ ”

 

The Blitz

The answer was “The Blitz.” Jay Talwar, senior vice president for marketing at HVCB, ascribes its origins to a conversation HVCB had with Hawaiian Airlines and its ad agency. “They said to us, ‘What if we focus on one market and just saturate it with a cooperative marketing program?’ And we said, ‘That’s great, but what if we invited everyone – all the hoteliers, the attractions, the travel sellers, all of them – to come and really try to get the tide to rise?’ And Hawaiian was good enough to say, ‘That’s fine. We know we’ll get our share. If the pie grows, our slice grows with it.’ That’s the birth of The Blitz.”

Talwar sketches out the thinking that went into the first trial run: “Let’s say we go to San Francisco for a whole month, and each week, we focus on a separate island.” The key, he says, was, for a month, to make Hawaii “unavoidable in that marketplace.” Doing that meant using every marketing tool available. It meant editorial visits to get the Hawaii story in local media – newspapers, magazines, radio and TV. It meant advertising: They cover-wrapped the San Francisco Chronicle and ran banner pages on its online version, SFGate. They put up billboards along the commuter routes of a demographic their analysis described as the habitual traveler. At night, they had “billboards” projected onto the sides of prominent buildings. They used social media and online contests to publicize special events. All of that drove traffic to the website of HVCB or an island chapter or a travel partner. “Basically, we did everything that you would do in Marketing 101,” Talwar says. “We just did it all at once.”

      Several HTA staff and board members also attended JATA, 
      including the new chairman, Atlantis CEO Ron Williams 
     (center.) The Hawaii booth at JATA is always an elaborate 
     affair, although HTJ has reduced its size in recent years due 
      to declining attendance at the travel fair.
      Photo: Irwin Wong

 

For later blitzes in Seattle, Los Angeles and again in San Francisco, HVCB fine-tuned its approach. In coffee-mad Seattle, marketers handed out free coffee to early morning commuters on the ferries, each week featuring coffee from a different Hawaiian island. The pitch: “You can actually go visit the farm where this coffee was raised. You can’t do that anywhere else in the United States.” Similarly, the second blitz in San Francisco took advantage of the city’s reputation as a culinary capital. “This time, we had a few guys with us named Roy and Alan and DK,” Talwar says. “It’s now connected with chefs and the farm-to-table movement. Now, we’re talking to San Franciscans in a language they understand. That got us a lot of great coverage in the local media.”

It worked. “We began measuring results 30 days out,” says Monahan. The steep spikes in visits to the HVCB website after the blitzes are unmistakable signs of marketing success. Perhaps a more meaningful measure is the level of participation among the travel industry partners. Monahan points out, “At one point, we had brand X; then X and Y; then X, Y and Z. Now, they all want to know as far in advance as possible what our blitz schedule is going to be so they can work that into their plans.”

The travel partners are more direct. “We use two metrics to measure marketing success,” says Jack Richards, CEO of Pleasant Holidays, the largest travel wholesaler to Hawaii. “One is brand awareness; the other is sales or passenger volume. And from our perspective, the blitzes have been tremendously effective on both fronts.” He also remarks on one of the keys to that success: Much of the money to pay for the blitzes comes from private industry. “You’ve got to understand that suppliers like me, we spent millions of dollars in matching funds to help drive visitors to the Islands,” Richards says. Exactly how much is difficult to ascertain, but, HVCB’s Monahan says, “We know the funding spent by these partners is a multiple of what we spent.” And HVCB has been spending between $1 million and $2 million per blitz. 

Beyond Marketing

Much of what makes marketing work isn’t the flashy media campaigns or public relations bonanzas; it’s what happens quietly in the background, and one of the keys to the recent successes of HTA and HVCB is their growing use of data. While the whirlwind nature of the blitzes makes it seem like those decisions were made by the seat of the pants, in reality they were grounded on hard numbers. The target cities were chosen because the data showed they accounted for more than half of Hawaii arrivals. Just as important, as HVCB’s Talwar points out, most U.S. East Coast visitors also pass through these cities, so it’s critical that marketers preserve as much airlift from them as possible. “Protecting the West Coast hubs allows us to protect our East Coast markets as well,” Talwar says.

Similarly, good strategic data was behind almost all the tactics used in the blitzes. Extensive consumer surveys allowed HVCB and its ad agency to craft advertising and public relations material based on the lifestyles and interests of the target audience. Demographic data and customer profiling helped identify appropriate media outlets and event locations. Social media allowed the marketing professionals to track the effectiveness of blitz activities in near real time. New-age marketing is all about data.

Hawaii’s marketers increasingly rely on sophisticated private-sector specialists to develop and make sense of all these numbers. In addition to DBEDT analysts (who recently moved under the HTA roof), these include companies like Hospitality Advisors, a Hawaii-based company with a global reputation as a strategic tourism consultant; Smith Travel Research, a respected industry consultant providing competitive set surveys that allow HTA and its marketing partners to see how Hawaii tourism is doing compared to its major competitors; and Sabre Airline Solutions, the giant travel conglomerate, which provides critical airlift analysis.

Airlift data is particularly critical for an island destination like Hawaii. Our economy depends on having enough air seats and, as the loss of Aloha Airlines and ATA demonstrated, maintaining that airlift is complicated. As David Uchiyama, HTA’s No. 2 man, points out, prior to contracting with Sabre, the state’s marketers had no idea if an airline’s route was having problems. As a consequence, it had no way of knowing if the airline needed help. “With the use of Sabre Aviation,” Uchiyama says, “we can now look months in advance to see booking pace, what the load factors are, and what’s the average fare they’re charging. Now, we can go to them and say, ‘We see that the route’s not doing so well. How can we support it with some kind of marketing boost?’ ” Those sorts of conversations are now commonplace.

Another quiet factor in the recent success of HTA has been the teamwork of Uchiyama and McCartney. HTA is not without critics, and one of the main complaints has always been that the organization’s structure makes it easy prey to politics. Most industry partners say they would prefer a much tighter focus on marketing, and less emphasis on cultural and environmental programs, and other priorities. (The money to fund HTA, after all, doesn’t come from the general fund; it’s paid by hotel guests through the transient accommodations tax.) So, when McCartney was selected to run HTA, many worried about his lack of a marketing background. Starwood Resorts senior vice president for operations Keith Vieira readily admits he preferred Paul Casey, the other major candidate for the job. “Mike had legislative experience and community experience,” Vieira says. “Paul had industry experience.”

Yet Vieira, like other industry critics, have been pleasantly surprised by HTA’s performance under McCartney. “Looking back,” he says, “I would say Mike McCartney was a very good choice.” Partly, that’s because McCartney has been careful to delegate most of the marketing decisions to Uchiyama, whose marketing background at Starwood puts him in good stead with the industry. David Carey, the CEO of Outrigger and another long-time critic of the politics and organization of HTA, points out, “Under Mike, they have a pretty good team in place. And now David’s so much more involved on a higher level.” Both Vieira and Carey acknowledge that McCartney’s political gifts have been useful, too, and not simply in dealing with the Legislature. In fact, his sensitivity and political skills have probably been most on display internationally, where he’s helped transform HTA’s relationship with key travel partners. The best example may be how the McCartney/Uchiyama team dealt with the loss of Japan Airlines’ Narita-Kona flight.

McCartney tells the story this way: Last spring, after losing money on its Narita-Kona route for years, JAL announced it was shutting the route down. For Kona, the result would be devastating, not only because Kona would lose a steady stream of lucrative Japanese visitors, but because, besides Honolulu, Kona is the only international point of entry for the state. Without JAL’s international arrivals, TSA would likely close its temporary facilities there, probably for good. With that in mind, the next time he was in Tokyo, Uchiyama paid a visit to Sunichi Saito, then JAL’s executive officer for passenger sales and marketing. He asked Saito a simple question: “How can we help?”

Those four words changed everything. The next day, Uchiyama was summoned to JAL headquarters to meet with Kiyoto Morioka, JAL’s VP for international passenger sales. “We’ve been flying to Hawaii for 55 years,” Morioka said in astonishment. “This is the first time anyone’s asked us that.” What ensued was a frenzied effort by JAL and tour operators in Japan, and HTA, the Big Island Visitor Bureau, and travel industry partners here to work together to develop marketing and promotional campaigns to create enough demand to sustain the route. This unprecedented cooperation succeeded in raising JAL’s load factor by more than 20 percent – not enough, ultimately, to preserve the route (as part of its bankruptcy restructuring, JAL shuttered 40 percent of its international routes) – but enough to set a new tone in the relationship and create a model for how to market in the future.

That same sensitivity to the needs of travel partners was on display during a string of courtesy calls made by the HTA entourage after the JATA travel fair. Over the course of a day, Ichikura-san chaperoned McCartney, Uchiyama and the HTA board members through a string of corporate offices around Tokyo. Along the way, they visited with executives at airline partners, such as JAL and Delta; at major travel wholesalers, such as JTB and JALPAK; and with trade organizations like JATA and the Japan-Hawaii Tourism Council. These meetings, as you would expect in Japan, were frequently formal and stylized. They were also surprisingly candid, with each side volunteering inside information about corporate strategy or political challenges, swapping industry rumors, and asking for opinions and advice.

In the end, it always came down to those four words: How can we help?

During one of the symposia at the JATA conference this September, McCartney sat on a panel that discussed how to get more Japanese from beyond Tokyo to travel abroad. But, seeing JAL VP Kiyoto Morioka in the audience (a courtesy in itself, since the audience was mostly midlevel managers), McCartney took a question about how low-cost carriers were going to affect the market, and he turned it inside out.

“We appreciate all airlines,” McCartney said, nodding to Morioka, “but we want to say a special aloha to Japan Airlines. Your Kona flight did very well for many years. But, because of the downturn in the world economy, you came to us to apologize that you could no longer fly to Kona. You showed us pictures of your trips to Hawaii when you were a child and told us how important Hawaii was for you. We will never forget that. We’ll never forget the commitment that JAL has for Hawaii. And I wanted to say, ‘We’re the ones who should be apologizing for not coming to you sooner to help.’ Thank you so much for all you’ve done for Hawaii.”

When McCartney finished, Morioka and his small entourage of JAL executives stood and bowed deeply.

Which media produce results in Japan

Click to enlarge image.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of mainland “blitzes”

Click to enlarge image.

 

Marketing “blitzes” in key Mainland cities generated lots of traffic to the GoHawaii website. For example, the June blitz in Los Angeles drove that city’s share of all traffic to the website from about 6 percent to 20 percent. Perhaps more important, Los Angeles’ interest in Hawaii after the blitz seems to have what marketers call a “long tail.” 

 

Where HTA spends its marketing Dollars

Click to enlarge image.

 

 

 

 

 

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Nonprofit Boards: Confused, or M.I.A.

BY DENNIS HOLLIER

     Photo: iStock

“When I look back on it,” says John D., the former executive director of a small but prominent nonprofit in Honolulu, “the board of directors just really didn’t understand what their role was.” He pauses for a moment, his face assuming a pained expression. “In some cases, they made their job more difficult by micromanaging the staff. But they also didn’t take care of their basic responsibilities, like raising funds or strategic planning. In the end, they made it impossible for me to do my job.”

His is a common sentiment among the leaders of Hawaii’s nonprofits, particularly those from small- and mid-sized organizations. Many executive directors, CEOs and even some maverick board members say privately that their boards are poorly prepared, misinformed and often burdened with damaging misconceptions about their roles. The result is a lack of clarity about the relationship between the board and the executive director, and about their respective responsibilities. Inevitably, this confusion leads to conflict and limits nonprofits’ effectiveness. And if you listen to Hawaii’s community of executive directors, it’s the boards of directors that are mostly to blame.

It’s true, some nonprofit experts are more circumspect. For example, Holly Henderson, who, as executive director of the Weinberg Fellows and Castle Colleagues, has helped train hundreds of executive directors and board members in Hawaii, believes these problems are an inevitable part of the evolution of a nonprofit. “What I see a lot of,” Henderson says, “are boards that aren’t working anymore. And although there are individuals who want to blame somebody, sometimes it’s just the same as blaming a kid of for growing out of a pair of shoes. Because, what works at one point in an organization’s life doesn’t work at another point. And it’s not necessarily anybody’s fault.”

She also notes that business people make up the bulk of nonprofit board members, and that they’re volunteers, often taking valuable time away from their companies and families. “You have people who want to help the community by volunteering their time,” she says, “and they’re not happy to be told they’re not doing a good job.”

