HomeMy WebLinkAbout2002-07-01 Utilities Advisory Commission Summary MinutesUAC MTG MINUTES 07 10 02 – APPROVED 8/7/02 1
UAC MEETING MINUTES
July 10, 2002
ROLL CALL _________________________________________________________________ 2
ORAL COMMUNICATIONS ___________________________________________________ 2
SPECIAL MEETING __________________________________________________________ 4
Election of Chairman and Vice Chairman ______________________________________ 4 APPROVAL OF MINUTES _____________________________________________________ 6 AGENDA REVIEW AND REVISIONS ___________________________________________ 6
DIRECTOR OF UTILITIES REPORT _____________________________________________ 7
UNFINISHED BUSINESS _____________________________________________________ 11
NEW BUSINESS ____________________________________________________________ 11
Agreements Related to the Termination of PG&E Interconnection Agreement and Successor
Agreements _____________________________________________________________ 11 City Auditors Assessment of Utilities Risk Management Procedures and City Manager Response _______________________________________________________________ 20
PUBLIC COMMUNICATION __________________________________________________ 39
RISK MANAGEMENT POLICIES ______________________________________________ 39
CONTINUTATION OF DIRECTOR OF UTILITIES REPORT ________________________ 47
ADJOURNMENT____________________________________________________________ 49
UAC MTG MINUTES 07 10 02 – APPROVED 8/7/02 2
ROLL CALL
Bechtel: We’re going to have two meetings to be held concurrently: the regular meeting and then a special meeting that was called for -- election of officers -- due to an oversight. The election of officers usually occurs with the July meeting, the first meeting of the new fiscal year.
It was not put on the agenda, so we’re going to run those two meetings concurrently. But we will
use the order which is typical, that is, we will have oral communications for the regular meeting
first and then we will have the election of officers, then move to the agenda of our regular
meeting. We will open and close both meetings simultaneously. Then we will have the election of officers, then move to the agenda of our regular meeting simultaneously. So I call to order both the regular meeting and the special meeting and have the roll call. Everyone indicate their
presence: Richard Carlson present, George Bechtel present, Dexter Dawes present, Dick
Rosenbaum present. Let the minutes show that Mr. Ferguson is absent and at this time I haven’t
heard from him and that our Council liaison, Bern Beecham, is on vacation and will not be
attending as well. Let me indicate on the notes that Mr. Ferguson is also now in attendance at the meeting.
ORAL COMMUNICATIONS
I have three cards for people who would like to speak to the UAC tonight on, it turns out, three
different subjects, which is good. I was alerted earlier, the first one is Spreck Rosekrans of the
Environmental Defense Fund and is present.
Rosekrans: Good evening, I’m Spreck Rosekrans of the Environmental Defense. I addressed the
City Council last week on the issue of Palo Alto’s support for a lawsuit that is opposing the restoration of the Trinity River in Northern California and I’d like to address this Committee on
the same subject tonight. I will note I had a pleasant conversation with Mr. Ulrich this afternoon.
The people I have talked to in most cities, or people in most cities have not returned my phone
calls, have not answered my phone calls for quite some time on this issue. When Mr. Bechtel
talked to me last week, he said “Well, gee, maybe you could make a case for this, maybe we
would support withdrawal of the lawsuit,” and I’m prepared to talk about all the issues, fluvial geomorphology, winter run salmon, delta smelt, X2, any electrical issues of course, the water supply issues, electrical issues. First …
Bechtel: Just a second. I’m going to set a time limit of five minutes.
Rosekrans: You’re going to have to ask me questions to hear all that stuff. And I’m not going to get into that right now because I only have 5 minutes. I am going to mention that this is not a system reliability issue. Every Central Valley Project power plant can still operate at full
capacity during periods of peak demand. It’s an off-peak energy issue and fundamentally for the
City of Palo Alto, a cost issue. The citizens of Palo Alto right now get a benefit annually of
something over $600,000 -- I’m sorry -- many millions of dollars from federal hydro power.
That benefit would be decreased by about $650,000 if this plan were to go through. I suspect that is why the lawsuit has been filed on behalf of Palo Alto. Mr. Ulrich said, “Well, the lawsuit is part of the process. We’re going to court and trying to get the right decision.” And I did mention
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that Judge Wenger’s courtroom in Fresno is the Western’s, the water district’s home court advantage. Everybody knows that, that’s why Westlands files the first day possible in each of
his lawsuits. If you follow water policy in California, you’ll see they’re suing up and down the
state. They’re suing cities, they’re suing other farmers, they’re suing native Americans, they’re
suing the environment, they’re suing the state government, they’re suing the federal government.
Their strategy is litigate, litigate, litigate. That’s who your teammates are. You’re opposing the federal government, you’re opposing native Americans, you’re opposing fishermen, and you’re opposing environmentalists. I don’t think I can make the case here in this short time for you to
withdraw from the lawsuit but I’ll make an easier request. I request that you ask the City Council
to take this to a vote. I don’t believe they voted on it. I think this is an important issue for the
City of Palo Alto. Let’s let the City Council vote. So I am asking you to recommend that the
City Council vote. Right now, the de facto position is supporting the lawsuit opposing the restoration plan. I’ve got packages of materials over here that I’ll distribute. I’ll ask if this Committee can distribute copies also to the City Council, some news articles, part of the EIS, ….
and letters from the Indian tribe. And there are some letters from legislators, one signed by
Byron Sher, former Mayor of Palo Alto asking Sacramento to drop its lawsuit. He hasn’t asked
the NCPA or Palo Alto to withdraw. I don’t know whether he will, but NCPA and Palo Alto are
involved in this, just like Sacramento is. Finally, August 20th, there is a summary judgment hearing. We don’t know what will happen after that but in my view, Palo Alto is making a choice by either staying in as part of the case or withdrawing from the case by that date. Doing
nothing means continuing to oppose the restoration plan. Thanks.
Bechtel: Thank you. Typically in oral communications we don’t ask or take questions on this,
but if there is any clarification or any questions from the Commissioners…
Carlson: Is it NCPA that is actually part of the suit or is Palo Alto also a party?
Ulrich: It is NCPA.
Bechtel: It is NCPA. That’s right.
Rosekrans: NCPA is nothing but its member cities. I understand that if you’re not on the agenda, you don’t get a discussion, but not discussing it, not addressing the issue is also making a
decision since we’ve taken a de facto position here.
Bechtel: I’m sure I agree with that totally, but I think you’ve made your point. Thanks very
much. Our next speaker is Herb Borock who would like to speak on the fiber to the home business case.
Borock: Thank you, Chair Bechtel. I received communication today that the fiber to the home
business case is tentatively scheduled for your next meeting on August 7 and as I understand you
will probably have a second opportunity to review it after the consultant gets input from you.
This is a subject that’s of wide interest in the community and normally your packet information is
not readily available the way, say the City Council packet or Planning Commission packet would be in the libraries. It would seem to me that since something becomes a public record when it’s
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available to the majority of the Commission that the business case that will be before you on August 7 when that becomes available to you should be available to the public and the public
should be told about it. When someone doesn’t know that something is available, they can’t ask
for it. And I hope it’s something that could be both available in printed copy and also on the
Internet so that people will have a choice of how to take a look at it. I know the Utilities
Department is very good about providing things like minutes of meetings that are accessible. So, that’s my request, so that you can have an informed public here on August 7th to participate in discussions, so you can give feedback to the consultant at that time. Thank you.
Bechtel: Thank you.
Rosenbaum: Are you saying that our packet is not routinely placed in the libraries where the other packets are?
Borock: That’s correct. There was a time when the Commission packet was in at least some
libraries but it’s not. The ones that are available are the various planning ones, Planning,
Architectural Review Board, Historic Resources Board, and the Library Commission, because
they’re in the libraries, and the school district. But there was a time when the UAC packet was
available and the other commissions in general are not.
Bechtel: Thanks for bringing that certainly to my attention. (Inaudible) but I think that may be
something we hopefully correct quite readily.
Borock: The main reason was not to have a packet where one person could be looking at the
packet in the library. But this is an issue, this particular subject matter, the order of magnitude are too great, where people are going to want to be looking at that at the same time. So, when you have an issue that’s of that wide interest, then usually what the City tries to do is to make
available the information in a form where lots of people could be looking at the same time.
Bechtel: We usually have a discussion on the next month’s agenda, it’s an agenda item. Thanks.
Our next speaker is John Nelson to speak to the audit report. John? Nelson: I would prefer to make my comments after the City Auditor’s presentation.
Bechtel: We can do that. Thank you.
SPECIAL MEETING
Election of Chairman and Vice Chairman
Bechtel: The first item, we move to the Special Meeting Agenda which is election of Chairman
and Vice Chairman. I will open the floor by saying that I enjoyed my term on the Commission
and certainly as Chairman of the Commission and being newly appointed, I’m now a rookie. I
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would like to pass the baton to one of my qualified colleagues, so I will entertain any nominations for Chairman of next year’s Commission. Mr. Ferguson has his hand up first.
Ferguson: Commissioners, I would like to congratulate you both on your reappointment, and
nominate Mr. Carlson as Chairman for the coming year.
Dawes: I’ll second that.
Bechtel: We have Mr. Carlson’s nomination by Mr. Ferguson, and a second. Do I have further
nominations? Any discussion? I declare the nominations closed and we’ll take a vote. All in
favor of Mr. Carlson as Chairman, please raise your hand. We have four votes -- let me indicate
on the notes that Mr. Ferguson is also now in attendance at the meeting -- so Mr. Carlson is declared Chairman, having been elected by a vote of 4 to 0. You may now take, let’s see, Scott Bradshaw, where is that, my -- so I don’t have a hammer on the table, but I will now pass the
Chairmanship over to you to conduct the second part of the special meeting which is the election
of the Vice Chairman.
Carlson: Well, thank you. I do want to thank my fellow Commissioners. This has been an
interesting year and this next year I am sure will be interesting. But we do need to elect the Vice Chairman so I will open the nominations for Vice Chairman. Mr. Dawes.
Dawes: We have a very experienced utility person and former City Council Member and former
president of NCPA who is extremely knowledgeable of all these matters and I would like to
nominate Mr. Rosenbaum for Vice Chair.
Bechtel: I second the nomination.
Carlson: Are there any other nominations? Is there any discussion?
Ferguson: So much for Dick’s retirement years.
Carlson: All in favor of Mr. Rosenbaum as Vice Chairman for this coming year?
(There were four ayes.)
Rosenbaum: Aye. At the City Council, we were happy to vote for ourselves.
Carlson: Well, I certainly look forward to this year that is definitely going to be an interesting one. Given the number of people that are here, my only thought is to move to the other reports as
quickly as possible. Should we have a report from you first, John?
Ulrich: I have a couple of recommendations. Perhaps you might like to look at them. First we
found an error in the agenda. Item 1 is listed as an action item. It should be listed as
information. The third item is listed as information and should have been listed as action. I think we can continue to do Item 1 as planned and ___ so that you have all the input and
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discussion that you’d like. Item No. 3, I would still suggest that we continue to have that and defer an action to a later date so that it can be posted appropriately on the agenda and that you’re
not being asked to make a decision this evening.
Carlson: You’re talking about the third New Business item?
Ulrich: Correct, Item No. 3 under New Business.
Carlson: You would like to defer that to a later date?
Ulrich: I’d like to defer your decision. And I think that will be next month.
Carlson: Okay. Well, that’s an important issue (inaudible) defer action.
Ulrich: Now, I would recommend that we follow the same order. We have two guests who have
come down from Roseville and I’d like to do that. I don’t think it will take a long period of time,
only because it’s an information item. We have had numerous discussions about this
beforehand. We know there’s a lot of material. (inaudible)
Carlson: New Business Item 1, there are people here from outside the area that should get priority. Let’s go through the agenda in the regular order, which means we’ve had all oral
communications except one.
APPROVAL OF MINUTES
Carlson: Are there any recommendations for changing the minutes.
Bechtel: Move approval of minutes of our meeting held on June 5th. Dawes: Second.
Carlson: It has been moved and seconded. Any discussion? All in favor?
All: Aye. Carlson: The minutes are in good shape.
AGENDA REVIEW AND REVISIONS
Carlson: We’ve gone through the agenda. Have any Commissioners been to any meetings?
There may have been one in June. I know I missed it. I don’t know if anyone else went.
Bechtel: There was an APPA Dallas meeting -- did anyone attend, John?
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Ulrich: I did not. Mr. Beecham did. He could give you some report when he returns. I suggest
we put that off.
Carlson: Let’s let Bern do it. John, why don’t you go ahead with your report then.
DIRECTOR OF UTILITIES REPORT
Ulrich: Yes, I have a number of items under Utilities Director. As you recall, we have this on the agenda so I can give you an update on current events, and allow you to keep up to date on things that we learned about over the last few days or last few weeks.
First item is the water update originally scheduled for the July meeting has been postponed to
next month, a month out of sequence. The report for August will discuss the approach to be
taken, identify information that needs to be obtained and also provide an estimated timeline that will be described in specific (inaudible) associated with this Water IRP will be coming. Now we expect this Water IRP to take nine months to a year to complete.
