Dear Chairman Tonko:

LIPA and its consultants have reviewed the two reports prepared by the staff of the Standing Committee on Energy of the New York State Assembly ("Committee Staff") entitled, Shedding Light on the Estimated Savings from the LIPA/LILCO Proposal ("Savings Report") and Shedding Light on the Financial Structure of the LIPA/LILCO Proposal ("Financial Structure Report") (collectively, the "Reports"). We appreciate the time and effort the Committee Staff has dedicated to analyzing the LIPA plan.

We all agree that the current situation, where Long Islanders pay the highest electric rates in the continental U.S., and where communities are in danger of having to levy punishing property tax increases to satisfy tax certiorari judgments, is untenable. LIPA's goal in developing this plan over the last two years has been to develop the best possible plan given the constraints of the environment in which we work, which include impending changes in the tax treatment of the transaction, LILCO's financial structure, prior actions that cannot be undone and the physical characteristics of the service territory, among other things.

In its analysis, the Committee Staff has reached some conclusions regarding the LIPA plan with which LIPA and its consultants do not agree. I would like to identify those areas where there may be misunderstandings and try to address them. Initially, it is important to distinguish between rate reductions, which are immediate and definitive, and rate savings, which are based on comparisons between LIPA's rate reductions and projections of LILCO's rates into the future. I should note that the Reports do not seem to contradict LIPA's basic claim that Long Island's electric rates will immediately drop by 18.2% in Nassau and 16.4% in Suffolk. The main difference between LIPA's projected 10-year average rate savings of approximately 19% and the Committee Staff's 8.9% seem to relate to the Committee Staff's use of incorrect assumptions and failure to fully recognize certain benefits of the LIPA plan which will not be reflected in LILCO's rates if the transaction does not occur. Before I respond to the specific concerns raised in each of the Committee Staff reports, let me address five of the more significant areas of disagreement.

• The Committee Staff states LIPA's projected 10-year rate savings appear to average 8.9%, not the 19% estimated by LIPA.

LIPA stands behind its savings estimates. Rate reductions of 18.2% in Nassau and 16.4% in Suffolk are immediately realized, with the additional rate savings over the first 10 years attributable to the factors outlined in detail in Parts I and II of this letter.

• The Committee Staff states "available data indicate that savings due to LIPA's lower cost of capital probably disappear between 15 and 24 years".

The Committee Staff's own analysis shows that LIPA's cost of capital will be lower than LILCO's for the first 25 years and dramatically lower after the retirement of LIPA's debt in 2033. Over a 40-year period, LIPA's capital costs are $5.5 billion (or approximately $140 million annually) lower than LILCO's projected capital costs.

• The Committee Staff states that LIPA's rates should increase 9% in year 11.

The Committee Staff's own capital cost analysis does not show the increases it predicts in LIPA's rates. Further, the benefits relating to the synergy savings from the BUG/LILCO merger will continue after the tenth year.

• Committee Staff states the total proposed LIPA debt would rise to $9.145 billion in 10 years.

LIPA's net debt outstanding in year 10 will be $7.435 billion, not $9.145 billion.

• LIPA will repay $947 million of principal in the first 10 years.
• A portion of LIPA's bond proceeds will finance a $757 million reserve fund which will earn interest to reduce annual debt service cost while the principle will be used to repay debt at the final maturity.

• The Committee Staff raises concerns over the cost of LIPA's debt financing on customers.

The Committee Staff fails to compare these costs to the capital costs to be paid by LILCO customers under the status quo. Over a 40-year period, the capital costs borne by customers will be almost 16% lower under LIPA than under LILCO.

The LIPA plan was developed after years of exhaustive analysis and negotiation with all parties. It is the only realistic plan for providing Long Island residents and businesses the rate relief so sorely needed.

