Loading...
HomeMy WebLinkAbout2003-05-07 Utilities Advisory Commission Summary MinutesApproved UAC 2003May7 Minutes Approved on 6/4/03 Page 1 of 65 UTILITIES ADVISORY COMMISSION MAY 7, 2003 Roll Call _______________________________________________________________________________1 Agenda Revisions______________________________________________________________________1 Oral Communications_________________________________________________________________2 Approval of Minutes __________________________________________________________________2 Director of Utilities Report____________________________________________________________3 Fiber to the Home Phase I Report ____________________________________________________5 Utilities Budget - CIP_________________________________________________________________29 Utilities Budget - Operating Budget _________________________________________________35 Gas Rate Proposal____________________________________________________________________47 Water Rate Proposal _________________________________________________________________51 Wastewater Rate Proposal___________________________________________________________51 Energy Risk Management ___________________________________________________________52 Gas Rate Proposal (concluded)______________________________________________________62 Next Meeting _________________________________________________________________________64 Adjournment _________________________________________________________________________65 Roll Call Rosenbaum: I am Vice Chairman Rosenbaum. Chairman Carlson will be listening in by telephone but he is not able to be here tonight with us. Could everybody please announce themselves? Ferguson, Bechtel, Dawes: Present. Beecham: Councilmember Beecham present. Agenda Revisions Rosenbaum: Alright, John, could we start off with a little discussion of the agenda? There seemed to be quite a few items here. I think we ought to attend to the fiber to the home item first. Then we have to do the budget items tonight. Why don’t we move the Quarterly Report after the budget items. And the GULP -- is it necessary to deal with that tonight? Ulrich: It would be helpful because of the gas supply that we’re trying to plan for. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 2 of 65 Rosenbaum: Alright, if we really want to do that, why don’t we make that the third item and put the Utilities Quarterly Report after that. That would be the fourth item. The last two items we can probably put off until another time or judge whether we think we’re up to dealing with them tonight. Ulrich: I would like to do the Energy Risk Management, at least get that information to you publicly, and have a brief presentation if I can. The person who is making the presentation won’t be here until after eight anyway so I think we’ll be able to accommodate that. Thank you for accommodating this very large agenda. I would like to point out before we get started that Mr. Carlson will only be able to listen -- not participate -- because we were not able to post the notice in enough time to adjust the agenda and show his location. Oral Communications Rosenbaum: Fine. Alright, next item on the agenda is Oral Communications. Is there any member of the public who would like to speak to us at this time on any item that is not on the agenda? Would you come forward please? If you could just let us know for the record who you are? Roda: I am Antonio Roda, Palo Alto resident. Is this the proper time to speak about the proposed fiber optics? Rosenbaum: Why don’t you wait until we get to that agenda item? Roda: OK. I just came in and I wasn’t sure. Sorry. Approval of Minutes Rosenbaum: Fine. Alright, seeing nobody else, let’s move on to approval of minutes. Colleagues, any corrections or changes? Ferguson: Just one correction on page 43. There is a vote on the Poe License Application issue, where Commissioner Dawes was Nay. Minutes show Councilmember Beecham voting with the UAC. That was a mistake. Ferguson, Bechtel and Rosenbaum voted Aye, and the inclusion of Beecham there was a typo. Rosenbaum: Yes, good. Thank you for that correction. Anything else? Alright, could I have a motion to approve the minutes as corrected? Dawes: So moved. Rosenbaum: Moved by Dawes, seconded by… Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 3 of 65 Bechtel: I’ll second. Rosenbaum: Seconded by Bechtel. All in favor of approval of the minutes? Ferguson, Dawes, Bechtel, Rosenbaum: Aye. Rosenbaum: The minutes are approved unanimously. We’ve taken care of the agenda review and revisions. Do we have any reports from commissioner meetings or events? Seeing none, let’s move on to the Director of Utilities Report. Director of Utilities Report Urlich: Yes , thank you. I have a couple of items that I’d like to quickly go through and bring you up to date on. Item 1 is just to mention what has been approved by the City Council since our last UAC meeting. We’ve had approval of a company called Three Phase to administer a Palo Alto Green Rate schedule that we’re proposing to the City Council for implementation in June. The Western layoff agreement was approved by the City Council. Second is items that are scheduled for the Council. I thought it would be valuable to keep you up to date as to what is moving along through the Council, some of which you review and some of which are part of the normal business that we’re conducting. The LEAP implementation plan is scheduled for the Finance Committee on June 3rd and the Council on June 30th as an action item. The GULP which you’ll be discussing a little bit later is scheduled for the Finance Committee on June 3rd and the Council on June 30th as an action item. The Strategic Plan Update is scheduled for the Council on May 12th as an information item. The Western O&M contract amendment is scheduled for Council on June 2nd. We’ll have some discussion about Senate Bill 888. Yesterday, Commissioner Ferguson accompanied me and several other NCPA members to the Senate Energy Utility Subcommittee of the Senate to testify on proposed Senate Bill 888, which is sponsored by Senator Dunn. Basically, it attempts to return obligation to serve and other aspects of the deregulation legislation of several years ago AB 1890, back to something that looks very similar to what it was like in the good old days before deregulation. This would be a very comprehensive and a very large change in legislation that would effect virtually every customer and every utility user in the State of California. There is very little that involves municipal utilities directly because we already have an obligation to serve. But it has some interesting ways to help us improve reliability of the transmission system, more assured of service that we get over the transmission from our generation delivered to Palo Alto. So we are very much in favor of it. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 4 of 65 It was a good day yesterday. We had an opportunity to listen to a lot of testimony on both sides, particularly from the opponents of it. Primarily, a couple of investor-owned utilities, and merchant generators, and those that are interested in continuing to have Direct Access as a favorable way of getting energy supplied to their businesses. I don’t know how all this is going to come out. There will be a lot more hearings. It’s going over to the Assembly and then if it gets far enough it will get to the Floor. Yesterday’s vote was 5 to 3 in favor of moving it on. I do want to express thanks to Mr. Ferguson for taking his time to 1) ride with me all the way to Sacramento and back, and 2) take a lot of time to give a very strong statement to the Senators. The next item is the NCPA Renewables RFP proposals. We’ve had some discussion on it. It is an integral part our renewable portfolio. 66 proposals were received back at NCPA so there are lots of renewables out there and a strong interest to sell it. It came to an excess of 2,000 megawatts, if you added it all up. 1,200 megawatts of that was at NP15. Mostly, wind and biomass with some solar geothermal and, of all things, ocean wave. Prices ranged -- and this will be very intriguing -- somewhere between, depending on what it is, $31 and $250 a megawatt-hour. The average price at NP 15 was $52. After we review all of this we’ll come back to you sometime in the late summer and early fall. The ISO has issued a press release to tell everybody that there is adequate electricity in California for 2003. Probably the most intriguing and probably far-reaching item of the evening: FERC issued a white paper on bulk power market design, quoting from the California Energy Market’s newsletter. I won’t go through and read all of this. Basically FERC’s promised white paper on Standard Market Design de-emphasizes the standardization of its efforts to get the nation’s diverse electrical industry marching to the same federal drummer. In fact, the term Standard Market Design that we’ve been kicking around (as “SMD”) is barely used in this April 28th white paper, called “Wholesale Market Power Platform(WMPP).” It’s been quickly nicknamed “wimp.” While reiterating the federal commission’s commitment to the concept of regional transmission organizations (RTOs), the white paper indicates that FERC will take an increasingly flexible approach -- allowing regional needs to dictate the elements of individual RTOs and implementation of schedules. Probably the best news of that is the SMD portion of it appears to be delayed for 2 years. However we are still watching and listening to see what Congress is going to do on energy legislation, including an electrical title. So that’s our whip through the energy picture for you. Thank you. Rosenbaum: Thank you, John for that complete report. Do we have any questions or comments from the Commission? I see none. Let’s move on to the Fiber to the Home Phase 1 final report. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 5 of 65 Fiber to the Home Phase I Report Urlich: Thank you. You have a updated report listed as Item #1 and the reason for the report tonight is what we are determining whether this is the final report on Phase 1. There were a number of questions you asked us to look into and prepare to answer, which we plan to do. Those items are listed on the first couple of pages of the report. I’ll turn it over to Blake Heitzman, Manager of Telecommunications, who will walk us through. Heitzman: I’ll start out with Neil Shaw here to handle the Uptown part of the report. I’ll handle the introductory and the customer survey work that was done since the last report. The cover memo that I provided you basically refers back to the rest of the report. I prepared it several weeks before we actually did the report, so use the numbers in the report. The one number I put in my cover memo is off by a teeny bit, so the actual numbers that we are presenting tonight are in the body of the report. The last time we presented the customer survey information, I expressed disappointment that we had not captured a fairly large percent of the customers responses on television and internet. We had gotten a non-applicable response from a large percent. So we went back to those people and we basically changed the terminology from “Would you switch?” to “Would you subscribe?” Many of these people did not have the service at the time, so better terminology would be “Would you subscribe?” We’d want them to come off the mark, either one way or the other, yes or no, rather than “it doesn’t apply to me.” So the new graphs in the customer follow-up response shows the changes introduced by that questioning. It moved up the responses somewhat in TV and also for the first time we have a full spectrum on the internet instead of just the high-speed subscribers. We also have the dial-up and so on. In your report, you have the new graphs. I have tables with those graphs to show you what the numbers are that make the graph. Bechtel: Excuse me Blake. When you say “new” and “new,” would you clarify? Because we have a September report, we have a current report, we have a hand-out which we’ve just received -- so when you say “new,” what do you mean? Heitzman: The hand-out that you’ve just received, I’m not sure, is that from Shaw? OK. The “new” is in the report that was issued for this meeting. The customer survey section is new, the part I’m referring to, so it is an update of the April 2nd survey. The graphs are slightly different. And we added a couple of graphs for some information we didn’t have before. We also tabulated this so it’s a little bit easier to read. I’m just going to quickly summarize what’s here because I know we’re short on time. The first part of the customer survey work talks about the demographics. It basically says the demographics look pretty much the same from this survey and the survey that was done in the fall, the “business-case” survey. The demographics are slightly different but they are pretty darn close. We felt there wasn’t a whole lot there to talk about. I discuss in this report, the Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 6 of 65 idea “Would you switch? to “Would you subscribe?”