Henderson’s perspective draws on the work of the nonprofit expert Karl Mathiasen, who divided nonprofits and their boards into three stages of development:

  • Small, informal “organizational boards,” dominated by the nonprofit’s founders;
  • Larger, more independent “governing boards” that begin the process of formalizing rules and procedures; and
  • Large, sophisticated “institutional boards,” replete with standing committees and many of the attributes of a for-profit corporation.

     Holly Henderson, who helps train nonprofit leaders, says conflicts 
     arise when nonprofits evolve, but their boards do not change with 
     them. 
     Photo: Rae Huo

According to Mathiasen, these transitions, particularly from an organizing board to a governing board, are often fraught with conflict. To make matters worse, as Henderson points out, executive directors and board members may evolve at different rates. This, she says, is why so many executive directors complain about their boards.

To some extent, it was always so. Several years ago, the Hawaii Community Foundation did a survey of executive directors to understand why turnover was so high among nonprofit leaders. “The No. 1 complaint that came out was the board,” says Christine van Bergeijk, the foundation’s vice president for programs. “There was really a great deal of sentiment that executive directors were all by themselves, and the board members were merely cheerleaders. The EDs said they needed the board to roll up their sleeves and do some of the hard work.” Board members, in other words, aren’t living up to their end of the bargain.

Of course, that’s only one side of the problem. Executive directors, for example, deserve a share of the blame. Many, particularly if they founded the organization, preserve their power by keeping their board members in the dark. And there’s a whole other story to be told about the level of professionalism among the leaders of the nonprofit community. So, the incompetence of board members isn’t the only problem facing nonprofits. “It’s true that our board is kind of passive,” says a board member from a small educational organization, “but I think the members would work with the executive director if she really needed help.”

It’s certainly telling, though, that although many executive directors were willing to share their complaints, none were willing to do so on the record, citing a fear of reprisals from their board or the inability to get nonprofit jobs in the future. Many also worried that public criticism would damage their ability to raise funds. For that reason, we’ve disguised the identities of most of the executive directors cited in this article as well as the organizations they run. Of course, this anonymity makes it difficult to gauge the validity of their complaints. But the striking uniformity of their criticism gives them credence.

For this story, we interviewed the executive directors, staff members, and members of the boards of more than a dozen nonprofits. We also spoke with some of Hawaii’s most respected nonprofit experts and consultants. Over and over, they brought up the same tales of board members who didn’t understand their roles or failed to embrace their responsibilities. Here are the three major areas where Hawaii’s nonprofit boards come up short:

     This chart from the Aloha United Way shows the responsibilities 
     of a nonprofit organization.

Board Development


“All my board members are just friends of one another. For ‘board orientation’ all they get is a pat on the back and a copy of our last annual report.” —Noelani K., executive director of a social services provider.


 “Too often, board members treat meetings like a social club. They don’t seem to take the work or the mission seriously.” —Tom K., executive director of a nonprofit intermediary organization.

 “We’ve had the same chairman of the board for 10 years.” —Mary N., CEO of a cultural organization.

 

“The board members absolutely refuse to attend any kind of board training. Even though none of them have any experience, they all say they already know everything there is to know about how to run a nonprofit.” —Amy L., executive director of an environmental organization.

It starts by picking the right board members. All too often, executive directors complain, new members are selected because they’re friends of other members. Except on some large institutional boards, little strategic thinking goes into identifying candidates and courting them to see if they’re a good fit. The result is often undersized, homogeneous boards that lack the skills needed to govern an organization responsibly.

This also poses problems for potential board members. For business executives contemplating joining the board of a nonprofit, it’s not simply a matter of whether you want to serve, but whether you’re a good fit. Amy Hennessey, a former board member for Community Links, a Honolulu organization that served as a sort of incubator for nonprofits until it closed earlier this year, says that means asking questions. “You want to ask about their expectations: ‘What’s your fiscal structure? Are you in financial difficulty? What’s your plan for the future? What are your expectations for my involvement on this board? How much of my time do you really need? In other words, what do you need from me in terms of time, money, intellect – all that?”

Of course, those questions rarely arise from new board members. Even worse, board members, even after they’ve been selected, are rarely told what’s expected of them or given an adequate orientation to the board’s duties. And, as one executive director pointed out, “There’s never any discussion of the division of labor between the board and the ED.” Clearly, there needs to be a more thorough education of board members.

But, as Henderson points out, board members aren’t necessarily going to embrace this education. “These are often prominent people,” she says. “A lot of them don’t take well to the idea that they need training. In fact, I rarely use the word ‘training’; I usually say ‘briefing.’ ” Whatever you call it, though, board training should be an ongoing process, not just for new members. Henderson gives the example of board rotation, the use of term limits to systematically replace board members. “One of the wonderful things about board rotation is it gives you the opportunity to get the board together and to do some orientation. Ostensibly, it’s for new board members, but long-serving board members can hear it as well.”

 

     Robbie Alm, VP at HECO and a member of several nonprofit 
     boards, says most boards offer only a basic orientation for 
     new members. 
     Photo: Olivier Koning

In most cases, though, there’s little or no orientation, and both executive directors and board members can share in the blame. “What I’ve seen a lot of, over the years,” says Robbie Alm, “is a failure on the part of everybody – executive directors, board members, board chairs – to really work out and understand what their roles are. It’s almost as if we assume we know, so we never really talk it out.” In the nonprofit literature, this is sometimes referred to as “blurred roles.” A board member from one local nonprofit put it another way: “Nobody knows a damned thing.”

Not everyone believes that boards are the problem. Tim Johns, CEO of Bishop Museum, for example, says there’s been a trend toward more and better training, so board members today have a better understanding of their roles. (It’s worth noting, though, that most of Johns’ board experience has been on mature, institutional boards.) He does note, however, that the pool talent in a community of this size is limited. “We do have a lot of nonprofits, so we may not have as many potential board members as you have in a larger community.” As a result, he says, people might be sitting on boards earlier in their careers. “If you were in San Francisco or Chicago, you might not be sitting on that type of board at that point in your career.”

Fundraising

“When I started our first capital campaign, my board chair said to me, ‘Why do I have to fundraise, isn’t that why we hired a development director?’ ” 
—Mary N., CEO of a cultural organization.

“When I tell the board that funders often require 100 percent board participation, they say, ‘Isn’t our time enough? We’re all professionals; our time is worth something.’ 
—John D., executive director of a human services agency.

“Several of my board members actually told me they would never ask their friends to support our agency; it would be too embarrassing.” 
—Amy L., executive director of an environmental organization.

“Our board chair said flatly he won’t donate, won’t raise funds, and won’t quit.” 
—Mike T., CEO of an arts group.
 

Money is king. And for most nonprofits, fundraising is the single most important responsibility of the board of directors. That’s because it almost always takes cash for organization to accomplish its mission. It’s true that board members are often recruited for other reasons – financial or legal skills, for example, or cultural or technical knowledge – but these attributes are rarely sufficient. A board member’s time and talent are useful, of course, but they don’t pay the rent or insurance, they don’t cover the salaries and benefits of employees, and most importantly, they don’t pay for food for the hungry, educational programs for the environment, medical treatment for the sick, or any of the countless other programs that fall within the missions of Hawaii’s nonprofits. That takes cash, says van Bergeijk of the Hawaii Community Foundation. And it’s the board members’ role to donate or, better still, raise that cash from the community.

“I think the prevailing expectation today,” van Bergeijk says, “is that, if you’re on a board, you must make sure the organization has the resources they need to do the job. That equals fundraising. It shouldn’t be only fundraising, but that’s the prevailing expectation. If you’re on a board, you’ve got to help raise money. And not everybody’s cut out to do that.”

This judgment is nearly universal among nonprofit professionals. And yet the board members of many nonprofits often fail to participate in fundraising in any meaningful sense, leaving it to the executive director or to one or two more committed board members. Christine Valles, a member of numerous nonprofit boards herself, and owner of Silver Lining Consulting, a company that advises nonprofit organizations, believes this problem, like many of those facing nonprofit governance, is another outcome from how board members are recruited in the first place. No one tells them what’s expected of them.

“It has to be clear to the new board member that they’re responsible for fundraising,” Valles says. “That’s universally agreed upon in the nonprofit world. They have to provide some means for the financial stability of the organization. But that part is really underplayed when board members are recruited. No one takes the time to say, ‘You know, you’re going to have to take the lead at raising money. You’re going to have to make a personal donation, and you’re going to have to ask your friends for their support.’ Even though that’s simply saying what boards do. You’ve got to say, ‘As board members, we’re all responsible for fundraising. So if you’re not actively asking people to give money, you probably shouldn’t be on a board.’ ”

This reliance on the board for fundraising isn’t universally true. Many organizations that provide social services, for example, rely mostly on government contracts for their funding. Other nonprofits depend largely on grants, either from government sources or from private foundations. And because the agency staff usually writes and prepares grant proposals, that relieves the board of some of its responsibility to raise funds.

It’s worth noting, though, that many private foundations and wealthy individuals will not support an organization unless every board member has contributed money. And the vast majority of Hawaii’s 6,000 or so 501.c3 nonprofit organizations depend on financial support from the community for their survival. In some ways, that’s the theory of having a board in the first place: to provide a link to the community, a way to ask the public for its support.

At large nonprofits with institutional boards, this concept is generally (though not universally) understood. One of the reasons the boards of organizations like the Aloha United Way or the Easter Seals are so large (Easter Seals Hawaii, for example, has more than 30 board members) is to spread out the burden for raising funds. In fact, new board members are often selected as much for their ability to attract financial support as for any contacts or skills. This is why most institutional boards try to attract bank executives as members. Robbie Alm, vice president of Hawaiian Electric Company, and a board member for more than 20 nonprofits over the years, points out that senior business executives recruited this way usually understand their role.

“Certainly, many of the large nonprofits are very deliberate in their efforts to do that,” Alm says. “And it works. If I agree to go on the board of an organization, not only am I going to give, but most likely my company will have a table at that fundraiser dinner, that we’ll be at that luncheon or attend that ball.”

The problem is that the board members of smaller and mid-sized organizations often fail to make that assumption. These nonprofits are frequently stuck at the organizing board stage of their evolution, and their members are either unable or unwilling to actively raise funds.

The solution is clear. Executive directors say their nonprofit boards need to be much more engaged in the organization’s fundraising. Members should donate according to their means and actively solicit donations from their friends and contacts. Holly Henderson offers perhaps the best advice for potential board members: “Pick an organization doing something you’re passionate about. That way, you won’t feel uncomfortable asking people to support its mission.”

Oversight

“We’re not responsible for the financial filings, we’re just an advisory body.” 
—James K., board chair of a cultural organization.

“The board has always refused to pay for an independent audit of our finances.” 
—Donna T., board member of a community development organization.

“The ED of my former agency never filed a grant report on time, and used the agency’s accounts like a personal slush fund.” 
—Tom G., staff member at a Honolulu social services organization.

Most nonprofit boards understand that they’re responsible for oversight of the organization. The problem is that, all too frequently, they believe this is limited to hiring and firing the executive director. In fact, their oversight responsibilities are more comprehensive. For example, it’s the board, rather than the executive director, that’s legally liable for much of the financial regulation of the organization.

Partly, this is the result of the Sarbanes-Oxley Act, Congress’s response to scandals at Enron and WorldCom. “Even though it was primarily targeted at publicly traded companies,” says Anna Elento-Sneed, an attorney at Alston Hunt Floyd & Ing specializing in nonprofit law, “there’s a section that applies to nonprofits. Basically, it says, ‘Thou shalt have transparency. Thou shalt have no conflict of interest.’ ”

That gets to the heart of a board’s function. Few board responsibilities seem as obvious as those that generally fall under the heading, governance. Executive directors say (some of them reluctantly) that these includes basic functions: assuring that the organization complies with legal requirements, like making its IRS filings on time; making sure there are adequate policies to prevent issues like self-dealing and conflicts of interest; and recognizing that the board is the organization’s primary vehicle for public relations. These responsibilities aren’t all that different from those that for-profit boards assume.

When you talk to executive directors, especially those that have been successful, they almost uniformly say that nonprofits and their boards need to be more “businesslike.” For the board, that means making sure your executive director and staff perform their duties as professionally as possible given their resources. It also means being accountable for your own responsibilities, which ultimately are the health and welfare of the whole organization. Because the board of directors isn’t simply an advisory body added as an afterthought. The board is the legal embodiment of the organization.

