• Mr. Studness makes inaccurate assumptions regarding required capital additions and uses a time period that dramatically distorts the results.
  
• Over a 40 year period that considers capital additions, LIPA's capital costs are $5.5 billion lower than LILCO's assuming LIPA's average cost of capital is 6.7%; on a present value basis, LIPA's capital costs are $2.7 billion lower than LILCO's. Under current market conditions, LIPA's average capital cost is 6.0% and LIPA's total capital costs over 40 years are $6.8 billion lower than LILCO's; on a present value basis, LIPA's capital costs are $3.3 billion lower than LILCO's.
  
• Mr. Studness fails to take into account either inflation or the time value of money. Assuming an annual inflation rate of 2.5%, electricity costing 12.87 cents/kWh in 35 years is the equivalent of 5.4 cents/kWh today.
  
  

• The LIPA Board, comprised of Long Islanders, will have a greater interest in controlling costs than the Albany-based PSC, which must maintain a state-wide perspective and does not have control over utility operating budgets.
  
• LIPA has designed the Management Services Agreement to give it the ability to control costs and to provide incentives and penalties to the Manager to control and reduce costs. Each year LIPA will review and, after appropriate modification, approve the operating and capital budgets for the T&D system.

• LIPA will have complete flexibility to acquire electricity on a least cost basis from all supply sources both on-island and off-island.
  
• LIPA will provide for increased competition immediately upon its acquisition of LILCO.

Differences Between Financing Investor Owned Utilities ("IOU's") and Public Power

IOU's and Public Power Utilities operate with completely different objectives and their financing mechanisms reflect this. IOU's are owned by stockholders who expect their company to serve its customers while maximizing stockholder profits. Since stockholder and rate payer objectives are often conflicting in a monopoly environment, IOU's rates are regulated by each state through a Public Service Commission ("PSC"). The PSC typically will allow the IOU to charge rates sufficient to cover operating expenses, return of capital through depreciation, and a return on its undepreciated assets. Depreciation typically is recovered on a "straight-line" basis, meaning it is charged to rate payers in even amounts over the estimated life of the asset. The allowed return on undepreciated assets is based upon the IOU's cost of capital which reflects a weighted average of its costs of debt, preferred stock and common stock. An IOU's cost of capital will change over the life of the assets depending on (i) the IOU's then cost of debt and allowed return on equity as established by the PSC and (ii) the IOU's capital structure. Assuming that the cost of debt and equity do not increase significantly, capital charges related to any specific IOU asset typically decline over time. However, in general, this decline is usually offset by new capital additions being placed in rate base -- additions that were noticeable missing in Mr. Studness' analysis. This approach puts a disproportionate share of the costs on current rate payers, but reduces the period over which the higher equity costs are charged to rate payers.

Comparing LIPA and LILCO Rates Using Real Dollars

On page 10 of his report, Mr. Studness uses a chart which shows the point at which he calculates that the capital costs of funding only the existing assets under LIPA begin to exceed the capital costs under LILCO. He then compares the total savings in the early years with the dissavings in the later years. He describes the results as "punishing". This is extremely misleading in two respects. First, a dollar of savings today has a greater economic significance than a dollar increase in cost 35 years from now. An economist should know that to make a proper comparison, you must, at a minimum, evaluate the results taking into account inflation by comparing the results in real, or today's, dollars (or as a corporate or governmental analyst would, consider the results using a present value analysis assuming an appropriate discount rate). For example, assuming an annual inflation rate of 2.5% over the next 35 years (a conservative assumption given the average rate of 5% over the last 35 years), the real cost of a kWh of electricity with a nominal cost of 12.87 cents in 2032 is only 5.4 cents. The only way to maintain a proper perspective in this type of analysis is to utilize a real dollar or time value of money approach; such a perspective is missing from Mr. Studness' report.