. The graph on Page 8, which is graph #1 shows the new numbers when you add in the “Would you subscribe?” information. It is slightly higher from the graph that you saw April 2nd. When you look at the 10% discount, obviously we’re well within the range of the first survey, which is down at the bottom. And if you look at the little table, it shows mid-points, which are basically the numbers that we got out of the survey. The spans of course are the uncertainty intervals. TV looks even better than before – in April it looked fine. When you look at the internet, again, it moved up a teeny bit, but it doesn’t quite reach the level we had in the first survey. Dawes: Blake, do you want questions as you go on with these tables? Heitzman: Sure. Dawes: I have been concerned about the penetration on TV as our second biggest revenue source. It seems to me that we’re looking at least 50% of the existing cable subscribers that are going to switch over. In the discussion of the other municipal services -- which was, incidentally, terrific, and I think that has added a huge amount to this -- it talked about penetration issues and pricing. One entity got into a price war with their local subscriber. You don’t really address that issue here. But is it my assumption that you believe you can gain roughly ½ of the existing cable subscribers to switch over at the pricing levels that you suggest here? Heitzman: Of course, there is the issue: if they start a price war, what will happen? I think Shaw has some information on that in his part of the report and again, that would be addressed in the 2nd Phase in the competitive studies. What we have here is, what they were asked is, “Given the current pricing, by the current provider, if you had a 10% reduction from that, would you switch?” So we’re assuming that if the current provider doesn’t drop their price right now, we would have that switch level that’s indicated here. This switch level is very conservatively based upon new penetration numbers and so on. There is some wiggle room, you might say. Certainly, when you look at the response of the non-subscribers at this time, we have a pretty good pool of people here for potential revenue sources on the TV. Also when you look at this graph, you see that our projections are well below the Muni average that other people are getting. I always feel that, if someone else can that level of penetration, Palo Alto ought to be able to. Dawes: It was not clear in the municipal write-ups whether or not there was competition or not. I mean, Alameda, I know there is and that they did it. But the others that I’m not familiar with. It was not really clear whether they started a competitive service against an existing entity or not. Heitzman: He {Shaw] says, every one of them is in a competitive market, with the exception of La Grange. La Grange is the only one that’s an incumbent. I would suspect Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 7 of 65 it’s unusual for there not to be a cable market in many of these areas. Basically, there are a couple of other points I want to present related to the survey. Again, now we finally have a full internet subscription number instead of switches from high -speed to “other” high-speed. So the new graph on Page 9 demonstrates all internet users or non-users. It’s just “Would you subscribe?” so some of those may be non-users. But it raised the level of the 10% discount a bit to where it looks a little more plausible to get the penetration. It didn’t get as high as we got in the first survey, but it is still pretty good. When you look at our penetration numbers they’ve dropped them a bit so there is some distance there. The penetration numbers that we’re using, as I said, they switch, and Neil will talk of this, they switch their basis for doing the penetration to the same discount factors that AT&T uses and Comcast uses in their commercial studies. They’re backed by decades of experience. If you get this survey’s results, and you use those discounts, they have experience that says that penetration will happen. It doesn’t say anything about what will happen when competition comes in. Those two graphs, the one of the TV and the full internet, are two of the main things that have been added to the data that you had last time, other than making it a nicer presentation, with tables and stuff for you to look at. Two other things came up in our discussions last time. One was “Would e-mail address conversion be a problem?” So we took the opportunity when we did the re-survey here to ask these respondents, what they thought about that. As you see, we only had a small number of responses on this question. We were dealing with a diminutive group, but we still felt like it would be worthwhile to test it, and see what kind of response there was. We had a little over 10% that expressed “very concerned.” To me that would imply the e-mail address is not a key issue, but probably a marketing issue that you would want to address. You do have subset of your customer base that would be concerned. So you would want to find a way to help alleviate that concern. It shouldn’t impact the penetration levels, but it might impact how you market it. Then, just for the heck of it, we asked something about whether they would be interested in a security system. We did not use any security system numbers in this report. But we got a small result that said they might be interested in doing it -- roughly 17% -- in that range. Again, not something to add to the report now, but a marketing area to investigate in the future. So those are what I think are the key results that came out of the re-survey. Do you have any other questions about that? I’ll be happy to answer them. If not, I’ll hand it over to Neil Shaw to proceed with the rest of his report. Rosenbaum: Why don’t you proceed? Heitzman: Okay, Shaw, you’re up. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 8 of 65 Shaw: As far as an outline for the discussion tonight, Blake has gone over the market research update. I wanted to talk about business-case model updates. I think there has been some significant ones there that we glossed over last time that I want to talk about tonight in more detail. Then touch on reviewing the network architecture business model and branding recommendations. Then to the extent we need to get into the utility broadband scan again from last time. Since September, we’ve made some significant model changes and this is related to the business-case model, the Excel workbook we used to run the financials. There are a number of things we’ve done both to streamline it and to bolster the accuracy of the model. The long distance and custom calling services have been removed, in that we are not looking at retail telephone services. We are looking at just a bulk charge on the telephone side. So that level of detail was not really required. The previous version of the model had the premium services broken out as HBO, Cinemax, Movie Channel, that type of thing. We did not get the level of relief we needed on that variable so we moved that to a single variable to make it more meaningful from a model perspective. We’ve added home security monitoring as a service option. Let me make this clear, we haven’t added any demand for that or any revenue or expense or capital, but it’s an option now. We can readily model scenarios. _________ boxes have been removed. Direct marketing costs have been added for each service. As has been mentioned in some of the past critiques, marketing costs and acquisition costs are fairly significant in this business, especially in the competitive business. So now we are able to delineate marketing costs between video, internet, telephone, security and so on. Same thing for billing. Billing could be done from a wholesale perspective. Billing could be done by someone else, so we’ve broken that out by service. Vehicle maintenance has been added as a per cent of the purchase cost of the capitalization of the vehicles. In this case, we are using 15% which basically reflects a 7 year replacement cycle or 10 years if you want to look at it more conservatively. Network upgrade costs have been added, that’s pretty significant addition in that there’s always been the concern over technology obsolescence, especially in an HFC system. You’re going to have to upgrade that network. We also assume that you’ve have to upgrade a fiber to the home system at some time in the future, so we are able to model that on a per passing basis. A network unit interface upgrade costs are added as well. The next thing we’ll talk about is changes in the key variables. The first piece that Blake touched on just briefly was that we have introduced new overstatement adjustment factors. The point of overstatement adjustment factors -- as it relates to translating research results into intent to purchase results -- is that when you get a call, or when someone responds to a telephone market research survey, and they say “Well, yes I think I’d be interested in that” or so they say “I’m very interested.” you have to factor that number of responses down to really account for the purchase intent. So the previous set of numbers we used before was from a consumer products group that has a lot of Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 9 of 65 experience in consumer products adoption -- with the addition of our new partner Dave Stockton. He has implemented a new series of numbers that falls in line more with broadband and pure telecommunications. Those are reflected here. What this results in is, in some cases, lower penetrations, but in other cases, higher penetrations. The telephone is a bit higher because the telephone results are bases on the second survey. Because the first survey on the telephone side was a yes/no answer, the telephone question on the second survey was a 5-point Likert scale. Rosenbaum: You talked about granularity in telephones, I don’t know what that means. Shaw: Where in the report? Rosenbaum: [reading] “This change was made to eliminate an unneeded level of granularity for telephone service.” Shaw: Oh, that was in the long distance and custom calling elimination. You didn’t need that level of definition or delineation in the telephone services. Level of detail. Less grains. More clumps. OK. So this is where the penetration numbers have shifted. The 2nd piece is in the level of construction budgeting. The cost of construction was reduced by 27% from $1,045 per meter passed to $759 per meter passed. This is due in large part to four factors. First of all, distribution fiber prices have been reduced 20% lower. The trunk fiber pricing is 40% lower, and construction costs are lower by 50% because the original estimate last summer was based on what were thought the prevailing wages in the Bay Area, using utility crews. The new estimate --- we’ve been fortunate enough to have access to actual construction bids from a high-cost area in the East. And that’s from an actual fiber-to-the-home project of which there is only 2 or 3 underway right now for municipal utilities. These are usually kept under wraps. We were able to get our hands on one of them. It just shows the geometric progression of cost reduction in the area of construction crews -- not only getting hungry for business, but also learning more about what it takes to build a true fiber-to-the-home system in mass quantities. So that’s how we’re able to get that new cost. Fusion splicing has also come down based on recent quotes. The cost of subscriber installation