PART I RESPONSE TO SAVINGS REPORT
The Savings Report states "LIPA and its consultants have literally supplied reams of data for which we are grateful, although, in performing the analysis, we continued to find gaps in both our requests and their responses that have led to additional requests and the need to make simplifying assumptions to bring our analysis to this point." LIPA is not aware of any outstanding, unanswered information requests. LIPA would be very interested to know what the information gaps are so we can fill them. Over the last three months, LIPA and its consultants have answered over 80 questions in writing from the Committee Staff, in addition to testifying in front of the Committee for over ten hours. We have provided information to the Committee Staff which they seem not to have taken into account when compiling their reports. For example, LIPA provided both 20-year and 40-year projections of the fixed capital costs for both LIPA and LILCO (perhaps the most important element of any analysis of this transaction); yet, the Committee Staff failed to utilize LIPA's more accurate 40-year projections -- instead relying on their own extrapolations beyond the 20-year data initially provided by LIPA. LIPA and its consultants made its projections based on reasonable assumptions to create an accurate 40-year comparison.

The Savings Report states "LIPA's projected rate savings, covering the 10-year period following LIPA's partial purchase of LILCO, appear to average 8.9 percent, not the roughly 19 percent average for the service territory as estimated by LIPA." LIPA strongly disagrees with this assertion. Specific comments are discussed below.

• The Savings Report states "LIPA's savings comparisons are to rates projected by LILCO to steadily increase over the period...LIPA uncritically accepts this forecast for LILCO..." As previously noted, the Reports seem to confuse actual rate reductions with projected savings. It is important to note that LIPA's initial rate reductions of 18.2% in Nassau and 16.4% in Suffolk are from what customers are paying today. Thus LIPA's rate cuts, which are projected to last for a minimum of five years, are not in any way based on LILCO's future rates, but rather on today's rates. LIPA reviewed the projected LILCO rates that formed the basis of comparison for the projected savings analysis. While it is true that the Public Service Commission has not been allowing rate increases for other utilities, much of the increase assumed by LILCO relates to its own unique situation and therefore comparison to statewide practices is inappropriate in this context. The modest increases in LILCO rates accepted by LIPA reflect three factors: (i) the near term termination of certain customer credits, (ii) the recovery of the outstanding Rate Moderation Component ("RMC") balance as required under the 1989 Shoreham Settlement Agreement ("1989 Settlement Agreement"), and (iii) nominal increases attributable in part to inflationary increases in labor, materials, fuel and property taxes relating to the transmission and distribution system.

  (i) As part of the 1989 Settlement Agreement, LILCO agreed to refund to customers, over a 10-year period beginning July 1, 1989, amounts referred to as the 1989 Settlement Credit and the Regulatory Liability Component. The annual amortization of these amounts equals $88.6 million. Based on 1996 system average sales this represents a credit to customers of 0.558 cents per kWh. Once these amounts are fully refunded to customers in mid 1999, this credit ends and LILCO's rates will increase by this amount.

  (ii) Also, as part of the 1989 Settlement Agreement, in order to mitigate potential rate shock, the Rate Moderation Component ("RMC") was created. The RMC ($402 million balance at December 31, 1996) represents deferred revenues that will be collected from customers under the Settlement Agreement if LIPA does not acquire LILCO. The 1989 Settlement Agreement originally provided that the RMC be recovered from rate payers in 10 years. In its last rate request filing with the PSC, LILCO indicated its willingness to extend the recovery period through 2001 but indicated that it would need assurance from the PSC that the balance would be recovered by that date. LILCO proposed that any amounts not otherwise recovered by December 1, 1999 be recovered in rates on a straight line basis together with a return on the unrecovered amount during the period from December 1, 1999 through December 31, 2001. LIPA's projected increases in LILCO's rates through 2001 reflect recovery of the projected unrecovered RMC balance.

