The city of Victorville squandered at least $116 million on efforts to develop electrical generating projects since 2005, according to the final report of the 2011-12 San Bernardino County Grand Jury.
The city’s failed power plant projects were among five elements of Victorville’s municipal and ancillary operations scrutinized by the 2009-10, 2010-11 and 2011-12 grand juries. The grand jury also considered the city’s overall financial condition, its use of interfund loans and restricted funds, hangar construction and airport bond expenditures. Last year and the previous year, the grand jury did not include any findings with regard to Victorville in those years’ final grand jury reports, which are traditionally released on June 30, the close of the governmental fiscal year. Included in the section of this year’s report pertaining to Victorville was a performance audit conducted by the San Francisco-based accounting firm of Harvey M. Rose Associates.
With regard to the power plant debacles, the grand jury examined two such efforts engaged in by the city of Victorville and the Southern California Logistics Airport Authority (SCLAA), which is an adjunct to the city dedicated to the civilian use conversion of the former George Air Force Base. Those two projects were the 500-megawatt Victorville Power Plant #2 (Victorville 2) and the 14-megawatt Foxborough Electrical Generating Station. The Victorville 2 project was initiated by city officials based on an evaluation and recommendation from Inland Energy, a firm with a significant financial interest in having the city build a large power plant. The Foxborough Plant was intended to provide low cost energy to tenants at the Foxborough Industrial Park. Both projects, the grand jury contends, were initiated without a clear project plan, project goals, adequate research nor due diligence to determine if they were consistent with other municipal power plant development projects and arrangements for their completion. And both, according to the grand jury, were marred by inadequate project controls and the reliance on recommendations from contractors who have had a financial interest in the projects.
“Contrary to industry best practices, the city of Victorville, and by extension the SCLAA, have initiated large high-risk capital projects without conducting proper due diligence or ensuring proper controls,” the grand jury report states. “Rather than conducting a competitive process for awarding major development contracts, city management has executed contracts to companies and individuals with previous experience or familiarity with the city. Rather than conducting transparent risk assessments and establishing clear project plans, city management has failed to fully assess potential risks and has not established project plans with clearly stated goals, budgets, milestones, or performance measures. Instead of establishing clear and effective controls, policies, and procedures, city management has allowed contractors to operate without close oversight and has not consistently enforced contract terms. The absence of fully assessed risks, established project plans, and instituted controls has contributed to substantial failures of at least two power generation projects that required considerable financial investment.”
According to the grand jury, after the cities of Victorville and San Marcos in October 2003 became the founding members of the California Clean Energy Resources Authority (Cal-CLERA) but were unable to attract other municipalities to join that joint powers agency, the city bought into a March 2005 recommendation by Inland Energy that the city should “commit to undertaking the development of a 500 megawatt hybrid plant at Southern California Logistics Airport without delay.” That recommendation, the grand jury noted, was based on Inland Energy’s observation that city possessed a “unique blend of positive political, economic, and infrastructure factors that favor the development of such a plant.”
Inland Energy, which stood to gain by its further participation in the project, according to the grand jury, in its “evaluation downplayed the financial risk to the city, stating that ‘The city’s economic risk is mitigated by the fact that such a fully permitted plant at the SCLA [Southern California Logistics Airport] site could likely be sold or transferred in 2007-2010 for far more than it cost, if the city elected not to proceed with the plant’s construction.’’
Furthermore, according to the grand jury, “The Inland Energy evaluation also noted that the city could initiate the project without a definitive plan. City management did not conduct proper due diligence before initiating the Victorville 2 project. Specifically, management did not conduct a thorough independent analysis of risks prior to recommending that the council approve the development agreement with Inland Energy and, notably, a subsequent agreement to purchase expensive turbine equipcment from General Electric. Neither city management nor Inland Energy established a formal business plan for the project and never established a project budget. Without such planning, the city and SCLAA proceeded without clearly defined goals, milestones, or performance measures. For instance, throughout the project and even after the city had committed over $182 million to General Electric for fuel generation equipment and related services, it was still unclear whether the city would own the plant or if it would be sold to a third party operator. City management did not prepare an independent risk assessment and there is no evidence that potential risks were formally discussed by the city council. Although no formal business or project plan was established, it is apparent from interviews with city officials and from a review of the Inland Energy agreement that the initial goal of the project was to make the necessary preparations so that the project could be ‘build ready.’”