Water legislation update. We have several bills, one is AB1823. This is the real important one
that mandates that San Francisco fix their water system, the Hetch Hetchy water system. It
passed in the Senate Policy Committee and will be considered next in the Senate Appropriations
Committee, probably on August 5th. The final step, with stops along the way, will be on the floor of the Senate. So we made real significant progress in putting focus on this (inaudible). Assembly Bill 2058 enabling legislation passed its two Senate Policy Committees and will go to
the Senate Appropriations next. It’s probably also August 5th, followed by action on the floor of
the Senate. Senate Bill 1870 passed its two Assembly Policy Committees and will go to the
Assembly Appropriations next but no date is set at this time. Last action will be on the floor of
the Senate. If you would like more details we have here some of the staff that worked on this. The next item is that today the San Francisco Public Utilities Commission Finance Committee,
we believe, approved – and I’ll give you a caveat – that they would go after a $1.6 billion bond
measure. The reason I say “we believe” is that Jane Ratchye was there until quite late this
afternoon, but they decided to go out and have a discussion about a particular wording in the
measure that had to do with landlord and tenant water use, and they’ll come back (inaudible). But the recommendation from the General Manager at the PUC was to go for $1.6 rather than $3.6 and rely on the spirit of the bill to be passed in the Senate. It appears that it’s moving in that
direction. Then it would be incumbent on all of the water users in the cities in the Peninsula to
be responsible for the balance of the bond. Rather than have San Francisco take on the whole
bond, those of us, two thirds of the members would pay San Francisco. Their move is to try to
keep this bond measure as low as possible, and don’t let us assume the control of the system through the bond. It has a good side to it, we can go out and carry our side of it. We have to pay for it anyway. Also, there’s a whole level of more control if we have a piece of the equity as
opposed to just paying a utility bill.
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Bechtel: But, John, would split funding make it more difficult for project management? The City is still going to be responsible as the owner of the system. You say we’re now equity
holders?
Ulrich: If you’re going to sell bonds, you have to have something behind it. The bonds were
sold (inaudible). Bechtel: Okay, all right.
Ulrich: There’s more to come on that since we don’t know the outcome of the vote.
Ulrich: (Inaudible) be changing it as we speak. But I wanted to give you an update. Carlson: I’ve got to ask you about this too. Does this mean each community separately raises
funds or we put together a joint financing agency that raises one bond for our suburban share?
Ulrich: I believe it will be the latter, and not be split.
Balachandran: The bonds are going to be transformed quite a bit in the next six months if these bills stand.
Dawes: BAWUA becomes an NCPA for water.
Carlson: Very interesting. Any other interesting news?
Ulrich: No, that’s all, any more on water. The other item is the Trinity River flow decision and the litigation update. You heard in oral communication about the litigation and I’ll give you a
brief summary, as I have done frequently. NCPA, on behalf of all its members – we’re of course
a member – did join the litigation against the Department of Interior seeking to set aside
December 2000 Record Of Decision, better known acronym-wise as ROD. The ROD would
decrease water diversion from the Trinity River to the Sacramento River by about 254,000 acre-feet per year and that’s based on average hydro years. This decrease of diversion would cause a loss of generation estimated at about 250 MW or 294,000 megawatt hours a year from the
Central Valley Project hydroelectric system. We receive power through our WAPA contract and
NCPA (inaudible). NCPA, commented extensively in the EIS (Environmental Impact Statement)
leading to this ROD decision in December 2000, requesting consideration of environmental
impacts on the Sacramento River and consideration of impacts on electric system reliability. NCPA, including, I believe, Sacramento Municipal Utility District, also asked for inclusion of not just water flow data, but other means of silt control to improve the river in the same way as
alleged by adding additional water.
The big issue here is the health of the fisheries on the Trinity River. The belief is that if you can
find other ways of improving and maintaining fisheries, water flow increase is not the only
solution. The NCPA requests were not met and the ROD was issued without our input, without taking into account the alternative means. Federal law does allow NCPA to join with other
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interested parties in this litigation to set aside the ROD and reopen the EIS to make improvements in consideration of other environmental impacts and other alternatives. This was
chosen as the only route that you can have to continue trying to impress the need for this
additional study. Staff in Palo Alto believes that the NCPA Commission and Council should
continue to support the due process that provides for reopening the EIS by environmental experts
who are charged with balancing the various impacts to come up with the appropriate solution. It is our understanding that SMUD (the Sacramento Municipal Utility District), NCPA members and their staffs, and the NCPA Commission and NCPA member city elected officials are
currently receiving e-mails and letters as part of an organized mail campaign urging members to
forego these rights in court and withdraw from this litigation over the Trinity River. The case, as
pointed out earlier, is scheduled for a court hearing on summary judgment on August 20th
NCPA’s support for litigation brought against the Department of Interior (DOI) and the record decision on the Trinity River was based on the concern that the DOI ignored some very real
environmental issues raised by NCPA and others (inaudible) of the ROD. The DOI ignored the
ROD’s impacts on endangered species in the Sacramento River and delta. The DOI also failed to
assess impacts of the ROD’s preferred alternatives on power system reliability. NCPA’s
litigation, consistent with our comments during the EIS process, argues that the ROD should be set aside until the Environmental Impact Report is updated to address these environmental and power system reliability concerns and that the DOI consider a wider range of alternatives for restoring the health of the Trinity River. Our hope is that a better alternative will be found for
improving the health of both the rivers and the delta as well as minimizing adverse air quality
and power system reliability impacts. All of these things obviously have a trade-off.
Palo Alto has an outstanding environmental record reflecting the early environmental focus of most of our citizens. We are one of the most environmentally responsible utilities in the nation. The same environmental consciousness holds sway at NCPA. The positions and actions at
NCPA are driven by a publicly elected Commission board which is composed of representatives
of each of the cities and other elected bodies whose members include Palo Alto. This
Commission unanimously supported NCPA’s participation in the Trinity River litigation. We
recognize that our legal duty and public responsibility to protect endangered species, but we believe that not all prudent alternatives to propose diversion reductions have been considered in the ROD that could equally protect endangered species.
Council and UAC and residents should also be aware that the proposed action by the DOI would
result in a 35,000 MW hour year energy loss for Palo Alto and the estimated cost is about $1-1/2
million a year to replace based on today’s energy cost alternatives. These are obviously estimates because the hydro years can also (inaudible). This amounts to approximately 3% of the annual energy consumption and commodity budget that we have. So we continue to recommend to
proceed to this hearing of our case in court, and to seek to improve the deficient EIS, and
ultimately to find a superior solution that mitigates all impacts. This is more than I normally
would give you, but it’s a very visible issue right now, with the court schedule in August.
Carlson: What percent of our load is that? I couldn’t….
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Ulrich: It’s 3% of our annual energy consumption (inaudible).
Ferguson: John, I want to reinforce one part of your comment there. I did participate in some of
the NCPA meetings that touched on the Trinity decision, both before and after the 2000 election.
We need to stress that Palo Alto has a very good environmental record. The utility has built
environmental protection and sustainability into its Strategic Plan. Alot of the reality of sustainability and environmental protection occurs at the working level, at the detail level, in the midst of individual project negotiations or during the rulemaking process. It’s a roll-up-your-
sleeves kind of process. Palo Alto has done well in preserving environmental values in all kinds
of technical tradeoffs. But in this particular instance, at the end of the Clinton administration
term, I think there was a miscalculation -- as was true in other kinds of regulation -- a tendency to
just get the regulation out the door before the term ended. A whole bunch of good faith efforts by us and others were cut short. Unfortunately, the only remedy available for people that are cut short in the rulemaking process -- even people who were doing good environmental work most of
the time -- is federal litigation under the administrative procedure act. That is the situation we
find ourselves in. I think Palo Alto meant to complete this process at the detail level. But it was
kind of a cram-down phenomenon at the end of the term. So now we have a whole bunch of
people for a whole bunch of different reasons wanting to get one more crack at it through the litigation in Fresno. Now I hope it all gets sorted out, but we were prepared to protect the environment when we came into those negotiations with our sleeves rolled up, ready to work through the details.
Rosekrans: Let me respond for a second.
Carlson: If you can just keep it to a minute. Rosekrans: I understand that the power utilities were put into a difficult spot with the timing of
the decision. The decision came right when the energy crisis was in full swing and people were
really freaking out. It wasn’t done, however, just because the Clinton administration was leaving
town. It was done strategically after the election. They were ready to go before, but they thought
it would help to get Al Gore elected if they didn’t do that. But of course the Bush administration is still supporting a proposal in a letter in this packet (inaudible) to them. The EIS figure for Palo Alto is, I believe, $650,000 if you divide up the megawatts. If the spot prices today lead to a $1.5
million impact, then maybe that’s the spot price, but that’s much higher than the long-term
amortized cost of generating power. The river’s been out 40 years, the study was in place 20
years. I don’t know whether NCPA did the EIS scoping comments. I know SMUD did not.
There was a mechanical restoration alternative analyzed in this EIS. It’s not entirely new. How about let’s go forward with what’s proposed, now, and then study the alternatives. The river’s waited a long time. The Hoopa tribe has been out of its traditional values -- that they have had
for hundreds upon thousands of years -- for the last 40 years. How long is this going to take? If
you want to question the science, you’re always going to be able to find something. But most
people agree that the river needs the water. Thank you.
Carlson: I’d like go ahead. I’m one of a few people who have actually been on the Trinity and this is an incredibly complicated issue. One of the key points we’ve been making is that it’s an
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EIS that’s too narrow, even from a purely environmental perspective. Change in that river has very broad impacts elsewhere that are not taken into account. That’s why it’s been incredibly
complicated, the sort of thing you can spend a lifetime on. And some people have. It’s very,
very complex. We’ve just got to move on, at this point. I hope something can be worked out.
That’s the end of your report, John?
Ulrich: I guess it is.
UNFINISHED BUSINESS
Carlson: We have no unfinished business as I recall. which means let’s move on to our two
guests that came down here from Roseville. Thank you, John.
NEW BUSINESS
Agreements Related to the Termination of PG&E Interconnection Agreement and Successor Agreements
Ulrich: I want to welcome here two staff from NCPA. As you recall we had discussions about
this at earlier meetings, and Don Dame and Dave are in attendance. We had discussions at our
October 2001 and our February 13, 2002 and our May 1, 2002 meetings. We had earlier
discussions, in fact, at our NCPA annual meeting late 2002. You have with you our set of recommendations. The recommendations are in the form of what we plan to have on the agenda for the City Council on July 15 next week, requesting them to authorize the City Manager to
execute the replacement agreements related to electric transmission and interconnection
agreement services. Now while this looks rather complex, it turns out to be rather complex. And
I think staff has done quite a good job in putting together in summary form the agreements (there
were several agreements) what each of those agreements does, who is to sign them, the time limit, the timeline for that and what the expectation will be when all of this is completed. There are key aspects of the agreements that are outlined in bullet form on page 3 of the CMR. So, at
your pleasure, Dave can go through a brief presentation as a summary and you’re welcome to ask
questions. Or if you would like more in-depth discussion of any item, Dave will….
Carlson: Dave, why don’t you go ahead and make a quick presentation.
Dockham: Thank you. Quick, I understand quick. I used to work in the City of Roseville. Perhaps we can start quickly by reviewing where we’ve been with regard to the Interconnection
Agreement that we’ve been operating under for the last 20 or so years to get some kind of frame
of reference for where we’re going.
The NCPA pool, including its member Palo Alto, has been operating under a Interconnection Agreement with PG&E since about 1983. Under that agreement, we received transmission access, control area services and backup generation amongst other services. We’ve since been
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notified that PG&E would like to terminate that agreement and cause us to operate under the ISO. The first termination notice was given to us in July of 1997. If you’re following along on
the slides, this is the one prior to this one. We were able to extend that termination notice out
until August of 2000 through settlements that were ongoing at the federal level. It was extended
out a little further until April of 2002. NCPA made an emergency filing to extend that out further
because we didn’t believe PG&E or the ISO was ready to accommodate this transition. We were successful in getting an additional 5-month extension which took us to September 1st of this year. Also, part of that emergency filing was a mandate that we enter into some technical conferences
amongst all of the parties and this termination be moved out in time. I think the important point
to take from all of this is that this termination has been evolving over a long period of time and
there are no more extensions available. In terms of the technical conference, we were able to
extract agreement amongst all the parties on how we would operate with the Western allotment 2948A, how we would schedule across the California-Oregon transmission project and how we would be able to use our entitlement under the South of Tesla principles.
We were able to agree on a comprehensive settlement package that is nearly complete at this
point. We retained the right to argue the Stanislaus commitments which is the firm transmission
right that we believe is embodied under the current Interconnection Agreement that assures that
we’re able to get our resources from the generators to the city loads, and all of this is expected to culminate in a FERC order sometime in August for implementation on September 1. In terms of the settlement agreement -- and I’ve caught up to the slides – the key elements associated with
this agreement are all of the existing IAs terminate and they’re speaking of NCPA’s and Silicon
Valley’s. We’re able to retain our scheduling flexibility. If you understand how the ISO works,
Independent System Operator, you trade in an open market and you bid for resources that are
available on that market. We’re intending to continue to operate virtually the same way we have in the past where we schedule our generation to follow the load up and follow the load down as it rises and falls in each of the cities. PG&E has agreed to retain its responsibility for scheduling
the Western resource, both on the generation side and the load side and assume all of the costs
associated with deviations that might occur in that process. NCPA will take over the
responsibility for scheduling the California-Oregon transmission project and the entitlements on
the South of Tesla portion of the 500 kv line. The key agreement that’s come out of all this is what’s the Metered Sub System Agreement and
this is the agreement that effectively replaces the Interconnection Agreement that we’ve all been
operating under. The construct of this agreement is that we are agreeing to operate under the
Independent System Operator tariff except as this agreement modifies that tariff. So we’ve set it
up so that we have some durability associated with this. It’s for a 2-year term and we have the off ramp at any time with six months’ notice to get out from underneath this agreement in the event there’s some unknown superior alternative out which at this point we don’t think there is.
The MSS, Metered Sub System Agreement, defines the interconnection points that we will have
with the ISO-controlled grid. The limitations that our generators have will be discussed and
defined in that agreement.
Probably the key benefit that we see coming out of this agreement over what exists today is in this area of emergency operations. Currently, under the IA everybody has to share prorata in any
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kind of curtailments that occur due to a system emergency. What we’ve done in this agreement is carve out economic blackouts and say we’re not going to be obligated to curtail because PG&E
hasn’t procured sufficient energy to meet their loads. We felt this is a real benefit that we’ve
achieved in this agreement.