  (iii) Finally, in making rate projections, both LILCO and LIPA used conservative assumptions with regard to labor and materials cost associated with operation and maintenance costs and certain pass-through costs, such as fuel and state and local taxes which were increased, in part, based upon assumed inflation rates. If LILCO's operating costs are overstated then so are LIPA's; consequently, there is no material impact on future savings.

  In light of the above, the projected LILCO and LIPA rates presented in the rate savings comparison provide a fair basis for projecting future savings assuming a LIPA transaction.

• The Savings Report states "…costs not affected by taxes or financing should be roughly the same between the two entities and fall into a category termed "variable costs" which includes items such as fuel, operations and maintenance. In its estimates, LIPA has these costs growing more slowly for LIPA than for LILCO..." The Savings Report presents a very misleading analysis. In its 10-year cash flow model, LIPA conservatively assumed that its variable costs (including fuel, O&M and property taxes) would be higher than LILCO's in the initial years; consequently, the rate of growth for this category of expenses is lower than that assumed by LILCO. Over the 10-year period, LIPA projects its variable costs will be $50 million greater than LILCO's projections; if LIPA's costs were reduced to equal LILCO's estimate, LIPA's savings would increase by 0.21%, not decrease by 3.1% as claimed in the Savings Report.
• The Savings Report states "If the rate stabilization mechanism, which shifts costs between different time periods, is eliminated from the calculation of rate savings for the 10-year period, LIPA's expected rate savings falls by 4.5 percent to 11.4 percent." The rate stabilization mechanism used in LIPA's model is common in the public power industry. It was specifically used so LIPA can build up its liquidity during its start-up phase and to "bank" excess revenues in the early years in order to allow LIPA to "freeze" rates at the lower levels for five years; and the rate stabilization deposits and withdrawals are equal, so there is no material impact on average 10-year rate payer savings.
• The Savings Report states "LIPA attributes savings from LILCO's merger with Brooklyn Union Gas. However, according to testimony from LILCO's CEO, these savings would occur with or without the LIPA/LILCO deal. If rate savings are estimated based on LILCO rates that also benefit from the merger savings, the expected LIPA rate savings fall by 2 percent to 9.4 percent as an average for the service territory." LIPA negotiated guaranteed synergy savings by BUG/LILCO; if synergy savings are not realized from the combination of BUG/LILCO, then BUG/LILCO shareholders must compensate LIPA for the guaranteed synergy savings. If, on the other hand, the LIPA deal does not occur and the synergy savings do not materialize, customers are not guaranteed any direct benefits. Thus, without the LIPA deal, no level of savings is guaranteed to be returned to customers. BUG/LILCO have agreed to put their shareholders at risk if management fails to deliver the synergy savings that they guaranteed. In addition, the terms of the various agreements provide LIPA with the ability to capture a significant portion of any synergy savings realized in excess of the guaranteed 2% for customers. Consequently, LIPA believes it is justified in including the 2 percent BUG/LILCO merger synergy savings in its savings calculations.
• The Savings Report states "If rate savings are measured against LILCO rates that contain the same expected rate reduction from Shoreham tax refunds as assumed by LIPA, the expected rate savings fall by .95 percent, to 8.45 percent." The LIPA plan settles this litigation for $625 million (as opposed to the $1.2 billion judgment if LILCO remains in place and appeals are not successful) in a manner which requires only $462.5 million of financing by Suffolk rate payers, minimizes the rate differential between Nassau and Suffolk Counties, and does not require an increase in Suffolk County taxes. Committee Staff should also note that, under the LIPA plan, all other pending tax certiorari cases will be settled, avoiding potential tax increases relating to these claims which could total $435 million.