It’s a concept that flies in the face of the egalitarian ethics of most nonprofits. “You want it to be all cordial relationships,” Holly Henderson says. “You want everyone to be equal. But in the end, you can’t get around the fact that the board is the boss.”

Now, if they’d just act like one.

 

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The High Cost of Affordable Housing

BY DENNIS HOLLIER

     Makani Maeva, Hawaii director for the VitusGroup, knows from 
     experience that the financing for an affordable housing project 
     can change dramatically before it is finished. 
     Photo: Rae Huo

“Building affordable housing is complicated,” says Makani Maeva.

She should know. As Hawaii director for the VitusGroup, an affordable-housing developer, she recently completed the Lokahi Apartments, 307 rentals in Kona. Between January 2007, when another developer laid the project in her lap, and July 2010, when the apartments first were offered for rent, almost all the financial and technical details of the deal changed dramatically: The permanent loan went from $16.4 million to $19.2 million; the original equity investors – GMAC, Wachovia and others – had to be replaced; $7.8 million in affordable-housing credits from the County of Hawaii became unavailable, replaced by a soft mortgage of $11.75 million from the state’s rental housing trust fund; and the cost of construction rose from $53 million to $60.6 million, largely due to interest costs.

“It’s like fried rice,” she says. “Because I thought I had one thing in the refrigerator, I thought the project was going to be structured one way.” In the end, though, the recipe changed completely.

The complexity of Lokahi’s financial arrangements is hardly unique. In fact, the average affordable-housing project in Hawaii is funded by at least seven financial instruments – industry insiders say some projects require as many as 14 – each of which comes with its own rules. That’s just the financing. The truth is everything about affordable housing is complicated and constantly changing – the money, politics, regulations, ethics. If you want to “fix” the system, you have to consider them all.

What is ‘affordable housing’?

Too often, affordable housing is equated with public housing and poverty. But the affordable-housing crisis affects a broad swath of the middle class. Developer Chuck Wathen, who recently founded the Hawaii Housing Alliance and is a longtime advocate for affordable housing, notes it would take 3.19 firemen to be able to afford the median-priced home on Oahu. It would take 3.63 school teachers or 5.2 hotel front desk clerks. “What we have isn’t just an affordable-housing problem,” Wathen says. “We have an income problem.”

He also notes that the shortage of “workforce housing” is most acute in the rental market: “A Mainland city of this size would probably have 400 apartment communities of over 300 units.” Yet there’s no financial incentive to fill this gap.

Kevin Carney, Hawaii vice president of EAH, a nonprofit affordable housing developer, explains the math. “It just doesn’t pencil out to do a rental project,” he says. “Let’s say you’re serving a market segment at 100 percent AMI (area median income) – a family of four that makes $80,000 a year or so. The rents you can charge at that income level just aren’t going to cover your debt and operating expenses. So you can’t build it. Instead, you build a condo and you sell those units to people with incomes of, say, 200 percent AMI or more. Then they turn around and rent them out as long-term investments.

“That’s our ‘shadow’ apartment market in Hawaii.”

    The VitusGroup recently completed the Lokahi Apartments, 
     307 affordable rentals in Kona. 
     Photo: Vitusgroup

The financial puzzle

Government programs account for almost all affordable-housing development, either through subsidies or by regulations that require developers to include affordable units in their market-priced developments. But neither approach has supplied much housing in the past two decades.

The centerpiece of affordable-housing finance is HUD’s Low Income Housing Tax Credit, which is administered in Hawaii by the Hawaii Housing Finance & Development Corp. LIHTC (pronounced Lie-Tech) was created to spur the private development of affordable housing, awarding dollar-for-dollar tax credits in exchange for guaranteeing a project will remain affordable for at least 20 years. By some estimates, LIHTC has played a role in the development of as much as 90 percent of all affordable-housing units in the country. Hawaii is no different.

Darren Ueki, HHFDC’s finance manager, explains that there are two kinds of LIHTC credits, one worth 9 percent and the other 4 percent of a project’s development costs. “We’re basically giving out anywhere from $27 million to $28 million in (9 percent) tax credits a year.” Yet he acknowledges that demand for affordable housing is much greater than that. In 2007, an HHFDC report projected the state would need to create more than 28,000 rental units over the following five years. Even by the most liberal estimates, the LIHTC program creates fewer than 300 units a year in Hawaii. That’s not surprising, since those credits only account for a small fraction of the cost of development.

For example, the credits don’t cover the cost of the land or predevelopment planning. (Developers say that, for an affordable-housing project to work in Hawaii, the land must essentially be free.) In addition, the developer must find investors with tax liabilities to purchase the tax credits. During the housing bubble, developers sold credits at nearly face value, and sometimes higher. Once the credit markets crashed, the prices plummeted to 60 cents on the dollar, though they are back to about 90 cents. Typically, the proceeds from these sales account for nearly all the equity in an affordable-housing project. “The problem,” says Carney, “is that will only produce between 30 to 40 percent of your equity needs. So you’ve still got to come up with the other 60 to 70 percent.” That, too, is affected by LIHTC rules.

For example, there’s the property’s income stream, the money earned from rents or sales. As in a market-price project, the affordable-housing developer can borrow money against this revenue, but the project’s income is restricted by HUD regulations, which limits the amount of rent (or mortgage payments) the developer can charge to 28 percent of the customer’s monthly income. At 60 percent AMI, for example, a two-bedroom unit at the Lokahi Apartments rents for only $833. That’s what makes it affordable. But these rent rules limit the property’s income and the debt it can support. Moreover, the lender will usually only permit an 85 percent debt-to-income ratio, reserving the remaining 15 percent as cash flow to cover operating costs and profit. Thus, the $60.6 million Lokahi Apartment project could only secure $19.2 million in permanent financing, less than a third of the development’s total cost. The balance had to be painstakingly cobbled together from federal and state subsidies and loans. In fact, for the typical two-bedroom affordable rental unit, the state has to kick in another $150,000.

Putting the financing together is a slow process. One EAH project in Ewa has been in planning for 10 years. Maeva eschewed the cumbersome 9 percent LIHTC credits altogether, opting instead for the state’s low-interest Hula Mae loan program, in which HHFDC issues tax-exempt bonds to help finance affordable-housing projects. An added bonus is that participants automatically qualify for 4 percent LIHTC tax credits.

Regulatory dance

Government regulations also provide incentives for and hindrances to development. For rental properties, the most important are the federal, state and county regulations that affect the affordability period of a development. Since any affordable-housing project exists only because of public subsidies, it seems fair to require the developer to keep the project affordable for a reasonable period. Of course, “reasonable” means different things to different people, and today it ranges from 20 years to 60 or more.

The need for these rules became clear in 2006 when the owners of the state’s largest affordable-housing project announced plans to sell when it came out of its 20-year affordability period in 2011. The planned sale of Kukui Gardens by the Clarence T. C. Ching Foundation would have put nearly 2,500 tenants out of affordable housing. Only the investment of more than $50 million by the state – along with extensive tax breaks and bond support and a partnership with nonprofit developer EAH – preserved the project. But EAH vice president Carney acknowledges Kukui Gardens is just the tip of the iceberg. “The low-income rental industry loses two apartments for every one that’s being built.”

Some affordability advocates, like Chuck Wathen, argue that the affordability period for rental housing shouldn’t end. Maeva isn’t one of them. “I say things shouldn’t be affordable in perpetuity,” she says, “because, if there’s no risk the thing will become market (rentals), then there’s no incentive to go in and rehabilitate it. What you’re then creating are really ghettos and public housing. You need to identify and recognize the finite lifecycle of a piece of wood and the termites’ appetite for that. If there’s no risk it’s going to turn into condos, then it’s not going to get any political attention. It’s not going to get any attention from new developers. And, at some point in time, everything needs to get redeveloped.”

Although Wathen clearly admires Maeva, he’s not convinced by her arguments. “Let me explain it to you this way,” he says. “When you develop these projects and you sell the tax credits to the investor, after 10 years, when they’ve got their write-off, they don’t want to hear about this project anymore. They want it off their balance sheet. They want to get rid of it. That means the developer gets the residuals of whatever you make after 15 years.” He says the Ching Foundation got a $148 million windfall from Kukui Gardens. Wathen asks, “Should private developers profit from public investment?”

The affordability period of rental housing has its analogs on the for-sale side. There, in exchange for opportunity to purchase below market-rate housing, the buyer agrees to terms like buy-back provisions and shared appreciation equity. Buy-back provisions give HHFTC the right to buy the property back at a designated price if the owner chooses to sell within 10 years. This strategy prevents flipping. Similarly, the shared-appreciation equity program requires the owner to share any appreciation in equity with HHFTC when the property is sold. The percentage share is established in the sales contract, and unlike the buy-back clause, never lapses. Like the affordability period, these tools are designed to preserve affordable housing.

In many ways, though, the availability of for-sale affordable housing is much more affected by state and county regulations that require a developer include a certain percentage of affordable housing in market-rate development plans. In Honolulu, this so-called inclusionary housing requirement is usually 20 percent. For the most part, these rules apply to any developer seeking rezoning or a variance, and the logic is clear: In exchange for the public’s permission to build, you must contribute affordable housing. But it’s not clear at all that inclusionary housing has resulted in more affordables.

Even Carney notes: “The tradition in Hawaii has been for major developers – your Castle & Cookes, your Gentrys – to supply the for-sale product of workforce housing. But nothing is free. They pay for that by increasing the cost of market housing.” Which raises an ethical question: If we, as a state, decide that affordable housing serves a critical community need, shouldn’t the costs of that service be born by the community at large? Yet, as Carney notes, under the current system of inclusionary housing, those costs are placed only on the other residents of the new development. This not only puts an unfair burden on new buyers (or renters,) the added cost is also a disincentive to building affordable housing. If 20 percent of your units have to be subsidized (to the tune of $150,000 each), it’s hard to make enough profit on the remaining units to justify the investment.

Is there another way?

Other strategies have been tried. During the Fasi administration, the city was a successful developer of affordable housing. Projects like Chinatown Gateway Plaza, Hale Pauahi Towers and Marin Tower in Chinatown are testaments to the viability of mixed-income development. Similarly, the controversial project proposed for River Street is also on city land. It’s true that those earlier projects were built when the city was flush and there was a civic commitment to affordable housing. Nevertheless, city development might be updated to suit the needs of today. Certainly, spreading the cost of affordable housing across the tax base is more equitable than foisting it on a few new buyers. It’s also less likely to discourage market-rate development.

The state has also been an affordable housing developer. Twenty years ago, when it began development of the Villages of Kapolei, it built out the infrastructure and provided developers with ready-to-build sites. In exchange, the state required those developers to make 60 percent of their units affordables. This project created thousands of affordable units, although, in practice, the 60/40 split didn’t work out financially for the developers. Nevertheless, the process might help circumvent some of the lengthy and costly aspects of getting permits and entitlements.

It may be that the best hope for increasing affordable housing is simply to make it easier for developers, even market-rate developers, to build. If you ask affordable-housing developers – whether specialists, like EAH and the VitusGroup, or large-scale community developers like Castle & Cooke and Stanford Carr – what’s the biggest problem in creating affordable housing, almost unanimously they say it’s the shortage of entitled land. That’s why there simply aren’t enough homes being built. Bruce Barrett, executive vice president for Castle & Cooke, puts it this way, “From a developer’s perspective, the lack of supply is the major issue that limits affordability.” He points out that, during the last housing bubble, the median home price on Oahu essentially doubled. “Why did it double? Because we’re building less housing stock now than we did in the 1950s.”

Which is not to say that subsidies don’t have a role to play. Jesse Wu, vice president at Stanford Carr Development, which has major affordable-housing projects in both Kakaako and Ewa, says, “The production of affordable housing is really limited by the amount of subsidy available. For most of these units, even when the land is free, we’re putting together $80,000 to $100,000 per unit to bridge the differential between what it costs to build the unit and what we charge as affordable rent.”

Courage of their convictions

Another impediment to affordable housing is when politicians and bureaucrats get in the way. During the early stages of the Lokahi Apartments project, Maeva voiced two common frustrations when the Hawaii County Council considered delaying a rezoning vote. “I said, ‘Pardon me, but everyone here acts like you’re into affordable housing, acts like you think it’s a need. Everybody got a bruddah bruddah who lives in a car, everybody got somebody no more job, everybody got a story. I say, to do nothing is a vote ‘No.’ It should go on the record that you’re against affordable housing.’