Dawes: Could that have prevented some of the blackouts we had in early ’01? Dockham: Yes.
Ulrich: All but one of the times we had these were for economic reasons that will be avoided
under the new agreement.
Dockham: A few of the other benefits that flow from this agreement following the settlement area, we have the ability to follow load. Other entities that are operating under the ISO Protocols
don’t have that ability. The use of the transmission grid will be based on actual use instead of on
gross load so, again, we’ve carved out this ability. To the extent there’s generation internal to the
city, it gets counted as being located internal to the city. You don’t pay for use of the
transmission system when you’re not using it. We’ve also obtained an exemption from the
summer reliability costs -- what those are is the ISO’s gone out in the last two years and procured peaking units because there was a concern that there wouldn’t be adequate peaking capacity in the state. Those costs are being spread to all market participants. But, as you all know, all of the
municipals have done that as well, have invested a lot of money to make sure that there’s
adequate capacity there to serve our loads. So in recognition of that, as long as we continue to
demonstrate that we’ve met our responsibility, we get exempted from these spread of costs that
are going to the rest of the market. And then finally, there’s beneficial treatment in terms of the way the grid management charges apply.
Ferguson: One question, you mentioned that we can get out of this on six months’ notice?
Dockham: Correct.
Ferguson: Can each of the signers get out if they want?
Dockham:: Not the counterparties. Only NCPA and Silicon Valley Power. We were looking for
durability and we got that from the ISO. Let’s see, the second agreement in this …
Ulrich: You might mention the length of time of the agreements (inaudible). Dockham: The Metered Sub System Agreement has a two-year term and that’s intended to
coincide, for the most part, with the termination of the Western 2948A contract. We also believe
that in that timeframe, we will have the control area operational so we will be able to make a
decision long term to compare and contrast if this is the best way to operate or do we go on with
the control area.
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Bechtel: A question on MSS, Metered Sub System. I understand the word “metered.” I understand “Sub System.” Is this a category that the ISO puts people in? I mean it’s not just a
made-up term for the purposes of this agreement. It must be some category of user.
Dockham:: Yes, it’s actually been in their tariff since inception, but there was a requirement that
you also be a participating transmission owner, which we are not. And so this process will revise the tariff to indicate that you don’t have to be a participating transmission owner to take advantage of this metered sub system arrangement. But, in addition to the protocols already
there, these benefits I have been talking about are new additions.
Bechtel: A second question. I know we’ve been discussing and working on this process a long
time but it seems like the outcome is a win for us. It seems this looks too good to be true. I’m just wondering how did the outcome …
Dockham: We’ll get to that. I think it’s a benefit given the alternatives. But the old operation
under the IA was superior -- if that was still an option, which it isn’t. Let’s see, I think I left off
with the second agreement that we’re working on with this group and that’s the revised
Interconnection Agreement. Just very simply, that’s intended to address issues of physical
interconnection of both the cities to PG&E’s grid, the ISO-control grid, and the NCPA generation to the ISO control grid.
Now, let’s get to your question a little bit. There really are no feasible alternatives for us at this
point. We need the control area services and we need operating protocols so everyone knows
how to operate, get energy onto the grid, and get energy off to the grid and we need to know how
those transactions are going to be settled. So, as we went through the scenarios to try and decide how we are going to proceed, the first one was let’s fight the termination for a little bit longer, but that was realistically only hope. We looked at the pro forma agreements that the ISO has in
place now. You may remember that at one point they were threatening to impose unilaterally on
all the cities utility distribution company operating agreements and participating generator
agreements that would have been a lot more burdensome than what we’re able to work out here
and then finally of course is our long-term plan of a separate control area. And then the second half your question is, what is this going to mean as we transition from the IA to operations under the ISO? We think it’s somewhere in the vicinity of 3/10ths to 6/10ths of a cent per kilowatt
hour. Those numbers have been folded into NCPA’s operating budget this year so they’re
reflected in what people are anticipating to pay.
But the single biggest difference that exists in terms of “it sounds too good to be true” is that at some point we’re going to be exposed to congestion costs. That’s in a state of flux right now. The ISO’s in the process of making a new filing to change the way congestion is charged and we
just don’t how that’s going to come out and so, that’s the real big risk in terms of going forward
and (inaudible) probably not as good as what we have had in the past where we were protected
from those kinds of charges. This slide is taken from a presentation that I made in Lompoc a
week or two ago. At that meeting we needed authority to move forward on these agreements to
keep the ball moving forward so PG&E knew we were ready to move, the ISO knew we were ready to move and so we asked for and received authority for the General Manager to execute the
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Meter Sub System Agreement, the replacement Interconnection Agreement and the Settlement Agreement as long as they’re in substantially the same form as what was presented at the
Commission meeting and they still are. In addition to the agreements that NCPA will be
negotiating or signing on behalf of each of the members, we will then follow up so that each of
the member cities has the opportunity to get the appropriate authorizations from their utility
advisory commissions and councils. We’ll be asking each individual city to sign what we’re calling an MSS binding agreement -- which is simply an acknowledgement that you’ve read and understand the MSS Agreement and will agree to be bound by its terms. We’ll have a scheduling
coordination services agreement and that will help to assure that all of the cities are continuing to
pay the bills that have been incurred on their behalf and that PG&E has indicated that ultimately
each individual city is going to have to sign the replacement IA because the cities are individually
connected to the PG&E system. We’re anticipating that this will all be completed sometime between July 31 and August 31 and (inaudible) some specific time tables laid out for that. With that, I appreciate the opportunity to be here. Are there some questions?
Bechtel: A couple of items. The biggest fear is going back to how it was, the state of
unrestrained accumulation of overhead at the ISO, that they were just increasing costs
dramatically. One of the problems was that going into the ISO, which was constructed in order
for us and everybody else to go into so it was inevitable and, I think, appropriate that all the cities do so. Are these capped in any way, the overhead charges, given the way you described their ability to add more to the pot.
Dockham: The costs are not capped. I think you’re speaking specifically of the grid management
charge, and what I can say is that there is so much pressure on them from the market participants
on the rate of increase of those costs. There is some (inaudible) negotiations going on right now I can’t speak about because they’re protected and privileged, but the market participants are exerting the appropriate influence to make sure that those costs get reined in.
Dawes: The second question. Do we, does NCPA lose its ability to schedule resources to take
advantage of peak pricing times? Certainly our Calaveras project (inaudible) is a wonderful peak
period resource that can throw off a lot of cash if it is turned on at the right time. But it looks like the ISO basically takes charge of scheduling those resources.
Dockham: No. I did not speak on that and I should have. We retain control of all the generating
units that don’t have a Participating Generator Agreement, and so the ones where we have these
PGAs, Participating Generator Agreements, signed are one of the geothermal plants, Alameda
and Lodi. All the other units remain in our control. Bechtel: What percent of our total resources at NCPA are not PGA?
Dockham: About 50%, I think.
Dame: That is kind of a hard question to address. The geothermal plants produce probably
about 20% of our energy. Their base load we don’t care whether their reliability must run or not. The ones we’re most concerned about are the single cycles because they have a limited number
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of run time hours. So we don’t anticipate, by retaining the right to control the resources that don’t have existing Participating Generator Agreements on, it significantly affects the impact of
our operations in any way whatsoever. Thank you.
Ulrich: Some of the risks are that these agreements do not settle disputes here around the
Stanislaus commitments, or prior charges that some parties may have disagreements over what we currently have, moving on to the new world.
Dockham: There are three categories of costs where we are currently in litigation with PG&E.
We have a grid management charge, a reliability services tariff and a scheduling coordinator
tariff. Funds are escrowed and bills are being paid in the grid management and reliability
services tariff instances but they are not in the scheduling coordinator tariff instance, and there is no accurate data out to give an idea of what the exposure might be. In the reliability services case, we got a favorable opinion from the Administrative Law Judge, so it is likely that those will
be refunded. In the grid management tariff case, I couldn’t even speculate how that one will turn
out, but there is no retroactive exposure above and beyond what we’ve already paid. We are not
settling those dockets as part of this overall Settlement Agreement package.
Swaminathan: I just want to add to this. It’s about George’s question, how it’s too good to be true. (Inaudible) part of lots of what has happened because FERC got PG&E and NCPA into its
settlement conference room. PG&E moved quite a bit during that period when FERC set a
deadline when it would take its own action.
Dockham: Pressure…
Swaminathan: That’s part of it. Also, with regard to ISO – what it costs – they have done a good job as to (inaudible) based on services they provide (inaudible) and so on. There are essentially 3
(inaudible) of charges (inaudible) to avoid two of those major (inaudible) which are (inaudible)
services NCPA (inaudible) provide (inaudible) services, so we don’t have (inaudible) ISO in that
respect. Also, in respect to cost projects, we get most of our load from Western. We (inaudible)
congestion (inaudible) so the cost increase is not as much as some of the other ones. With respect to Calaveras cost – which is the only generation resource we have, with NCPA ownership, we can still maximize value. We can sell Calaveras energy to the ISO market. We
can still do that (inaudible).
Bechtel: Shiva, on my comment. I was maybe more surprised that I was thinking about the ISO
movement. It seems as if the ISO is giving up more than they might have a year or 2 ago when they were trying to assume this authority.
Swaminathan: I don’t (inaudible).
Dockham: I think part of the benefit of this technical conference is that everyone got to under
understand each other’s positions a little better and the ISO desperately wants the municipalities
to become a part of their operating system, and I think through these negotiations, it is beginning to understanding what the municipalities need and then they can get on this effort to
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accommodate that and do it in a way that will facilitate other municipalities eventually joining the fold. We were kind of forced into it, but they’re hoping this will be a first step.
Ferguson: A question for our staff. It says the costs are projected to increase just over a penny
per KWh. That’s from what basis?
Ulrich: The current (inaudible).
Carlson: The transmission charges are doubling (inaudible).
Swaminathan: (Inaudible) slightly, only long term. Not on September 1. Given what we are
going to get the Western (inaudible) charges and so on (inaudible). Carlson: It just comes on top of all those other increases that we’re facing.
Swaminathan: There are some price caps on the IA. In other words, they cannot increase the
rates for their (inaudible) transmission and soon (inaudible) and all those costs (inaudible), but
there are some price caps we can (inaudible).
Rosenbaum: I was wondering why the City of Roseville got crossed out, presumably at the last minute.
Dockham: Roseville is going to sign its own agreement because they’re not connected to the ISO
control grid. They’re connected only to Western. So, they’re able to extract even more benefit
out of this agreement and avoid many of the transmission charges because they won’t be taking service across the Cal ISO control grid.
Rosenbaum: Roseville has always been a member of the pool, though.
Dockham: They will have a separate replacement on (inaudible) and they still intend to operate
in the pool. They’re able to have a separate agreement specific just to their situation. Balachandran: There is a comment over here that the projected cost increases have been
included in our budget projections and our rate projections.
Ulrich: Those are listed on page 7 of the CMR. (Inaudible) those included in the budget and our
(inaudible) rates (inaudible). Dawes: Final question, not directly on the IA but it does address the CMR. On page 6, it talks
about three potential long-term alternatives, build generation, building transmission as a separate
control area. I would just like to suggest to the Chairman that alternatives 1 and 2 are dismissed
as being too expensive at this point in time. But some point in the future, in the next 6-9 months,
if we could have a presentation n the basic economics of in Palo Alto generation or teaming with another local generator to buy into a local generation plant, maybe in the City. I think it would be most enlightening.
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Balachandran: We will get that done, Commissioner, and you’ll probably see it before 9-12
months.
Rosenbaum: John, why isn’t this an action item? Why aren’t they seeking our
recommendations? Ulrich: You have had input into all this in the last 4-5 times that we have had it on the agenda.
You have an opportunity to either give us direction that we relate to the City Council or you can
come to the City Council meeting if you would like to have some changes. What we’re doing is
taking what we believe is the appropriate agreement to the City Council.
Rosenbaum: Well, I don’t have any trouble with the agreement, but it seems to me this packet of material has surely not been in front of us. The City Council would expect that the UAC would
have looked at this agreement in some detail and deliberated. I am surprised that --
Ulrich: Typically we have brought the contract agreements themselves to you to review and we
have relied on our legal help to do the terms and conditions so that what is in the agreement is
spelled out. Would you like to do something different? Rosenbaum: I saw it as an action item when the agenda came out and it struck me as being
appropriate. I am surprised it was switched to being an information item.
Ulrich: I want to be accurate because the memo that is addressed to you dated July 10, that is
item No. 1, the request on there is it is an informational report and I can’t change the agenda and make it an action item. So, it was an error on the part of the agenda preparation.
Ferguson: I agree it should have been an action item, but I also want to point out John that you
really did a good job in running us through the transmission charge issues on at least three
occasions. Don has been here at least twice. He spent a generous amount of time on these
issues, so I’m not disappointed with the outcome at all. But procedurally here, yes, it should have been an action item.
I have a corollary question. Bern Beecham voted on the 27th at the NCPA meeting to sign on
behalf of the city. Did any one of the Commissioners here get a call from Bern in connection
with that?
Bechtel: No.
Ferguson: We are going to deal with our City Auditor’s comments a little later. But here again,
we have to do a better job in sequencing these things so that we use the Commission at the right
time for the right purposes. As I see Dick’s comments on what Council assumes is behind a
UAC action, we ought to present our advice in the right framework when its time for the Council
to see it. Seems like we can take any action within the scope of the agendized action topic.
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Ulrich: I am sure hoping for a few recommendations, but I guess I would like to continue to point out that we are doing incredible due diligence on this.
Ferguson: I would make it an action.
Ulrich: Then again, I can’t say one thing in one report and then add an agenda item for a public meeting that asks to do something else. If you would like something else to change…
Ferguson: Couldn’t the UAC make a direct recommendation to supporting the agreements? You
said it was an action item, right here on the agenda.