The Savings Report states "Available data indicate that savings due to LIPA's lower fixed costs probably disappear between 15 and 24 years after LIPA purchases LILCO depending on a variety of assumptions one makes. After that point, LIPA's rates may be higher than LILCO's." On June 24, 1997, LIPA and its consultants submitted to Committee Staff an analysis which compares the fixed capital costs (including debt service, bond coverage and GENCO capital costs recovery) under LIPA's public power approach and the LILCO status quo fixed capital costs (including LILCO amortization, depreciation, return on capital and federal income taxes) for the next 40 years. Chart I on the following page summarizes the results of LIPA's analysis assuming LIPA sells its acquisition bonds at its assumed interest rate of 6.7% versus LILCO's cost of capital maintained at its current rate of approximately 9.5%. The analysis shows the impact of fully amortizing LILCO's regulatory asset (in the year 2029) and LIPA's acquisition bonds (in the year 2032). As shown on Chart I, LIPA's costs are less than LILCO's for the first 25 years, equal for the 26th year, slightly higher for years 27 to 35 and dramatically lower thereafter. Over the 40 year period LIPA's capital costs are $5.5 billion (or approximately $140 million annually) lower than LILCO's. On a present value basis, LIPA's costs are $2.7 billion lower than LILCO's.

Under current market conditions, LIPA's average borrowing cost would be 6.00%, not 6.7%. At a 6.00% average borrowing cost, LIPA's costs are less than LILCO's for the first 28 years, equal for the 29th year, slightly higher for years 30 to 35 and dramatically lower thereafter. By using the same approach with current market rates, LIPA's capital costs are $6.8 billion lower over 40 years. On a present value basis LIPA's plan saves customers $3.3 billion.

The Savings Report states "The savings from the merger of LILCO and BUG appear to apply only for the first 10 years." The synergy benefits that BUG/LILCO achieve as a result of their merger will be permanent. Because any future management services contract with LIPA will be on the basis of cost, plus a management fee, LIPA expects to retain the benefits of these savings in one of two ways: (i) through renewal of the Management Services Agreement with BUG/LILCO after competitive bid, or (ii) through award of a new management services contract in the eighth year to another party who is aware of the level of costs paid by LIPA in the final year of the current agreement and who agrees to guarantee savings at least at the BUG/LILCO level. The Savings Report states "If one accepts LIPA's assumptions, savings are higher in the first 10 years compared to the period thereafter with a noticeable change in year 11." As stated in the Savings Report, predicting total cost beyond 10 years is difficult, given the impact of future tax rates, fuel costs and labor costs. However, fixed capital costs are easier to predict. As shown in Exhibit B of the Committee Staff's Savings Report, (and Chart I above) LIPA's fixed capital costs will still be lower than LILCO's in year 11 (and through year 25). Further, as discussed in the paragraph above, the Committee Staff's statement that the benefits of synergy savings will disappear after the first ten years is incorrect.

"Even with LIPA's presence, LILCO will effectively continue as a monopoly on Long Island while the rest of the state moves toward competition in electric energy supply." The statement that "LILCO will effectively continue as a monopoly on Long Island" is hard to accept given the the Committee Staff's knowledge of the details of the transaction.

As the proposed Management Services Agreement and Energy Management Agreement make clear, LIPA, not BUG/LILCO, will be responsible for determining all of Long Island's energy policies into the future while obtaining the benefit of utilizing LILCO's highly trained work force. LIPA will also set rates for the T&D System. BUG/LILCO will be contractually obligated to manage the T&D System in a manner consistent with the policies and budgets established by LIPA. In addition, BUG/LILCO has no assurance that it will continue to manage the T&D System after the eighth year as the Management Service Agreement will be rebid at the end of the sixth year. Therefore, LIPA (not LILCO) will be the electric utility on Long Island. Additionally, LIPA, at its option, can purchase all of LILCO's power plants in the fourth year, taking BUG/LILCO completely out of the electricity business.

Because of the high cost of replicating the T&D system on Long Island, LIPA's T&D System will remain a natural monopoly with its rates set on a "cost of service" basis (as is currently the case). As is true elsewhere in the United States, competition will develop over a period of time in the power supply component only. Geographic constraints limit the competitive opportunities on Long Island compared to many other electric service territories. LIPA's Power Supply Agreement with LILCO provides a price ceiling on LIPA's current capacity requirements, while allowing LIPA to purchase future capacity and all energy solely on an economic basis.

