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A highly efficient maze of generators, heat-recovery units, chillers, and electronic controls, MATEP provides electricity, steam, and chilled water to Harvard's medical-school complex and six affiliated hospitals that serve 135,000 patients annually. Photograph by Stephen Sherman

Harvard's most ambitious and expensive construction project to date is not a classroom building, library, or laboratory. It is a $350-million, 62-megawatt power plant, conceived during the oil price shocks of the 1970s and now facing a different kind of energy crisis as competition and deregulation rock the electricity industry.

The Medical Area Total Energy Plant (MATEP) supplies electricity, steam, and chilled water to Harvard Medical School and six affiliated hospitals nearby. The plant, whose 333-foot exhaust stack looms over Boston's Fenway-Mission Hill neighborhood, was a creative--if sometimes ill-fated--attempt to provide the institutions with some control over volatile energy prices. By capturing and reusing heat that would be wasted by a conventional power plant, MATEP was designed to save energy and cut fuel bills by about one-third. But from an estimated cost of $50 million when first proposed in the early 1970s, MATEP's price tag ballooned sevenfold: community and state environmental concerns delayed construction, and higher interest rates drove up the cost of financing. MATEP was finished in 1980, but it took six more years to obtain the air-quality permit needed before it could fire its diesel engines and start generating electricity.

Despite the substantial cost overruns, the plant has performed well, providing dependable service around the clock to the hospitals and medical school. Now, however, new upheavals in the energy industry threaten to alter some of the regulatory and economic underpinnings that support the plant.

Beginning next year, if the legislature agrees, all Massachusetts power customers will be able to shop for an electric company much as they now choose among long-distance telephone companies. Under the Massachusetts plan, utilities would no longer enjoy monopoly rights to exclusive "franchise" territories. The industry restructuring is intended to lower the Commonwealth's relatively high electric rates by forcing power companies to compete in an open market.

Already, consumers in Massachusetts--including hospitals and other institutional energy buyers--are looking for ways to cut back their power costs in the newly deregulated electricity market. In one sign of the coming upheaval, the John Hancock Mutual Life Insurance Company decided in January to dump Boston Edison next year and buy power for its 38 Boston buildings from an Atlanta-based power company, Southern Energy Trading and Marketing Co. The switch--which is expected to lower Hancock's electric bills by about 10 percent--could cost Boston Edison $2 million a year in lost revenue.

In another indication of the changes sweeping through the electricity business, Harvard itself plays the power market, buying up to 19 megawatts from Boston Edison for resale to MATEP's institutional customers. The University buys the electricity only when it is cheaper than MATEP's own costs of production.

Harvard administrators are now weighing whether the University should continue to own the cogeneration plant in this more volatile market. "To prepare for the risks and opportunities that will come with deregulation, the University is exploring all of its options regarding the future of the plant," says Carter Wall, M.P.P. '93, a former Merrill Lynch investment banker hired last fall as Harvard's manager of energy strategy. Beyond her financial expertise, Wall has substantial experience in the policy aspects of utility restructuring: in the early 1990s, she was assistant director of the Harvard Electricity Policy Group at the Kennedy School, a forum for utility executives, regulators, environmentalists, consumer advocates, and academics to discuss the restructuring of the U.S. electric industry.

"We recognize that Harvard does not need to be in the energy business," Wall says. Although historically there have been good reasons for Harvard to be an energy provider, she explains that, "because of the changes in the industry, those reasons may have ceased to exist. But maybe not."

When MATEP began generating electricity in 1986, the utility industry was much more staid and predictable. Although Boston Edison lost the income derived from supplying electricity to the six hospitals--Beth Israel, Brigham and Women's, Children's, Dana Farber Cancer Institute, Joslin Diabetes Center, and New England Deaconess--its business as a whole was not threatened, and the medical school, the hospitals, and MATEP had what looked like a solid, long-term relationship.

Today, the ground under that relationship no longer looks so firm. The hospitals are part of a health-care and education purchasing group called the Medical Area Service Corporation. MASCO does joint planning and development work for the institutions in the Longwood Medical Area, and contracts jointly for janitorial and transportation services. MASCO, in turn, is a member of the Massachusetts Health and Education Facilities Authority, a bonding agency that is conducting a national search for a joint electricity provider for its 309 members. Collectively, the institutions spend $130 million on electricity annually. By packaging this power demand, the authority hopes to use its market clout to win favorable prices, says Robert Ciolek, the authority's executive director.