Ulrich: I cannot list in a public document that we are asking for action, when on the document itself, it is listed as information only. I believe you can tell me very clearly and for the record here, and give me direction you would like to move as you would if you were speaking directly to
the City Council. If you would like us to do something different, then what is in our report needs
to be redirected by some kind of action. Tonight is convenient because everything is right here.
Ferguson: So is a motion in order to support the staff work in this document?
Carlson: Yes.
Ferguson: So moved.
Carlson: It has been moved and seconded that we support recommending approval of this to the
Council. Any discussion? Bechtel: I have one comment. I think this will come up also in the auditors’ report, about what
the duties of the UAC are. I do see that staff has incorporated the UAC’s advice, so at least it’s
noted that we gave them advice on earlier presentations of this information, but I agree definitely
with Dick that it would seem even though something is presented (inaudible) defer topic, it is
now in the final draft (inaudible). Ulrich: Although I wish I could go back and change the words on the document that I sent to you
on July 3, we aren’t likely to do that. All I can do is confess publicly that we ...
Dawes: I will call the motion.
Carlson: The motion has been called. All in favor of the motion, say aye.
UAC Members: Aye.
Ulrich: I feel good now.
Carlson: This has been an impressive negotiation from our perspective on a difficult subject. We really made progress.
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Dawes: Did we ever congratulate NCPA and all the associated staff who did this work?
Ulrich: Yes, all the people that did all the work.
Dawes: Hats off. Dockham: Thank you. It was a local effort, everybody was a big help in meeting the FERC
deadline.
Carlson: But basically, we have to do it all over again in two years, right?
Dockham: Oh boy, I hope not.
Carlson: We’ve got a 2-year agreement. Obviously that will be the basis of a longer-term
agreement, but we don’t have a longer term agreement.
Dockham: Right. We have options in two years.
Bechtel: Thank you very much for coming down.
City Auditors Assessment of Utilities Risk Management Procedures and
City Manager Response
Carlson: Okay, Item No. 2, presentation by the City Auditor. We’ve all seen pieces of this but
we’d love to see the presentation. This is an information item, right?
Erickson: Sorry to say this is also an information item as much as I would love to ask for your
recommendations.
Ulrich: It is listed correctly on the agenda.
Erickson: I am very pleased tonight to present our assessment of Utilities risk management
procedures to you. But first by way of introduction, I would like to introduce Edwin Young,
Staff Auditor, in my office. He’s done the lion’s share of the work on this project. He came in
November, new to the City and we threw him on the Utilities first thing and it has sucked up a lot of his energy. I deeply appreciate all his work. What I’d like to do is step through with you pretty quickly – you see it is a long presentation – I want to step through each of the audit issues
that we identified in the report and the associated recommendations. Then I would like to have
John respond and I think he also has a short presentation to make. I am pleased to let you know
that we have basic agreement on all the recommendations, which isn’t always true in the audit
process. But what I would like to do is to try to move quickly through the presentation, but please feel – and I know you will – stop me if you have comments or suggestions, otherwise I’ll just keep moving through it.
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Carlson: Sharon, something dawned on me that we’re recording this. This is Sharon Erickson, the City Auditor, making this presentation.
Erickson: Yes We all seem to know each other at this point. The objectives of this review were
approved by the City Council. That’s a good reminder. I work directly for the City Council. I
am one of four people who are appointed by the Council directly. When I got this job, one of the things that I knew that I needed to look at was Utilities. Utilities is basically half the City. That was also City Council’s direction. They gave me a pretty limited scope which was fine. It was
more than enough which we’ve listed here which is to assess the adequacy of Utilities risk
management procedures, to assess the appropriateness of designated scopes of authority and
levels of management oversight, and to assess the adequacy of management reporting. This
scope only touches, and I want to make this very clear, on one piece of what Utilities as a department does for the City. This is one piece, it’s a large piece in terms of dollars but one small piece in terms of all the functions the Utilities serves. As a way of background - and I
don’t really need to remind you of all this - but the electric supply business supplies 28,000
customers. The Western contract is over 70% of the City’s needs but prices have been volatile –
and you’ll hear this through the presentation - since deregulation. On the gas side, we supply
23,000 customers. We have past suppliers listed and current suppliers have changed. And, again,
prices were extremely volatile during the energy crisis. In terms of commodity transactions, this chart illustrates 2000-2001. Our commodity purchases total about $78 million. That was 86 transactions. Those were purchases, sales and layoffs. So you can see the average of some of
these transactions is quite large.
Dawes: This is also a very unusual time period. It’s not normalized (inaudible) a normal
situation nor are the margins appropriate. 57 to 131 isn’t what is typical. Erickson: And let’s all hope we get back to typical real soon.
Dawes: I’m not sure we will.
Erickson: And that’s why we are dealing with this issue. In terms of organization, we’ve got the CPAU Resource Management Division that’s responsible for implementing gas and electric supply strategies. We, of course, have you all to provide advice to the City Council on a wide
variety of utility issues, not just this one. In 1998 the City Manager formed the Risk Oversight
Committee, which we fondly call the ROC, which consists of the Director of Utilities, Assistant
City Manager, and Director of Administrative Services and you’ll hear more about the ROC
through this presentation. In terms of business risks, as a result of the deregulated energy markets and volatile energy crisis, CPAU business risks are, of course, much different that they were in the past. The quote I’ve used is that Utilities was a sleepy little business until recently.
And it is not that way any more, and we can’t necessarily expect that it will go back being the
nice stable little business it was. Risk management we are defining as reducing the prospect of
losses, for these purposes.
Carlson: Sharon, let me step in here because there’s an important thing that people that aren’t (inaudible) don’t understand. The risk we are talking about here is primarily risk for customers.
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We have a right under nearly all our contracts if we have to, to raise rates. We raise rates, we pass it on. The City is not going to lose here, but our customers have a lot at risk. So this is
mostly ways of protecting our customers.
Erickson: Absolutely. We are talking about commodity costs. We don’t generate power, we
don’t have natural gas wells within the City limits for the most part. We go out in the market, we buy power and we service customers in the City of Palo Alto.
Carlson: And we pass on all of those costs and if something goes wrong, the City doesn’t have a
loss in nearly all situations. It’s the customers that are at risk. We’re trying to protect our
customer-voters here.
Erickson: Right, although we may talk about it later. There are instances where the City has had to recognize potential losses on its financial statements, so these can have a big effect on the City
as a whole.
Dawes: Will you digress at some point and talk about it? That’s a very weighty statement,
“recognizing losses on financial statements,” but it’s a mark-to-market situation. Then you flip
back to Commissioner Carlson’s remarks, those costs or lost profits or losses – those are weighty words – are basically passed on to the customers in the future. This is an accounting convention that shows up on a balance sheet at a particular point in time. But it is not a loss to the City.
Erickson: I should clarify. Let me be very explicit here that what I am talking about is a note on
last year’s financial statements. It’s a footnote on the statement but those footnotes can have an
impact on the City. And that was a footnote noting a potential loss of $35 million on (interrupted)
Dawes: What is the effect to the City?
Erickson: Well, anytime you have that kind of contingent liability, if the City were to go out and
issue bonds, it could…. Dawes: Even though it’s cost that is passed on to the customer?
Erickson: Yes, and it’s a note. It’s a note on (inaudible). It’s things that accountants love to
worry about.
Dawes: Well, it seems to make good headlines but aren’t really real.
Bechtel: They end up being real for customers even if they’re not a direct City risk, although
there are some situations in other communities and a great example being Orange County where
they basically had a rogue trader that put the city at risk, not just the customers.
Erickson: And let me also be very clear that in this case, we recognized a potential loss. We didn’t see that size of loss from that contract so that was a note on the financial statements at one
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point in time. The only point I wanted to raise is that the Utilities Department does not stand alone; it stands as a component unit of the City as a whole. So, although we recover the cost
through rates from our ratepayers, it is an integral part of the city and a very large part of the
City’s financial position.
Rosenbaum: Just briefly, I think for the purposes of risk management, we’re defining interests in the City to be synonymous with the interests of our customers.
???: Yes.
Erickson: In terms of audit results, let me make clear first that a performance audit by its nature
focuses on areas of improvement. We’re looking at areas of high risk. We’re looking for possible improvements. That’s our role in this case. We do not go in terms of a financial audit where we would certify financial statements. This was a performance audit. So in terms of
results, we found that CPAU has made considerable progress in addressing risk management
issues and in improving its evolving risk management program. Like I said, we’re looking for
improvements to be made and we found that additional improvements are needed and can be
made to protect the City’s financial interests even further, to prevent unauthorized transactions to
the extent we can - I’ll add in all the caveats here – and to ensure to the extent we can lower and stable electric and gas rates.
The first issue we dealt with in the report was the recommendations in the 2001 Risk
Management Study need to be addressed. This was a previous Risk Management Study where
CPAU consultants have identified a series of gaps in CPAU control infrastructures, and in 2001
Deloitte & Touch made more than 50 recommendations to bring CPAU in line with industry best practices. We, of course, began our audit in November of the same year, 2001. Many of those recommendations during our audit haven’t been fully addressed at this point and/or implemented.
For example, the one we will touch on again – and I thought this is a good place to bring it up –
is Deloitte & Touche strongly recommended a separation of duties and this is where we bring in
the middle office concept. We talked some about this but this is in conformity with industry best
practices. A front, middle and back office would be normal in an energy business. We’re a public utility but that doesn’t mean we can’t learn and that’s why, I believe, CPAU brought Deloitte & Touche in to being in those best practices. The front office here is basically the
trading arm. The middle office monitors those trades and ensures compliance with policies and
procedures. The back office is more the accounting function, tracking, reconciling, keeping the
records. We’ll talk more about that separation later on.
We made two recommendations in this area: that CPAU continue to implement the D&T recommendations and establish target dates for completing each recommendation and then No. 2,
that CPAU provide written justification and obtain approval from the ROC, the internal body, for
any recommendations are not implemented and provide written progress reports to the ROC so
that the ROC can monitor and enter into other oversight levels as needed that would detail the
status and target date of each of the D&T recommendations.
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The second major issue that we dealt with was that oversight roles, responsibilities and authorities need to be defined. And this is something that you’ve already raised this evening.
The City Council, the UAC, and the ROC all have oversight roles, responsibilities and authorities
and those authorities and roles are still evolving. Again, this business has changed dramatically
and we’re all moving quickly to compensate and adjust to those changes. All those bodies are
involved in making important decisions that affect energy, finances, contracts, strategies, plans, policies, procedures and practices and those decisions, of course, directly impact ratepayers and, ultimately, may affect the City’s finances, operations and reserves. So, we made a
recommendation here. We left it pretty broad so as not to be restrictive. I pretty much threw the
ball back into your court which, in conjunction with the ROC and the City Council, CPAU
should clearly define those roles, responsibilities and scopes of authorities for each of those
bodies in the risk management process, including the ROC, the UAC and the City Council. Then establish formal policies and procedures commensurate with those oversight roles. So, put it in writing so future bodies know the decisions (inaudible) roles are.
The third major issue that we raised in the audit report was that commodity purchasing policies
need to be improved and clarified. The first issue here was signature authority. City staff long
operated under the assumption that they were authorized to purchase commodity so long as the purchase was to meet demand was for less than three years. In rereading the Muni Code, it’s my opinion the City Manager’s signature authority is generally limited to $65,000. We found, of
course, that CPAU, because of this long-standing procedure, had signed contracts exceeding
$65,000 without specific Council authorization. There are a couple of examples of that. Now
CPAU has already formed an internal working group to address my concerns, concerns from the
Administrative Services Department that coordinates purchasing for the City and the City
Attorney’s Office. So, we are working on those issues. I made two specific recommendations in this area. That is, in lieu of allowing CPAU unspecified dollar authority, the City Council should award base contracts. These would be enabling agreements – we talked briefly about this in the
past. It would function something perhaps like open purchase orders. Those base contracts
would specify not-to-exceed dollar amounts, durations and some type of volumes in the not-to-
exceed capacity for electric and gas commodity transactions Those base contracts would also
clarify what types of business CPAU staff is allowed to transact under authority of that contract. This would enable CPAU to go forward to the City Council, get public approval. It would be on the public record that a contract has been entered into or a series of contracts, and then staff
would be fully authorized to transact business under that contract. Some of those transactions I
understand and am comfortable with could be millions of dollars. That can be typical of the way
staff currently does business You don’t need to tie staff’s hands that way. I think that with this
process, we should be able to give the City Council, make sure that the Council retains the authority, that the Council (inaudible) ratepayers and, at the same time, ensures that CPAU staff have the flexibility they need to respond to this changing marketplace.
Dawes: When I read this, I thought this had the potential of being totally unworkable, a
bureaucratic nightmare, tying the hands of the traders – “tying the hands” is too strong a word,
but to extend the length of time between dealing with the problem and being able to sign a
contract. Often a price is good for a very short time and price is very important in this activity. John, I assume it’s a give and take sort of a thing and I just don’t see how this is a workable
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situation to bring in the City Purchasing Department, submit RFQs, get quotations. I mean, they’re gone, all the quotations are gone (inaudible).
Ulrich: Well, we’ve had some learning experience in this area. I think ultimately we can find a
way to do that. As you recall, we received approval from the City Council for purchasing 25MW
in the post-2005 era back in November. We’ve been working quite diligently to find a process that will allow us to basically sign enabling agreements with parties that do all the credit checking (inaudible). And the only remaining part is the price which can have a very narrow
period of time to make that decision. That’s where we’re moving toward. So, these things, as
Sharon pointed out, are things that we’re quite aware of and are trying to (interrupted)
Dawes: Basically, a list of the creditworthy counterparties, is that (inaudible) a credit limit (interrupted)
Ulrich: As you know, in the purchase of electricity or gas, there’s more to the deal than price. In
terms of delivery, what happens if they can’t deliver it? Do they have resources (inaudible)
actually (inaudible) a number of things that we would have to verify in the RFP process. The
point is in the ideal world, what you want is to be able to understand your energy needs and put
out an RFP that covers the conditions that you’re looking for, gather all of those -- Dawes: Our RFP process can be six months, I mean we’ve been through that and everything for
the Fiber to the Home (interrupted)
Ulrich: We’ve had this discussion before. The point of the auditor, though, is to point out that
we have to find a way that you can have open competition for this commodity that we want and to be able to do it in a very prompt way.