Second, Mr. Studness ends his graph in the 35^th year, leaving the impression that the rate differential he presents will continue indefinitely. In fact under his analysis, if he had extended his chart by one year, he would have shown that LIPA's rate would drop to equal LILCO's projected rates since LIPA's debt was now fully retired. Furthermore, as discussed in the section below, had he considered the impact of future T&D capital expenditures, the date at which LIPA's capital costs would begin to exceed the capital costs of LILCO would be delayed, and extending the chart one year, he would have shown that LIPA's capital costs drop significantly below LILCO's once LIPA's debt is retired.

LIPA's Comparison of Capital Costs

LIPA and its consultants have created an "apples-to-apples" analysis which compares the capital costs under LIPA's Public Power Utility approach and the LILCO status quo. For this analysis LIPA has included future capital expenditures. The chart below summarizes the results 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 9.5%. The analysis was calculated over forty years to show the impact of fully amortizing LIPA's acquisition bonds (2032) and LILCO's regulatory asset (2029). As shown in the chart below, LIPA's cost are less than LILCO's for the first 25 years, equal for one year, slightly higher for the next nine years and dramatically lower thereafter. Over the 40 year period LIPA's capital costs are $5.5 billion 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%. As shown in the chart on the following page, LIPA's cost are less than LILCO's for the first 28 years, equal for one year, slightly higher for the next six years 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 $3.3 billion.

"Inflated Hypothetical" LILCO Rates to Bolster Savings

In his report, Mr. Studness states that he believes the projected rates for LILCO are not realistic because on average they are higher than LILCO's current rates. In making rate projections, both LILCO and LIPA used conservative assumptions with regard to operation and maintenance costs and certain pass-through costs, such as state and local taxes and Nine Mile Point 2 operating costs, which were increased at an assumed inflation rate. If LILCO's costs are overstated then so are LIPA's; consequently, there is no overstatement of future savings. However, there are also specific non-cost items that contribute to the projected increases in LILCO's rates over the next 10 years which Mr. Studness apparently has not considered.

First, as part of the 1989 Settlement Agreement, LILCO was ordered to refund to customers, over a ten 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 rate payers of 0.558 cents/kWh. Once these amounts are fully refunded to rate payers in mid 1999, LILCO's cost of service will increase leading to higher rates.

Second, also as part of the 1989 Settlement Agreement, in order to mitigate the potential rate shock of the Settlement, the Rate Moderation Component (RMC) was created. The RMC ($402 million at December 31, 1996) represents deferred revenues that would otherwise have been collected from rate payers under the Settlement Agreement. The Settlement originally provided that the RMC be recovered from rate payers in ten 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. The projected increases in LILCO's rates through 2001 are designed to recover the projected unrecovered RMC balance.

Third, the operation of any utility involves labor, fuel, material and other costs, all of which are subject to inflation. For instance, LILCO signed a five year agreement with its unions in 1996 which provided for an average increase of approximately 3% in salaries for covered union employees. Normal increases in such costs due to inflation will ultimately be reflected in rates. To the extent such cost increases do not occur, both LIPA and LILCO rates shown in the comparison would be lower and the savings would remain the same.

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

The Shoreham Litigation Settlement

One of LIPA's objectives was to gain control of the Shoreham Tax Litigation so that LIPA could settle it in a fair and equitable manner. LIPA sought to provide a means for funding it which did not require the sale of Suffolk County bonds which would require an increase in property taxes. LIPA also sought to provide the benefit to Nassau in the near term while stretching out the repayment obligation of Suffolk. Consequently, it was clear that any solution would require bonding. (Mr. Studness suggests paying the settlement, with a rate surcharge on Suffolk rate payers: "This would create a rate differential between the two counties of 18% in the first year and 8% in each of the following four years. This was apparently unpalatable to LIPA" (page 7). LIPA indeed found such an approach unpalatable as did Suffolk County officials and as LIPA believes would Suffolk County rate payers.) If LIPA did not issue its bond to fund this settlement, it is clear that Suffolk County and/or the other taxing jurisdictions would need to do so.