“ ‘You’re trying to make me solve all kinds of other problems. Saying, ‘Oh, there’s going to be increased traffic because of this affordable housing;’ ‘Oh, you need to increase the sewer system;’ ‘Are you sure we don’t need more parking?’ But I’m not here to solve every problem you have in the County of Hawaii. I didn’t create them and I’m not making that kind of money. I’m saying I can help you solve your affordable-housing problem; if there are other problems, that’s your kuleana.’ ”

In other words, shut up and let me build.

 

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Hawaiian Electric Transformers

BY DENNIS HOLLIER

     From left: Lynne Unemori, Darcy Endo-Omoto, 
     Tayne Sekimura and Dave Waller 
     Photos: Rae Huo

“You can’t run an operational company like this without leadership that’s experienced in operational issues,” says Robbie Alm, executive vice president for Hawaiian Electric Co. “That’s not me. That was never going to be me.”

Alm isn’t being modest. He’s trying to explain the origins of the Clean Energy Team, a small cadre of company engineers, planners and policy wonks who are behind the greatest corporate transformation the Islands have seen in decades. The changes began two years ago, Alm says. That’s when the utility signed the historic Hawaii Clean Energy Initiative (HCEI) with the governor, and agreed to some audacious goals, including a legal commitment that, by 2030, 40 percent of its power generation would come from renewable energy.

It was the technological, structural and regulatory challenges of meeting these goals that gave birth to the Clean Energy Team. But Alm believes that the leaders of this group, 10 mid-level managers and young vice presidents, will lead the company far into the future. He also believes one of them is likely to be its next CEO.

A Top 250 Leader

Hawaiian Electric Industries – parent company of the electric utilities HECO, MECO and HELCO, and American Savings Bank – has been in the first, second or third spot on the Top 250 since 1990. In the 1980s, the parent company always ranked fourth or fifth.

 How it Started

In the years leading up to the Clean Energy Initiative, HECO (along with its Neighbor Island partners, MECO and HELCO) found itself increasingly beleaguered. Its public image had been battered by a series of highly publicized conflicts over issues like the construction of transmission lines on Waahila Ridge and the expansion of power plants at Kahe and Keahole. There was also a sense among the public that the company’s existing clean-energy programs were just empty gestures. “The company found itself in fairly unhappy straits,” Alm says. “The editorial writers were against us, the Legislature wasn’t happy about us, and the environmental and historic preservation groups were against us.”

The company also had built-in financial problems. As HECO chair Connie Lau points out, the company’s efficiency programs and changes in technology meant that even when the economy was expanding, and costs increasing, sales declined steadily. In fact, net revenues have declined in each of the last six years. And, as Lau notes, although the company is allowed by statute to earn 10 percent profits, by 2008 they had fallen below 4 percent.

“If you look at the late 1990s,” says Alm, “we were kind of booming. By the 2000s, though, the economy’s not doing so well. The stock market took that tech dive, interest rates went way down, and we hadn’t been in for a rate case in quite awhile. Financially, the company was challenged. And we weren’t helped at all by being so unpopular with the public. People used words like ‘arrogant,’ ‘monolithic’ and ‘oil-addicted’ to describe us.

“And then, Linda Lingle comes in,” Alm adds, “and she clearly doesn’t like us. If you go back and read her speeches, particularly those leading up to the 2006 legislative session, we were sort of public enemy No. 1. Again, it was our addiction to oil and unwillingness to change.” It wasn’t just idle complaining; the Lingle administration was clearly taking Hawaii’s dependence on fossil fuels seriously. “So, in the 2006 legislative session,” Alm says, “she had those big bills to alter the playing field. And a lot of it passed.”

Maurice Kaya, the former state energy administrator and one of the original authors of the HCEI, points out that some of those laws were transformational. “One,” he says, “was the recognition that the efficiency programs, which were run by the electric utility, were sort of the fox guarding the henhouse. So that was taken away from them. In that same context, we were able to convince the Legislature that there was really no business motivation for the utility to change their ways and get off oil.” In short, Kaya paints a picture of a company financially and structurally unprepared for a clean energy future. It was hard to avoid the perception that the 109-year-old utility was in decline.

So in 2007, when Kaya and Bill Parks, the Department of Energy official who helped write the HCEI, came to Alm with a proposal to radically transform the state’s energy system, it’s not surprising that the utility was interested. In the fall of 2008, after its due diligence, Hawaiian Electric signed on. All that was left was the execution.

     Dan Giovanni (left) and Robert YoungOperations Team

Operations Team

The nuts and bolts of utility work are in operations. That’s what happens in the big power plants, on the vast networks of transmission lines, on the distribution grids that feed electricity to the customer, and in the master control room that oversees it all. Operations is also usually the lair of the most conservative, risk-averse engineers.

At HECO, though, operations is a hotbed of experimentation. It’s the crucible for the schemes and analyses of planners. It’s where the formulations of policy makers and regulators are put to the test. It’s also the site of a remarkable little research and development program into the use of biofuels in traditional steam generators. It’s a good thing, too, because renewable biofuels are a critical part of the company’s clean-energy plans, and it’s hard to see any of those plans without the strong support of operations.

Dan Giovanni
Age:
 62
Title: Manager, Generation Department

 

Clean-Energy Responsibilities: Conducting R&D and developing operational plans to convert HECO’s existing fleet of generators to use biofuels.

“The devil’s in the details,” says Giovanni, explaining some of the difficulties of converting from fossil fuels to biofuel. “It means a lot more than asking: ‘What’s the price?’ ‘Does it meet sustainability criteria?’ ‘Can we get it here in time and in volume?’ Those are the simple questions.” The more important questions, at least for an operations guy like Giovanni, are the technical ones. “ ‘How will it behave once we commit to it operationally within our infrastructure?’ ”

Giovanni is leading the utility’s own little R&D program into that question. “We’re going to take one of our largest and most important generating units and operate it for a month on biofuels – 30 days, 24/7. It’s a $12 million test: $5 million worth of equipment, $5 million worth of biofuel, and about $2 million worth of experts from around the world to do the testing and analysis. They’ll look at the environmental impacts, the combustion impacts, the thermal and performance impacts, and the fuel stability question. There’s no shortage of technical questions. But I can tell you this: Six months from now, our team will be the most informed people in the world on how to use biofuels in a conventional steam power plant.”

Robert Young
Age: 
55
Title: Manager, Systems Operations

 

Clean-Energy Responsibilities: Run the operations center so the grid can reliably incorporate the most renewable energy possible.

Part of the idea of the Clean Energy Team is the inclusion of operations guys like Young and Giovanni in the mix. Like all the engineers on the team, they have a fundamental grasp of the tension inherent between adding more and more intermittent energy sources, like wind and solar, and maintaining inexpensive, reliable power for customers.

“There’s this conflict,” Young says. “We have to protect the system, but we know that if we don’t do anything, eventually we’ll be subject to higher and higher fuel prices that will drive the cost of electricity up.” He points out that this tension chaffs the fundamental conservatism of engineers.

“Being in operations, I’d like to see more stable resources,” he says. Like Giovanni, he sees biofuels as a critical part of dealing with the intermittency of most renewables. “The fallback really is that some generation sources have to burn some form of fuel. Biofuel is a way to get off crude oil.” And Giovanni’s research program has provided him some hope for clean energy.

“In the beginning, there was a pretty high level of anxiety for us engineers,” he says. “The unknown is always daunting. But, from the operating side, as we’re working through things, the comfort level is getting better.”

The Planners

For nearly 100 years, the basic model of an electric-power utility has been relatively simple: Produce electricity in power plants and send it to customers through transmission and distribution lines owned by the utility. If customers need more electricity, fire up another generator. If demand drops, reduce production. This model fit well with the physics of electricity, which require that production and demand move in unison.

But the clean-energy future is less predictable. It’s going to include generation, like wind and solar power, that can’t be fired up at will, and won’t be controlled by the utility anyway. The same opacity will apply to customers as well, many of whom will generate some of their own power. This intermittent, unpredictable power is the bugbear for modern utility engineers, whose principal objective is to produce reliable, high-quality power for their customers.

Some of the key players on the Clean Energy Team are the planners who struggle to cope with this conundrum. It’s their job to design the systems and acquire the resources that will allow the company to integrate ever more renewable energy sources onto the grid without the customer – that’s you and me – even noticing.

Colton Ching
Age:
 43
Title: Manager, Corporate Planning

Clean-Energy Responsibilities: Long-range planning to ensure the company has the generation, transmission and program resources to meet its renewable-energy goals and maintain reliability.

“My group has a hodge-podge of responsibilities,” Ching says. “Part if it is internally focused: We do strategic planning for the company. That includes a lot of internal reporting and risk assessment. But the other half of my department is externally focused: planning – we’re talking 20-year planning – related to long-term use of resources in the system. What are our future needs going to be for transmission? For new generation? What kinds of new demand-side management programs should be deployed? And, most important, how would those resources work together so that we can develop some long-range plans to serve our customers?”

Ching describes how the work of his group dovetails with the work of Leon Roose and Scott Seu, the other key planners on the Clean Energy Team. “I’m going to oversimplify this, but the real focus of Leon’s group is to look at the integration of these new resources on our grid, to look at the math, science and actual day-to-day, minute-to-minute, second-to-second type of solutions to answer the question of how you connect a large wind farm or a lot of PV (photovoltaic solar) power to the grid. How do you make use of their energy, but maintain reliability to the customer. It’s very technical, very focused on shorter time frames.

“My planners look at a broader time scale – from an hours perspective up to a multiyear perspective. And because our time frames are so different, the tools that we use and the analyses we perform are very different. But Leon and his folks and me and my folks, we’re literally joined at the hip. Because we have to look at all these time scales when we plan our system.”

Ching also notes that members of the Clean Energy Team have a responsibility to help change the culture within the company. “Aside from the technical, operational and planning things that all of us are tasked with, we have to affect that sort of change in the rest of the employees as well. We’re the saints that have to spread that gospel.”

Leon Roose
Age:
 44
Title: Manager, System Integration Department

Clean-Energy Responsibilities: Analyzes the potential effects of integrating new renewable-energy sources into the grid, and develops implementation strategies using technologies like the interisland cable, smart grid and advanced metering systems.

Roose’s role on the Clean Energy Team is to figure out what it will take to add new, renewable generation to the system. That turns out to be much more complicated than it seems. “Some people think: ‘It’s a small island system; it must be simple,’ ” Roose says. “But it’s completely the opposite. When you’re a small grid, the physics of electricity are actually more complex, because it’s easier to upset the grid when a small disturbance happens.” It’s his job to make sure that doesn’t happen.

It helps that over the years he’s held most of the planning positions in the company. Now, with systems integration, he is responsible for transmission planning and generation planning. “And I’ve added to those functions the planning for what we call our distribution grid,” he says. “Which means I’m responsible for system protection. That’s how we put in relays and other things on our lines so, when you have a problem, it protects the equipment as well as the public.” These kinds of devices and strategies are also going to be a big part of the smart grid, he says, and that’s the real future of integrating the dramatic amounts of renewables on the grid.

Scott Seu
Age: 44
Title: Manager, Resource Acquisition Department

Clean-Energy Responsibilities: Using tools like power-purchase agreements and feed-in tariffs to negotiate and purchase as much renewable energy as possible.
 

If it’s Roose’s job to figure out how to integrate renewable energy sources onto the grid, it’s Seu’s to actually go out and buy it. That means everything from putting out the requests for proposals and negotiating the power-purchase agreements, to actually administering the contracts. It’s a remarkable commitment to clean energy. “People say ‘seamless,’ ” Seu jokes, “But we’ve still got a few seams to work on.”

In many ways, the leading edge of the clean-energy future is the relationship between the utility and the independent wind farms and photovoltaic arrays and other renewable-energy sources that the HCEI envisions. As Seu points out, feed-in tariffs will help to formalize that relationship, and he’s been a key member of the negotiations on the docket now before the PUC. “As we got into details,” he says, “it quickly became about much more than just distribution issues. It got into talking about all the details of how you develop contracts for renewable-energy resources.”

After all, one of the principal tenets of a feed-in tariff is that the price of these new sources should no longer be tied to the price of oil. “So what should be the appropriate price?” Seu asks. “We want to come up with a fare that will be fair to the developer and pay them a reasonable profit. Yet, at the same time, all that is going to be paid by our customers.”

His point, though, is clear: “I don’t think we’re ever going to build a brand new fossil-fuel power plant again.”