Dawes: Girish, can you envision this set of rules operating among your staff?
Balachandran: Let me just outline how this is going to work. The way the process is envisioned
to work is to get an RFP out to get a set of enabling agreements. So we’re going to get a set of enabling agreements of maybe five different counterparties. And each of those counterparties will have a dollar limit on it and those enabling agreements go to City Council and get approved.
And they have a term on it, say seven years, and we will have a dollar limit in each of them. And
then to implement our strategy of purchasing and selling energy, we can essentially pick up the
phone, get three quotes, and execute right away.
Dawes: So, you’re confident that you’ll never need quotes outside of those five approved counterparties?
Balachandran: Well, there’s a cost to implementing a process by which open competition can be
implemented. There are certain processes that we have to go through. I think what we worked
with the City Auditor’s office this process, I see it as upfront, there’s a lot of work that needs to
be done, that there’s a new process for us, but once we get that in place, it will essentially be business as usual.
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Bechtel: Girish, will you have, hopefully, a process for signing an agreement with someone for
seven years that periodically we will check, go back and re-audit these counterparties to make
sure they stay on the qualified vendor list?
Balachandran: Totally. As a matter of fact, we plan to revisit this process with a frequency of between 1-3 years. Say, we put this RFP out – in fact on the gas side, we hope to put it out in maybe two months from now, so it’s 2002. Two or three years from now, who knows who’s
going to be bankrupt, and who our suppliers are? Well, it just depends. Depending on market
conditions, depending on the performance of the existing suppliers, we may decide to go out and
get new suppliers. Or we say, they’ve been working great and we just keep them for 3-4 years.
And if the dollar limits are getting (inaudible) on any one supplier because they’re giving us good prices, and the dollars are (inaudible), we go back to Council and change the dollar limits of that (inaudible).
Ulrich: I think we’ve learned a lot and you’ve been along with us on this wild ride in going out
and getting contracts to be placed in the middle of all the Western and FERC decisions, and
we’ve learned a lot from that. And we’re also better now in being able to determine when we’ve
got bad news and cancel these contracts. What we’re looking for with the recommendations here is a process that we can deal with these things on an ongoing basis if they do come up.
Dawes: I was just afraid that it was getting too much of a bureaucracy and I wanted to hear from
line people that this is something that is eminently feasible and I am certainly satisfied.
Ulrich: Eminently? Now you (laughter) Carlson: Before you sit down, Girish, what I am concerned about is that this works for direct one
to one contracts. Some of these markets are getting sufficiently sophisticated that it’s getting
easier and easier to just buy power on the exchanges. By definition, competitive means you have
hundreds of bidders and sellers competing every minute in those exchanges. But operating there
doesn’t fit within these narrow, old-fashioned 19th century contract rules. Balachandran: Well, I think I can distinguish the two things. One is we don’t have an electric
futures market that’s working for the products we want to buy over here. When that happens,
we’ll deal with it. Right now, the process we are trying to (inaudible), essentially the over-the-
counter market, and we are going to use a standard industry contract, like the (inaudible) contract
on electric and the (inaudible) contract for gas. So that’s essentially what the industry is using. Carlson: I thought the gas futures…
Balachandran: On gas futures. there are a couple of issues on that. One is the legal issue of
whether we as a public entity can actually use that, use the futures market. And were just
initiating a process of investigating that. Now, we have to take small steps before we get there
because we want to get our risk management controls in place, get that working with the physical products that we are buying and then we’ll consider moving to financial products.
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Carlson: Because that’s something that just doesn’t fit in this (inaudible).
Ulrich: But you’ve got to expect that the kind of business we are in with all this volatility
whether or not it is worth (inaudible) sleepy old days, if you can handle that. We’re not in the
business of trades and making money, we’re in the business of buying commodity as used by our customers. What’s important to me is to forecast the needs and be able to have a purchase strategy that fits our tolerance for risk. That’s why we have laddering and that’s why we’re not
out looking for the lowest price. We’re looking for a stable and reliable product and delivery. So
we should not be having knee-jerk reactions to going and buying stuff. But on a monthly basis,
we’re going to have to fine-tune things to be able to buy or sell (inaudible). I don’t want to paint
a picture that we’re looking at a process where we’re going into far more trades than we have to have (inaudible). (Inaudible) flexibility (inaudible) do something on a moment’s notice. We need guidelines and support within a framework of authority that we have to go and buy
commodity.
Carlson: But in the longer run, true risk management for our customers may be the most efficient
way to do things, probably is going to be to operate in the futures markets to cover ourselves.
Ulrich: You’re doing that, it’s (inaudible) yourself. We’re still doing the (inaudible). We’ve made tremendous progress in (inaudible). I think the City Auditor needs to finish her report.
Need to point out that the things she’s referring to are things we’ve been working on and part of
the implementation. The report from Sharon and D&T is looking from the standpoint of getting
us to the world class or at a point where (inaudible) best place to operate. We’re just moving up
(inaudible). Next year, we’ll be making more improvements Carlson: Sorry to interrupt. This is important material and let’s keep going.
Erickson: No, I appreciate that you think it’s important.
Balachandran: May I just pass on one more thing. I did ask Don Dame to stay back; he’s still here. So the questions you want to address to him also, feel free to do that. He has a wider perspective because he’s involved in operations. We’ll talk about that later.
Erickson: Let me go on to the fifth recommendation which actually is a corollary issue, which is
City Council delegating authority and clarifying CPAU purchasing and sales authority under
pooling agreements with NCPA and other agents. For example, at the current time, staff can pick up the phone and enter into a deal through NCPA. We also need to clarify ____. It’s corollary to what you’re raising - how we can authorize staff to do that – because under our current $65,000
limit, this is an issue. So, we do need to clarify how the City Council can delegate that kind of
authority. And once we set up that process, that may be a process we can use in the other
markets in the futures.
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Bechtel: Sharon, couldn’t we have a blanket agreement there also at least (inaudible) with NCPA that this month or a month later or some basis, any transactions in excess of $1 million be
reviewed. I assume something (interrupted)
Erickson: Something to that effect, exactly.
Rosenbaum: This business about $65,000 per transaction and the staff feeling that the authority to buy commodities long term (inaudible). The attorney has looked at this over a many-year
period. Why have you suddenly decided – I guess you and the attorney agreed – that a different
reading of the Code is now appropriate?
Erickson: I wouldn’t want to speak for the attorney but I believe we’ve come to the agreement that a different reading is appropriate. I was the first person to raise it in recent memory. I believe when we all looked it over, we realized that this was something we needed to tighten up.
Rosenbaum: You’re saying Ariel changed his mind.
Erickson: I believe it was (inaudible).
Rosenbaum: You don’t want to say. I can say it.
Carlson: I think it’s more surprising that somebody is more conservative than Ariel.
Rosenbaum: That would be my point.
Erickson: I’m speechless.
Ulrich: I’m not jumping in here
Erickson: Moving right on …
Carlson: Fortunately this is not going out over the cable.
Erickson: (Inaudible) which is also in a similar vein, competitive bidding, which, again,
commodity transactions have previously treated as being exempt from the Municipal Code’s
formal competitive bidding requirement. And so, when we went in to look, we also found
examples where contracts had not been competitively bid, of course, because that was the understanding. Now, again, CPAU has formed a working group to address this issue in conjunction with the previous issue that we just talked about, the signature authority, so that we
can ensure more robust competition for energy contracts. And we made one recommendation in
this area.
Carlson: I want to mention something here because it sounds like there’s no competitive
bidding. As I understand, the way things actually work is that these are extremely competitive
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commodity markets. You call a bunch of people, you make a quick decision, you do the best deal. You don’t go through an RFP process because the prices are changing every minute.
Erickson: The City is a government bureaucracy. We have a very structured formal bidding
process, of course. One of the key things that we looked at was documentation of those
competitive bids and they weren’t in the records. When somebody gets on the phone and wants to do a deal, but I need to see as an auditor coming in later that there were three competitive quotes given, that that person did consider competitive quotes. And that’s what we were unable
to document. So, that’s where we wanted to clarify how we can do that, get those things in
writing in the file so that we’re covered that way and we’re in compliance with State code which
says we’re a public agency, we’ve got to competitively bid.
Dawes: You see that documentation being submitted by the offerors are informal notations on a piece of yellow paper that, say, I talked on 10/21 with Sempra and they offered 4.59. Three
minutes later, I talk with PacifiCorp and they offer whatever. I mean, are we talking realistic
documents or are we talking bureaucracy and dancing on the head of a pin and we need to put in
a change to the City’s ordinances?
Erickson: Well, let me tell you, I come down on the side of realistic documentation, but on this issue, I punted. So our recommendation is to refer this to the City’s Purchasing Manager who is
the authority in the City on purchasing matters, and I will be working with Utilities and
Purchasing to help come up with a solution that is workable.
Dawes: And the idea would be workable in a competitive environment?
Erickson: For example, the Deloitte & Touche recommendation has been that we simply tape record conversations and have tapes available. I mean, there are a lot of solutions out there. I
don’t want to get that specific in this report, so we’re throwing it back to Purchasing. We’ll work
with Utilities to ensure that this is a workable solution.
Carlson: That is very important, clearly thinking workable and that’s (inaudible). If you wanted to tie things up, you could completely paralyze the system.
Erickson: No, I am a Palo Alto resident and I really like it when my lights go on, my heat goes
on. The next issue that we raised was energy speculation. Of course this a major issue for any
risk management program, so, of course, we were going to look into this issue. The City has a
policy that prohibits energy speculation. Of course that policy also prohibits buying energy that is not needed for meeting load. Now, when I looked at that, I said, strictly interpreting (being a stickler for detail), the current policy wouldn’t allow Utilities to buy any surplus energy. I
suspect that we always need to be in a slightly surplus position so that if the temperature changes,
my furnace does go on. So, of course, what we found was that CPAU records show instances of
sales of electricity and gas energy and I can logically infer from that we were in a surplus
position. So, again, we’re making some recommendations here. We actually came up with three
recommendations in this area. One is that the City Council should clarify its policy on buying over load and allow for purchases that need reasonable contingencies while retaining the
UAC MTG MINUTES 07 10 02 – APPROVED 8/7/02 30
prohibition on speculative purchases. In the report we talked about perhaps bracketing load. Load is an estimate and its an estimate that changes. The eighth(?) recommendation was that the
CPAU should provide the ROC with detailed transaction reports that provides assurance that
commodity purchases are not in excess of forecasted demand. This is simply laying out a clean
spreadsheet that shows on March 21 we purchased 1,000 MBTU of gas for this particular time
period. In keeping track of that and providing that level of detail to the ROC so that when the ROC is also approving purchases, they can see whether or not those purchases are in excess of load.
The third recommendation in this area is to set up a formal exception report system, having done
all this other stuff. My fear was that if we set up a reporting system immediately, we could be
getting a lot of exception reports. I wanted to minimize the number of exception reports by coming up with some clarification from that first recommendation (inaudible) No. 7, on what purchasing for load means.
Carlson: There is an important question here. The obvious exception is that we did buy over
load that it was such a shaky contract through WAPA with PG&E. It was so uncertain that
PG&E was desperately trying to get out of that. We bought a huge amount of backup power way
in excess of our needs because we didn’t know if the existing contract would disappear tomorrow. So, how does that fit?
Erickson: Let me be very honest that it caused considerable consternation until I dug through the
records and found very clear documentation that the Council and you all were completely
informed of that situation. We make the policy, the City Council makes the policy. It is not
imposed by anybody else. We make that policy and we can decide how we want to stretch that policy. The other issue, though, is that the Enron contract, as I understand it - and I was not here at the time – was an insurance policy.
Dawes: Absolutely, much more of an insurance policy than was originally asked for.
Ulrich: The process worked. Bechtel: However, the client had died and the poor window suffered.
Dawes: (Inaudible) later on there are discussions of long-term contracts and pitfalls thereof.
Long-term contracts also have some very wonderful attributes which have been extremely
beneficial to the City of Palo Alto Utilities over the years. We have one that will be getting into a different (inaudible) into it after (audible) which is the run of the river contract for WAPA where we didn’t really know what we’re going to get. We just know we got a certain percentage
of a moving target and No. 7 is basically not consistent with that situational (inaudible), and I
think everybody at this table agrees that this is an extremely fortuitous long-term contract which
we have entered into and are glad to do so. But are you simply saying that the City Council has
to rationalize its pronouncements in order to have the Utilities Department enter into that kind of thing?