Build ready meant that the city would design the plant, obtain the requisite permits, and procure land so that another firm could construct and operate it. The grand jury said that Inland Energy represented that it would take roughly 24 months to fully permit the plant so that a developer could purchase the development rights, build the plant, and either operate it or allow another firm or the city, through Victorville Municipal Utility Services, to operate it.
However, according to the grand jury, “City management and the city council never formally established a budget for the Victorville 2 project. The closest approximation of a project budget can be found in the Inland Energy contract.” That budget, the grand jury noted, estimated $5.5 million in costs over a two year period, which was simply for the “permitting” of the power plant and did not include the cost of land purchases, potential borrowing costs, such as bond issuances, and staff time. Over time, the actual cost escalated.
According to the grand jury, “The city entered into the no-bid contract with Inland Energy based on a proposal from the company.” The grand jury noted that city management and the city council committed to the having Inland Energy lead the way with regard to building the plant largely on the basis of Inland Energy’s participation with Baltimore-based Constellation Energy in the successful development of the High Desert Power Plant, sometimes referred to as Victorville 1, the permitting process for which was first undertaken in 1998 and which came on line in 2003 and was widely seen as a lucrative success for the private interests.
“The development agreement with Inland Energy was based on a previous agreement between Inland Energy and Constellation Energy for development of the High Desert Power Plant,” according to the grand jury. “The agreement was written by attorneys representing Inland Energy using the High Desert Power Plant contract as a template. Although the city attorney reviewed and provided comments on a draft contract, it does not appear that the city attorney or other city managers actively negotiated the terms of the agreement to be substantively more beneficial to the city than the template contract it was based on. In fact, the agreement that the city entered into appears to be significantly more generous to the developer than the template agreement.”
The city made inadequate review of the contract terms, the grand jury found, noting the “agreement vaguely defines and poorly controls the provision of services. The agreement with Inland Energy allows for the company to be compensated for two types of services: (1) ‘development services’ and (2) ‘supplemental services.’ The agreement defines ‘development services’ as including: negotiating any agreements necessary to implement the project, and securing those permits and approvals required to entitle the project for development, including any task having the purpose of improving or enhancing the value of such entitlements. These services were the core of Inland Energy’s role in the Victorville 2 project and included the permitting of the plant. These services were eventually expanded to include assistance with the construction of the plant. Inland Energy was paid approximately $12.2 million from 2005 to 2010 for development services related to the Victorville 2 project. The agreement broadly defines ‘supplemental services’ as including: any on-going technical or management task deemed necessary by the city manager of Victorville including supervisory, administrative, consulting, advisement and other management services. While these services, to an extent, may have been related to the Victorville 2 project, the supplemental services clause has been used to justify services completely unrelated to the project. Specifically, the city has paid over $607,000 to Inland Energy through May 2010 under this clause for other, consistently unsuccessful, projects. These expenditures have included over $166,000 for consulting services related to the city’s unsuccessful efforts to obtain federal grant funding under the U.S. Department of Homeland Security’s Immigrant Investor Program, also known as ‘EB-5’, and over $182,000 for consulting services related to the city’s unsuccessful attempt to develop and construct a power plant at the Foxborough Industrial Park in the Bear Valley Redevelopment Project Area. Additionally, Inland Energy was paid over $258,000 for consulting services related to the city’s efforts to investigate the possibility of becoming a community choice aggregator. While this service was related to the Victorville 2 project, it ultimately provided no tangible benefits to the project, the city, or SCLAA.”
According to the grand jury, the contract performance terms were poorly constructed and implemented. “The development agreement contains no effective performance measures for Inland Energy,” the report states. “There are no specific mechanisms that would allow the city council or city management to hold the contractor accountable for its performance.”
The compensation structure specified in the development agreement with Inland Energy provided for two payment methods: a monthly management fee at a rate of $150 per hour for “consultant” staff and $250 per hour for “senior consultant” staff, and a portion of “project operating profit.”
