The Philadelphia Inquirer
February 18, 1996
The heat is on
the Gas Works
nearly destroyed it. Its rates are the highest in the region. Competitors
PGW: The price of politics
On a 98-degree day when winter
fuel supplies seemed a remote concern, a Philadelphia Gas Works official
sat in a hearing room on Arch Street last July and explained how the
city-owned utility was hurtling toward its doom.
Harry A. Connelly, a punctilious and bespectacled PGW vice president,
testified to an audience consisting mostly of unoccupied metal folding
chairs that an emerging class of natural-gas marketers was plotting to
steal PGW customers as utilities opened up to competition.
Connelly said his biggest fear was Peco Energy Co., the utility that
sells electricity to city residents and whose suburban gas mains run up to
the city's boundary.
As members of the Philadelphia Gas Commission fidgeted, Connelly said
the competition would first target PGW's biggest customers, offering them
Then the marketers would spread out from the city's affluent
neighborhoods like a virus consuming PGW's base of 519,000 customers. He
said PGW could be left serving primarily customers who could not afford to
pay their bills.
When would the erosion occur? "Are we talking about 10, 15 years
away?" someone asked.
"I would anticipate within a year or two, if that," Connelly
The gas commission fell silent. Someone suggested Connelly's comments
be stricken from the record so that competitors might not be tipped off.
But it is too late to hide: PGW, the nation's largest municipal gas
company, is in danger of being toppled.
PGW is at a crossroads. The tumult that has engulfed it during the last
year as it skirted financial crisis and hunted for its first permanent
chief executive since 1989 is only a sample of things to come.
PGW's new managers, installed last month, are taking command of a
half-billion dollar enterprise that remains politicized, debt-ridden and
larded with giveaway programs, even after a year of cost-cutting by a
With the highest rates in the region, PGW is ill-prepared to compete.
If it fails to shape up, a profitable asset for the city government could
be turned into a burden on every city taxpayer.
PGW threatens to become "a long-term drag on Philadelphia's
future" unless it operates more like a privately owned business, said
a December study by the Pennsylvania Economy League, a nonprofit
In a rapidly changing environment influenced as much by events in
Washington as in City Hall, PGW is trying to catch up with other energy
The new chief executive, James Hawes 3d, a former telecommunications
executive from Nebraska, says he is well aware of the competitive
challenge ahead. He said he hopes to expand PGW's market, perhaps even
pushing beyond the city's borders with new ventures.
But Hawes acknowledged that "our first goal will be to get this
place running on all cylinders."
That will be a tall order, demanding a rapid cultural change at an
organization that for most of its 161-year history operated in a protected
market and could afford to be slothful.
PGW suffers from "a certain institutional lethargy," said E.
Talbot Briddell, the head of Phoenix Management Services, the Chadds Ford
turnaround firm that has operated the utility for 14 months. "People
tend to think in terms of millennia around here."
The result is an organization that critics say has a confused mission
aimed as much at serving political masters as serving PGW's customers.
"Without shareholders, PGW has returned dividends in the form of
influence to its stakeholders: the politicians and interest groups,"
said Rotan Lee, the former school board chief who was named to head PGW's
board of directors in 1994.
PGW has squandered the competitive advantages it enjoyed under
"You'd think that with tax-exempt financing and without the need
to pay shareholders, we could run this sucker and provide gas at a lower
cost," said Ben Hayllar, the city finance director, who estimates
those municipal benefits are worth $75 million annually to PGW.
With no clear mandate to watch costs, PGW developed into an
organization that tolerated inefficiency. A consultant last year said that
even after 17 percent of PGW's workforce took early retirement and the
staff shrank to 2,027 employees, PGW still employed more people than other
utilities of similar size. PGW has never done a companywide study to
determine the right staffing levels.
It is a system that tolerated abuse. An audit last year discovered that
333 city employees had signed up for low-income discounts at a cost of
about $1 million. Only about $250,000 of that has been recovered from
ineligible employees - the remainder covered by the vast majority of
customers who pay their bills.
And it is an organization that condoned pilferage. When PGW hired a
sleuth to look into its transportation department last year, purchases of
auto parts suddenly fell from $115,000 a month to $35,000. Four employees
were later fired for alleged thefts.
PGW also has a history as a source of political patronage, though
officials such as mayoral chief of staff David L. Cohen say the utility is
far less of a hiring hall than it was during the reign of Mayor Frank
In 1972, Rizzo ousted the private firm that had managed PGW for 75
years. The mayor claimed the city could do the job for less. He created a
nonprofit board of directors to manage the utility.
That paved the way for Rizzo to launch a hiring spree that continued
even after he left office. In 1984, during the Goode administration, Rizzo
became head of PGW's security and hired 32 retired police officers. Their
function was never entirely clear even to PGW's managers.
Most of the officers took buyouts last year. And with PGW's workforce
shrinking these days, it is hardly the reliable source of jobs that it
Politicians still have some measure of influence, however.