Any time bonds are used to fund an expenditure, the total cost will be greater than the expenditure. In bonding the Shoreham judgment, this will be the case whether it is funded by LIPA on behalf of Suffolk tax payers or directly by the County. Because LIPA sought to minimize the differential between Nassau and Suffolk rates initially to limit the issue of electric rates as a factor in economic location decisions, it used a bond structure which deferred any payments on these bonds for five years and then phased in the debt service over the next five years. Full debt service would be payable in equal amounts over the next 20 years, so that as growth occurred in Suffolk County the relative burden of this surcharge would decline. However, this deferral of debt service does increase the total repayment amount. That is why LIPA was very interested when it learned of Suffolk County Legislature Presiding Officer Rizzo's proposal to pre-fund the settlement amounts with the use of Suffolk County bonds secured by a proposed increase in the County sales tax. Since LIPA's primary objective in this regard was to settle the Shoreham Tax Litigation, if the County can fund the settlement at a lower cost, LIPA would agree to this approach; if not, LIPA is prepared to fund it in accordance with the original plan.

As stated above, any bonding will result in total costs greater than the amount of the funded settlement which will be repaid primarily by Suffolk residents and businesses either through a rate surcharge or property or sales tax receipts. Therefore, to include the rate surcharge in a comparative analysis of LIPA and LILCO rates distorts the benefits of the LIPA acquisition.

Burden of Capital Costs for Rate Payers Under LIPA and LILCO.

On page 3 of his report, Mr. Studness states "Irrespective of how the T&D assets are valued, the economic value of the assets that LIPA will acquire is clearly dwarfed by the debt it will incur. LIPA's $7.7 billion debt must be carried by assets with an economic value of $1.45-$1.78 billion, a difference of roughly $6 billion. The issue for investors is whether LIPA is capable of carrying such a burden." The assets that LIPA would acquire through the purchase of stock are projected to be capitalized by $6.416 billion of LILCO's debt, preferred stock and common shareholders' equity as of 12/31/97. To properly compare LIPA's and LILCO's capitalization in order to determine the relative burden on current or future investors, LIPA has adjusted the $7.582 billion of debt issuance to eliminate those bonds issued for non-acquisition purposes as shown below.

LIPA's Lack of "Credible Cost Constraints".

On page 12 of his report, Mr. Studness states, "...the [PSC] Staff's desire to cut LILCO's rates demonstrates how the PSC's ratemaking capability can be used to constrain LILCO's costs. . . Unfortunately, no outside entity will have authority to discipline LIPA's costs. LIPA will determine the level of rates that it needs to cover its O&M costs and debt service, and it will have full authority to set rates at that level. There will be nothing to prevent rates from being pushed to self-destructive levels." The LIPA Board, reflecting Long Island constituencies, will have a greater interest in controlling costs than the Albany-based PSC, which must maintain a state-wide perspective and does not have control over utility operating budgets that LIPA would have. It should be noted, the current level of LILCO rates and all prior rate increases have been approved by the PSC. Additionally, as is standard in the public power industry, LIPA's bonds will be repaid from revenues after the payment of O&M costs, which means that Wall Street (bondholders and bond rating services) will exert continuing pressure on LIPA to control its O&M costs.

Mr. Studness states on page 3 of his report "LIPA will essentially be a financial shell, as BU/LILCO will run the utility much as it does now." This characterization fundamentally misrepresents the proposed transaction. As the proposed Management Services Agreement and Energy Management Agreement make clear, LIPA, not BU/LILCO, will be responsible for determining all policies and procedures for the T&D System while obtaining the benefit of utilizing LILCO's highly trained work force. LIPA will also set rates for the System. BU/LILCO will be contractually obligated to manage the System in a manner consistent with the policies and budgets established by LIPA. In addition, the characterization of LIPA as a financial shell ignores the fact that LIPA is acquiring very significant and very real assets and that BU/LILCO has no long term assurance that it will continue to manage the T&D System, as the Management Services Agreement will be rebid at the end of the sixth year.