UAC MTG MINUTES 07 10 02 – APPROVED 8/7/02 31
Erickson: No, but that is exactly why I wanted No. 7 to be in place before we did No. 9. Because I looked at those graphs of forecasted energy in 2005, I got pretty concerned about the
number of exception reports that would be generated depending on the weather, so that’s where
we needed Council to adopt its policy to define load before we set up the exception reports
Carlson: Can we interrupt a minute? We ran out of tape here. Bechtel: We’ve got 5 minutes I think he says. We should take a brief break in order
(incomplete)
Carlson: Let’s go ahead and break and let him (inaudible) and then we can continue because this
is fascinating. Sharon, if you want to continue with your fascinating presentation here. Erickson: Thank you so much. The fourth major issue that we identified in the report was that
improvements in management reporting are needed. CPAU does prepare numerous reports and
we have examples of many of them filling binders upon binders on their shelves. Oh, and e-mail
boxes. However, current reports we pointed out that don’t include or at least we didn’t find
copies that include, or least we didn’t find copies that included on a routine basis detailed line
item data on commodity transactions. Interim financial records that facilitated analysis of risk detailed portfolio analysis showing allocation of performance by type. By this I mean spot versus long-term contracts, fixed versus spot market purchases for different time periods. So we made
three recommendations in this area, and I’m sure you would add to that list. CPAU should
prepare detailed financial and portfolio reports that show financial results in performance for
each transaction as well as summary results for all positions in the energy portfolio. The CPAU
should restructure standard reports so as to provide each risk oversight body with data that’s relevant to its roles, responsibilities and authorities once those have been established. And then the City Attorney should also clarify which information should be held confidential and advise
CPAU in preparing policies and procedures for handling confidential information. We noted that
there’s several reports labeled confidential. We had questions about which pieces of that
information was confidential, and it is an issue that we’ll have to address if we’re preparing more
detailed reports outlining all of our positions The fifth issue here is that a formal middle office function is needed. This goes back to what we
discussed before. A middle office performs critical management functions. Deloitte & Touche
pointed out that it ensures compliance with risk management policies and procedures, verifies
credit worthiness, and monitors trader activities. CPAU, of course, didn’t have a formal middle
office. CPAU traders and staff in the Resource Management Division were performing front and back office functions. It’s a small office.
Bechtel: Surely nobody in the front side does the back side too?
Erickson: No. Yes, Council risk policies stipulate that the same person cannot make, confirm
and report on transactions. I think John will talk about this a little further when he comes on
later, but we made four recommendations in this area: that the ROC and CPAU segregate and clearly detail the roles, responsibilities and authorities for front, middle and back office
UAC MTG MINUTES 07 10 02 – APPROVED 8/7/02 32
personnel, that the City go forward with establishing a formal middle office function, and that the middle office, once established, report to the Director of Administrative Services. This is where
the CPAU already pays for two back office personnel, two accountants in the Administrative
Service Department. So, recommendation 16 would be to provide additional training in
accounting for energy transactions for staff performing both middle and back office functions.
What we’re doing on this - and, again, I’ll say that John’s going to talk about this either later or now – is even at current staffing, what we’ve found is utilizing staff that CPAU already pays for in Administrative Assistant Department and they already have on the floor. We can get
accomplished this separation of duties by moving the middle office function to report to a
separate Director. We can accomplish a kind of check and balance at staff level so that we don’t
have to elevate the stuff outside of the staff level. Again, I was trying to come up with practical
recommendations so that Utilities can make trades on a timely basis. The middle office function, the current thinking is that one person is to be hired the risk manager to head up the middle office. That person would functionally sit on the same floor with CPAU traders but would report
separately to ensure that separation. I also want to say that staff is way ahead of us on this and
has already formed their own IROC, Internal Risk Oversight Committee and have gone forward
to the ROC to get its blessing to do this. Three people are currently shaking down what a middle
office function would look like, trying it out to see what kind of reports would be necessary, how the reporting structure would work, how they would approve trades and long-term trades. So, I think by the time staff comes forward with a proposal to hire a risk manager, they’ll have more
experience with this function and will be able to give a better job description for that person.
Going to the next issue, which management controls need to be improved? Auditors always
love this one, of course. We selected and tested 28 transactions for compliance with CPAU risk
management policies and procedures. This is your standard auditor stuff here. So, we tested 18 gas and 10 electric transactions. These transactions varied in size from $58,000 to $4.3 million. Our results included instances of counterparty credit limits exceeded, tracking sheets not timely,
and performance reports not issued. It reinforces the need for reinforcing basic management
controls. Again, I think this is something that a middle office will help with. We also tested that
sample of transactions for other standard management controls. Of course, this included proper
approval authorities so we ran into the same issue of contracts and deals executed prior to Council approval, which we’ve already talked about. We also found that supervisory review was not documented on any of these deals and that several transactions were misclassified, which,
although it sounds like a small deal, as we’re recommending new reporting mechanisms, the
proper classification of transactions in those reports will become more important. I feel very
confident that by clarifying roles and expectations and preparing written procedures, we can
address these issues that were misunderstandings, incomplete procedures, procedures were in draft. And this will help ensure that if unauthorized transactions were to occur, they would be detected timely. We made a series of recommendations in this area. There are three of them:
written risk management procedures should clarify who’s authorized to execute agreements on
behalf of the City, require supervisory review of all transactions and clarifying procedures for
handling different types of transactions.
Recommendation 18 is that the middle office under the Director of Administrative Services Department should be responsible for ensuring and enforcing compliance with risk management
UAC MTG MINUTES 07 10 02 – APPROVED 8/7/02 33
policies and procedures, ensuring that supervisory reviews and oversight actions are documented – and, by the way, reviews are happened now – and make sure that (inaudible) controls are
observed. The middle office should also then monitor trader transactions, perform detailed
reviews of all transactions, establish approval limits and authorities for transactions for each
oversight level and designate responsibilities for verifying that transactions are properly and
correctly executed. These are pretty standard controls in my book. I don’t think it’s going to add a lot of time to any given process. We’ll set up performance (inaudible) and get the systems (inaudible).
The next issue is that CPAU should involve the City Council in reassessing the performance of
its energy portfolios. On the electric supply side, and I’m telling you what you don’t need to
know here, for many years, Palo Alto ratepayers have benefit of low-cost federal power. Volatile energy markets, of course, puts significant pressure on not only CPAU’s finances but the City’s finances whenever prices declined and commodity contracts lost value. And this is where the
Enron contract came in. Again, I want to stress and clarify that that was a footnote on the City’s
financial statements. When we looked at the net of that contract, which was a fixed price
insurance policy against anticipated PG&E actions, of course resulted in a net loss of about $3.8
million. The point here, and let me digress a little bit, is that it is very easy for people to assume that a long-term fixed price contract is a very safe bet. The point I wanted to make is it’s not always the safest way to go and that there are risks to that policy as well.
Dawes: I might add that, while you point out that there was a loss in the Enron contract on a
paper financial statement, initially we sold the surplus power at a profit and lost a net, I guess
was $2.8. But during this period of unstable prices, the Utilities Division was able to sell power
that by virtual of its excess hydro contract in the (inaudible) ended up with a very considerable extra cash flow. So while you said it navigated the energy crisis, I would say navigated it spectacularly successfully. While one of the steps along the way -- our insurance policy -- ended
up with a loss, it was much less than the profits that were made in our selling of excess hydro
power acquired under a long term contract. And I would have recommended having some bullet
point that there was balance of practice here.
Erickson: Let me go on to stress again the uncertainty which was what I was dealing with. Again, my scope was not to second-guess CPAU business decisions. I’m looking for policies
and procedures and how to mitigate risk. This, again, is what CPAU and you all were facing
while I was blissfully working for another city and not worrying about (inaudible) which does not
have a utility. That is the illustration of electric (inaudible) forward prices for 2002 at different
time periods. So, what were we going to have to pay for 2002 at different times? So, in September 2002, what did we think we were going to pay for 2002? You can see how it was shifting, and for the staff to navigate that was extraordinary, I agree. There is no guarantee that
we are going to, certainly hope we won’t have to face that kind of uncertainty in the future but, of
course, there is no guarantee and we have additional uncertainty.
On the gas supply side, the CPAU strategy’s been to purchase gas at fixed prices over a variable
length of time. We call this the laddering strategy. Throughout 2001-2002, CPAU continued to purchase gas at fixed prices for periods as long as 24 months. Pan Canadian price deals have
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cost us $4.3 million in value as market prices declined. So, that’s a value loss. CPAU gas costs are currently higher than market prices.
The next graph shows the bid week price. And, again, here the illustration is to reinforce that
these strategies… The market is changing, is changing more rapidly than we can set any one
strategy in place and think that all we have to do is send John and Girish and their staffs off to come up with a magic bullet for this marketplace. And that was the point I wanted to make; I know that you all know that. The point I wanted to make with the City Council is there is no one
right strategy, in my opinion, that we can count on in going forward in the future. So, the point
here was to make sure that the City Council is involved and understands risk management, that
these decisions will be made, strategies, questions and change (inaudible) have to approve these
changes. Dawes: Of course, the ultimate shedding of risk is to go to a market-based pricing scheme,
which, of course, PG&E does. It doesn't meet one of our objectives of low and stable pricing.
So the only guarantee once you deviate from that, the only thing you guarantee is that supply
prices will either be above or below the market. You never know which way, but be one way or
the other. As this graph shows, we delivered huge values to our customers for a considerable
period of time through our laddering arrangement which is a technique which we debated and approved and discussed, going to the politically expedient low risk role of going to market and chose laddering instead as a risk strategy. But it does lead to these kinds of anomalies where one
time it could be less than; other times, more than.
Erickson: Although I would argue that the spot market is not without its risks and the folks in
Long Beach… Ulrich: That's right. Long Beach is a Kansas Gas & Light (inaudible) because Long Beach did
the same kind of strategy and they got into big, big trouble because the prices went up.
Dawes: Right now they would be ahead of the game because what Sharon is criticizing
(interrupted) Erickson: No, that’s precisely my point. And if it isn’t clear, let me be precisely clear that no
one strategy is going to work here. We’re going to have a mix and that strategy is going to shift.
My point is to make sure that the Council is up to speed on these issues, that when you
recommend a shift in strategy, Council understands that that’s entirely appropriate. I’m confident
that there is no one great strategy. If we had it, we would be very wealthy. Ulrich: This was debated long and hard. We decided that we would not have a strategy in the
sense of trying to forecast and predict the market or pick the kinds of risks to our customers in
seeing the price go whatever direction it went. So, the laddering strategy is a strategy that was
accepted and, as far as I can see, unless we can be real certain we’re near the bottom of the price
curve, we will use that laddering strategy as our strategy for purchasing. I think that's where real positives have been shown here of how less dramatic those price shifts have been on the customers.
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Erickson: But, for example, CPAU has already deviated from that strategy in the sense of going
ahead and purchasing far more gas for the full year in advance of what you would have otherwise
done when the market was low.
Ulrich: We did that by going forward and saying… because we thought the prices were low. The point of it is I think you're trying to say the communication that we have in this area has been very good but we have an obligation to keep the City Council informed and for them to buy into
and accept or give us direction to do something else.
Carlson: We recommended that you go ahead and buy more gas.
Ulrich: You did more than that. Remember what you said. What were the those words? It was more than just go out and buy a little bit more.
Carlson: As I recall, I said you were being too cautious at this time and this is a great market and
you should buy all the gas you could get.
Ulrich: That was correct. Erickson: The other piece of the whole issue of reassessing risk strategy is, of course, the role of
reserves. The City has sizable rate stabilization reserves that is another key piece of our energy
portfolio strategy. Those reserves mitigate electric and gas market price exposure and cushion
the impact of volatile commodity cost and they will continue to be a key factor as we move
forward. Another issue is that commodity purchases, of course - and again you will know – have become
complex financial transactions. I’m repeating myself here. But the point was to make sure
decision makers at all levels understand and are aware of the various risks of their portfolio
decisions, and that was particularly important as we’ve got new Council members who are being
thrown into this pot post-energy crisis but in the middle of the volatile situation. We want to make sure they are up to speed on the risks and rewards of what we’re out there in the market doing. We made three specific recommendations in this area, that CPAU continue to regularly
and actively review the performance of the energy procurement strategy, quantify the risk and
cost of (inaudible) alternatives and communicate the risks and costs and recommended revisions
to the City Council, that the ROC and CPAU include in their analysis the financial risks of using
fixed price contracts in the laddering strategy and identify alternatives that might take advantage of market trends and third, that the CPAU conduct a peer study to provide the City Council with background information comparing CPAU commodity strategies with other municipal utilities.
And here the point was to give the City Council, who may be unfamiliar with what other
jurisdictions are doing, a context for decisions they may be asked to make.
We have a couple of other issues. One is that a quality assurance program for the energy model
is needed. It is a complex spreadsheet model staff has developed using a series of Excel spreadsheets that is used to optimize energy resources and generate portfolio forecasts and do
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financial evaluations. CPAU, of course, needs this data to be accurate, and we’re recommending that a quality assurance program be instituted and that - the auditors’ favorite of all favorites -
that an official archive of final documents is needed. It’s currently on a shared drive and we need
items that have been marked “Draft” to be marked as “ Final” so that we can track all of your
actions through all of these ups and downs.
Bechtel: You did recommend removing the shredding machines?
Erickson: I tell you, this auditor uses the shredding machine very carefully. We made two
specific recommendations, again, that CPAU develop a quality assurance program for testing,
reviewing and verifying the accuracy of data used in the energy model and that CPAU establish a
formal archive, whether it’s electronic and/or paper, that contains final official records of minutes, reports and so on.
In conclusion, let me say that - again I want to say this – CPAU has made considerable progress
in addressing risk management issues and improving the evolving risk management program.
Additional improvements are needed to help and protect the City’s financial interests. Our audit
recommendations are designed to reduce potential risk to the City. I want to thank City staff for
their support and cooperation during all of this, especially John and all the CPAU staff, Girish and his staff in the Resource Management Division who weren’t always thrilled with having us there but who were always hospitable. In particular, I want to thank Karl Knapp who has guided
us through the final steps of this audit. We had ASD staff involved, Joe Saccio and Julie Pai and,
of course, Carl Yeats. Joe and Julie are helping to work right now on the IROC that I mentioned
before. The city Attorney’s office has been involved, Grant Kolling. The City Manager’s office
has been involved. I want to thank all of those people and, again, Edwin Young from my office. If there are any questions, I am happy to answer; otherwise, I’ll turn it over to John. We did
include the City Manager’s response in the back of our audit report, and I assume that John’s
going to give you some of the highlights of that response.