Ann Land, a former city councilwoman and member of the gas commission,
was appointed in 1992 as PGW's community-relations manager. Her main duty
was to handle customer complaints directed to City Council members. Her
$53,000-a-year job was targeted for elimination last year but was spared,
sources said, after City Council President John F. Street called PGW
officials. Land's new title is manager of city affairs. "I'm doing
the same thing I've done since coming here, which is mostly constituent
services," said Land, who referred other questions to PGW.
The utility also hires its share of politically connected contractors
and law firms. It is spending $2.3 million this year for legal costs,
about two-thirds of it to outside law firms, many of which contributed
generously to Mayor Rendell's re-election campaign.
But PGW's biggest political costs are not the contracts it gives to the
well-connected or the jobs it has doled out to retired politicos.
Rather, PGW's biggest political costs are the discounts it gives its
own customers at the behest of elected officials.
About 11 cents of every dollar collected by PGW pays for social
programs to subsidize the poor and the elderly. Those costs may address
legitimate social concerns, but they increase the utility's rates and
exposed its flanks to competition.
Rizzo was largely responsible for one action that represents the type
of social patronage that continues to cost PGW customers millions of
dollars each year.
In 1973, under pressure from an organization of senior citizens, Rizzo
and the City Council voted to give 20 percent discounts to people aged 65
and older. PGW is the only utility in the country that gives such a
discount without regard to a customer's income.
The cost of the senior discount was downplayed at the time. Nor did the
city emphasize who would pick up the tab: other PGW customers.
But in the 22 years since the discount went into effect, PGW customers
have paid $223 million in discounts for senior citizens - not counting an
estimated $17 million this winter.
The discount will cost the typical PGW residential heating customer
about $30 this year. Because seniors are not required to report their
income, middle-class customers who pay PGW's full rate are, in effect,
subsidizing their wealthier neighbors who might be older than 64.
Few City Council members express eagerness about taking on the
political risks of challenging the senior discount. "We politicians
are terrified" of senior citizens, said City Councilman W. Thacher
Longstreth, who is 75 and opposes the discount.
The senior discount is not the only example of the city's political
leaders' extending benefits to a broad class of PGW customers.
Two years ago, the Philadelphia Gas Commission, whose five members
include three elected officials, moved to restructure a discount program
for poor people who had fallen behind in their payments.
Led by City Councilwoman Happy Fernandez, the gas commission quietly
approved a new program that attempted to curtail abuses by customers who
repeatedly re-enrolled in the program, only to default again.
In correcting the program, the gas commission extended the discounts to
all low-income customers - regardless of whether they had payment
PGW did not have to conduct an advertising campaign to spread the word
about the new program.
By the end of its first year, more than 60,000 customers had signed up
for it, nearly double the number of customers who had been enrolled in the
program it replaced. The new program limits a customer's payments to 7.35
percent of monthly income; the poorest customers pay a minimum of $30 a
The enrollment topped out at nearly 70,000 customers last summer before
PGW began examining the rolls and eliminating customers who earned above
the income limits. That's how PGW discovered 333 city employees in the
PGW estimated that the discount program would cost other customers $38
million for the fiscal year that began Sept. 1.
The gas works estimated that the total cost of social programs has
swelled to about $58.5 million a year, including the costs of a $3.5
million conservation program that is still struggling to become
cost-effective in its fifth year. That amounts to $105 a year for the
average residential customer with a total bill of $924.
PGW has always blamed its problems on external causes: As an older
utility, it faces higher costs to repair aging pipes, and its urban
location means it has a lot of poor customers who don't always pay on
All that is true.
But much of PGW's excessive costs have as much to do with how it does
business as where it does business.
PGW's managers permitted it to amass a huge debt rather than confront
its escalating costs. Its debt-to-equity ratio is nearly double that of
It also accepted excessive overtime, sick time and absenteeism as
standard costs of doing business.
Until last year, the department that manages customer-service operators
and PGW's district offices budgeted on the assumption that 20 percent of
its workforce would not show up each day. "That was one of the points
that alarmed us," said Mitch Arden, an executive with Phoenix
PGW not only employs more people than most utilities its size, but its
2,027 employees cost an average of $58,033 a year in wages and benefits,
$6,366 more than the average of 10 other utilities, according to a study
Labor leaders say that PGW's bloated management ranks are the cause of
the high personnel costs - the utility had one manager for every three
union members before last year's buyout reduced the ratio to four-to-one.
"The real problem is they got so many people here who have no gas
experience who were put in by politicians," said Joseph G. Given, the
head of the Gas Works Employees Union.
PGW also costs more to be regulated than other utilities. PGW
ratepayers this year will absorb $2.1 million for the gas commission's
budget, a cost that is basically dictated by the commission without public
debate. The cost was $1.3 million two years ago.