According to the grand jury, “There is no cap to the amount that can be billed. The company’s 2008 projections for the operational expenses of the 500 megawatt plant includes this compensation, which was estimated to be $4.5 million per year by grand jury sources. Further, the development agreement contains no clauses to limit this compensation to a defined period of time or a capped amount. Assuming that the plant was built and then operated for 30 years, Inland Energy would be entitled to compensation of approximately $135 million over the life of the plant (without adjusting for inflation). Under this scenario, Inland Energy would be compensated with an additional $135 million over 30 years for what was estimated in the agreement as 24 months of design, development, and permitting work. The operating profit clause appears to be an unusual form of compensation and potentially troublesome for the effective sale and operation of the plant.”
Inland Energy’s management of the project was particularly poor in one regard, according to the grand jury, resulting in the city’s loss of a $50 million deposit with General Electric.
“In 2007, as Victorville 2 permitting was nearly completed, Inland Energy began advising the city to move forward with the purchase of equipment for the proposed plant,” according to the grand jury. “Inland Energy initiated negotiations with General Electric (GE) and advised the city, with some urgency, that it was important to make a commitment to GE due to the length of time required to procure the equipment and the desire for the plant to go online in accordance with the state’s energy demand schedule. Several city officials have stated that Inland Energy was driving the process to develop the Victorville 2 project with equipment purchases. Specifically, Inland Energy officials were briefing city officials, in closed session ‘workshops,’ with slide presentations that recommended the city move forward with a large financial commitment for the equipment purchase. On December 4, 2007 the city council ratified a resolution, which had been previously adopted in closed session, authorizing the city to execute an agreement with General Electric to purchase certain power plant generation equipment at a total contract price of $182,036,824. The contract called for the city to make an immediate initial down payment of $52 million on the equipment. The remaining $130 million was due in November 2008. According to city management, city officials were confident at the time that additional funding could be secured due to perceived demand from other jurisdictions in Southern California. Ultimately, city officials moved forward without any written or legal commitments from these jurisdictions, without bond financing in place, and without a committed third party prepared to purchase the development rights. City officials ultimately could not secure funding for the remainder of the purchase price of the power plant equipment. As a result, the city did not make its second scheduled payment in November 2008 and, on April 16, 2009, GE declared that the city had defaulted under the contract. Further, GE asserted that the city still owed additional amounts under the contract termination clause, although the city disputed the obligation. On May 18, 2010, approximately one year after the city defaulted on its obligation, the city and SCLAA came to an agreement with GE to settle the dispute. According to the settlement agreement, GE shall retain all funds ($50,020,000) provided in the initial payment. However, as a future sales incentive, the city is entitled to credits of up to $10 million on future purchases from GE, subject to certain conditions. The credits expire on April 30, 2016.”
The grand jury noted that city management is still trying to sell the development rights to the project. “City management asserts that the Victorville 2 Project is still ‘active’ as the city has purchased land and accumulated entitlement permits for the power plant,” the report states. “City management has made attempts for over three years to sell the development rights to the project. Despite a request for proposals sent out in May 2009 to 13 firms, which had expressed interest, the city has not been able to successfully identify a project developer. City officials have noted that potential buyers must negotiate primarily with Inland Energy, due to the clause in the firm’s development agreement with the city granting the right to five percent of project operating profits, estimated at $4 million to $5 million annually, for the life of the project.”
According to the grand jury, “The Victorville 2 project has cost the city over $76 million to date including approximately $50 million lost to General Electric for the power plant equipment, $12.1 million disbursed to Inland Energy for development services, $3.8 million to other services providers, and $8.6 million for the purchase of parcels for the project. This estimate of project costs does not include funds dispensed for consulting services provided by Kinsell, Newcomb, & De Dios, the city’s bond underwriter and to Goldman Sachs for financial services.”