Carlson: Any other questions? Or should we proceed with John? Ulrich: I am going to take the summary approach. Sharon has done a very good job of walking
through each of the points. As you can imagine, the staff spent considerable amount of time with
Sharon and Edwin, particularly going through all the recommendations so we clearly understand
them. Sharon and Edwin spent a lot of time listening to our responses and working with us to
understand a business that I don't either one of them had all the jargon and all the utility background. So they listened a lot, reviewed or attended virtually all the UAC meetings and worked with us for a long period of time. So I think the audit results speak to the fact that they
got in and dug into what we’re doing in more than just a surface review. If you look back at the
kinds of risk management policies and tools that we've had -- it goes way back into the middle of
the 1990's and earlier -- when deregulation started and we were moved way away from being able
to purchase our commodity once a year and sitting back and waiting for the right time in the next
summer to go and buy some more gas. We've come a long way in looking at the volatility of the
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market. All of the decisions sure helped us with the Enron cancellation, finding replacement gas, a supplier and operations organization to replace Enron. Those were really key things.
What's pointed out here is that we (Utilities and ASD) have done an incredibly good job of
managing what is important to the residence of Palo Alto. We've been able to show that we
continue to look out for their best interests because they do pay for everything that we buy, whether we do a good job or otherwise (inaudible) The most important thing we have in Utilities is our integrity and our ability to demonstrate to our customers that we know what we are doing
and they trust us. So, by having an audit, going through this and pointing out things we can do to
improve just allows us to keep making that continued step forward to doing things the best we
possibly can. I appreciate Sharon's point – people have reminded me that this does not occur
very often where an auditor actually says really positive things. Their role is to look for things that are not going well. When she said that CPAU has made considerable progress in addressing these risk management issues and improving its evolving risk management program, I take as a
compliment that we've done quite well.
I will not go through each and every one of the points, but as Sharon pointed out, we have a
report in the back of the Audit Report from the City Manager addressing all the items that are in the audit. There are 24, as Sharon went through earlier; each one of those we agree with and we have listed a status because some of them are underway, some have an additional length of time
it's going to take to put them in place. There is a level of costs in resource commitment that will
be required to get all this done. We need to look at what some of those costs will be, we need to
prioritize these in a way that the ones we do (inaudible) and, candidly put the ones that don't have
as much impact in a lower priority. So, those are listed here in the status. We will refine that and
have a more complete, and with timeline, that will be done shortly. I believe, though, that everything here is calculated at least (inaudible) to be completed by the early part of 2003. So, the staff thinks it can do it.
Dawes: Frankly, John, I was shocked to see the D&T contract for risk management escalate to
¾-million dollars. Are we getting our money's worth on that? Frankly, I was sort of under
whelmed by the only presentation they made to the UAC which was maybe a year ago. It seemed like an awful lot of money.
Ulrich: You want to say something?
Balachandran: The ¾-million dollars is a cumulative amount from the time they started and
they've done a number of reports for us. We've had two people who have been major contributors to --
Dawes: It's all risk management?
Balachandran: Oh, yeah. And Thad Malit who has subsequently left (inaudible). He still works
for D&T but on another project. We do have Karl Van Orsdol who’s actually back there in the
audience from D&T who's working for us right now . They have been very valuable, they bring in the perspective of best management practices. Karl has worked with public power so he
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brings additional vision that some of the other consultants don't have. He's consulted for public power so that's been very helpful, bring credibility to the recommendations (inaudible). At the
moment he's also working on helping the temporary middle office in developing guidelines and
policies. So the increase that was requested of the Council was $300,000. It could be less than
that if we hire a risk manager (inaudible) but if he (inaudible).
Ulrich: I think the way to look at this because we spend a lot of time analyzing this, whether this is the right thing to do. Let's take into account that you need to have advice on this kind of
business beyond what we have internally. We can't expect the City Auditor who doesn't come
with all that knowledge to be able to come and tell us about every best practice. So, if we waited
for the auditor, or wait for us to go with our own strengths, we'd be further behind in the curve of
getting up to best practice. Dawes: Were their recommendations woven into, was it helpful to you, Sharon?
Erickson: Yes, I won't comment on the price because I'm a very cheap person. We were able to
build on the work that they had done. One of the ways we could get up to speed so quickly was
building on the recommendations they had already made. For example, the middle office, the
separation of duties was a recommendation they had already made. Once we got a hold of their reports, we would just go from there. So it did facilitate our work to a large degree.
Ulrich: It also has an end point. It’s not an ongoing fixed cost. If there are any questions of me,
I will be glad to go into more detail, but the point I want to convey is there is a clear plan to
(inaudible).
Bechtel: I have one question. I think Sharon may have said this at an earlier meeting that there was no attempt to prioritize or to weight any of the recommendations. Am I understanding you
correctly?
Erickson: That is correct. Utilities has agreed to implement all the recommendations. We got
agreement. Some of the recommendations are pretty broadly state and are going to require some thought to implement. Some of them will take longer and some have to go through the whole food chain here and start out with the ROC, the Utilities Director, and then the ROC, the UAC
and the City Council so it’s going to take them a while. The only recommendation that I am
aware to date that will definitely cost dollars is the hiring of a risk manager. And that's
something, I believe, that we all agree is a function that we need to have on the staff.
Bechtel: John, it's a follow-up question. Do you have a strong sense among your team as to what the most important, the highest priority items are, on an operational basis?
Ulrich: I think the answer is yes even though I can't quantify dollar amounts. The separation of
the office is one that needs to be completed. There's a clear path of training and responsibilities
to be laid out and implemented. There's not whole lot of unknowns there. It needs to be done.
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Carlson: If there are no more questions, we have a public member to comment on this issue at this time. Do you want to go next? This is John Melton from Calcaterra Road in Palo Alto.
PUBLIC COMMUNICATION
Melton: Thank you. I wanted to comment briefly and generally on the Auditor's Report. First of
all, I think those parts of the report that deal with best management practices are very valuable
and I'm sure that the Utility Department will embrace those enthusiastically. However, I share
the concerns that you all expressed early in Sharon's presentation. The Utility Department is,
first and foremost, a business. Even though it's wrapped inside of a city, it is a business and it happens to be dealing in what is currently a very dynamic marketplace. I think we all agree that that's not going to change anytime soon. It seems to me that it's very risky to take the approach
of saying we need to somehow shoehorn this business into the policies and procedures that the
City of Palo Alto follows in its other businesses and its normal operations. We've had a report
here recently where in general it takes City of Palo six months to culminate a contract. These
guys have to do contracts in six minutes. You cannot layer those requirements, the bureaucratic requirements and policies and procedures of the rest of the City on top of the Utility Department and expect it to succeed. It'll just get wrapped up and flounder. I think the better approach, and
the approach that I hope you will all take, is to address directly how those general City policies
and procedures need to be modified specifically for the purposes of the Utility Department. I
think the Utility Department needs its own operating rules, which are different from including
signature authorities, RFPs. A lot of the business practices need to be different for the Utility
Department from the rest of the City, because it's an entirely different business. Thank you.
RISK MANAGEMENT POLICIES
Carlson: Any questions? Any further discussion on this issue? Or should we move on to our final item of risk management policies -- which we're not acting on, but we're introducing
tonight?
Ulrich: This goes hand in hand. You can see that a lot of work has been done, is being done on
the energy risk management policies. Listed in the background of the memo is all of the steps, all of the things that have been done to make improvements (inaudible) policy. Staff brought certain policy elements to the City Council for approval. We've been operating under an Interim
Risk Management Policy and Procedure – it's an IRMP&P – which will be the last time I'll refer
to it that way.
Bechtel: Can't you put some vowels in it? Ulrich: We didn’t spend much time on that obviously. We listed a number of steps of
improvements that have been made. What we’re at today is using recommendations that we have
coming up with improvements in policies. They’re articulated in outline form on page 3 of 6
under discussion highlights. The risk management policies that were approved by the Council
contain a clear business objective. The proposed energy risk management policy contains a
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slightly different set of primary and business objectives, each of which are elaborated in the policies. You want to go through that summary?
Carlson: You have some slides, don’t you?
Bechtel: I have a question under 4, page 4. It has general transacting guidelines and it says maximum transaction term of 10 years. I assume that if we were to deal with the Western contract, and we have already done it, which is for a longer contract, the 10 years would fit a
guideline only if you go to Council. These are just guidelines I’m assuming. Is this correct?
Ulrich: Yes, the 10 years seem like a long term in today’s market.
Bechtel: Then in the case of Western, it may not …
Ulrich: Right, we’re not going to go back to Western and ask them to reduce our contract term.
Carlson: We’ll take as many years we can get.
Ulrich: Yes, I know you can never get enough. Is this a good way to go through this? Bechtel: That was the only question I have on the entire document.
Ulrich: I guess we spent a lot of time about risk management policies. You’ve see this one, it’s
a definition of risk. This one we talked at some length and it’s a very good pictorial of how the
risk management structure is and where it’s transitioning to. City Council has approved risk policies. The City Manager oversees that and then discussion about the roles of the ROC. Down where the middle office in the area blue is the transition to where we’re going. All of those
functions are currently being done in Utilities. We now have the ability to transfer these and
have more of a barrier between the front and back office by having the risk manager assume
those responsibilities. So, the risk manager will provide risk measurement reports to the ROC,
will come to the ROC with dilemmas that can’t be solved in negotiations between the front and the back office, provide management reports, will question how the front office is forecasting and their purchasing plan. So you have give and take and a clear commitment once each of the
offices have done their role, that we’re doing timely and accurate transactions, and there is
appropriate oversight.
This one is summarizing that we’re going to continue to make improvements and develop (inaudible) best practices as soon as we find (inaudible) best practices, we’ll move on to (inaudible). The summary of the risk management program continues to evolve all the time.
We’re supporting everything we’re doing with our strategic plan. Strategies 2, 3, 4 and 6 are
clearly involved. We’re going to incorporate recommendations from our outside consultants and
from the City Auditor. I’m kind of repeating things I’ve already said. Sections from existing
policies are incorporated in our improvements. I think this is quite a good summary of business objectives that reflect the balance of stable rates, low cost and efficient processes. Speculation definition refers to forecasted load so we have clarity over that. Authorities and responsibilities
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clarify delegation of authority. Separation of duties is more clearly defined under roles and responsibilities of oversight bodies. Operational policy moved to the guidelines and procedures.
And our counterparty present policy is (inaudible). Our reporting requirements are more
detailed.
Bechtel: John, you didn’t say, though, of all these new reports, how many we will get to see? Ulrich: We’re really not quite sure. That is obviously (inaudible).
Bechtel: The one that would be fascinating to see, but I’m not sure we ought to, is the portfolio
one with the transaction log on a daily basis. We’ve been looking at that and the reason it’s
interesting to me is that we have been looking at that with respect to our long-term plan. We’re going to be looking at a similar chart that says our load and what we’re using to fill it. And the purchase report and so on will be almost an actual of the plan you and Girish and the rest are
putting together for the next year because you’re going to be using your laddering and contracts
and be buying so much on that. Now, is that what that transaction report will be, the line by line
spreadsheet graph of how that’s being bought?
Ulrich: It could be produced where you see each and every transaction, but more of … Bechtel: Not that we should it, but I’m just saying that the end result will be a chart, could be a
chart to reflect our mix that (inaudible).
Ulrich: We have brought those charts for you to look at. One (inaudible) of this is that we’ve
learned where we have a forecast for whatever it is we need, we have a laddering strategy we are able to see how we’re purchasing to fill that load and then will be able to see what we’re paying for it over time. And it will also get to the concern, are you ever at any time buying more than
your load? You will be able to see what we purchased as compared with the load. You will be
able to have that kind of dynamic review. We’re trying to find a way to have those reports and
see how well we’re doing.
Bechtel: But I can see a very complex report because you’re also not only buying by the month, but by the day, by the hour, essentially.
Balachandran: Yes, that’s level of detail that .
Bechtel: You’re not going to go that far ... Balachandran: It is unnecessary, but I think over here on the policies we have a couple of places,
I think the general statement over here, reports for the UAC should allow it to review the City’s
risk position to carry out its advisory role to the City Council. So, the way we’re looking at it is,
reports that go to the City Council at (inaudible) you can see that. And maybe some reports of
more detail. It’s going to be an evolving process; we’re giving you a set of draft reports and you’re going to give us feedback. Say, you know, this is going to be more useful if I see it in this format or that, just as we’ve gone through other reports’ formats. And we’ve gone through
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the same kind of process with the ROC, but the ROC, yes, this is the kind I want to see, I want to see something else. The City Auditor has made some additional suggestions about your reports.
That’s also going to be evolving. The general theme of the UAC is going to be longer term and
strategic, but also it’s a duller -- there’s going to be a lot of reports that you haven’t seen that
you’re going to get to see.
Swaminathan: We look at daily reports (inaudible). (Inaudible) at daily reports (inaudible) but it will not be a part of this reporting structure.
Balachandran: If you’re interested, I can provide it to you, but I don’t think it’s appropriate as a
UAC.
Ulrich: Our objective is still going to be one that I think you made clear to me and staff, that you want to be able to see information that tells you how well we’re doing in meeting the strategic
plan goals and objectives that we have, that you want those down to a relatively small number
that we can monitor on an ongoing basis. That also means that you have other more detailed
reports to give you satisfaction that we’re meeting some of the more important goals of the
overall strategy. That’s what we plan to do.
Ferguson: Just a couple of comments on this. We’re headed in the right direction. The first time -- two years ago now -- Girish introduced the risk management committee concept to us, I had
my doubts and said I was worried about the “paralysis by analysis” phenomenon, and being over-
consultanted. It’s worked out pretty well. It has served us well in this wild, crazy price
environment. We didn’t expect that environment to hit so immediately. It was nice to have
thought about some of these things ahead of time. I’m glad we’re taking this step. The introduction of a middle office function meets the auditor’s needs. That is well and good. Having a professional person’s second set of eyes looking at the checklist, the punch list of risk
management procedural guidelines, is a benefit. If it takes five people to do that, if there are five
different parts of city government doing that, we’re doing the wrong thing. But one smart person
doing that -- if we can attract a person to do that job -- that is not too much analysis to add.
