Energy Speculation Gone Wrong in Vernon

We've been following developments in the tiny Los Angeles County city of Vernon for months, as the state Legislature has pursued the unprecedented action of forcibly dissolving the scandal-plagued town. As we've continued to remind readers, the motive behind AB 46 is hardly a concern for good government: rather, the county's political elites, led by Assembly Speaker John Perez, are attempting to seize control of the city to get at its public utility and massive corporate tax base. Yet a report in today's LA Times suggests that they may get more than just money from Vernon, as the city has accumulated sizable debts through a series of energy deals gone wrong.

In the past, city officials have offered glowing estimates of its financial health, but declined to offer details when asked more probing questions this year. This led the Times to hire an auditor to review Vernon's books for the past 10 years. The results of this audit suggest that, over the past six years, Vernon has lost over $130 million in net assets due to mushrooming debt, declining tax revenues, and yes, increased spending on salaries, benefits, and legal fees. As a result, rates at its electric utility have gone up sharply, and Moody's currently assigns its debt a lower rating than many nearby cities; in order to meet the $56 million or so in debt service it owes over the next decade, the Light & Power Department is expected to keep hiking rates or finding ways to cut costs.

So what went wrong? Apparently, as energy prices began surging in 2001, Vernon decided to push the construction of the natural-gas-fueled Malburg Generating Station. Though records suggest that the city had enough in its reserves to pay for the project, it chose to issue bonds instead. When Malburg went online in 2005, it was a money-loser from the start, as natural gas prices soared following Hurricane Katrina. In order to protect itself against future volatility, Vernon created the Natural Gas Financing Authority, which issued over $430 million in bonds in 2006 to purchase a 15-year supply. Three-quarters of this supply was purchased at a fixed price of $7.50 per cubic-foot unit; though this was substantially lower than the post-Katrina price, natural gas has since dropped sharply, and now sits at about $4.12 per unit. Moreover, despite the initial losses on Malburg, Vernon moved forward in 2006 with another large generating project, the Southeast Regional Generating Center, which was slated to cost $500 million. Perhaps for the better, opposition from nearby cities led them to abandon the plan. Yet more grim news came in 2008, as the city's heavy involvement in derivatives trading became terribly costly. With interest rates falling, the declining values of derivative instruments were largely responsible for $69 million in investment losses between 2008 and last year. During this period, Vernon sold off a number of properties, including the Malburg station, and the recession put a severe dent in its utility revenues.

It may be tempting to frame this as support for the case of disincorporating the city. After all, if utility rates are expected to skyrocket to cover these losses, it'll be harder to paint Vernon as a safe haven for business. Yet we don't really see much difference between all of this and the green-energy follies of cities like Anaheim and San Diego. Vernon officials are certainly guilty of foolish speculation with taxpayer money. But then, so is most every government in California.