Ron Cox
Age: 53
Title: Manager, Energy Solutions Department

Clean-Energy Responsibilities: Help customers minimize energy use and reduce their bills through programs like demand-side management and the application of advanced technologies.

 Although renewable-energy sources, like solar, wind and biofuels, may seem sexy, in the short term, conservation and greater efficiency will likely play a greater role in helping the state reach its clean-energy goals. It’s Cox’s role to expand and reinforce programs like Energy Scout that help customers reduce the energy they need from HECO.

But like many on the team, Cox brings a breadth of experience that’s invaluable in the group’s customary give and take. He came to the utility after a career in the nuclear Navy. “My first year with the company, I was in operations doing strategic planning,” he says. Then he moved into power purchasing and fuel contracts, including going through the regulatory approval process for critical issues, like biofuels. In fact, this expansion of responsibilities gets to the heart of the Clean Energy Team, Cox says. “This is just the recognition that we needed to make some organizational changes. Today, we literally have three managers doing what I used to do. One manager does nothing but buy biofuels, another manager does traditional fuels and another does power purchase contracts.”

According to Cox, this is a sign of the company’s commitment to clean energy “We’re out there on the leading – sometimes bleeding – edge of trying to implement change. For example, I don’t think any other state has set a target of 40 percent renewables as early as 2030.”

Public Face of Change

Of course, careful planning and resourceful operations are essential to the company meeting its clean-energy goals. But they’re not sufficient. The ambitions enshrined in the HCEI will require a partnership between the utility and the community. It means going out and engaging the public. It means accounting for people’s skepticism and managing their expectations. And it means focusing on customers and service as much as technology and policy.

In some ways, this perspective is built into all parts of the Clean Energy Team. Operations and planners, for example, are already obsessed with reliability and customer service programs. But the team also includes members whose principal focus is how the company’s clean-energy plans impact public and customer relations.

Lynne Unemori
Age: 50
Title: Vice President, Corporate Relations

Clean-Energy Responsibilities: Communicate the company’s green objectives, to both employees and the public.

Unemori points out that there’s both an internal and external aspect to communicating the company’s clean energy goals. Internally, she says, it’s important that employees realize these goals aren’t just window dressing; they represent the utility’s future. “It’s critical to make sure they understand our mission, our vision of what the goals are, how we’re going to stay focused. Most important: making it clear that every employee has a role to play in our future.” Unemori also acknowledges that the company has to communicate that same sense of conviction and commitment to a skeptical public.

That public – the ratepayers and taxpayers who will ultimately underwrite the goals of the HCEI – has to know they have a stake in the process. “Another key message,” Unemori says, “One, I think isn’t always easy – is that we have to make investments in order to harvest this energy, to get the infrastructure in place, to be able to reliably include renewables. This investment will come with a price tag, too. But, if you look at it in a bigger context, it makes a lot of sense.”

Dave Waller
Age: 61
Title: Vice President, Customer Service

Clean-Energy Responsibilities: Ensure that the company’s clean-energy programs, like demand-side management or net metering, operate seamlessly for customers.

Waller, who had an earlier career in the petroleum industry, brings a unique perspective to the team. Ultimately, he says, clean energy, like anything else the company does, has to benefit the customer. “Really, to affect all the change that we’re looking for, the customer plays a very important role in that process. What we really want to do is make sure that, in every product, every service, every interaction with the customer, we execute that with clean energy in mind.”

Although it’s tempting to envision the work of the Clean Energy Team in a technological or regulatory framework, Waller notes, “The effects and the work of clean energy really don’t happen until they happen in the customer’s place of business or at the customer’s home.”

Regulatory Dance

In large measure, the future of the utility is in the hands of the Public Utilities Commission. Its shape will be decided through an unprecedented welter of dockets before the commission. The most important – the feed-in tariff and decoupling – which the commission has already agreed to in principle, represent revolutionary changes in the way the company does business. The feed-in tariff will encourage the development of ever more renewable power by establishing in advance the price the utility will pay independent producers. Decoupling removes the perverse incentive to sell more, not less power. It does this by decoupling the company’s income from sales; instead, the company will be rewarded for encouraging conservation and adopting more renewable-energy sources.

Of course, that’s the theory. But figuring out the details of these regulatory changes is the primary responsibility of a couple of members of the Clean Energy Team. In fact, the regulatory framework is so important that almost every member of the team has participated in planning and negotiating the PUC’s final ruling.

Darcy Endo-Omoto
Age: 46
Title: Vice President, Government and Community Affairs

Clean-Energy Responsibilities: Work with the Public Utilities Commission and Hawaii’s consumer advocate to develop a sound, clean-energy regulatory structure.

As a regulated utility, none of HECO’s ambitious plans can happen without the approval of the PUC. That’s the bailiwick of Endo-Omoto. “When you put the whole puzzle together, I have the regulatory part,” she says. “I’m also responsible for government relations, which is the liaison between us and the Legislature, the (state) administration, the City Council and the federal side. Also under my area: We do all community relations – neighborhood boards, etc.”

“I think we have to take these aggressive steps, not only because of what state law requires of us in terms of our renewable portfolio standards, but also because of what I can see happening on a national level with respect to climate change and global warming.”

Tayne Sekimura
Age: 48
Title: Senior Vice President and Chief Financial Officer

Clean-Energy Responsibilities: Ensure that clean-energy plans, especially decoupling and feed-in tariffs, leave the company on a sound financial footing.

For regulated industries like HECO, it’s sometimes easy to forget they’re publicly traded companies that still have to make a profit for their investors. As CFO, Sekimura’s role on the team is largely to ensure that, in the rush to meet the company’s clean-energy goals, they don’t lose sight of those basic corporate responsibilities. “I’ve still got to be able to recover costs,” she says. “I can’t give away the candy store.”

The clean-energy agreement inevitably will mean new structures, new financial models for the company. But, as Sekimura notes, they still have to make economic sense. “It’s my job, as financial steward of this company, to make sure, when we go down these paths, that it’s not devastating from a financial standpoint,” she says. It’s a perspective that colors how she negotiates issues like decoupling and feed-in tariffs. “These are not just financial instruments for the sake of increasing profits,” she says. “They’re really the underpinnings of a financially healthy utility that’s able to do these new things and, at the same time, be a supplier of reliable electric power.”

 

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Building Wealth: A broker’s guide to real estate investment

BY DENNIS HOLLIER

So you want to be a real estate tycoon?

     (27) 1 Bedroom Units $3,9750,000 (FS)
     Photo: Kevin BlitzSo, you want to be a real estate tycoon?

If there’s one thing we’ve learned from two years of stagnation in Hawaii’s real estate market, it’s that there’s more to investing than simply buying low and selling high. That’s speculation. Experts will tell you investment is much more calculated. That means if you want to be a real estate investor, you’ll need to know a lot more. More about the property. More about the market. And, especially, more about yourself. Which is why the brokers who specialize in advising investors often start by asking, “Why do you want to invest in real estate?” In the end, your success as an investor probably depends on the answer to this question.

What Size Investor Are You?

It’s sometimes convenient to think of real estate investors in three categories: beginners – often successful businesspeople – who have saved up money and are looking for a place to park it; medium-size investors who are beginning to see that it’s possible to make a living in real estate; and large, sophisticated investors who sometimes preside over a diverse portfolio of property.

Real estate professionals often elaborate on this theme. For example, Matt Bittick, a prominent local broker who recently founded Bishop Street Commercial, sketches out a matrix of these three kinds of investors. Along one axis, he places investors A, B and C, and along the other axis he puts corresponding larger levels of investments. Of the smaller, A-level investor, he says, “Maybe it’s their first one, or first couple of transactions. They’re definitely putting in less than 50 percent of the equity in a large investment, or buying a much smaller property for a much smaller price.” In any case, they’re usually unsophisticated and acting alone.

     Matt Bittick, Bishop Street Commercial 
     “The B-level investor has also learned a key tool: leveraging the 
     equity in one building to buy others.”
     Photo Courtesy: Matt Bittick

If they continue to invest in real estate, as they accumulate property or experience, they become more efficient. “The B-level investor,” Bittick says, “is the category where you have enough property to handle property management in-house. This investor is kind of developing a team that he can support from the income that the property produces.” The B-level investor has also learned a key tool: leveraging the equity in one building to buy others.

“At the C level,” Bittick says, “you have the capacity to sell and buy any kind of product. You’re able to compete at all levels: It’s being able to buy, sell and close multiple deals with multiple resources on financing, and the capacity to take down larger assets.” To do this usually means having a well-developed professional staff. More importantly, it implies a network of relationships in the investment community. “You may have the relationships to bring in equity partners, relationships with debt partners.” Typically, C-level investors weave an elaborate pattern of corporations, limited partnerships and holding companies out of these relationships.

Bittick sums it up this way: “A, you’re on your own; B, you’ve got managers; C, you’ve got partners.”

Not everyone subscribes to this outline. Some, like Eric Smith, president of local brokerage The Kaulana Corp., thinks the truth is simpler. “I think there are really only two kinds of investors,” he says. “There are active investors who are trying to upgrade or increase the value, or otherwise create more than they bought. And then there are passive investors who buy products that have a cash flow. They’re not looking to dramatically change the property one way or the other.”

Smith, like many brokers, is also an investor and developer. And although he, like many of his peers, prefers to hold his cards close to the vest, he gives a short list of examples from Kaulana’s portfolio: “We had a building in Kaimuki. We fixed it up, re-tenanted it, held it for a long time, and then we sold it. We have a property in Kalihi that we renovated and we’re looking to redevelop, to add value. We have a property in Waipahu that we increased the value on; now we’re asset managing it. We did a small deal up in Kunia where we changed the use of a retail building and then we sold it.” In other words, there are many ways to approach real estate, but, as an active investor, Kaulana’s strategy is always to add value.

Other brokers see investors as a more diverse group. “I see many more levels than that, personally,” says Ray Hulick, president of Commercial Real Estate Services. “I’m a real transactional commercial broker, so I see a lot of transactions.” He points out that people invest in real estate for many different reasons. “There are some people who may make a living at it, who invest in themselves, and are very successful at it,” Hulick says. These people correspond neatly with Bittick’s A- and B-level investors. Hulick also describes some of the C-level investors: “There are larger companies that need larger acquisitions to fuel the corporate structure. They have to constantly make acquisitions.” But he notes that there are other investors who blur the lines: wealthy, sophisticated businessmen who decide to take a stab at real estate; kamaaina families trying to diversify their portfolios; or serial investors who buy one property, fix it up, sell it, and move on to the next. “And I represent a lot of business people who just want to buy a building to move their business into,” Hulick says.

But he agrees with Smith’s distinction between active and passive investors. “Most sophisticated investors are looking to convert the property to create value,” he says. Real estate professionals call this yielding. “Some of the stuff that was really successful several years ago was when people were buying warehouses and converting them into retail space.” This kind of change means you can charge higher rents, raising the building’s income stream – in effect, increasing its yield. “And when you’re dealing with sophisticated investors in larger acquisitions, they’re looking at several different ways to create profit centers so it works for them,” Hulick says. Frequently, for example, they know their experience and economies of scale mean they can manage the building better and cheaper. One thing is certain, though: They run their numbers scrupulously.

Anatomy of an Investment

Most brokers say that inexperienced investors have no idea how much work goes into real estate investment. “The biggest area they don’t understand,” says Hulick, “is the due-diligence side – what it takes to thoroughly analyze a property to make sure you minimize your risk. That means really understanding what it’s all about: knowing if the building has economic problems, obsolescence problems or environmental problems, what its intended use is for the investor.” He points out that all of this information comes with a price. “If you’re really going to do an acquisition correctly, you really need to hire some people and spend some money during what they call the inspection period. So it costs you money. It may cost you thousands of dollars to inspect it to make sure what you’re buying is real.”

Much of this means relying on other professionals. “That means you’re probably going to buy a Phase-I environmental report to make sure there’s no bad dirt,” Hulick says. “You may or may not need that for financing from a bank. You’ll want to have an architect walk through to make sure there are no code violations. You’ll want to make sure you understand the condition and shape of the building – what they call its functional obsolescence – when a building needs a new roof, or it’s not laid out correctly for the market, and what it’s going to cost to convert it.”

Hulick adds that the same kind of due diligence goes into the existing tenants, if any. They represent the building’s prospective cash flow. “You want to understand if the rent is above or below market, what’s going to happen when the lease reopens, and how your investment is going to be treated. So the strength of the tenant is critical. And in a downtown office building, you might have 40 to 100 tenants in your portfolio. You’d have to look at each one and make sure each is meeting its objectives, paying its rent on time. You have to consider all of this to understand how this investment is going to yield over the next five to 10 years.”