The grand jury was as scathing in assessing the city’s performance with regard to the effort to build the much smaller Foxborough Power Plant, which commenced in 2004. That plant was intended as a small generating station to serve two anticipated tenants at the Foxborough Industrial Park, Nutro and ConAgra. The plan was for the electricity to go directly to the industrial park’s tenants without being conveyed onto the state power grid, thereby saving users the ten percent surcharge the state levies, and encouraging occupancy and expansion of operations into and at the industrial park
“The Foxborough Power Plant project was initially conceived as a method to provide low cost energy and steam to two incoming tenants at the Foxborough Industrial Park on the assumption that these two incoming tenants, Nutro and ConAgra, required a total of between five and ten megawatts of power for their operations,” according to the grand jury. “The city procured no-bid services from a consultant firm, Carter and Burgess, Inc., beginning in June 2004. This firm was retained to design, develop, and construct a cogeneration power plant to service the energy needs of tenants at the Foxborough Industrial Park in the city’s Bear Valley Redevelopment Area. The project was undertaken by the city without a thorough assessment of risks or sufficient expertise. Through a series of mishaps the project was never completed, wasting tens of millions of dollars of public funds.
“Neither city management nor Carter and Burgess established a risk assessment, business plan, or formal budget,” the grand jury report continues. “Without such planning, the city proceeded without clearly defined goals, milestones, or performance measures. In fact, the project was initiated with the broad objective of providing low cost power directly to tenants at the Foxborough Industrial Park without connecting to the California electrical grid system. However, toward the end of the project city management changed course and looked at options to connect the plant to the grid system.”
The grand jury said the project failed because of “dramatic growth” in its price tag.
“According to interviews with city officials, the Foxborough Power Plant project was initially estimated to cost the city approximately $17.5 million,” the grand jury report states. “However, the costs of the project quickly rose to $22 million. In April 2005, approximately 10 months after the project commenced, the city council approved a $41 million bond issuance for the project. In June 2006, approximately two years after the initiation of the project and four months after the anticipated completion, the city council approved a second bond issuance that provided an additional $21 million in financing to Carter and Burgess. The final cost of the Foxborough Power Plant project topped $91 million with press accounts stating that over $95 million had been spent. Out of this amount, Carter and Burgess was paid approximately $8.2 million.”
The city was ill-served by Carter Burgess, the grand jury said, and was able to prove that in court, though it has yet to recoup the money lost.
“Due to a series of mishaps, including an overestimation of the power needs for certain tenants, multiple design revisions, and the failure of certain power generation equipment, the Foxborough Power Plant was never completed,” the grand jury report states. “Following the cancellation of the construction project, the city initiated civil litigation against Carter and Burgess relating to the failure of the project. In December 2010 a Riverside County jury unanimously ruled in favor of the city and awarded Victorville $52,116,367 to be paid by the developer’s parent company. Despite the award of approximately $52 million, the city will still be left with approximately $40 million in losses. Further, the judgment award has not yet been paid and is under appeal.”
The grand jury recommended that the Victorville City Council “Draft and implement planning policies and procedures for all city and SCLAA capital projects. Such policies should incorporate best practices, including an independent evaluation of risks and fiscal impact.” Furthermore, the grand jury called upon the city council to “Draft and implement capital project controls, policies and procedures for all city and SCLAA capital projects. Such policies should incorporate best practices such as establishment of a project plan, including a project budget, which is periodically revisited and formally approved by the city council and/or SCLAA Board of Directors in open sessions. The policies should also include requirements for implementing performance measures that are regularly reported to the council during the life of a project.”
In addition, the grand jury said “Victorville needs to establish procurement controls, including requirements for competitive bidding, increasing levels of control over approval of professional service contracts based on cost to the city, and standard documentation requirements for the payment of invoices.”
And the grand jury indicated that Victorville has failed to adhere to California’s open public meeting law, the Ralph M. Brown Act.
“The city council should establish policies to ensure that its operations are consistent with the requirements of the State Government Code relating to open meetings and best practices, as they relate to government transparency,” the report concluded.
While issuing a prepared statement that “Certainly the findings and conclusions are cause for concern,” Victorville city officials noted that “Many of the recommendations were implemented previously and the city is committed to making every effort to continue to implement recommendations, which will continue to ensure the economic stability of the city.” But city officials suggested that the report was in part “inaccurate” as well as “inflammatory”, as well as out of date with regard to some facts and two years late.
“Many of the findings and recommendations would have been better timed for release in 2008 or 2009, as significant progress has been made since then,” according to the statement.
The city also noted that Jon Roberts, the city manager under whom the events referred to in the report transpired, is no longer with the city.