has also come down quite a bit. The original estimate of $300 was really a best guess, based on trial activity last summer in different areas of the country. Like the construction piece, over the last 8 or 9 months we’ve had an opportunity to really get in a more production-oriented environment, with higher volume activity, to realize that it doesn’t take that long and that much labor to do an install. So what do all these changes mean to the business case? We put a lot of stock in the business case last September, and now the numbers have changed quite a bit, so let’s take a look. The working capital figures haven’t changed that much -- that’s mainly due to operational expenses in the early first 2 years of the case. The bond amount has come down by 33% to 33.4 million, so the total funding requirement has come down to 36.2 Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 10 of 65 million. That’s a significant reduction. The bond payment, revenues come down, expenses come down, but the revenue expenses come down in a way that makes the project more profitable -- due to the fact that the operating income does not come down to level of revenue, at least to that percentage. Cash flow, let’s see what else, return on investment slightly lower and it takes an extra year to get a payback. Just to refresh everyone’s memory, a year’s deposit of net cash means when your level of cash reserves or cumulative cash is equal to or greater than any debt in the business, which is composed specifically of your 20-year bond and your utility loan for working capital. The working capital is assumed – that’s a loan from a utility -- and it earns interest over that entire 20-year period. Now what we’ve done with the addition of what we mentioned earlier, with the addition of the upgrades , is that we have handicapped the April 2003 case, because in September 2002 we had some upgrades in there. But the way the model calculates the now, it came out to be lot more that in the previous case. When we do an apples-to-apples comparison, take the upgrades out of both scenarios, the return on investment is higher and the year’s positive net cash is lower. Commissioner Rosenbaum asked a question about revenue per subscriber and I think that when we penciled out this answer, it was a very interesting answer, so I wanted to share that with everyone, in that average revenue per unit or “RPU” is an industry term for average revenue per subscriber, based on the service. What this means is that we’ve got, between commercial and residential, the annual total for monthly and non-recurring revenues for these individual services. So in cable television, this would include basic, expanded basic, your premiums, your sit-top rental, your advertising, your TV guide revenues, things like that. In the case, the 5th year, (this is only really meaningful when you get out into the mature cycle of the case), so we looked at it in the 5th year. So what is it for all of these services? We looked at what it was last September and what it is now, and actually, even though the numbers have changed quite a bit in terms of penetration, the RPU’s are just about the same. Very close, except on the telephone because we’ve lowered our telephone pricing a little bit based on recent research. Now when you compare that to AT&T Broadband’s actuals for 2002, we’re actually pretty close. Given the fact that our pricing strategy is at or 10% less than the incumbent, we feel pretty good about this in that the current pricing for AT&T is $48 for internet and $51 for video, but this 2002. The RPU numbers for the business case are 2007, because they are 5th year numbers. I’ll show you how you can back this up. Bechtel: Neal, can I ask a question? The source of your AT&T data -- is it from their annual report or last quarterly report? Shaw: Yes. What this means is that we’ve got your 5 business-case RPU’s close to AT&T’s actuals, which when we back it up and create a year one equivalent for our business case, our year one equivalent, assuming that we grew at 1% rate increases, would be about $48.64. That is not a 10% reduction. So when we do a 10% reduction against AT&T’s RPU, we come up with $4.00 off the cable rates, and we’re going to run Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 11 of 65 those number in a minute. The internet rates are over 11% lower, and the telephone revenues, include long distance in the AT&T RPU, and the telephone revenues in the business case are for a wholesale type rate. But what is does, is it shows you that if you bring in partners and they’re averaging $40 to $50 orders in RPU on the telephone side, you should be able to work out a deal where they not only pay a base rate but also kick in some type of an acceleration factor if they’re earning that much money. Dawes: Do you know if that’s per line or is that sort of an average customer? Shaw: Per subscriber. Per telephone household. The next thing is that Commissioner Dawes asked for some sensitivity analysis. What we show here is a table that shows the top 5 most sensitive variables in the case. This is as the expected value varies + or - 20%. So as can be expected, the internet price is the most sensitive variable because internet product is the highest margin. What we did here since the case breaks even in the 14th year, we’ve run the net cash value in the 14th year as the outcome as these variables change from best to worst case. So the expected value for net cash is 5.4 million, that is what the case generates in it’s normal state, and then as you vary these variables, for example as the internet price varies from $32 to $48, it brings the net cash to a negative 7.7 million in the $32 case, and 18.3 million in the $48 case. Dawes: Remind me again, net cash is the amount that will pay off the debt existing at that time? Or it’s the amount in excess of the amount to pay? In other words, the 5.4 is the amount of debt we would have on the books at that time? Shaw: No. 5.4 would be the net of your cash reserves and your outstanding debt. Dawes: So this is in excess of the outstanding debt? Shaw: Correct. Dawes: I thought that the case had break even in your 14th year, so it should have been $0? Am I missing something? Shaw: Well, it breaks even in the 5th month of the 14th year, so it breaks even during the 14th year and at the end of the 14th year, you’ve got 5.4 in access net cash. So your cash reserves are 5.4 million in excess of your utility loan and your bond balance. It is kind of a made-up variable because these are hard to determine in a leverage case break evens, but that’s what we’ve devised here. If your variable on internet price dropped to $32, your net cash in year 14 is going to be negative, so you’re probably moving out another year on your payback. You have internet penetration, internet price, construction costs, basic cable penetration and expanded basic price. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 12 of 65 So the next logical question is how bad can these things get if I want to maintain a 14 year payback? Because it is interesting to note that if it goes down to $32, it’s negative 7, but how low can it get before I still maintain my payback in the 14th year? And the answer, which we call threshold value, is $36.71 for your internet price, which is 10% less than your $40, or a little bit less than 10% less than your $40 expected value for price. Your internet penetration is 30%, which is a little over 10% less, your construction cost per meter passed can go up to $8.65, your basic cable penetration can drop by 4% to 23%, and your expanded basic cable price can drop over $4.00. Dawes: Did you escalate those values or are those values flat throughout the forecast period? Shaw: They all change according to the model. Dawes: So there is some escalation. These are the initial factors that you then escalate over the period? Shaw: Yes For instance, the residential internet penetration in year 5 -- that’s a steady- state value that’s grown from the first year to the 5th year and it stays at that steady state. The price in year 1 for internet is steady. Instead of taking that price down, we keep the price the same and double the capacity that’s delivered to the customer over 5 years, so the value doubles but the price stays the same. It is not clear where internet pricing is going to go in terms of broadband access. The internet price is not grown. The internet penetration from year 1 to year 5 is grown but it stays the same at year 5, construction costs stay the same, basic cable penetration at year 5 is steady-state, and the expanded basic cable price goes up by 1% a year. Rosenbaum: Mr. Shaw? Shaw: Yes. Rosenbaum: You show an expanded basic cable price expected of $20. Isn’t that much lower than what we’re talking about? Shaw: That’s in addition to the basic cable price of $15, so that’s the incremental cost for expanded. If you are a basic cable customer, you pay $15. If you want expanded on top of that, you pay $35. Rosenbaum: That’s really $35? Shaw: Yes. But it’s for the tier. The tier is priced and costed separately. We took a look at a lot more business-case model scenarios. Let me go through these fairly quickly. April 2003 is a base line case. Again this is $759 fiber to the home scenario with the penetration results we’ve been talking about before with retail internet. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 13 of 65 One of the things that we wanted to do was reflect a true 10% reduction on the prevailing AT&T RPU, which is a $46 RPU for Palo Alto and the case is still pretty decent. It moves out the net cash to 15 years, _________ to 6.9. The cash flow is very healthy and so is the net income. It’s not a deal breaker. I ran Commissioner Rosenbaum’s scenario, 30/30/30, and I wish it was better. The problem with this is that while you lower the price on cable, your cost stays the same for programming, so if you’re going to do something like this, you need to take some things out of the tier, like ESPN and those sort of things that cost a lot of money. You just cannot take the kind of a margin hit. Beecham: You might remind everybody what 30/30/30 is. Shaw: Oh, sorry. 30/30/30 as I remember it was 30% penetration on video and internet, and $30 price on video and internet. Rosenbaum: I appreciate you doing that. Actually, when I put in the numbers I came up with a total revenue much lower, something on the order of 6.7 million, and you know, later on we might discuss what are the differences. I noticed in some of the numbers you provided today, you’re including the commercial customers, and I’m not sure whether that … Shaw: Included the small business customers? Yes. It’s a much, much smaller piece. But yes, these all include commercial customers. Rosenbaum: That seemed to make the difference between about 25,000 possible subscribers and 30,000 which was significant. Anyway, let’s talk about that later. Shaw: I came up with a triple 33 which refers to basically what is called a triple play, where you would sell the same 3-service bundle to all households, and you would get a 33% penetration. So this is to reflect a little bit lower on telephone for the people who don’t like 38% penetration on telephone, about the same on internet which is 34% to 33%, and in taking cable up from 27% to 33%. And keeping the pricing all the same, and this case really looks good. The ROI’s 10%, it takes 12 years to get all your money back. The issue that came up was what happens if your internet comes down to $30, like SBC and Verizon are attempting to do, and it’s not good. It’s hopefully not something that’s going to happen. Tends to poison the well for everyone. It doesn’t help the case at all. I’ll let the numbers speak for itself. I just want to run through the architecture in the business model piece real quick. The architecture summary hasn’t changed much, the numbers have changed a little bit since the last time we ran them. Just to summarize, the single fiber system still holds the financial edge and we recommend these single fiber costs for planning purposes. Even though you use a single fiber, the misconception is that you use a single fiber in the service drop -- and that’s just not the case. You’re going to put in at least two fibers in Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 14 of 65 the drop from