While LIPA is expected to have a relatively small in-house workforce, it will be comprised of individuals with the experience necessary to carry out its oversight and policy setting functions. This work force is intended to be effectively equivalent to the executive office of a large corporation. In addition to the outsourcing of the day-to-day operations of the T&D system to BU/LILCO, LIPA also plans to use outside experts when necessary to carry out its responsibilities, e.g., annual engineering review, audits of billings under the contracts, annual operating and capital budget setting, etc. LIPA believes this structure will be the most cost effective means of delivering safe and reliable service to the electric customers on Long Island.

LIPA has designed the Management Services Agreement to give it the ability to determine the operating and capital budgets in order to control costs and to provide incentives to the Manager to control and reduce costs. The operating budget will be comprised of two components, the Direct Cost Budget and the Third Party Cost Budget. In order to comply with Internal Revenue Service rules for management contracts related to property financed with tax-exempt bonds, the Direct Cost portion of the Budget will be established for the initial year of the contract and escalated using appropriate cost indices in each year thereafter. The Direct Cost Budget will include labor costs and charges for the use of BU/LILCO owned assets. The Third-Party Cost Budget and Capital Budget will, however, be negotiated and approved each year. The Third-Party Cost Budget will include all costs incurred to operate the system that are paid to third-parties such as postage, supplies, telecommunications, outsourcing, etc. The Capital Budget will include all incremental costs incurred for the approved capital projects.

In approving both the initial and each subsequent annual budgets, LIPA will consider a number of factors including, among others, the 1997 rate year information filed with the New York Public Service Commission. LIPA will also consider actual historical costs, comparable costs at other companies, planned efficiencies and expected and known changes in facts and circumstances including the BU/LILCO guarantee of their synergy savings. LIPA has not in any way agreed to "grandfather" into rates the 1997 rate year information which Mr. Studness has attacked as "excessively high." However, unlike Mr. Studness, LIPA recognizes the fact that the costs of LILCO's T&D system are influenced by the fact that it is on an island. The system is subject to more extreme weather conditions than many other utility systems of similar size, and much of the eastern end of the service territory is more rural in nature which causes the cost per customer and cost per kWh sold to be higher. Mr. Studness also fails to note that the lack of industrial and other "base load" electric customers on the island results in a very low load factor (annual kilowatt hours sold per kilowatt of peak demand served), which results in higher T&D cost per kWh. All of these factors will be considered by LIPA in establishing budgets which will balance the objections of reducing cost with maintaining a safe, reliable electric system.

In addition to the internal diligence LIPA will use in setting the T&D budgets, LIPA will hold public hearings prior to the establishment of initial rates as well as prior to any proposed rate increase.

As noted above, the Management Services Agreement contains other provisions that are designed to protect LIPA's customers from excessive costs. The contract requires that the Manager absorb the first $15 million of annual cost overruns thereby creating a significant incentive for the Manager to operate within the budget. In addition, the contract provides a further incentive for the Manager to operate more efficiently. The Manager will retain the first $5 million of cost savings and share with the customers 50% of savings in excess of that up to a cap. If cost savings exceed the cap, customers will receive 100% of the benefit of such savings. Because LIPA will be approving the budgets annually, it will be able to ensure that the combined budgets are realistic and that the customer is benefiting from the most efficient operation of the system possible. In fact, LIPA's plan is very much like the highly praised incentive regulation schemes adopted by recently privatized utilities around the world.

On page 17 of his report, Mr. Studness says that, "...LIPA's rates will rise to 14.3 cents in 2032 as a result of three factors . . . . Third, the BU/LILCO synergy benefits terminate after the tenth year, which is equivalent to ending a 2% subsidy." This is incorrect. Any synergy benefits that BU/LILCO achieve as a result of their merger will be permanent. LIPA expects to obtain the benefits of these continued savings in one of two ways. First, though renewal of the Management Services Agreement with BU/LILCO after competitive bid, or second, through award of the new management services contract in the eighth year to a third party who is aware of the level of synergy savings offsetting costs in the final year of the current Agreement.