Over time, LIPA will offer its wholesale and retail customers full power supply choice while such customers continue to pay for the use of LIPA's T&D System. LIPA's T&D rates will be sufficient to recover LIPA's costs, including debt service. This model for retail competition on Long Island (i.e., competitive power generation and monopoly distribution) is very similar to the retail competition programs being implemented in most parts of the country. In fact, the LIPA plan allows competition on an equal basis for both wholesale and retail customers. Without the LIPA plan, the limited competition available would only benefit certain high volume customers at the expense of other customers. Looking to the future, LIPA is already evaluating the cost-effectiveness of a cross-Sound cable as a way to open Long Island's power market to greater competition. This is something that might never occur under the status quo.

PART II RESPONSE TO FINANCIAL STRUCTURE REPORT
The Committee Staff has raised concerns with regard to the amount of debt to be raised initially and subsequently to the LIPA/LILCO transaction. LIPA's fixed capital charges to its rate payers (comprised of its net debt service plus coverage) must be compared to LILCO's allowed fixed capital charges (which reflects its pre-tax return on the rate base plus depreciation). As shown in the table below, the fixed capital cost per month per customer is lower under the LIPA plan than under LILCO:

	LILCO Status Quo	LIPA Assumed Interest Rates(1)	LIPA Current Market Interest Rates(2)
Average Monthly Capital Cost per Customer - 1998 to 2037	$77	$65	$63
Savings versus LILCO Status Quo		15.6%	18.2%
(1) LIPA acquisition bonds @ 6.7% assumed average rate (2) LIPA acquisition bonds @ 6.0% average rate in current market

The Financial Structure Report states that "On average, LIPA will only finance 20 percent of its total capital improvement needs over the next 10 years with internally generated cash. In contrast, LILCO has funded all of its capital improvement needs over the last few years with internally generated cash." Cash spent by an investor owned utility for capital improvements is included in rate base and customers are charged a taxable rate of return and depreciation on such rate base. Cash funded capital improvements are not a one time expense as implied by Committee Staff. One of the greatest advantages of the LIPA/LILCO transaction is LIPA's tax-exempt cost of capital and avoidance of federal income taxes. Future capital costs will always be lower under LIPA than under LILCO. The Financial Structure Report states that "Bondholders will be unable to secure their position with collateral, as is generally becoming commonplace in the industry, and will look for alternative forms of security." Public power bonds are secured by a pledge of revenue, not a mortgage of the assets. Neither LIPA staff nor its consultants are aware of any public power bonds secured by a mortgage on property. LIPA's bonds will be repaid with net revenues (revenues after payment of O&M expenses) and will not have a mortgage pledge or collateral.

The Committee Staff further states that "As a result, LIPA includes in its initial bond issuances $674 million to provide bondholders with the following protections…"

• Bond insurance: $34 million. Municipal issuers do not use bond insurance to reduce risk to bondholders; they purchase it to reduce their own borrowing cost. Purchasing bond insurance enables LIPA to borrow at "AAA" rates, dramatically reducing its borrowing costs even after paying the upfront premium. This produces direct benefit to customers.
• Debt Service Reserve Fund: $640 million. Committee Staff acknowledges that this is "common practice with public authority bond issues"; It will be invested in U.S. Treasuries or similar obligations and the interest will be used to reduce annual debt service costs with the principal applied against the final year's debt service payment.

Committee Staff states "The total proposed LIPA debt, as depicted in Table 1, would rise to $9.145 billion, due to LIPA's plan to issue $1.075 billion in bonds over the next ten years to finance capital expenditures." This assertion is incorrect. LIPA's net debt outstanding will be $7.435 billion after the tenth year, not the $9.145 billion that Committee Staff states. The Financial Structure Report fails to state that customers will have repaid $947 million of these bonds by the tenth year and that LIPA will have debt service reserve funds of $757 million at that time. In addition, the debt presented in Table 1 includes $462.5 million of bonds to fund the Shoreham tax litigation settlement which will not be necessary if the Suffolk County ¼ cent sales tax plan is adopted.