All this effort separates the true investor from the dabbler. But it’s expensive. “You’re probably going to spend between $5,000 and $15,000 to consider buying a building,” Hulick says. Maybe more important is the cost in time, and serious investors must balance these costs with the potential rewards. Developers like Kaulana, for example, receive numerous offers over the transom. “We get sent maybe 100 properties a month,” Smith says. “Of the 100, maybe 10 are worth a second look. And of these 10, maybe one deserves serious investigation.” There is, in other words, a lot of weeding in the garden of real estate investment.

That means investors have to be disciplined. “I don’t think you can be successful by just doing the shotgun approach,” says Bittick. “You need to be more calculated. Focus on certain price-range parameters, certain market segments, maybe a certain market area.” With some admiration, he points to Kaulana’s investment strategy. “They wouldn’t bid for large assets. If it’s over $5 million, forget it; I don’t care what the return on investment is. They want to own and operate the asset themselves. It’s got to be on Oahu, probably east of the airport, but not in Hawaii Kai. And it cannot be industrial.” This kind of focus, Bittick points out, is the essence of expertise. “They can learn about that particular kind of real estate and become a mile deep and an inch wide,” he says. “And they can save themselves a lot of time and money.”

Bittick also points out that, as investors grow more sophisticated and add to their team, scale is important. “If you start doing that,” he says, “and you have mouths to feed and salaries to pay, you need a larger property to support that.” In other words, growth usually implies larger, not more, investments.

Hulick puts it another way: “Over time, you realize that it takes just as much work to buy a $3 million building as it does to buy a $25 million building. Same amount of work; same amount of time. So, as you rise through levels of sophistication from a single acquisition to several acquisitions, you realize what bite, or what size, investment fits your needs or your growth criteria.”

One result of this phenomenon is the tendency for Hawaii investors to look to the Mainland once they reach a certain size. In part, this is a way to manage risk. “Their decision is to diversify from just having all their eggs in one Hawaii real estate basket,” Hulick says. But there also simply may not be enough options for them in the Islands. “As investors become more sophisticated, it’s harder and harder for them to find more of the same property in Hawaii. There’s more competition, and the yields may be different. To solve their growth requirements, they may have to go to the Mainland.” That’s certainly been the case for most prominent local investors, from Alexander & Baldwin, to the Shidler Group, to kamaaina family companies such as Watumull Properties.

Why Hawaii is Different

Part of the problem for local investors is that there really are no bargains in Hawaii. In depressed markets like Las Vegas, Southern California, Florida and Phoenix, cash-rich investors are buying foreclosed commercial property at 30 percent or 40 percent discounts. Even given the considerable decline in rents in Hawaii, local investors haven’t seen those kinds of opportunities. One reason is that most large Hawaii landlords have deep pockets. “A lot of these guys are not in any hurry,” says Al Kauwe, president of Kauwe & Associates brokerage. “They’ve paid down their building quite a bit; their debt service is light; and even with a falling income, they can still pay their mortgage. So they’re thinking: ‘Why should I sell?’ It’s still what they call a cash cow.”

Even as prices remain high, cap rates – the income properties generate – are declining. This further dampens enthusiasm for investment. “The big investors,” Kauwe says, “they’re kind of holding off because they’re watching rents drop. Rents in every aspect of commercial real estate – industrial, office and retail – are off, maybe by an average of 30 percent, over the last two years. A lot of the investors are standing by because they don’t want to pay $5 million for a building based on office rents at $1.50 a square foot, and then a year from now find their rents are only $1.25. So they’re waiting for rents to stabilize.”

So, for all you would-be real estate tycoons, these are challenging times. Yet, many brokers evince a strange optimism. Real estate, after all, follows an inevitable cycle of ups and downs – even in Hawaii. Within those cycles lurk tremendous opportunities for those with the means and smarts and daring to exploit them.

“I think we’re in that kind of cyclical path,” says Ray Hulick. “And whether you’re a 50-year-old person or a 20-year-old person, you only have so many cycles of up and down in the stock market or up and down in the real estate market, so you really have to be sensitive to those cycles.” Half in warning, he adds, “Because each cycle may last 10 to 12 years.”

     Photo Courtesy: Peter Savio

Peter Savio’s Seven Creators of Wealth

By Dennis Hollier

Peter Savio, one of Hawaii’s biggest and best-known real estate investors, offers these seven steps to wealth.

“I’m going to tell you how wealth is created in real estate,” Savio says. “If you understand these principles, you’ll know why you want to buy real estate. You’ll know how you can make money when the market is going up, and when the market is going down, because you’ll know where the value is being created.

“Just to put this in context: When I first came into real estate 40 years ago, the house was a brand-new, three-bedroom, two-bath home in Hawaii Kai for $25,000. It was unaffordable. People couldn’t qualify for the loan; they couldn’t save up the down payment, which was an astonishing $2,500; and the monthly payment was an unaffordable $250. Forty years later, that same house is worth $600,000 to $700,000. It was a real struggle to buy that house, but the people who bought it, if they managed their wealth correctly, they’re multimillionaires.

“So, what are the creators of wealth?

“The first wealth creator is the concept of appreciation. That’s the one everyone knows. To use our Hawaii Kai example, our house went from $25,000 to $600,000, so it increased in value $575,000. Almost everyone will tell you we buy real estate because of this appreciation. But that’s not true. Appreciation is simply not the greatest wealth creator; it’s superceded by one of the others by five, 10, 15 times.

“The second wealth creator is the savings account called mortgage. When you think about it, your mortgage is basically a forced savings account. If you take out a $400,000 loan, you’re making a legal promise to save $400,000 over the next 30 years. It’s like a giant piggy bank.

“The next wealth creator is the constant monthly payment. The constant monthly payment is the fact that, when you buy real estate, in effect, you lock in your biggest one-time expense – housing – for 30 years. So, as rents go up, your mortgage payment tends to go up much more slowly. (Although your mortgage stays the same, your insurance and taxes still go up.) So, the person who bought that house for $250 a month in Hawaii Kai, 30 years later is probably only paying $300 a month. But the person who rented for $200 a month because he or she couldn’t afford the $2,500 down payment or the $250 a month mortgage is probably paying $2,000 a month in rent now.

“The fourth creator of wealth is the ability to prepay on the principal on the loan. A lot of people don’t realize that, if you make additional payments on the loan every month – or even just occasionally: $50 here, $100 there, take your $2,000 tax refund and pay it on your principal – it will actually save you tens of thousands of dollars in interest. If you pay an extra $50 or $60 a month, you could take a 30-year loan and bring it down to a 15- or 20-year loan, which means you could save $70,000 to $80,000 in interest. You’re making money by paying it off sooner.

“The next wealth creator is tax savings – the fact that, when you buy real estate, the federal government gives you certain tax advantages. The government subsidizes you anywhere from 15 percent to 25 percent, let’s say, in terms of your monthly payment. So, if you’re renting for $1,000 a month, and struggling, you can probably buy for $1,250 a month and be in the same position. A lot of people don’t understand, that when you pay rent, you’re actually paying twice: You pay rent to the landlord of $1,000, but you also pay $250 in additional taxes to Uncle Sam.

“The sixth creator of wealth is the concept of leverage. Basically, in real estate, you can control a valuable asset for very little cash. Let’s assume you buy a property for $100,000, and you put 10 percent down. That’s $10,000. If you had that $10,000 in the bank at 2 percent, you’d be earning $200 a year. If you take the same $10,000 and buy that $100,000 property and it appreciates the same 2 percent, you earn $2,000. Which deal do you want? Leverage allows you to magnify the return.

“The seventh wealth creator is more complex and it’s going to confuse the hell out of you. Because of the way mortgages are amortized, in effect, when you make principal payments, you’re actually receiving interest, tax-free, on the principal you’ve paid. That’s because, although the amount of your mortgage payment is fixed, each month the amount of interest you pay goes down, and the amount of principal goes up. That’s because you only pay interest on the principal you still owe. Let’s say you borrow $212,400 at 5 percent with a 30-year amortization. Your monthly payment of $1,140 is constant for the whole 30 years. On your first monthly payment, you pay $885 in interest and $255 in principal. The next month, your interest goes to $883, and your principal goes to $257. That extra two dollars added to your principal payment amounts to 5 percent annual interest on the $255 in principal you’ve already paid, tax-free. Every month, this amount goes up, so that, on the last payment, in 2040, you still pay $1,140, but your interest payment is just $5, and your principal payment is $1138. Basically, you’re just paying that to yourself.

“The wealth creators are the same whether you’re buying a home or investing. But, on the investing side, the tax savings is even greater. That’s because, in addition to being able to deduct the interest, the property taxes, and the mortgage insurance, if any, you now get to deduct the maintenance, the advertising, the repairs, even the gas you use to drive over to check on the unit – all the expenses you get to deduct because it’s a business.

“On top of all those deductions, the government also tells you that, by law, your unit is losing value because it’s getting older. So, you depreciate it on your taxes, which gives you another three, four, five thousand dollars. So, the investor has an eighth and ninth wealth creator: additional tax savings and depreciation.

So, of all those wealth creators, which one do you think is the most important? The greatest wealth creator is the constant monthly payment. Because you’ve locked in your rent, as your income goes up, you can use that money to buy stocks, buy bonds, save up and buy real estate, pay off your loan sooner – it will all create wealth for you.”

 

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The Billion Dollar Gamble: State Investment

BY DENNIS HOLLIER

Photo: istockphoto.com

What a difference a billion dollars makes.

Until recently, the state treasury – officially, the Treasury Management Branch of the Financial Administration Division of the Department of Budget and Finance – has operated in relative obscurity. With its staff of seven or eight employees, the treasury acts as cash manager for the state government. Its primary responsibility is to make sure the state always has enough cash reserves to meet its ongoing obligations: payroll, debt service, pension contributions, etc.

The treasury also manages the day-to-day investment of so-called excess funds: monies collected, but not yet spent, by state agencies. As it happens, that’s a lot of money – more than $3 billion at last count. Even so, these investments are hardly sexy, consisting mostly of safe, low-yield, highly liquid instruments like U.S Treasury securities, Federal Agency securities, collateralized CDs and something called SLARS, student loan auction rate securities. In other words: boring, boring, boring.

Then, in February 2008, the market for those auction rate securities collapsed. Overnight, the state’s $1 billion investment in SLARS ceased to be either safe or liquid. And suddenly, the treasury didn’t seem so boring after all.

Where the money goes

So, where did it go wrong? Georgina Kawamura, director of the Department of Budget and Finance, and the official state treasurer, describes treasury operations as a juggling act. “Here’s the day,” she says. “We get daily reports from the banks to let us know our ‘checking account’ balance. We also know, on a daily basis, what investments will mature.” These figures, combined with information about payments that will go out, constitute the calculus of the day’s excess funds, the funds available for investment. This begins yet another juggling act.

For the most part, treasury investments are scheduled to mature around large payments. Scott Kami, administrator of the Financial Administration Division (FAD), which oversees day-to-day operations of the treasury, gives the example of payday. Payroll, he says, averages about $8 million per pay period. “Normally, we schedule about half of that to mature on Friday, and the other half to mature on the following Monday. Because, historically, that’s how the checks clear.”

Armed with that information, treasury accountants can now contact brokers, banks and other financial institutions to find investment opportunities. In this way, the treasury’s responsibilities of cash management and investing are always intertwined. Every debt obligation and every dollar of excess cash must be meticulously tracked because, as Kawamura points out, “All the money is invested. All of it is earning interest.”

And yet, in a scathing report on the Department of Budget and Finance released in March, state auditor Marion Higa turns most of these mundane details on their head. For example, the treasury uses an almost indecipherable, handwritten, color-coded monthly calendar to monitor its investments. It calculates excess cash from manually prepared worksheets rather than electronic spreadsheets like Excel. And it deals with brokers through a decidedly informal system of e-mail and faxes.

Still worse, Higa says, is the treasury’s lack of oversight. The report notes that the FAD failed to prepare and review bank reconciliations, failed to produce a monthly investment report, and routinely allowed investment classes to exceed their statutory limits. In her view, it was this lax supervision that allowed the SLARS calamity. When the independent accounting firm Accuity conducted the state’s fiscal year 2008 certified annual financial report, it also said flawed internal controls led to the SLARS purchase. In her report, Higa points out that treasury staff never even saw the offering documents for these investments. Those documents clearly state many of the risks pertaining to SLARS.