the service pole to the home. This only effects how much you size the distribution network. I’ll say it again – we should not rule out the 2 fiber systems because as those things evolve, by the time you’re ready to buy, the electronics might overcome that outside plant. Dawes: Could you say again the single fiber thing? I didn’t understand that. Single fiber is really two fibers or is it different from the other? Shaw: Well, you size the distribution network from the active node past every home for a certain penetration figure for one fiber per home. But from the service pole, from the drop and closure, to the home, that drop you’re going to purchase with two fibers in it, minimum, maybe even four. It’s all sheath costing, mainly you’re paying for the kevlar sheath and everything and the fiber cost is really incidental. So you’ll never put in a drop with less than 2 fibers in it. Dawes: So this means you could only do ½ the penetration that you thought you could? Shaw: If you size it for a single fiber at the network interface unit, in the distribution network, that’s a risk that you’d run. Bechtel: Neil, could you say a little about why you think two fiber electronics may be less than single fiber? Shaw: I don’t know that they are. Right now, they’re not, but it may be in the future. When you look at the economics, the two fiber system is always going to be more expensive than single fiber, in pure fiber dollars. So what they have to do is come up with a better mousetrap, in terms of electronics, to overcome that deficit right out of the gate. We haven’t seen that yet, but that doesn’t mean it’s not right around the corner. Things happen so fast in this business that you never know what’s gonna happen. The blown fiber approach did save tons of money but the other production costs really kept that alternative at bay. There is a lot of stuff going on in the US in terms of trial deployments, and it may still make sense in some scenarios down the road. Fiber to the home vs. HFC, I don’t want to spend a whole lot of time on this but HFC has a slight edge over fiber-to-the-home financially. But strategically, that financial edge is just not enough to justify taking the risk on fiber-to-the-home in the short run. Dawes: Neil, I cannot understand working capital requirements on the order of 4 times for the fiber alternative, 10 million dollars, essentially, as I understand it, funding start-up losses. I just don’t understand it. Shaw: That’s because you’ve got a, in year 7, you’ve got an upgrade requirement of $350 per year on the HFC system that you don’t have enough cash reserves to cover, so you’re going back to the bank, basically, in the 7th year. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 15 of 65 Dawes: I thought that you had put upgrade costs in the fiber model as well. Is that year 10 and out of this model then or?? Shaw: Yes, it’s in year 10 and there’s enough cash reserves to cover that, to fund that internally, and we have to take out debt in the form of working capital to fund the HFC upgrades. What’s happening is that you’ve taken an $18 million dollar loan out that you’re paying down from years 3 through 10, because it’s a 10 year bond. Then in year 7, here you go. You haven’t built up enough cash reserves to fund that upgrade. Dawes: My understanding from the write-up was that you’re essentially converting to an all-fiber system in year 7 with this upgrade? Shaw: Yes. Dawes: So in year 7, the two systems are equal, is that correct? Shaw: Yes. Dawes: So we could do, one alternative is, well it’s a two step process here. It’s build a cheap one and then get there in your 7th, perhaps with considerably less capital costs in year 7 than what we would have to spend now. Shaw: Theoretically, that could be the case. Here’s why you don’t want to do that. HFC was designed to be a broadcast network for TV. Two-way service has really pushed the limit of the technology. Reliability is a constant problem as we’re hearing from a lot of municipalities that we’re talking to. There is not really a suitable upgrade path. Given the HDTV video on demand another ultra high speed internet services that are coming the path, you're going to run out of capacity soon. And there are upgrade paths to do that, but it’s going to require more compression than there are today. Dawes: Sorry to interrupt. HDTV is really not mentioned here. Does the system that is proposed, the fiber system proposed, include immediate offering of HDTV or is that something you can’t buy today? Or just how does that work? Shaw: If you’re able to partner with, whether your partner or whether you do it yourself, it would be in your best interests to purchase HDTV equipment and offer that right away. Dawes: Is any of that included in this analysis, in terms of head-end costs and investment? Shaw: There’s enough head-end cost to cover that type of investment. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 16 of 65 Dawes: So those channels that are broadcasting HDTV now, such as Channel 9, (who I know does a fair amount) and a lot of the sports stuff is done. From a marketing standpoint, we would be able to say, as a differentiating point to Comcast, that we would offer HDTV from the get go? Shaw: Absolutely. Basically, HDTV offers no competitive advantage over Comcast once they upgrade. The thing that I like the least about this, given the time I’ve spent in this community, [the thing] you’d hate the most, is that this would basically require in the 7th or 10th year, whatever year you want an upgrade, the upgrade would be going on in the backyards and down the front streets of your community. This would not be upgrading trunk routes. This would be upgrading every last mile of coax, which is in the trees and everywhere else, and it would be a mess. As we have seen in comments like from Cedar Falls utilities and some other folks, they’re really not liking the HFC system in terms of maintenance. You know, it's not just talk when they talk about amplifiers going crazy on them, connectors coming loose, and little aluminum spurs being antennas for hairdryers, ham radios. It’s just a mess. As the municipal scan shows, there is not municipal broadband system being considered today going forward just doing HFC. Just to review really quickly, the business model recommendation: on the video side, we believe that Palo Alto should offer retail video services. On the internet side, we believe that Palo Alto should offer its version of the retail internet access service and also look to lease capacity to qualified third-party ISPs. And on the phone side, that Palo Alto should lease capacity to qualified CLECs as well. Just to complete the branding piece: on the branding side, what we are recommending is that the city brand the network as a mother brand. This is sometimes called ingredient marketing. Where, for instance in Provo, they came up with the notion “iProvo.” iProvo really denotes the community network, and then you’ve got sub brands below that or product brands below that denote the individual product offerings. In this case, where you’ve got a wholesale telephone relationship with a telephone retailer, the retailer would be able to say “Shaw Telephone brought to you by , or powered by, Palo Alto Net or something like that” and that would be the mother brand. If you had a relationship with an ISP, like AOL, and they didn’t want to leverage the Palo Alto brand, they wouldn’t have to, but they would have that availability. The analogy that is probably overused the most is the “Intel Inside” type idea but the mother brand would really bring that to life for the system. In terms of summary recommendations, these traditional single fiber-to-the- home system as a reference model for planning purposes, don’t consider HFC as a viable network option, offer retail video, retail internet, lease capacity to third party ISP’s, and third party CLECs. Just in terms of wrapping up the municipal scan and some of the issues there, Tacoma, the penetration numbers were lower and kind of an anomaly in the last table because Tacoma power serves 130,000 homes. The actual franchise is only granted for an 80,000 Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 17 of 65 home service area. And 20,000 of those homes are apartment complexes that were already under contract, so that’s how that number came about to be so low. Dawes: As part of this discussion, I had raised the issue some time ago about the legalities and the municipal scan shows there are some major constraints in certain areas on this. There was a statement earlier on that we would get input as to our legal position as to what we could or could not do. Legal folks have been holding us off here. I do not want to go down any paths Ariel says, “you can’t do that” later on, so where do we stand on the legalities? Are we clear as far as you know, to offer these kind of branded services in the way that Uptown has scoped it out here? Heitzman: I did get some input from Grant on some various questions that we asked him. I guess there are some good things and some other things that aren’t well-answered at this point. Basically, he has re-affirmed some of the things he said in the first correspondence to us, speaking that when we talk about video, that yes, you have to have a franchise with the city, yes, there would have to be a charter amendment establishing a separate board for content. There will be some FCC regulations that will be involved. He’ll have to study that some more. When we talk about internet, his response is basically, he wants to know whether the city would be an ISP, so he asked what is meant by retail operator. It seems that before he will give us a response on the internet we need to decide these questions. Are we going to be retail, or wholesale, or what, and then we can come back to him and say, this is exactly what we mean, please look into this. We questioned him about access for internet services providers other than ourselves and basically a uniform criteria for all other service providers would have to apply. Dawes: Neil, have you baked in a franchise fee, payable to the City? It certainly sounds as though if we need a franchise, we ain’t gonna get one free, when Comcast pays a per capita. Shaw: We modeled that as a roundtrip net zero, so we do not include that in the business case. Dawes: It seems to me that the lawyers are saying tell us what you want to do, and we’ll tell you yes or no. Why can’t they tell us what we can’t do, so that we have to go through that nonsense? Heitzman: Are you asking me rhetorically – I don’t know that I could give you an answer back. Ulrich: I think part of it is that they’re reluctant to study something that may have a dead end. I think they would like to have more clarity about what it is we’d like to do, and then they’ll study that. Regarding the franchise expectations, as we’ve been discussing this with legal, is that any type of service such as this would have to have an arm’s length Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 18 of 65 relationship with the city. So we’d have negotiations with the city to determine what that franchise fee would be. Dawes: Incidentally Neil, you mentioned that this was without the franchise fee. Were the AT&T numbers, Comcast numbers with or without the tab? Looking at my bill, well this is a blended bill, so you can’t tell. Shaw: No, our AT&T RPU numbers are without franchise fees. Because that is typically added later, like a tax. Rosenbaum: Mr. Shaw, have you finished your presentation? Shaw: Just to finish up, I think the key points on the municipal scan are here. The rest, if you have any questions, please ask. I don’t want to take up anymore time on tables. The Grant County penetration, yes video penetration is kind of low there. That’s because they really stepped out on the bleeding edge of technology, and offered an internet protocol, only video system, that was really in it’s early stages. Actually, they had some interoperability problems between some of the equipment manufacturers. But they really stepped on themselves there and the word got out, and no one wanted to take a chance of switching to a poor video quality product. We aren’t talking about that here. We aren’t talking about a poor video quality product. We might talk about introducing IP video as a premium