If PGW were regulated by the Pennsylvania Public Utility Commission,
the cost would amount to $1.2 million this year, according to the PUC's
funding formula. As a municipal utility, PGW cannot be regulated by the
state without a legislative act.
One of PGW's biggest costs resulted from its own sloppy collection
practices, which PGW often complains were imposed upon it by politicians
on the gas commission.
PGW wrote off $87 million in bad debts in the last two years. Eight
cents of every dollar paid by PGW customers covered the cost of old,
unpaid bills of their neighbors. Two cents is considered high by industry
It is impossible to calculate precisely how much PGW's practices cost
But a typical Philadelphia residential heating customer pays $127 more
a year for natural gas than a suburban Peco customer using the same amount
of gas, even though Peco pays out 13 cents of every dollar it receives in
various taxes and 11 cents in profits and dividends.
City Hall long could afford to neglect the utility as long as it
generated a reliable stream of profits: PGW pays the city treasury $18
million a year regardless of its performance. The city also gets a
discounted gas rate that saves it about $900,000 a year.
But those benefits are guaranteed only as long as the utility is
healthy. And as Harry Connelly told the gas commission last summer,
competitive forces already are pushing against the barriers that PGW has
"It is not necessarily possible to keep putting fingers in the
dikes sufficient to keep the dikes from being breached by the
onslaught," he said.
In the last decade, changes imposed by the Federal Energy Regulatory
Commission have deregulated the prices of natural gas at the wellhead, as
well as the cost of transmitting the fuel up pipelines from the
gas-producing regions along the Gulf Coast and in Appalachia.
Meanwhile, state regulatory agencies are relaxing rules that give
exclusive monopolies to utilities, allowing increasingly smaller gas
customers the freedom to choose their energy suppliers.
While PGW is not controlled directly by state regulators, it is
nonetheless affected by these outside forces. Some of its customers have
demanded lower rates or threatened to move their operations elsewhere.
PGW has already seen much of its industrial load flee for cheaper
alternatives. Almost all of its large customers buy their gas from
brokers, whose costs are lower than those of regulated utilities such as
PGW's latest fear is that brokers will consolidate groups of smaller
customers and sell them gas. It's already happening in suburban areas,
particularly in New Jersey, where brokers can form groups as small as five
customers to sell them gas: five restaurants under the same owner, for
All PGW gets from a broker is a "transportation fee" for
delivering the fuel through its pipes. Connelly said he is concerned that
PGW's revenue will shrink because of competition, but PGW's fixed costs
will not. PGW would be forced to recover its costs from fewer customers -
pushing rates up at a time when the markets are forcing them down.
It's a slippery slope that Steven P. Hershey, the Community Legal
Services attorney who serves as the public advocate, calls a "death
Another competitive threat is called a bypass. It occurs when a large
customer taps directly into the interstate pipelines that typically carry
gas to local utilities such as PGW.
A large customer that builds a bypass can avoid any payment to the
local utility whatsoever. In recent years, federal regulators have lifted
restrictions on bypasses.
Utilities typically respond to a bypass threat by cutting their prices
to large customers. But each time a utility cuts its charge, it shifts the
burden to other customers.
By dropping its price, PGW last year averted a bypass by the Grays
Ferry Cogeneration Project, the gas-fired expansion of the Schuylkill
Station power plant at 26th and Christian Streets.
The Grays Ferry project will increase PGW's gas volume by 20 percent,
but it will contribute less than $3 million a year to the utility, less
than 4 percent of operating income.
Papers filed with federal regulators in connection with the Grays Ferry
project indicated that Sun Co. Inc. also has considered bypassing PGW to
supply its South Philadelphia refinery.
Not just big customers may bypass utilities in the future in the
free-market free-for-all envisioned by some energy experts.
Connelly said he feared that smaller customers may try to buy gas from
a neighboring utility.
One current PGW customer, Chestnut Hill College, is considering
replacing its oil-fired boilers with an efficient natural-gas heating and
But PGW would need to build a new gas main down Germantown Pike to
supply the volume of gas that the college needs. PGW has balked at the
There is a much closer supply: Peco operates a medium-pressure gas main
beneath Northwestern Avenue, less than 100 yards from the college.
So far, Peco has declined to serve Chestnut Hill College without PGW's
In an interview, Peco senior vice president Robert Patrylo said the
suburban gas utility has no intention of extending its gas lines into the
city to nab PGW customers.
But PGW officials said they fear that in the not-so-distant future
utilities such as Peco may not be so respectful of neighboring turf.
Connelly was questioned about the potential of an intrusion last
"Do you know whether or not Peco has any plans either on the shelf
or more concretely to enter the Philadelphia gas market?" asked
Hershey, the public advocate.
"At the moment, I'm assured that they do not," Connelly said.
"Do you accept those assurances?"
Connelly's response: "No."
Staff writers Craig McCoy and
Tom Torok contributed to this story.