The state uses a handwritten monthly calendar to monitor the
treasury’s $3 billion portfolio.

What Are SLARS?

Auction rate securities are basically debt instruments consisting of bundles of securities – in this case, student loans. The interest rates are set through periodic auctions: sellers offer securities at the lowest rate they’re willing to accept; buyers indicate the highest rate they’re willing to pay and how many they want to buy at that rate. This process is designed to determine the lowest interest rate at which all available shares of a security can be sold at par. This is called the clearing rate, and it serves as the interest rate for that entire issue of SLARS until the next auction. In the event an auction fails, the rate is set based on a pre-established relationship to some benchmark, usually the London Interbank Offered Rate, or LIBOR. Naturally, brokers assure buyers that auctions never fail.

To be fair, these auctions appeared to work efficiently for more than 20 years. And because the auctions usually happened every seven, 28 or 35 days, investors like the state treasury could treat SLARS as liquid investments, even though the underlying securities might not mature for 35 years. But sustaining that liquidity meant that all the available SLARS had to sell at every auction. That didn’t always happen, but the underwriting broker quietly bought enough to keep the auction from failing. Between auctions, brokers often tried to unload these securities on their customers.

Nevertheless, in 2007, when the financial markets began to implode, these securities began to accumulate on the wire-houses’ books, and brokers regarded them nervously. They encouraged their sales divisions to push ARS aggressively, even though insiders knew the auctions were becoming tenuous. Another sign of some distress in the market was the steady increase in interest rates, which, in the case of SLARS, eventually reached 7.35 percent (compared with 2.07 percent for two-year CDs.) For most investors, higher interest rates reflect higher risk. And yet, in the six months leading up to the market failure, the Hawaii treasury’s holdings in SLARS went from $427 million to over $1 billion, and from just 14 percent of the state’s portfolio to nearly 30 percent.

Of course, the state of Hawaii wasn’t the only investor surprised by the failure of the ARS market. Thousands of individuals and hundreds of institutional investors were caught off guard. A diverse group of government entities – states, counties, water-district boards, et al. – now found themselves stuck with these now long-term investments. Although most individual investors eventually recouped their investments through settlements with the wire houses that underwrote the auctions and government regulators, institutional investors have been obliged to write down their ARS as part of the “mark to market” standards of generally accepted accounting practices. In the summer of 2008, for example, the state acknowledged a $114 million impairment on its certified annual financial report as a result of its SLARS holdings. Though Hawaii may have the largest holdings, it hasn’t taken the worst blow. Jefferson County, Ala., is verging on bankruptcy due to the failure of the auctions.

Closer to home, Maui County found itself stuck with more than $30 million in SLARS when the market crashed. Like the state, Maui seems to have relied on assurances by a broker, in this case, Merrill Lynch, that these were highly liquid securities. Also like the state, Maui invested heavily in SLARS in the months leading up to the market failure.

Different Responses

Despite the similarities between Maui and the state, there have been striking differences in how they responded to the SLARS debacle. For example, the state continues to defend its investment. “The one thing that gets lost in this whole discussion about ARS,” says Scott Kami, “is that the securities themselves are very sound investments. There hasn’t been any default on them, and we continue to get all our interest paid when it comes due.” Moreover, he says, the yield on the state’s ARS, approximately 1.9 percent, is higher than that earned by the state’s other investments. He points out the yield on 30-day CDs is almost zero.

Kawamura takes another tack. “I think people have put too much emphasis on the write-down,” she says. “Everyone thinks we’ve lost money. We have not.” She acknowledges that accounting principles required the state to estimate an impairment on its SLARS holdings. She also admits that if the state were to sell its holdings today, it would likely incur an additional $250 million loss. But Kawamura views these as purely paper losses. “That’s assuming that you’re going to sell,” she says. “Of course, we haven’t sold, and we don’t intend to.”

But Maui County treasurer Suzanne Doodan is not convinced by the state’s arguments. “I spouted those same lines for the first few months,” she says. “But these are no longer short-term instruments; you have to compare them to 30-year investments.” So, while the state’s 1.9 percent yields on SLARS may look good compared to current rates for bank repos or short-term CDs, they’re low even compared to the 4.75 percent yield on a 30-year U.S. Treasury note. SLARS might have been attractive as short-term investments, but they are liabilities as long-term investments.

This difference in perspective led Maui to pursue a different strategy than the state. This January, the Maui County filed a federal lawsuit against Merrill Lynch, the broker that sold them the SLARS. (To see Maui’s lawsuit filing, click here to download the PDF file.) Like other institutional investors around the country, Maui alleges Merrill sold SLARS as “cash equivalents” even though it knew, or should have known, these investments were unsuitable for Maui’s needs.

The state declines to discuss whether it’s pursuing legal action related to SLARS. “We’re obviously letting our attorneys take care of reviewing our options,” says Kawamura. Tung Chan, commissioner of securities at the Department of Commerce and Consumer Affairs, acknowledges receiving complaints “against these companies – Citi and Merrill – related to ARS.” DCCA policy, though, is not to disclose the name of the complainant. It remains to be seen if the state, in steadfastly defending its investment in SLARS, has lost its opportunity for legal recourse.

“I wonder if they missed the date to file,” Doodan says. “I think it’s a two-year statute of limitations.”

A Better Way

There are other important differences between Maui and the state, according to Doodan. “To my knowledge, the state has only used two brokers for years and years and years,” she says. “In contrast, we go out to at least five, six, seven, eight brokers. And every few years, we go out and solicit new brokers.” It’s also interesting, she notes, that, while Maui has suspended doing business with Merrill, the state continues to use the same broker who sold them the SLARS as bond underwriters. (This same broker, Pete Thompson, of Morgan Stanley Smith Barney, played a key role in persuading the Legislature in 1998 to add SLARS to the list of acceptable investments for the state treasury.)

There is another difference between Maui and the state. To coordinate its investments and cash-management obligations, Maui uses sophisticated, Web-based software called QED. This program was specifically designed for treasury operations and automates many basic functions of a treasury. It continuously updates the status of investments, including the current value of securities. It also provides templates for more than 600 different reports, most of which can be produced almost instantaneously. This ease of reporting simplifies the supervision and oversight of the county treasury. That’s probably why more than 40 states and thousands of counties and smaller government entities use QED.

For its part, the state relies upon a software program called Microsoft Dynamics, which is primarily a program for enterprise solutions or customer contact management. Although it has been adapted to be used for financial purposes, it doesn’t address many of the specific needs of a state treasury. As one expert put it, “This is like hunting an elephant with a shotgun.” This may help explain the treasury’s failure to routinely produce the reports called for by its own investment policies. It may also explain why the state’s investment activities are largely tracked on manual worksheets or even handwritten calendars.

Most state treasuries are far more transparent and seem to sustain much more oversight than Hawaii’s. New Mexico – an apt comparison with Hawaii because of its population of 2 million people and treasury of about $5 billion – offers an excellent model for an efficiently run treasury. “I can tell you,” says chief investment officer Sheila Duffy, “we have a lot of oversight in New Mexico. And we like it.”

Structurally, that oversight takes the form of two standing committees. The Treasury Investment Committee, Duffy says, consists of treasury officials and two securities experts from private industry. The other oversight group, the Board of Finance, supervises the broader activities of the state treasury, which corresponds roughly with Hawaii’s Department of Budget and Finance. Neither group is passive.

“We have a once-a-month report, a book really, that we deliver to the Treasury Committee” and to Board of Finance, Duffy says. This substantial report – produced automatically using QED software – summarizes the treasury’s existing investments, including asset details, yields, and trends compared to a benchmark. These reports and the minutes from committee meetings are available on the treasury’s Web site, along with numerous other reports and resources. In contrast, although Hawaii’s state treasury policy requires monthly status reports for the director of the Department of Budget and Finance, this report hasn’t been prepared since 2007, according to the state auditor. Moreover, there’s no outside authority to review such a report.

The Cure

How can Hawaii improve its often informally structured, poorly supervised and cloistered state treasury? And what can we do about its extraordinary burden of SLARS?

As for the auction rate securities, the answer may be nothing. “For now, our liquidity issue is covered,” says Kawamura, by which she means that, as the treasury’s longer-term investments mature – and they’re allowed by statute to carry some investments out to five years – these are gradually replaced with the SLARS. And the state seems intent on either holding onto them until maturity – another 35 years, in some cases – or waiting until it’s possible to sell them at par. That might seem farfetched. After all, the allegations of fraud, negligence and collusion that have been leveled at the wire houses have stigmatized SLARS as an investment. But some believe the SLARS market will revive; Kami said as much in his Dec. 27 testimony at the state Legislature. Even Maui County finance director Kalbert Young holds out hope.

“I would point out,” Young says, “since the SLARS market failed in February 2008, there’s been a slow return of activity in this market.” He doesn’t mean the actual resumption of successful auctions – not yet, anyway – but that the underlying securities have started looking increasingly attractive to investors. “We’ve been getting calls from other institutions interested in buying our ARS,” he says. “Not at par, of course, but better than it was. Even Merrill Lynch was willing to purchase some.” Nevertheless, Young says, “we still want to pursue our legal filings.”

Improving Hawaii’s treasury operations may prove easier. It’s simple enough to look to the examples of other states, like New Mexico and New Jersey, that have modernized their treasuries. Software solutions typically come with extensive consulting services and are cost effective. (QED costs less than $100,000 a year, after the initial setup.) But the most important lessons probably come from history.

After the disastrous 1994 bankruptcy of Orange County, when the county treasurer’s wild, unsupervised speculation in risky derivatives cost the county over $2 billion, the California state auditor issued some familiar-sounding recommendations: Have a Board of Supervisors approve the treasury’s investment policies; appoint a committee to oversee investment decisions; require frequent, detailed reports from the treasurer; and establish stricter rules governing the selection of brokers and investment advisers.
Those sound a lot like the recommendations of the Hawaii state auditor. They’re also suspiciously close to the kinds of best practices employed in New Mexico. In other words: boring, boring, boring.

Risky Strategies

State’s mix of risky & safe, traditional investments

CASh

Demand Deposits1
$229,770,000

Cash with Fiscal Agents
$5,980,000

U.S. Unemployment Trust
$265,499,000

Investments

Investments Time Certificates of Deposit2
$618,192,000

U.S. Government Securities
$528,130,000

Student Loan Auction Rate Securities3
$1,006,975,000

Repurchase Agreements4
$1,151,620,000

Total Investments
$3,304,917,000

Total Cash and Investments
$3,806,166,000

1. The state routinely failed to reconcile bank statements. In addition, funds were often left in sub-accounts that did not earn interest.

2. At least five times, the state exceeded the 50 percent limit on CDs from a single issuer.

3. The state’s portfolio of SLARS remains at roughly 30 percent of its total investments.

4. Repurchase agreements exceeded the 70 percent statutory limit in four out of 12 months.

Source: State auditor’s report

 

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Using Lasers to Measure the Wind

BY DENNIS HOLLIER

Chris Sullivan
Program Manager and senior Aerospace Engineer 
Photo: Kevin Blitz, Oceanit

Idea

Engineers used to rely on meteorological towers to measure wind speed. But “met towers” only give you data for one location; they don’t tell you anything about wind velocities around a valley or along a ridge. Wind 3D, a product being developed by Oceanit, creates three-dimensional maps of wind velocities within a radius of three miles.

Technology

Wind 3D uses LIDAR — light detecting and ranging — a laser technology that bounces light off particles in the air, or even off air molecules themselves, to measure wind velocity. “It’s quite mind boggling,” says principal investigator Chris Sullivan. “The design of the system is to get back like one-billionth of the light that you sent out.”

History

LIDAR isn’t new, but Oceanit innovations have created a smaller, cheaper and more reliable package. According to marketing manager Ian Kitajima, Oceanit originally developed LIDAR systems under government contract to help unmanned airplanes drop propaganda leaflets accurately. Later, they used similar technology to measure cloud heights above airports and aircraft carriers.

Market

Oceanit believes the first market for Wind 3D will be wind prospectors who want to correctly site expensive wind turbines. “If you can get 5 percent to 10 percent better efficiency based on the layout, over a 20- or 30-year period, that could be tens of millions of dollars,” Kitajima says.