We were talking about reporting here a minute ago and my second comment goes to how this manifests as practical results. What is it that changes as a result of this new person’s work?
Rather than get lots more detailed reports coming automatically to UAC or to the Council, I
would like to see the CMRs that come out -- where decisions indicate a particular risk, big dollar
value, or change of strategy, or something like that -- those reports should have a half-page
checklist of 8 items -- I don’t know, more than 5 and less than 20. Those are the bullet labels for the things we think are important, the procedural hoops that should have been cleared in the course of making this decision. The new middle office person adds his or her signature to the
report and certifies, “Yep, I watched this transaction develop and I’m satisfied that the staffers
cleared these hurdles.” (Inaudible) written so that for under 10 years, whatever (inaudible) down
to (inaudible). It doesn’t matter too much to me, the exact label. But visually, for our purposes,
to ease your workload and to communicate to the public, it would be nice to get that down to a
short little checklist.
UAC MTG MINUTES 07 10 02 – APPROVED 8/7/02 43
Balachandran: That is the role that middle office, the risk manager would play for the large part with the Risk Oversight Committee and would extend in some manner to (inaudible) .
Rosenbaum: I’d like to make a couple of comments. First, I want to commend Sharon and Mr.
Young for what I thought was a remarkable job for people who came into this not knowing
(inaudible) business. You picked it up very quickly. Let me ask a question to get to my point. This middle office, are they going to review the future price forecast that the front office makes, which are really the basis for our buying decisions?
Balachandran: The middle office will have to have access to their own forward curve and they
can decide how they’re going to do it. They can decide whether they want to depend on us or
they can do samples or they can subscribe directly to sources. So we could be getting e-mails and faxes of market prices and they could be doing the same thing. But that’s something that the middle office, the risk manager will work out according to his or her satisfaction and to the ROC.
That is that person’s responsibility. So they’ll have access to (inaudible).
Carlson: So they’re not just reviewing transactions. They’re dong their own forecasting?
Balachandran: They need to get access to their own prices. So that’s what I’m saying. Rosenbaum: Well, they may use the same prices. Let’s distinguish between forecasting….
Balachandran: I’m talking about forward price.
Rosenbaum: Well, you’re talking about forward prices as obtained from the market as opposed to Henwood. They were the people who have come up with the curves, which will be then be the basis from which you make decisions as to what actions to take.
Balachandran: Not necessarily, right, because the Henwood price is (inaudible). It’s based on
certain assumptions and the market is market which is the actual price we transact at. And we
have to make a judgment as to which you are going to use. So, we look at both and, you know, the front office will look at the charts – it’s a risk assumption office, so we make a judgment call based on the strategies (inaudible) the recommendation. The middle office is going to look at the
recommendation and provide his or her critique to the ROC, saying we think its okay, we think
that, uh uh, we’ve looked at the Henwood forecast, prices are dropping. Because of this, we
don’t think the front office should buying this much.
Rosenbaum: All right. I guess that’s my point. I question whether that’s the role of the middle office, but I think the middle office ought to be trying to prevent rogue trades that put the City at
great financial risk.
Balachandran: That is one role that they do. They verify and they advise the ROC too. This is
appropriate risk (inaudible).
Dawes: It’s a second-guessing function?
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Carlson: Yeah, that’s what it sounds like. I think that’s pushing the envelope to (inaudible).
Ulrich: Do you want to delve into that or do you want us to come back for some more
discussion?
Carlson: Definitely worth some discussion.
Ulrich: We’ll work out all those details with the IROC (inaudible).
Balachandran: Why don’t you just look at the policies to clarify what exactly the policy says
about the middle office? Maybe that’s what … Bechtel: So where is that, what page?
Balachandran: Page 5.
Ulrich: It says here that the Middle Office provides the primary independent management
oversight role. The Middle Office institutes, supervises, and reviews all risk management activities. Its responsibilities include monitoring CPAU’s risk exposures and ensuring
compliance with policies, guidelines, and procedures. The Middle Office adopts and updates as
necessary the Energy Risk Management Procedures so that portfolio management functions
occur in compliance with Council-adopted Energy Risk Management Policy and ROC-adopted
Energy Risk Management Guidelines. The functions of the Middle Office can be broadly
defined as quantitative analysis, compliance review, credit administration, and management reporting. Each of those functions are defined below.
Balachandran: I think a lot of what I talked about was in the quantitative analysis but there are a
number of other functions that they do, which is, I think, what you are talking about, which is
compliance review, credit administration and management reporting. In the quantitative analysis
function, they maintain settlement price, they maintain forward price curves (inaudible) other market price database and they would evaluate on both a transaction basis and a portfolio basis. Karl?
Van Orsdol: I’m Karl Van Orsdol with Deloitte & Touche. Basically, the middle office can use
the forward curves developed by the front office, but because they have to do independent
valuation of, for example, value at risk, the value of the portfolio, they have to take an independent look at what future prices are so they can do the method, the quantitative analysis of risk and exposure. That is, they’re not doing any sort of second guessing. They’re just ensuring
that they have an independent view of the market.
Dawes: Is this a mark-to-market function basically?
Van Orsdol: Mark-to-market or value at risk.
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??: ___ value at risk and that is certainly worth going _____.
Van Orsdol: The purpose is not to second guess what the front office does. The purpose is to
ensure that the front office is doing correctly and there is an independent source to look at it. But
really the primary function of the middle office is to ensure that traders are held within their
risks, both in terms of credit or in terms of exposure to serve as second set of eyes; to ensure that each transaction, when each transaction’s ticket is filled out, all the information is filled out, all the information is filled out correctly and is entered into a system for recording; to ensure that the
back office, then, can confirm all the transactions that are taking place; ensure that the activities
of the front office are within the set Policies & Procedures set forth.
Balachandran: Just to clarify over here, I may have overstated the role of the middle office in terms of second guessing by the front office.
Van Orsdol: I wouldn't think of it as second guessing. I would think of it as being able to access
independent information to ensure that the valuation of the portfolio and the estimation of the
risks are correct.
Carlson: I think the concern we all had is a new party stepping in saying you shouldn't have signed that contract (inaudible). (Inaudible) adding a week to the decision (inaudible).
Van Orsdol: Actually, the way we've seen this develop, it actually should free the traders up
much more. What's gone on is that when there's been individual transactions, there's been
concerns and comments from a variety of parties as to whether this was a correct or an
appropriate transaction. What the risk manager, the middle office, does is he sets out the parameters so that every trader when they come to the office that morning, they know their position and they know where they are in respect to the limits that they have in terms of specific
counterparties, in terms of credit, in terms of their risk exposure. So it allows them to be operate
much more effectively because they know exactly where they stand.
Rosenbaum: It seems to me the primary risk to our customers, in terms of paying more than they might otherwise pay, is the accuracy of the forecast from the front office. Someone has to say, "I don't think we ought to buy for four years, buy for six years or two years, go with the market for a
while." The decision to buy the Enron contract, that was something we all bought into and it
turned out that was a bad decision which put our customers at risk. We thoroughly reviewed and
approved, but it seems to me that the real risk is in -- it is my view the auditors are more
interested in the rogue transactions. When you in your audit report mention that when we entered into the Enron contract, there was a lot of risk there. That's certainly true, but we could have made other choices. But that's not the sort of risk I thought an auditor is concerned with.
Carlson: We knew the risk. At least we knew the risk was there. We just stumbled into it.
Ferguson: It was not a bad decision. It was a good decision with a bad outcome.
Carlson: Go ahead, Karl.
UAC MTG MINUTES 07 10 02 – APPROVED 8/7/02 46
Knapp: Actually the other three forms of risk that the risk manager (inaudible) can be just as
large as the forecast (inaudible) risks so another type of forecast (inaudible) over or under
forecast what we needed to buy and then end up being exposed. Operational risks (inaudible)
could be a really big problem if you don't have controls and credit risks (inaudible) you bought
something (inaudible) money, yet they run out of business even though they're under contract. So that's the other pieces that the risk manager has to deal with all of those (inaudible). I think that one person centrally managing (inaudible).
Bechtel: Karl, with respect to what you mentioned about I guess the demand side. I was just
thinking that the front office is going to (inaudible) demand side forecast. How is that risk
mitigated? Not through the middle office as I look through this. It mitigates through us in some cases because we discuss it on an annual basis (inaudible) so the long range demand forecast is usually put together by the resource planning group and then we discuss it (inaudible).
Balachandran: Yeah, I think there is. I think over here what the ways we mitigate that risk, the
risk of demand being higher or lower, we can take the portfolio approach and in the electric side
particularly we have all different recommendations we make for purchases we accounted for
(inaudible). And so we can predict load relatively well, maybe a couple of years out. So, you know, in the long term we (inaudible) pretty big gap (inaudible) to account for them. There are ways to hedge load which are pretty expensive, which essentially (inaudible) buying insurance.
But that, just like some of the weather products that we've seen - Shiva explained the hydro side -
they're very expensive.
Bechtel: My question was really in the context of middle office vs. front office. Knapp: To answer that, one piece of that is to make sure that you're errors are due to variables
that are moving around, not because your forecast has (inaudible) issues. That's one of the
recommendations that they had up there, that the middle office is responsible for making sure
that the models we're using don't have errors in them.
Bechtel: Okay.
Balachandran: Verifying…
Knapp: Sometimes systematic error.
Carlson: Any more questions on this?
Bechtel: Chair, what should be our action here? Should we take a pseudo vote or no vote?
Carlson: I was going to ask John because I think we've gone over the (inaudible). I'm not sure I
want to do it again next time.
UAC MTG MINUTES 07 10 02 – APPROVED 8/7/02 47
Ulrich: I want you to be comfortable with it. I'd appreciate a consent, I guess a support vote that what you believe is that we've done all the things that we should. And I would recommend that
we bring it back briefly next meeting for you to formally act upon.
Ferguson: I move that the Commission indicate its support for the staff work on this report and
bring it back next meeting in final form reflecting our comments tonight. Bechtel: Second.
Carlson: It's been moved and seconded. I'm not sure if this needs a motion, but we may as well
go ahead. Anybody have any problems with it? All in favor?
Commission Members: Aye.
Carlson: Okay, so that's what we're going to do. But we don't want to go through the report
again. Anything new, any changes? Bring us the deltas, don't (inaudible). Okay, that is it as far
as I see on the agenda. Now, you have the new information?
Ulrich: If you'll bear with me for a second. If you wouldn't mind taking a moment to look at the agenda for next month and also just affirm the date and time for the next meeting.
Carlson: The next meeting will be Wednesday, August 7th, 7:00. We have the agenda here and
I'm waiting to see if we've got a final update on the water (inaudible).
CONTINUTATION OF DIRECTOR OF UTILITIES REPORT
Ulrich: If it's agreeable with you, I'd like to go back to revisit my Director of Utilities Report and
open it back up for a moment so I can give you an update from what I discussed earlier.
Carlson: Okay, go ahead.
Ulrich: If you'll bear with me, I have to read this. This is from Jane. The San Francisco PUC
decided to hold over the bond measure until its meeting next Wednesday, July 17. They did
accept Director Pat Martel's amendment and made the total $1.6 billion, which is just the City's
$900 million portion of the regional system, $7.4 million for inside of the City. They were supportive of the measure but they are working out details around this pass-through (inaudible) in the City itself, not our concern. It's expected to be passed on to the full Board for their
consideration on July 22. It only needs one reading.
Carlson: So, they are assuming passage of the State legislation that allows BAWUA to become a
fully fledged agency as far as money-raising powers go. Ulrich: This will give it, with this schedule that they're on, assuming they approve it, it can go as
late as July 29th for passage and then it will still be able to get on the November ballot so it looks
like they're on schedule. (Inaudible) approve it on the 22nd (inaudible). That's my revised
Utilities Director Report.
UAC MTG MINUTES 07 10 02 – APPROVED 8/7/02 48
Rosenbaum: It would interesting (inaudible) some aspect (inaudible) is what if the San Francisco
measure fails?
Balachandran: You're going to get all that next month.
Ulrich: (Inaudible) would like to go through that now?
Bechtel: Let's come back to the next month's agenda. Mr. Borock pointed out about the Fiber to
the Home Market Report. It would be useful if we could get it in advance. Could we ask staff to
try to (inaudible) interested people to get (inaudible). Can we at least have it on some Internet …
Ulrich: As our plans and policies go, the way we've being doing it is we usually release it on late Friday afternoon before it’s scheduled for review, and then it's a public document. We do make
it available (inaudible) send to people that are interested now. So it's available in my office and it
will be available and we’ll make it available …
Carlson: This one in particular, I wonder if we shouldn't put it on your web site?
Ulrich: Remember that this Fiber to the Home presentation isn't necessarily the final business plan either. I have no problem putting this on the web site, whatever you want to do. This may
not be the big business case …
Rosenbaum: I guess that’s my question, what is going to be the ultimate action? I have heard
about a plan going to Council in September, October (inaudible). What is (inaudible)? Ulrich: This is an introduction so you know what the business plan is. We have a person
working on giving you an update on what we're working on, the data that we have and also our
survey work. So, we'll give you all that information.
Carlson: Yes, I think in this case it should be on the web site, both paper and electronic. Ulrich: Everyone agreeable?
Carlson: There's so much interest and these are people (inaudible) on the list (inaudible). Does it
cost as much (inaudible).
Rosenbaum: Whose web site, the City’s web site?
Carlson: Yes, the City’s web site. Any problems? This will be an information item in August.
Ulrich: Yes.
UAC MTG MINUTES 07 10 02 – APPROVED 8/7/02 49
ADJOURNMENT
Carlson: Okay, motion for adjournment? Dawes moves, Ferguson seconds. All in favor?
Commissioners: Aye.
Carlson: We’re adjourned. Thank you.