"What hospitals and colleges have going for them is that they are very attractive customers. They use a lot of electricity. They're not going anywhere and they pay their bills on time," Ciolek says. "So grouping together desired customers increases their chance of getting a little bit of an edge in terms of a discount."

The situation for the six MASCO hospital members is much more complicated, due to their long-term contracts with the Harvard energy plant. The hospitals' contracts for MATEP power, steam, and chilled water run through 2015. Those contracts are binding and enforceable. But according to Rick Shea, MASCO's president, if energy costs drop on the open market, the hospitals may want price concessions from MATEP. "The world's changing enough," he says, "that Harvard and the rest of the institutions realize that if rates tumble everywhere, the rates will have to be reviewed, so it's still fair given the conditions in which we live."

The Massachusetts utility-restructuring plan, which will allow power companies to compete for electricity sales to retail customers, does not apply directly to Harvard, Carter Wall notes, because the University is not a utility. Thus MATEP's prices are not now regulated by the Commonwealth's Department of Public Utilities. But the hospitals do pay a power price pegged to Boston Edison's lowest retail tariff, discounted by 2 to 3 percent because the energy is sold to tax-exempt, nonprofit institutions, she explains. So as deregulation influences the external market price for power, the competition in the restructured utility industry will likely affect MATEP, too. Even though MATEP is not directly subject to the Massachusetts deregulation plan, "The contracts make a reference to a pricing structure in a regulated industry. We're going to have to reinterpret what that means," Wall says. "We're working with all of the institutions served by the plant to define the appropriate rate structure before January 1, 1998, when the Massachusetts utility-deregulation plan is scheduled to take effect."

Besides power, MATEP generates substantial streams of cash. Operating revenues for the fiscal year ending June 1996 were $53.9 million--more than enough to cover operating expenses, Wall says. But beyond those costs, the revenues are not sufficient to cover fully the payments on the debt the University incurred to build the facility. Harvard still owes $336 million for the plant's construction. The bonds used to finance the huge project have maturity dates extending to 2032.

In other words, "MATEP's doing better and better every year operationally," Wall says. But when debt service is included, the plant loses money. Pressure to lower rates for the electricity it sells obviously wouldn't help.

Revenue from electricity sales, however, accounts for only about one-third of MATEP's income. The rest of the revenues under the contracts come from steam and chilled-water service, Wall notes. "The hospitals will have to continue to take steam and chilled water from that district system," she says.

The hospitals, Harvard, and MASCO have assembled a working group to thrash through issues raised by utility restructuring. Rick Shea thinks "there's a pretty good spirit of cooperation between Harvard and its hospitals."

In a sense, Harvard finds itself on both sides of the table, since it is both a buyer and seller of MATEP's energy. The medical, dental, and public-health schools are all MATEP customers. Now Wall and Thomas Vautin, associate vice president for facilities and environmental services, have come up with five principles to guide Harvard's decisions on MATEP as it moves forward into the era of deregulation. They are:

Maximize the University's return from MATEP's operations.

Provide alternative sources of capital for expansion or reinvestment in the plant. "As the plant ages and the Longwood area continues to grow, there will be a need for additional capital investment," Wall says. "Right now, Harvard has the sole responsibility for capital for investment in the plant."

Maintain the high reliability of energy services to the Longwood Medical Area institutions.

Realize the optimum benefits from the restructured electric-utility market.

Insure appropriate security and control of Harvard's energy supply. "Harvard and the hospitals have enjoyed some very definite benefits from controlling the energy supply in the medical area," Wall says, "both in terms of reliability and in our ability to respond to the growth and changing needs of the institutions there."

As Harvard administrators and their energy customers work through these issues, they will have to deal not only with a restructured electric business. They also confront a health-care industry that is itself going through a dramatic period of consolidation and cost-cutting.

This dual restructuring--among electric utilities and hospitals--is bound to further complicate matters. Morris Pierce, a University of Rochester expert on cogeneration and district energy plants, says it would be logical for the hospitals themselves to consider buying MATEP.

"It's a classic 'make or buy' decision. Do they want to do the food service or hire Marriott?" notes Pierce, who runs a library and an Internet mailing list covering energy systems. "If I were the hospitals, I would get together and buy that thing."

Wall says the University, like every energy-service provider, is trying to determine "what our role in the newly competitive electric industry will be." In looking at all the alternatives, she says, "We do want to limit the amount of money we have to spend. I don't know if that means we will get out of the business of operating the plant, or get out of part of it. That's what we're doing now. We're trying to figure out the answer to that."

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