service, but not as the baseline offering. Thank you. Rosenbaum: Okay, thank you Neil Shaw. I’m sure we’ll have some questions, but I want to do first is allow our member of the public who is interested in speaking to us to come forward and if you would give us your name once again? Roder: My name is Antonio Roder. I am a Palo Alto resident and my two comments to make about this survey. First of all, the City survey that was sent to me, that I received by e-mail, I decided to trash it first. I trashed it indeed because I was disillusioned and felt that there is no sense in asking me what to do because it’s not going to make any difference. And I believe that when you presented the figures that you presented on the very low response on the survey, and the significant change in the responses between last year and this year, between the two surveys that you ran, I think they both show, to my mind at least, the fact that people said “to hell with It., nothing is going to happen, I’m not going to do it”. I eventually picked up that survey from the trash and did fill it out and send it in. But if my reaction as a person who is very interested in this topic and in what is happening with internet in this community, if my response is any measure, you can weigh what responses you got in the light of this. Secondly, and that’s all I’m going to say, it has to do with, I was here last year I think it was or two years ago, when the contract was awarded to AT&T at that time, the 500-lb gorilla, which became Comcast and became the 1,000-lb gorilla. Comcast wanted $62 for my internet access this year. I dropped the AT&T TV some time ago because it was lousy. Went and bought Dishnet Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 19 of 65 which works fine and gives me services that AT&T could never give me. Then it became Comcast, and now Comcast says to me, you don’t have TV, is going to cost you $60 a month for internet, and I went to SBC, my telephone company, and I said give me DSL and I’m getting DSL for half the price. What I’m trying to say that if at that time when the contract was awarded to AT&T when had done what we are doing tonight, and it started a process of bringing fiber-to-the-home, we would be a hell of a lot further ahead, than we are now. And I urge you to go ahead and do it now before another cycle happens and another bunch of disillusioned customers come up here and do what I’m doing now. Thank you. Rosenbaum: Thank you Mr. Roder. I do have a card from Herb Borock. I know there are many people who are interested in this here. I would really urge you to try to withhold comments tonight because we do have a very long agenda, but Herb, you put in a card. Borock: I know about withholding comments. I’m Herb Borock. I believe it’s important to get public input as early as possible rather than have it all come at the Council meeting. Rosenbaum: My point is that we are going to be meeting as least twice more on this subject. Borock: I understand Vice Chair Rosenbaum, however, what you decide on Phase 1 will constrain what the study is on Phase 2. So I believe it’s important to have public input. I want to let you know that I’ve asked the City Attorney to examine statements of economic interest in terms of conflict of interest. I’d hate to have to go all the way down the road where some private company was upset with your decision will start looking at things like that, so I hope the attorney’s office does something about that. The was too little time for me to read the entire report. I guess it first came into the library earlier this week, and has not been on the Internet. My perspective may be different from most people here. The people I’ve talked to have been very active on this issue believe they want to get something done and are quite happy to have the Council adopt a fiber-to-the- home system, and then let staff work out what the final details are. I believe that the decision that is being made in a political environment with the Council, rather than staff, needs to make the decision about whether the architecture is a passive optical system or an active Ethernet system, which is the only system that has interoperability among providers and can implement bandwidths of 100 megabit per second and 1 gigabit per second. I also believe that the only way to deconstruct and demystify the business plan and staff recommendations regarding system architecture is to begin with the difference between the passive and the active system, and then look at the difference between one fiber and two fibers for each of these systems. There is an existing standard for two fiber active system, Ethernet system, that permits interoperability among equipment providers, and there is currently an effort to adopt the one fiber active Ethernet system that would also permit interoperability among providers. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 20 of 65 Now passive systems that you’ve been shown are really proprietary systems where customers must share bandwidth from the active node where some of that bandwidth may be unused due to sharing protocols, and where there are security concerns due to the shared bandwidth. The only differences between a one fiber and a two fiber passive system in this business plan I believe is the fact that the two fiber passive system is being used as a surrogate for two fiber active system in determining system costs. That is, at this point, does not appear to be knowledge of what those costs are on the active system. On just a few assumptions, and again I haven’t read the plan so I may get some of these wrong, but it appears that the business plan is using the 38% penetration rate. That’s the penetration rate for phone, some people will get internet without phone and some cable without phone and internet, I need a number that picks up all of those. The assumption of using the AT&T average revenue per unit, rather than using the corporation number, I would use Palo Alto. We have a cable system. If you can’t get the Palo Alto number, you can use the JPA numbers to get average revenue per unit. I think those would be more sensible. I do hope that we take the time necessary to educate the council so they can make the decisions that serve all of Palo Alto, rather than just the early adopters. Thank you. Rosenbaum: Thank you Mr. Borock. Sanford Forte? Forte: Good evening, I’ll be brief. With due respect to the fine work that Uptown has done, we’re looking at projected expenditure of 36.some million dollars to install fiber over a 14 year payback period. Look back 14 years. 14 years ago is 1989. Look how much has changed in the way of technology since then. When this project started, wireless technologies weren’t even a factor. Some communities are installing wireless networks to get most of what the citizens in Palo Alto who have answered these surveys want, with the exception of video. What we’re talking about here really is a relatively high risk venture in an environment where disrupted technologies are really the norm. For instance, and again, I will keep this brief, we’re assuming certain kinds of price drops will occur for various kind of technologies. We don’t know that yet because there are very large questions about whether or not the large communication and content cartels will through lobbying efforts have effect on legislation that prevents communities like Palo Alto to even be able to get their hands on the content that they want to push over these networks. That’s just one of many issues that I could bring up. I just brought that one up but I won’t bring up others. So my sense is here that broadband is a wonderful idea for Palo Alto. We should have broadband is this town. We can have a fiber network in this city. We could deploy a wireless network right now that gives citizens everything they want except for video for 3 million dollars a year. I mean for 3 million dollars period for the network. The city could be taking profits from the subscribership to that network, and paying out over a scaled period of time to have fiber built to the hub or to the home, whatever it wants, at Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 21 of 65 no risk to the city. My question is, why haven’t we in the business case begun to look at viable opportunities and alternatives that are coming from the wireless side, Vivato Systems, Motorola’s Canopy, Technology from Proxim, and many others that will appear and occur in the next 2,3,4,5 years. Thank you. Rosenbaum: Thank you Mr. Forte. Alright that’s all the cards I have. Colleagues, are we ready for questions for Mr. Shaw? Do we have any? George? Bechtel: Vice Chair Rosenbaum. My question is more of a procedural one. I have questions about the next steps and nothing specific on the presentation we heard tonight, so whenever you are ready to move to the next step, I’d be happy to talk. Rosenbaum: Sure, let’s hold off on that until we see whether there are any questions for Mr. Shaw. Rick, do you have anything? Dexter? Dawes: Yes, there was a question asked about content. It’s certainly one of the largest costs that the system will have to bear. Earlier on, there were statements made that companies are doing aggregations for municipal systems. What sort of assumptions have been made, Neal, about that? Are these based on specific actual costs today or are they assumptions that have other derivation? Shaw: Okay. The programming cost assumptions are based on what we’ve been able to piece together for different tier prices and individual program prices. But the simple answer to the question is that the assumption is that we, Palo Alto, will purchasing programming from the National Cable Television Cooperative. Dawes: Do you have their price list? Do you know what we would be charged for these various tiers? Shaw: The tier pricing, they are not allowed to give pure channel pricing to any non- member. You can’t become a member until you have secured a franchise. So it’s a little bit of a Catch-22, isn’t it? They’re brilliant people running this group. But they are able to provide tier pricing, so what we’ve done in the past is provide sample tiers and then they’ve come back with okay this tier will cost you $6.00, this tier will cost you $10.00. That’s what the assumptions are based on the plan. Dawes: Was part of the municipal screen to make discreet inquiries about cost and the satisfaction of dealing with this entity, and do all these people deal with them? Shaw: All these people deal with them. The only group we’ve come across that doesn’t is someone who’s not allowed to because they’re not a franchised operator. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 22 of 65 Dawes: Thanks. Are the prices the ISP’s projected to pay us $27.50 a month, based on fact? That’s been a huge problem I know in the industry. That’s there been very little competitive folks coming over either CLECs, I guess, it is a little bit different than over cables, because the prices are just untenable. What led you to the $27.50 and is that a viable number? Shaw: The only published price point that we had was a deal that I believe AOL cut that had a $35.00 price point, that the cable company that unbundled their high speed data system was charging to the retailers. We didn’t think that price point was sustainable in a wholesale market so we picked an average of $27.50 just as an educated guess. Dawes: So that’s your number base. Shaw: That’s our number. There is no industry sources for this marketplace, because it’s just forming. Dawes: I agree with you on branding. I made a suggestion and I’ll make it again -- just because I like to make suggestions. I think the Palo Alto Telecommunication Holding -- or “PATH” -- is an excellent one. A fiber path would be our overall brand, so I’ll just leave it at that. The suggestion is in the record. Ulrich: If you repeat it enough it may get legs. Dawes: Exactly. Rosenbaum: Let me ask a couple of questions. I thought you had a very nice discussion about the possibilities of wholesaling the ISP and you did mention the Covad situation. The obvious question is, why would any ISP want to put itself in the situation of competing at retail with its wholesale supplier? Why would anybody sign up, if we were going to provide retail ISP? Shaw: Well, for the same reason that there are so many ILECs, although some are merged with the RBOC. The RBOCs had to open up their network. The Covads , the Rhythms, the Northpoints -- they all had something very specific to add to a given national market. They thought they had something better to add than SBC and the rest of the world. Unfortunately, the FCC allowed the RBOCs to put these companies out of business. If that model seemed to be ________________, but it just wasn’t allowed to grow. I would say that these retailers are going to grab this as an opportunity to grab heretofore unavailable network connections, and really leverage it and add their value, either through some type of affinity marketing or some other type of thing that is very specific to a given market segment. It’s a fine line to walk, but the upshot here is that, given the risk of building a system -- and Mr. Forte’s right, it’s a lot of money -- you don’t want to cede the success factor (which is the internet product line) all to third Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 23 of 65 parties. Palo Alto must seize that opportunity and take it and control that in the public interest, and open the network to qualified ISP’s -- who want to take the chance and will trust that the city won’t be anticompetitive, like the RBOCs are. Rosenbaum: You even mention in your report that what one of the problems is that we might want to offer specials. We might want to cut our rates, thereby squeezing these other ISP’s just the way SBC squeezed Covad. What is your response to that? Shaw: Well, there is a $12.50 margin, on average, between the retail price point and the wholesale price point. Given the fact that the average cost in the case for backbone is less than $7.00, I think the case is reasonable that Palo Alto (while the profit motive wouldn’t be the greatest) if they’re slashing costs that much to put these other guys out of business, then the business case isn’t going to be in trouble. So I don’t think the business could sustain that level of anticompetitive behavior because your pockets aren’t as deep as SBC’s, or AT&T’s. Rosenbaum: Alright. You mentioned once again in this same discussion of wholesale ISP’s, that there might be some virtue to trying to sign up AOL, Earthlink, MSN so that people wouldn’t have to change their e-mail addresses. Has there ever been any place where those 3 companies have agreed to something of the sort? Shaw: They typically sign exclusives. I know at Qwest, MSN captured all of Qwest’s internet accounts. And Yahoo has SBC. So it would be quite a feat to get all of them on, which is one of reasons we didn’t want to hang our hat on wholesale. Because if you didn’t get all of them, you’re really giving up quite a bit. No, there isn’t really a situation other than dial-up where they all use the same network. Rosenbaum: Alright, I guess my reaction to that section is that we probably ought to go retail. You’re only suggesting the wholesale to try to satisfy some public demand for open access, but you don’t really have your heart in it. Am I missing a point? Shaw: Now, are you trying to put words in my mouth? [laughter] I think that the wholesale has its advantages, in that there’s definitely many competitive players in the market, certainly application providers that can get their start here. We can’t hang our hat on that. But it is something that should be opened up. Especially for people who don’t want to change their e-mail addresses. Hopefully, if you can get a couple of big fish, it should accelerate the penetration, as well. Rosenbaum: Fine. Alright, I think those are the questions. Do we have any comments? Dexter? Dawes: Yes, I’m sorry there are so many pages here. I’ve made so many notes that I don’t get caught up until later on. In the cities survey, it talks about the issue -- apartment Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 24 of 65 houses in Tacoma that have cut exclusive deals with the existing incumbent provider, and that this was an issue. They were dropped out of the denominator, thereby increasing the penetration. To me, I don’t know to what extent this has happened in Palo Alto. During our survey, when you were talking to apartment dwellers, and admittedly it was a low percentage, was there any effort made to find out whether this was an exclusive deal? Or that they were locked into a certain cable provider through having all their units interconnected? How are we going to figure out if this is a problem or not? Heitzman: There wasn’t any attempt to discern this as an issue. It wasn’t something on our radar screen, as a possibility that we’d thought of. I don’t know if we have anyone here on staff who is familiar that type of activity in Palo Alto. We have some people who used to work for Cable Coop. I know Manuel is fairly familiar with some of the activities in the City. Do either of you guys know whether that has happened? No, we don’t have any knowledge of that having happened in Palo Alto. So the Cable Coop was the predecessor to the current provider. I could see where it could be possible in a complex, but we have no information about it. Dawes: It’s not totally on point, but I was fascinated by some of these financing options that were listed under the screens. Certificate of Participation through an Underwriter? I’ve been in the financial business a while and I’m not really sure -- are they selling stock or what? This is Truckee, California, our good buddies up there. What are they up to? Shaw: They’re going through a unique funding process that’s being driven by a company called Aggregate Networks. They use some pretty strange vehicles, like securitizing leases. I don’t know exactly how it works but they did manage to get enough money to think about going forward. Dawes: Well, it’s pretty mature now and I think it’d probably be surfaced in the next phase, but clearly, if there are ways to reduce the financial risk of this, it’s a great way to secure support for the system. Clearly, having innovative financing techniques, or maybe not so innovative, that when we talk later on about the trend in our reserve situation, that may play in as a factor, too. There is a lot of concern who is going to pay the bill -- if this thing doesn’t fly that way it’s supposed to fly. As we go on I’d like to see more about that. Shaw: That will be addressed in Phase 2. Rosenbaum: Any other comments? Let me make a few comments about the municipal broadband scan. I’m not in anyway suggesting that I would like more work done on my behalf. If staff takes heed, they can decide what to do. Number 1: I guess I was a little disappointed that 5 of the 11cities in the scan were not yet in operation. It did provide some information on the architecture they were talking about, but nothing else. Dexter Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 25 of 65 brought up the competitive situation. I thought it would be helpful to know what the competitive situation was in each of the cities that were actually operating. The numbers look quite good in Braintree and Cedar Falls, not so good in the other places. Here in Palo Alto, we may have as competitive situation as possible and that may not exist in the other cities. There wasn’t any information about the financial performance of the 5 or 6 cities that are actually in operation. Honestly, I think that would be beyond the scope of what we expected from you. But without any financial information, the only financial report that exists on the performance of municipal telecommunications is the one that was done by these two University of Denver professors, sponsored by TCI, which presents quite a negative picture of municipal telecommunications finances. I did give a copy of that to staff. The problem here is that if there is an election, I’m sure the incumbent providers here are going to make use of that. And there isn’t any means to counter it. Finally, I do think the Tacoma situation is worth looking into in greater detail. 4 years ago at the CMUA, I heard the project manager for Tacoma give a very glowing speech about his expectations. They were so confident in what they thought their performance would be, they were running ads on the radio making fun of TCI because TCI has such a terrible performance. He actually played one of these ads for us. Further, they’re only charging $26 for expanded basic. You put all that together, unhappiness with the public over existing service, a very low price -- why do they only have 34% penetration? I think someone ought to try to figure that out. Scott Bradshaw probably knows all those people. He can go and talk to them. The internet penetration is even more puzzling because the three ISP’s that Tacoma’s dealing with are all charging $30 bucks, and they do have this $100 set up fee. If you’re only charging $30, people ought to be willing to put up with the one-time $100 fee. So why they have such a low penetration is worthy of a little more investigation. Otherwise, as far as the whole report goes, I thought it was quite interesting to read, well written. I was pleased. We’re almost ready for a vote on the question to approve Phase 1. But before we do that, George you had a question about process? Bechtel: I’m a little surprised at the comment you just made, Dick, about approving Phase 1. We’re supposed to look at recommending moving to Phase 2, but maybe you want two votes, I’m not quite sure how you want to handle that. My questions would really deal with Phase 2, so if you want to take up a Phase 1 vote first, go ahead. Rosenbaum: I thought the Agenda Item was approval of the Phase 1 final report? Bechtel: I’m just looking at this staff recommendation which says, UAC approve moving forward with Phase 2. So that’s what I’m looking at. Rosenbaum: Alright, they’re both intended to mean the same thing. Alright, are we ready? I mean, would you like any further discussion as to this wholesale vs. retail ISP? Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 26 of 65 Dawes: Could I craft a motion, Mr. Vice Chairman? Rosenbaum: Go right ahead. Dawes: I move that the UAC approves the Phase 1 report, and recommends moving forward to the Phase 2 FTTH business plan. Rosenbaum: Do I have a second? Bechtel: Second. Rosenbaum: Alright, we have a motion and a second to approve moving forward to Phase 2 and approving the Phase 1 final report. Do we have any further discussion? Bechtel: I would like to discuss by what we mean by Phase 2. Rosenbaum: Alright, go right ahead George. Ask your question. Bechtel: One of the things we saw in the September report was, for example, a detailed financial projection year by year, and so on, with various scenarios. Under Phase 2, would you include that? As I look at what’s in the staff report under Phase 2, the only thing that discusses finances is Point #5, which is Financial Strategy, including discussions with the City’s financial group, etc. Neal and Blake, what did you mean by that point? Shaw: Phase 2 – the ultimate deliverable for Phase 2, besides the background strategies and plans, it all culminates in a 24 month and then annualized budget beyond that, that we can hand off to the operators of this future business. They can run the business based on that budget. That’s a budget that has 24 months and covers all the operating aspects of the business. That flows down into cash flow statements, income statements and balance sheet. Bechtel: Great -- because that’s exactly what I would have asked for if you said you hadn’t had it. OK, then second point is on the Phase 2 final report. Do you plan to include enough of the Phase 1 material that you’ve given today in that Phase 2, so that we could have a standalone final report for your entire phase? I think it would be a great document to have. As you’ll see going through our own City budget, it’s spread across a number of different documents. It’s really great to have one book, particularly when we’re trying to sell this to people, and foreign people, and so on. Heitzman: George, do you mean take that 340 page binder and stuff some more pages in it? I’m just joking …. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 27 of 65 Bechtel: No, what I mean is to extract the important elements from the short report that we have been given and make it flow properly. I would like to see it flow properly. Something that would be truly a business plan -- that you could hand to a VC, for example. Shaw: The only reservation I would have, and the counsel I would give you, and I know this is difficult in a public setting, is that a business plan given to a VC is not typically published on the internet. It would make it very difficult for the future operators of this business to have that floating around. At some point, if you want this business to succeed -- pull back a little bit on the amount of details required to be discussed in a public setting. While we have no qualms with providing as much detail as you want, you are venturing into a kind of bad territory in terms of the way telecomm business is actually run in a more proprietary environment. That’s the only thing I would say, is that as we get into the business planning, what we’re talking about, actual execution strategies, pricing plans, positioning, you don’t want to give your competitors a year or more to marshal their forces against you, when you provided them the family jewels. Bechtel: No, I understand that portion of it, but I would have assumed anyway that Phase 2 would be published in some way as today. So what I mean by a standalone plan is just to make a single document out of Phase 1 and Phase 2, so that we would have that. I don’t mean for you to add detail at all that’s not already presented to us today and some months before. Shaw: Okay, yes, that’s no problem. Bechtel: And finally, I would like to amend the motion before us to include some additional points in Neal’s report to us, to make it more definitive. It seems to me he was looking for us to make some recommendation about services and so on. I would like to amend the motion to include adding on Page 1 that the scope of Phase 2 should take us at his recommendations, which is to pursue the deployment of an FTTH system, instead of the hybrid fiber coax system. Second, is to use a single fiber system as a reference architecture. And three, offer retail video services, retail and wholesale internet access. And finally, wholesale access to third party CLECs. Just to make it clear that that’s the scope of Phase 2, at least the parameters of Phase 2. Dawes: As author, I have no objections. The way I phrased the motion was accepting the report which meant accepting the recommendations. Rosenbaum: Alright, I think we’re ready. The motion is approve the Phase 1 final report, noting specifically approval of the three Uptown Services recommendations on Page 1 of their report and to move on to Phase 2. All those in favor? Group: Aye. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 28 of 65 Rosenbaum: That passes unanimously. [Clapping] I am corrected. It passes unanimously with Commissioner Carlson absent. Ulrich: Mr. Chairman, may I take a few minutes and discuss the deliverable dates? I’d like to suggest that we change the date after discussion with Neal and staff working on this and looking at the forthcoming calendar, I recommend we move out the information report from June 4th to the following meeting which is scheduled for July 2nd. That would provide more time to finish material, allow Mr. Shaw to do some other things that he has to do, and I think the short period of time would allow for a better report. Rosenbaum: Alright, then the intention would be an information meeting and you would ask for action at the following meeting in August, then? Ulrich: That’s correct, unless there was something in that interim report that would make us want to move it out, or change the date, or have a special meeting date. I would like to spend enough time at the July meetings so that we don’t have a lot of other items on the agenda so that would allow for a considerable amount of time for discussion. Dawes: If that was scheduled as a second meeting, I could attend. I probably won’t be able to do July 2nd. Bechtel: I would also prefer that we not hold this on July 2nd. I’ll be on vacation. Rosenbaum: Alright, July 2nd is our normal meeting date, but two commissioners have indicated they are not going to be available. What would you suggest? Ulrich: It is your pleasure to schedule another special meeting at a special time or try to do this on a Wednesday evening? I will have to spend time talking to Mr. Shaw about days. We worked out the July 2nd would be, since it’s a normal workday here, to try to schedule it on that date. Shaw: The Wednesday prior special meeting? [Inaudible discussion re available dates] Ulrich: We’ll come up with another date and then float it by you, and have plenty of time for public notice. Rosenbaum: Good. Alright. Ulrich: Just one more thing, since two members will not be here, you’re suggesting we do not have the normal meeting on the 2nd? Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 29 of 65 Rosenbaum: No, I think if you’ve got other items and we can muster a quorum, then we ought to go ahead with our more routine items, unless you think they’re of such importance that everyone out to be here. Ulrich: Alright, so we would typically have the normal meeting on the 2nd and then work out another date for the fiber to the home report. Rosenbaum: Right, so Commissioner Carlson is far away and I think he can comment whether he is available on July 2nd, are you there Dick? Carlson (Phone): Am I allowed to say anything? Rosenbaum: Sure -- you can say whether you can be here on July 2nd. Carlson (Phone): Yep. Rosenbaum: Alright, so there are three of us: Rick, you’re here? Ferguson: I’m not available. Rosenbaum: Oh, you’re not available? Why didn’t you say something? Alright. So there is no meeting on July 2nd. Ulrich: If each of you just send me your schedule, then I’ll work around it and get back to you. Rosenbaum: Fine. Alright, anything else on this item? Ulrich: No, thank you very much. Rosenbaum: Alright, Neal thank you very much and staff, thank you all. What I’d like to do is take a brief break now, and we will get into the other items on the agenda. Thank you. Utilities Budget - CIP Rosenbaum: Alright, let’s call the commission back into session. The next item we’re going to take up is the approval of the budget. We will start with the CIP. Is there any staff presentation here? Ulrich: Mr. Chairman, we do not have a presentation. We sent copies of the City’s proposed capital budget, the one you have. CIP is listed as draft, as requested from year’s past. You wanted an opportunity to see and digest that before the final copies Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 30 of 65 were produced. So you’ve had that a couple of weeks and then the one you got just the other day hot off the press is the operating budget. Within those two documents are the enterprise funds which I assume you want to discuss related to utilities. So I would suggest having gone through the documents there are some changes that we’re going to want to make because there are some typos and some last minute changes that we’ve made. So I’d appreciate your comments and thoughts so that we can incorporate those into out final recommendation that we would make to the Finance Committee. Our turn is next Thursday, the 15th. Mr. Carlson has confirmed that he will be there at the meeting to represent the Utility Advisory Commission. So we appreciate your input and then your final support for us to go forward with the budget. Rosenbaum: Alright, we have questions on the CIP? Rick? Ferguson: You want us to go person by person or section by section? What’s your pleasure? Rosenbaum: Let’s try section by section. You’re thinking of individual utilities. Which one would you like to start with? Ferguson: Let me just start with the computer project which is owned by the electric utility but reimbursed appropriately by the other utilities. Page 130, Number 9537, I believe. Customer Information System. I have no problem with the project. My question is whether we have numbers yet indicating either a higher level of collections or a lower level of errors? Is there a dollar payback from this move to new software? Is it measurable yet? It’s the kind of thing that takes a while to show up, but it almost always does show up. It’s a nice number to cite if you have it available. Baldschun: Don’t have any numbers with me tonight. If you’re talking about the impact of a billing system to reduce year-end collectible expense, in other words, to keep reminding customers to pay on time, then following up with notices. Is that what you’re referring to? Ferguson: Not so much that. It’s just the wholesale improvement in the computer system, the customer information system. You’ve added a whole bunch of new features. Baldschun: Yes, there is a huge difference with this system and the old system. We can do our reporting capability for the staff. For example, just recently we were asked how much revenue our 50 largest customers produced, and that report is able to be generated right now. It took about 4 hours of programming by our staff, not IT staff, but utility staff. That’s how easy and user-friendly the system is. So we can extract data and give that information. I gave it to John and some of the Council members. The big thing coming up is customer web access. That’s going to make a big difference. So far the new system has really been more beneficial for management to get information and Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 31 of 65 understand trends in our operations. But from the customer standpoint -- they just get a bill -- there’s not much of a change. There will be a change with customer web access gets launched, and we’re just about completed with Phase 1. We’ve had to do a lot of quality assurance testing. We’ve been using consultants in IT. They should roll out in a few months to Phase 1. Customers can access their billing system online, get their billing information, and then later on, they’ll be paying their bill over the internet. Ferguson: Thanks. Rosenbaum: Any other questions on this item, in the electrical area? Dexter? Dawes: Actually my questions are more general, rather than try to pick apart individual projects or anything. It’s more asking a professional opinion probably of engineering staff, Scott or others as to the opinion as to the adequacy of our funding of preventive maintenance and system improvements. I know that we have an accelerated basis for installing, and replacement of underground piping. In your opinion, are we ahead of the curve in terms of modernizing our facilities and keeping up to date and looking forward to reducing our outages? Are we holding our own, or Heaven forbid, falling backwards? Bradshaw: You’re talking about a number of issues but overall, my take on the system is that we’re essentially holding our own. We have areas within the system which are aging to the point where their aging is starting to accelerate the outages. On other parts of the system, we are catching up and we’re replacing, working on underground systems and we’re replacing aging underground systems right now that have been in the ground as long as 30-35 years. The life of the cables and parts that were put in originally in the 60’s -- that life span was only 15-20 years. Now we’re at as much as 35 years on that system. Those systems we’re actively working on replacing, the underground systems. Some of the overhead systems are aged, and we’re working on replacing some of the [neutral?] systems and upgrading to 12KV. Overall, we’re pretty much holding our own. From my view of the outage logs, our outages have not increased and they’ve not decreased. Essentially, what that tells me is that we’re doing a better job of getting to the bad spots and fixing those bad spots. But at the same time, we’re not making marked improvements in the condition of the system. Dawes: If you had more money, would you necessarily recommend spending more or do you think the spending level is about right? Bradshaw: I think that if we had the money, we would be hard pressed to find the staffing and the manpower and the contractors to do the work. I think, we’re right now, in a position where the spending we have is well balanced with the engineering staff that we have to manage the engineering and manage the contracts along with availability of contractors out there. I don’t see us being able to accelerate that very much without Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 32 of 65 conflicts with being able to schedule and do