The Financial Structure Report states "LIPA's documents include a projected ten-year 'revenue requirement schedule' consistent with these rate reductions, which indicates that LIPA's obligations will exceed its revenues by over $1.322 billion in the third through the tenth year (see Table 2)". This statement is incorrect. Table 2 shows that LIPA plans to provide for its annual O&M expenses, debt service and coverage requirements through a combination of charges to its customers and rate stabilization fund withdrawals. The rate stabilization fund contains excess revenues, including debt service coverage, net receivables and investment earnings. Use of the rate stabilization fund allows LIPA to increase its liquidity reserves and smooth out its revenue requirements while meeting all of its obligations.

The Committee Staff states "LIPA also plans to make no principal payments during the first two years which allows for more rate reduction ..." As LIPA's financial advisor stated at the Committee's last public hearing on June 19, 1997 in Albany, the deferral was not done to increase savings, but was done in order to provide additional cash reserves to meet any unexpected expenses in this "start-up" situation. This is prudent financial management.

The Financial Structure Report states "the issuance of $7.262 billion over twelve to eighteen months has been noted by many financial experts as problematic." We disagree. New York State Comptroller McCall told LIPA that "many fund managers have expressed the view that LIPA would have no difficulty placing its bonds, barring significant deterioration in the fixed income markets."

I should note that the State of New Jersey sold a well publicized $2.8 billion pension bond issue last week (not included in the Figure C of Committee Staff's Financial Structure Report detailing the largest municipal bond issues). The bond issue was reported as being "heavily oversubscribed with more than $40 billion of offers, 14 and-a-half times the bonds available" according to the Assistant State Treasurer in a Bond Buyer article. I should also note that the Notes to Figure C state that the "largest short-term issuance is $4 billion issued by California in 1994", but this ignores New York State's two larger note issues, each $4.3 billion in size sold in 1984 and 1985; both the same size as LIPA's largest tranche.

The Financial Structure Report states "A single large bond deal has the potential of crowding out other municipal bond issuers, driving up interest rates and increasing costs to taxpayers," but later states "LIPA does propose to address this problem by issuing the debt in three offerings." As LIPA and its financial advisor have testified to the Committee, LIPA will coordinate with Comptroller McCall and will issue its bonds in tranches to minimize its impact on the market. LIPA is confident that there will be significant market demand for its bonds and that such bonds can be sold with little, if any adverse effects on other issuers.

The Bond Buyer recently quoted the senior underwriter of a leading municipal bond department specifically addressing the concern that LIPA will temporarily drive up interest rates for issuers: "We think that's far from the truth". The Bond Buyer reported that the underwriter stated that he "has been telling issuers who are concerned about the effect the deal will have that 'I wouldn't want to price the same day as LIPA.' But its cost to them will be 'very little,' he maintained."

CONCLUSION
LIPA's response clearly indicates the dramatic advantages of the LIPA plan over the status quo or any available alternative. Indeed, it is noteworthy that most of the Energy Committee members and members of Long Island's Assembly delegation publicly endorsed a similar takeover proposal that LIPA put forth in June, 1995, which contained smaller rate reductions, lower savings and larger debt. Your earlier recognition that a public takeover is the only viable way to lower Long Island's burdensome electric rates, and the point that no real alternative has been proposed, indicates the importance of implementing the LIPA plan as soon as possible. As I believe we both agree, the status quo is unacceptable. The residents and businesses of Long Island must have relief now from the highest energy costs in the continental U.S. The LIPA Plan is the best and only real means for providing such relief.

Sincerely,
Richard Kessel
Chairman