 

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Roadblocks on the Road to Hawaii’s Smart Grid

BY DENNIS HOLLIER

The Kaheawa wind farm is not being fully used because of 
limitations imposed by an aging power grid on Maui.
Photo: David Croxford

High on a ridge overlooking Maalaea Bay, a small group of students from the Horizons Academy scramble out of vans into the vast open space at the top of the Kaheawa wind farm. They gape for a moment in the brilliant morning light. It’s an impressive sight: the giant white turbines of Kaheawa – 20 in all – standing majestically along the ridge that slopes to the sea, as astonishing as the heads of Easter Island.

“Cool,” says one of the young students.

Noe Kalipi, a spokeswoman for First Wind, the company that built the wind farm, tells the students that each turbine is 168 feet tall. Taken together, the 20 turbines have a capacity of 30 megawatts, or more than 10 percent of Maui’s peak load. That combination of majesty and power capacity makes the Kaheawa wind farm a symbol of the state’s rush to meet the goals of the Hawaii Clean Energy Initiative: 70 percent clean energy and 40 percent renewables by 2030.

Cool, indeed.

But Kaheawa poses as many questions as it answers. How do you integrate variable electricity generation from wind farms and photovoltaic systems into the electrical grid without compromising reliability? How do we pay the enormous cost of modernizing the grid to accommodate these renewables? And how do we monitor and regulate these changes to make sure the grid is ready for the 21st century? Most experts believe that the answer to these questions lies in a collection of new technologies and practices known collectively as the “smart grid.” In fact, Maui Electric Co. (a division of Hawaiian Electric Industries) has joined the Hawaii Renewable Energy Institute, the U.S. Department of Energy, General Electric and a few other partners in a smart grid pilot project in Wailea. But it’s not clear that MECO (or the rest of the state) is fully ready for the smart grid.

How “Smart” Works

There are many definitions of a smart grid. “No two people can agree on what that means,” says Robbie Alm, senior vice president of HECO. But for the purposes of MECO and what they want out of the Wailea pilot project, the smart grid is all about communication. In some cases, that communication empowers consumers with smart meters and advanced metering infrastructure, which let utility customers monitor their energy use in real time. In combination with time-of-use rates, smart meters may reduce peak load on the grid by encouraging consumers to move some of their consumption to off-peak times, when rates are cheaper.

Probably more important is to have more data about the grid itself. “For example,” says Chris Reynolds, MECO’s superintendent of operations, “if we could see that power was being injected into the system from a PV (photovoltaic) system, then we’d know what was going on. Then we could find ways to mitigate that if it should drop off all of the sudden.”

Speaking to Power

It sounds easy enough. The problem is that even the traditional grid – a model that’s nearly 100 years old – is surprisingly complicated. Sure, its basic elements are familiar: a power plant that generates electricity, high-voltage transmission lines that carry the power long distances, substations and transformers that step the voltage down to useful levels, and a network of distribution lines to deliver electricity to the end user. This generic view of the electrical grid makes it seem almost mechanical: add fuel – oil, coal, bagasse – to the hoppers at one end, and 120-volt electricity comes out the wall sockets on the other. In its particulars, though, the grid is complex; more like an organism than a machine, it’s full of fidgets and sensitivity. The utility is constantly monitoring its vital signs, especially frequency and voltage.

Reynolds points out that the pulse of the modern grid throbs at the remarkably consistent frequency of 60 hertz. Maintaining this frequency depends upon a fairly steady balance of power generation and load. If MECO loses a generator, or the wind dies suddenly at Kaheawa, the frequency falters.

Most utilities handle these problems with what’s called “spinning reserve,” having extra generators up and running and ready to come online. “In place of spinning reserve, MECO uses load-shedding,” Reynolds says, basically cutting power to prearranged customers. “At 59.3 hertz, there are some pump leads at HC&S that will come off-line. Below 58.7 hertz, then we’ll start opening up distribution points on our customers.” In other words, a 2 percent drop in frequency can mean localized blackouts. It can also fry customers’ electronics.

The traditional grid has evolved tools to deal with normal fluctuations in load. MECO’s power plant at Maalaea, for example, isn’t just one generator; it’s 21 generators of various sizes and types. They range from small, “fast-start” generators to deal with sudden outages, to enormous combustion turbines that are much more efficient, but take longer to start. An automatic system controls the generators’ output based on variations in load.

These controls work fine for a grid dominated by consistent power, like diesel generators or hydroelectric, but they’re not responsive enough to handle Maui’s increasing suite of wind and PV power. Instead, MECO has to limit renewables.

For example, through a process known as curtailment, the utility routinely dials back power generation at Kaheawa. Sometimes curtailment at the wind farm is partial; sometimes it is 100 percent. Similarly, MECO restricts the installation of PV systems to less than 3 percent of the system’s peak load, or less than 10 percent of the load on any one circuit. Although these strategies run counter to the utility’s own preferences, probably nothing short of a smart grid will ease the restrictions.

Technical Problems

One of the challenges facing MECO’s smart-grid aspirations is an aging infrastructure. Over the past several years, the utility has modernized its systems, particularly by improving its SCADA, the supervisory control and data acquisition system it uses to control critical elements on the grid.

But the utility still has many substations that haven’t been integrated into its SCADA system, and the system has no means to see beyond the substations to monitor the load of its customers (or the production of most independent PV systems). Also, many of MECO’s generators are aging and inefficient – the oldest, a steam generator in the Kahului plant, was first put online in 1947 – meaning MECO’s high-voltage transmission lines carry 69,000 volts in some areas and 23,000 volts in others. These are all challenges on the journey from existing infrastructure to smart grid.

But the greatest technical challenge is isolation. On the Mainland, most local grids are linked to one another in a super-grid. It’s possible, for example, for a customer on the East Coast to buy electricity from a power provider in Texas or even Canada. That’s important because this interconnectedness makes it easier for utilities to provide some of the ancillary services that are essential to an effective electrical system. As Carl Freedman, one of Hawaii’s most respected experts on utility regulation, likes to point out, an electric company provides customers much more than kilowatt-hours of electricity.

“For example,” Freedman says, “they also have to provide reliability,” a quality that includes things like operational and spinning reserves. Operational reserves ensure the grid has the capacity to supply the maximum load. Freedman explains: “If somebody turns on a 1,000 horsepower motor or turns off a 1,000 horsepower motor, operational reserves mean it isn’t going to shut lights off and destabilize the grid.” Spinning reserves, on the other hand, represent the utility’s ability to handle the loss of a generator (or wind on a wind farm). “On Oahu,” he says, “they have a spinning reserve sufficient for the loss of their largest unit. In other words, they would have enough units up and spinning so that they could lose that unit without dropping load.

“Spinning reserves and operational reserves are both identifiable services,” Freedman says, as are basic utility functions like voltage regulation, transmission and power generation. “On the Mainland, there’s a huge market for all this stuff. If you don’t have something, you can go out and get it.” Freedman points out how this simplifies the way a utility operates. “Each utility, for example, needs to carry sufficient capacity – or contracts for capacity – to meet its loads. But they don’t need to provide the emergency capacity of the largest load like we do here, because they can buy that. In fact, they can buy it for free by having a bilateral agreement with somebody else, saying, ‘You cover me, and I’ll cover you.’ ”

This highlights the challenges facing MECO and HECO as they build their smart grids. Because they’re island grids, they’re completely isolated. Freedman notes: “Each one of these systems has to supply all the ancillary services: all the generators, all the reserve capacity, all the reliability. We have to do it all on each system. So, the job of a smart grid here is a tall order.”

Capital Problems

Not all the challenges facing the smart grid are technical. Rebuilding something as complex as the grid – even a small one like MECO – will be fabulously expensive. “As an example,” says Chris Reynolds, “the meter that’s on a typical home costs about $25. For the smart grid demonstration project in Wailea, we’re looking at a cost of about $400 per meter.” He adds that MECO has about 67,000 meters.

Freedman takes an even broader perspective. “According to DBEDT,” he says, “we’re about to spend $16 billion – that’s billion with a ‘B’ – on capitalization for this energy transition.” He notes that, although the goal is to reduce our $7 billion annual expenditure on fossil fuel, that’s still a fantastic upfront investment. “The question is how are we going to capitalize this. This is a major issue for the state that hasn’t been addressed by anyone, really.”

It’s certainly hard to see how the Hawaiian Electric companies can afford it. “I don’t know what we’re counting in the smart grid,” Freedman says, “but if you include the (undersea, interisland) cable, then you’re talking a billion dollars just to hook up Lanai and Molokai. If you’re talking, like the utilities, about hooking up Maui as well, then you’re talking several billion dollars. Well, the whole capitalization of all the electrical infrastructure right now is something on the order of $3 or $4 billion.” Even if, as now seems likely, the state decides to finance the construction of the cable, Freedman points out, ratepayers will have to repay the debt. It’s still a capital liability on the utilities books.

One of the ironies in this smart grid bagatelle is that many of the policy initiatives intended to promote more renewables further aggravate the capital problems for the utility. For example, the financial arrangements that underpin distributed generation – power-purchase agreements, net-energy metering, feed-in tariffs –all appear on the utility’s books as liabilities. Each, after all, is a commitment to purchase power from customers. The feed-in tariff, at least, also shows up on the income side of the books because the customer still buys the same amount of energy as before. With net metering, the customer’s PV output simply rolls his meter backwards, reducing his bill.

Also, most of the utility’s assets – and collateral – traditionally were in its physical plant: generators, power lines, substations. “Looking forward,” Freedman says, “it looks like they’re not going to be increasing generation anymore. The new generation is going to be in renewables, it’s going to be distributed, and loads are going to met by energy efficiency. And none of those things have the utility’s own capitalization.” Hawaiian Electric Industries is publicly traded; it’s hard to see how these changes in capitalization won’t affect the company’s market valuation. “In the long run,” Freedman says, “the utility’s business model is being challenged a little bit by the whole move to renewables.”

A local smart grid is thus far from inevitable, even with Hawaii’s incomparable resources for renewable energy; even with an ambitious agenda for reform in the Hawaii Clean Energy Initiative; and even with a cadre of utilities and citizens committed to the idea of a clean, distributed power generation.

Up at the Kaheawa wind farm, the students from Horizons Academy gather in the scant shade of a giant turbine to pose for a group photograph. Squinting into the late morning sun, the children smile for the camera. It’s supposed to be a picture of Hawaii’s future – the children and the energy that will power their adult lives – but that future is not yet fully in focus.Kaheawa Wind Farm

• Minimum: As little as 6 mph of wind will turn the long, elegant blades of the Kaheawa turbines.

• Maximum: When the wind reaches 55 mph, the blades feather and each turbine stops spinning.

• RPMs: Regardless of the wind speed, the turbines top out at 21 rpm – slow enough for nene to fly through in formation.

• Best wind: At 23 knots, the optimum wind speed, each turbine produces 1.5 megawatts of electricity.

source: first wind inc.

 

P.A.C.E.: Supercharging the Solar-Energy Industry

Many homeowners and businesses want solar energy to lower their electric bills but can’t afford the upfront cost – as much as $25,000 for a standard residential installation. But a new form of funding called PACE – property-assessed clean energy – offers a nearly painless solution.

How PACE Works

People who want to purchase clean-energy technology, such as solar water heating or photovoltaic systems, for their homes or businesses will be able to borrow from a special revolving fund established by the state. In return, they agree to pay the money back (plus interest and administrative costs) through an added assessment on their property taxes. In most scenarios, PACE funding will have no effect on the availability of federal or state tax credits.

How It’s Funded

To establish the PACE revolving fund, the state would issue general-obligation bonds. These would be guaranteed by the incremental increase in property taxes. In theory, PACE shouldn’t add any costs to the state budget. It’s even possible that federal grants would pay for the administrative costs of setting up the program and establishing a certification process.

Who Would Be Eligible?

One of the charms about PACE funding is that it’s tied to the house, not the homeowner’s credit. As long as you can afford to keep up with the property taxes, you would be eligible to borrow money for any qualified clean-energy system. What’s more, when you sell your home or business, the obligation to pay goes with the property. That makes sense, because an investment like a PV system adds value to your home, but is worthless to you when you sell.

Will It Happen Here?

The Sierra Club and Blue Planet Foundation are advocating strongly for PACE. It also enjoys broad support in the Legislature and with Gov. Linda Lingle. Legislation introducing the program, HB 2643, has already passed unanimously in the state House, but it still faces challenges in the Senate and in conference. Advocates such as Sen. Kalani English warn that, given the state’s fiscal troubles, it may take more than one session to pass.

 

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