Nine Mile Point 2 Power Plant.

On page 3 of his report, Mr. Studness implies that LIPA's acquisition of the Nine Mile Point 2 ("NMP2") power plant will result in higher costs and greater risk to Long Island rate payers than if the LIPA/LILCO transaction did not occur and ownership of NMP2 remained with LILCO. In the absence of the LIPA/LILCO transaction, rate payers will continue to pay for the cost of NMP2. The difference is that under LIPA, the cost is reduced due to LIPA's lower cost tax-exempt financing and exemption from federal income taxes. Mr. Studness implies that the cost of NMP2 is in some manner avoidable under continued ownership by LILCO and that LILCO could buy power on the market in lieu of taking power from NMP2. There is no question that the cost of power from NMP2, inclusive of the capital and other fixed costs of the plant, is above the cost of alternative power sources in the market. However, there is no basis to conclude that this is a cost which Long Island rate payers would be able to avoid under LILCO, or that under LIPA this cost obligation should be avoidable.

The cost of NMP2 to rate payers will be reduced by approximately $27 million annually due to LIPA's lower cost of capital and exemption from federal income taxes. The cost of power from NMP2, including allocation of all capital and other fixed costs to energy produced is approximately $0.095/kWh based on present and targeted future operations of NMP2 with continued LILCO ownership. Under LIPA, this cost will reduce to less than $0.08/kWh. The operating cost of the plant is approximately $0.025 per kilowatt-hour, which is lower than the operating cost of any of the on-island oil and gas-fired generation owned by LILCO or any other on-island power supplier. Therefore, LIPA's acquisition of the LILCO 18% share of NMP2 reduces rate payer cost compared to the status quo of continued LILCO ownership.

Power Supply.

On page 15 of his report Mr. Studness notes that LILCO's cost of on-island power supply is approximately $0.05/kWh, of which about $0.031 is fuel and variable O&M, and about $0.019 is for capacity charges (e.g., depreciation, return on capital, taxes, and fixed administrative costs). These numbers depend upon assumptions regarding fuel costs, capital charges, depreciation schedules, and other items, but are reasonably representative of LILCO's costs. LILCO's on-island cost of power supply is not significantly above the market. The main opportunity for power supply competition on Long Island is in meeting load growth and, to the extent the older existing LILCO plants require major capital improvements, it will become increasingly more cost effective to competitively bid for new power supplies. In the interim, Long Island customers will pay for capacity (the fixed cost of power supply) at a cost which is well below what new capacity (new power plants) would cost to construct. This is not a burden to the rate payer -- it is protection against cost increases. If the power supply market was immediately opened to competition and LILCO were allowed to charge what "the market will bear", LILCO could charge the cost of a new power plant for its existing base load steam units. Absent cost increase protection, open competition would likely increase, not decrease rates. The LIPA transaction protects against competition bidding rates up due to the lack of ability to access lower cost power supply markets off-island.

Mr. Studness claims that there is $0.03/kWh power available in the wholesale market to displace LILCO on-island power supply. Presently, there is no such supply deliverable as firm supply to the LILCO system in any significant amounts. The existing transmission system to Long Island will likely only support approximately 100 MW of additional firm power supply, equal to about 2.5% of the total LILCO on-island power supply. Even if a new 600 MW cross-sound cable is constructed, this capacity, combined with the 100 MW potential additional firm deliveries from off-island sources over the existing cables would equal approximately 18% of the LILCO on-island capacity. The LIPA plan achieves 17% rate reductions without reliance on the "phantom" competition assumed by Mr. Studness.

It is for this reason that LIPA sought to assure that the LILCO generation would continue to be available for Long Island, and to cap the costs so they cannot go up beyond that which is justified based on reasonably incurred, necessary costs to maintain plant operation and availability. The 6% savings claimed by Mr. Studness would require that all of the LILCO generation be displaced by wholesale power at $0.03/kWh. It is a physical and economic impossibility for the reasons stated above.

LIPA will purchase energy from any source which is on-island or can deliver energy to the island at lower costs to serve customer energy needs. Any savings from this competition will be in addition to the average 17% immediate rate reduction in the LIPA plan. The LIPA plan is not precluding any competition which would otherwise be available to reduce customer rates.

On page 16, Mr. Studness likens the power supply agreement to "a 15-year installment plan" purchase of the LILCO on-island generation plants. He claims that "LIPA pays depreciation and interest for 15 years after which the plants will be fully depreciated". This is not true. The plants will require capital additions over the fifteen year period and many of those additions will have a depreciable life well beyond the end of the power supply contract term. LIPA will not have responsibility for costs beyond the term of the agreement, and the plants will not be fully depreciated at the end of the term of the agreement. Furthermore, LIPA will have the option to renew the power supply contract under comparable terms to the initial agreement.

Competition and LIPA.

On page 25, Mr. Studness claims that "Long Island will be deprived of the financial benefits of competition for a very long time as a result of LIPA's high debt service costs and its commitments to buy power from BU/LILCO at uneconomic prices." LIPA's debt service cost will be substantially lower than the capital cost burden which LILCO presently has and would continue to have in the future. As a result, competition on Long Island will begin at rates which are significantly lower than would occur absent the transaction.

Mr. Studness' reference to purchasing power from BU/LILCO at uneconomic prices is a misrepresentation. LIPA will purchase capacity (the capital and fixed cost of the power plants to make them available to LIPA to meet customer needs) of the on-island generation at prices which reflect the existing cost of the LILCO generation. The cost of LILCO generation presently reflected in rates is less than $200 per kilowatt of capacity, which compares to $600/kW to $750/kW for new combined cycle power plants. LIPA has no obligation to purchase energy from the LILCO generating plants. The total cost of energy (fuel and variable O&M costs) from the LILCO plants, at an average of $0.03/kWh to $0.035/kWh is also not significantly above the market.

The primary opportunity for competition will be to meet the needs associated with load growth and to replace retired LILCO generation to meet the existing energy needs of customers on Long Island. The provisions of the Energy Management Agreement provide for the least-cost energy supplies to be purchased by LIPA, regardless of source.

Under the LIPA transaction, competition can begin immediately and the amount of power supply open to competition will grow increasingly over the fifteen year term.

Threat of Distributed Generation.

Mr. Studness makes several claims regarding distributed generation and includes statements regarding the current state of the art and trends in combined cycle generation, all leading to the mistaken conclusion that LIPA will be threatened by distributed generation.

His report makes comparisons between the cost of combined cycle gas-fired and coal-fired power plants. LIPA agrees that combined cycle plants burn less fuel than coal fired plants per kilowatt hour, but since there are no coal fired plants on Long Island, it is not clear that this comparison is particularly relevant. It is further true that a state-of-the-art gas-fired plant can produce energy for about $0.03/kWh for fuel and variable O&M (excluding capital and other fixed costs). However, contrary to Mr. Studness' claims, the size of the present state-of-the art combined cycle plants have been increasing, not decreasing in size. In the past 5 to 10 years, combined cycle plants which comprise the lowest cost producers have nearly doubled in size from the approximately 140 MW size to over 300 MW per plant for the latest, most efficient plants. It is these latter plants which produce at the cost Mr. Studness refers to in his report, not the smaller machines. Power plants in a size range of 300 MW are not what the industry refers to as "distributed generation". These plants are simply what today's power producers are installing in the competitive market to produce at the least cost.

As the competitive market unfolds, price will largely dictate what type of power plants are constructed. If smaller, distributed generation (at sizes much smaller than 300 MW) results in costs lower than larger units, then such smaller units will be installed by suppliers and the market will demand such sources.

Mr. Studness refers to the future of customers installing their own "micro turbines". There may come a time when technology enables small power plants at individual homes and businesses to compete with larger power plants. Such a transformation will require many years. The LIPA plan of meeting all incremental customer needs with competitively bid power supply, and the ramp-down of existing LILCO generation over time would accommodate the development of distributed generation by customers. It is important to recognize, however, that any customer developing their own power supply to meet their needs will either have to rely on LIPA or others for back up power supply, or either (i) be satisfied with periodic losses of power supply for extended periods, or (ii) install 100% redundancy to their "in-home" or "in-business" power supply. Under no circumstance can LIPA envision that large amounts of customers will create power supplies which completely isolate themselves from LIPA's T&D system or the power supply support such system provides.

Because LILCO customers have had the incentive of the highest retail rates in the continental U.S. for energy conservation and development of totally self-supporting power supplies many years, it is difficult to imagine why LIPA would be at significantly greater risk when its retail rates will be 17% lower than the present LILCO rates.

LIPA expects that distributed generation will have a role in Long Island's future power supply, as will energy efficiency, renewable energy power supply sources, and larger, state-of-the-art, combined cycle power plants. The future will involve a mix of sources, not a single source. LIPA's resource planning will take these alternatives into consideration. LIPA's power supply arrangements for the use of the existing LILCO generation until it is no longer cost-competitive is consistent with these alternatives. LIPA also agrees with Mr. Studness' report claim that distributed generation is likely to make more gains over time. That is completely consistent with LIPA's power supply contract with LILCO, which allows for increasing amounts of power supply to be met by sources other than LILCO over time, with the potential for all of the power supply to be met by others after 15 years, with no further obligation to LILCO. Cost-effective distributed generation is not considered a threat by LIPA.

Summary.

Mr. Studness correctly notes that a LIPA acquisition should generate significant savings as a result of LIPA's lower cost of capital and exemption from federal income taxes. Due to these factors, LIPA's rates will be substantially lower than LILCO's over the long term.

Mr. Studness incorrectly claims that LIPA's capital costs will be higher than LILCO's by $200 million in total over the next 35 years. Mr. Studness makes inaccurate assumptions regarding required capital additions and uses a time period that dramatically distorts the results. Over a 40 year period that considers capital additions, LIPA's capital costs are $5.5 billion lower than LILCO's assuming LIPA's cost of capital is 6.7%; on a present value basis, LIPA's capital costs are $2.7 billion lower than LILCO's. Under current market conditions, LIPA's average capital cost is 6.0% and LIPA's total capital costs over 40 years are $6.8 billion lower than LILCO's; on a present value basis, LIPA's capital costs are $3.3 billion lower than LILCO's. Mr. Studness fails to take into account either inflation or the time value of money. Assuming an annual inflation rate of 2.5%, electricity costing 12.87 cents/kWh in 35 years is the equivalent of 5.4 cents/kWh today.

Mr. Studness incorrectly claims that LIPA will not be able to control costs. The LIPA Board, comprised of Long Islanders, will have a greater interest in controlling costs than the Albany-based PSC, which must maintain a state-wide perspective and does not have control over utility operating budgets. LIPA has designed the Management Services Agreement to give it the ability to control costs and to provide incentives and penalties to the Manager to control and reduce costs. Each year LIPA will review and, after appropriate modification, approve the operating and capital budgets for the T&D system.

Mr. Studness incorrectly claims that "Long Island will be deprived of the financial benefits of competition for a very long time as a result of LIPA's high debt service costs and its commitments to buy power from BU/LILCO at uneconomic prices." LIPA will have complete flexibility to acquire electricity on a least cost basis from all supply sources both on-island and off-island. LIPA will provide for increased competition immediately upon its acquisition of LILCO.