the engineering work and support that engineering adequately. Dawes: Thank you. Rosenbaum: Any other questions of the electric? George, you have something you in water? Bechtel: I do. Do we really need 4 new vehicles, 4x4 vehicles to chase down problems in our water distributions system? Ulrich: Where are you, George? Bechtel: I’m looking at Page 199, Projects, Misc 210. Ulrich: It turns out if you look at that, it jumps out as one of the most important things we had to do for the year, purchase those vehicles. In actuality, that’s not the case. Bechtel: It’s not important to you? Ulrich: Everything purchased we make important. If we believe 4 vehicles is important to buy, then it would be in the budget. But some of the items that are in there are not appropriate, because we’ve made other changes that will preclude us needing those 4 vehicles. Bechtel: One of the things I tried to do in going through this book -- I’d requested a list of all the projects in some sort of a list form -- is try to match up some of the expenditures in the CIP with what’s in the operating budget. That brings me to the point. One of the reasons it doesn’t match up, and it’s been said before in previous discussions on the budget, is that the actual expenditures don’t track necessarily with the plans. In other words, you can approve an appropriation for something, yet the money may not be spent for it. Which brings me to my final point on the question of CIP – are we spending all the money that’s being appropriated? Or are we -- Scott had a point about finding contractors -- are we really spending all this money? Ulrich: We are spending the money. Some of the money takes a little bit longer to spend sometimes than is shown in the budget, mainly because you have to have carry over, you have to have the budget approved and in there before you can actually go out and commit the money. Sometimes that money is not committed, although it’s in the budget, until the end of the fiscal year. So the actual spending of that money is in the next year and may continue on. We’re spending the money -- but sometimes it’s not spent in the fiscal year that it’s budgeted. You can’t commit that money unless it’s already in a budget. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 33 of 65 Baldschun: Unfortunately, it’s more of an art than a science here in Palo Alto. Because the money is budgeted, you see a very clear description of what we’re going to spend the money on. But sometimes you’re not able to finish the engineering or get ready to go on the schedule you have planned. Also it’s very difficult to get costs, actual expenditures back in a very short timely manner. I know you’ve heard that before. We are hanging our hat an awful lot on the new SAP system that is in place. I think you’ll be real pleased. We are in the prospect that this is going to be a work management system. It’s primarily designed for utilities and large public-service projects. Ulrich: We have a budget in excess of 35 million dollars of capital work. That’s why the book is so thick. It’s imperative that we be able to manage that in a very timely and very effective way. We do look at those reports and try very hard to manage it. I think the real question, the most important one, is are you getting the work done that you say you’re going to get done? That’s as important as how much money you actually spend. The drive is not to spend the least amount of money. It’s to get what needs to be done in a cost-effective way. Bechtel: I agree, John, and it seems to me when running businesses the amount of money you spend is really a reflection of what work is actually done, what’s contracted and so on. The reason for my question was do we have a big gap between what our appropriation is and the actual expenditures? Are we running a backlog of unfinished projects and so on? I haven’t heard that answer. It’s big? Little? Or maybe it’s on plan. Bradshaw: We do have a couple of projects that are behind schedule. One of them is the El Camino reservoir project. That is a significant one that is running behind schedule. We will be significantly behind schedule on that, and the money will not be spent as it’s been originally scheduled. That’s a good example of one that because of number of issues including permitting, and legal issues and coordination issues that will be delayed. That’s just a good example of what can happen. We do have an underground district 38 project that we had out to bid. The bids came back but we’re going to have to cancel that bid because of not being able to come to agreement with SBC on their portion of the contract. Since SBC took over Pac Bell, they have reviewed the agreements we have with Pac Bell. They find they are not in agreement in our previous agreement with Pac Bell. We’re going to have to sit back down with SBC and re-work a new agreement and re-bid that project. That project’s one that could be delayed significantly, depending upon what we can work out with SBC. Dawes: Scott, is that going to effect all the underground projects? They’re a partner in that whole 50 year deal. This sounds pretty ominous. Bradshaw: It depends on what we can work out. We have to sit down with them, come up with a strategy and work on agreement. It is something we want to get down. I know they want to get done, and both utilities are required to do that. It’s a matter of hashing Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 34 of 65 out the details so we have an agreement. Depends on how long it takes to hash out those details. There are several sticking points that they want changed, and we’ll have to come to an agreement with them. I don’t know how long it will take to do that, but once we come to agreement with them, then we should be able to get back on track. Ulrich: The whole point here is that we take this very seriously and do monitor where we are spending the money and where we’re not. And we’re also operating under quite a different budget system than I’ve been used to in the past. When you know you’re going to under spend, it’s as important as you go back to the City Council and request a budget amendment ordinance BAO if you’re not going to spend the money. There’s a lot of communication on what we do and what we don’t do. Rosenbaum: Rick? Ferguson: Before we leave the off-road vehicle item. It caught my eye as well, not because of the dollars, but as I scanned through this… Ulrich: We put that in there purposely so you wouldn’t read the rest of it. Ferguson: Try to avoid the environmental “tin-ear” risk that we’ve talked about earlier. This is one that jumps right out. It evokes images of the staff barreling around the hillsides in the off-road vehicles. I don’t know if you can change the text here, but you might introduce it with appropriate environmental protections. Many people are concerned about the Foothills. We always get comments about it. So why take the hit, when you can draft it better. I had another water related comment as well. On the Pardee Park well activity, you provided for public outreach. Just a request that you get in touch with the new Duveneck neighborhood association and the Community Center neighborhood association on that. We’ve had a good time in the neighborhood associations working with the City on projects. Ulrich: We did meet with Santa Clara Water District. The test well or the measurement well belongs to them. It does not belong to the City of Palo Alto. And we did request and I believe they did comply with a lot of communication and noise abatement, and also visual abatement of the project. Ferguson: This is the Pardee well #0208 that was going to go in the northwest corner, the “remote” corner of the site? Ulrich: Well, we took the one that’s in there now, that’s just been completed, I believe. On all of these large projects we do have a communication plan, whether it’s part of an ordinance or not, to make sure the customers in the area are aware. This is an important Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 35 of 65 area. You need to keep in mind, that with 35 million dollars worth of work being done each year in CIP, the coordination and communication with the public is absolutely imperative. In fact, Scott with his safety meeting this morning had people in to talk about looking after people who are riding their bicycles along the bike paths -- how to make sure we don’t have congestion and safety problems. It’s a very big deal here to make sure these projects are managed well. Rosenbaum: Do we have other items on the CIP for discussion? Ferguson: One on the gas utility, the Page 171, Item T222, the security fencing. We talked earlier about grant programs, federal security grant programs, and the California Water Bond Act as providing a way of getting some reimbursement for that. Is there any plan? Baldschun: Part of the plan is that we are investigating those grants. We’ll be looking at whatever funding we can secure that way. We did not include that in here because we’re not sure we’re going to get anything, but we are looking in to those. Ulrich: I should also say the decision matrix did not include grant money as part of the critical path. All of this was put together, some of it very quickly, and others over the last few months with a lot of thought. We are going to do this work and at the same time, try to go out and get this grant money. Rosenbaum: Anything else on the CIP? Bechtel: I move that we recommend to the City Council the UAC approves the CIP. Rosenbaum: Do we have a second? Dawes: Dawes seconds. Rosenbaum: We have a motion by Bechtel and a second by Dawes to indicate to the City Council that the UAC has reviewed the CIP. All in favor? Group: Aye Rosenbaum: That passes unanimously. Let’s go on to the operating budget. Utilities Budget - Operating Budget Ulrich: As with the CIP, I do not have a special report. I just draw attention to the document. As you can imagine, a tremendous amount of time was put into this by a lot Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 36 of 65 of people. Some of them are here this evening if you’d like to ask some questions or focus on our enterprise funds. Rosenbaum: Alright, do we have questions for staff? George? Bechtel: I have questions. If it’s alright with you, I’ll just go down my list of questions encompassing both from the summary through the funds. Unfortunately I don’t have my copy of the book. Rick loaned it to me. I was curious -- since we’re taking over the traffic signals, on page 286, I have a note to myself: “explain traffic signal rate scheds.” I think it means we are recovering money through some sort of a rate schedule. Could you explain what that means? Baldschun: Council’s approved rate schedules for street lights and traffic signals over the years. Over the years we have pretty much partially recovered the costs from those rate schedules. The proposal is that (1) the electric utility fund is going to pay for the operation and maintenance cost for street lights and traffic signals, and (2) the general fund is going to pay for the capital costs of street lights and traffic signals. That requires a change to the rate schedules because the rate schedules currently apply to City facilities, and there are charges associated with that. There will no longer be rate schedules applicable to City-owned traffic signals or City-owned street lights, although there are some non-City traffic signals and street lights that will continue to be applicable to these rate schedules. Bechtel: In other words, when we billed ourselves we had to have a rate schedule. Is that what you’re saying? It couldn’t just be handled like rent? I’m curious now. Baldschun: Whether or not we could have a direct charge? I think we could have direct charge. I think we could, let’s put it that way, just like we handle other things. This goes back even before I was here, these rate schedules, so they’ve been around and that’s the way it’s been handled in terms of the charge from the utilities to the general fund for these operations. Ulrich: Some of this is historical. Randy can go into all of that. But typically, utility people do not like to move energy without measuring it. When it goes through a street light we want to be able to measure it. We like to balance the books at the end of the month. You know, where are we getting the electricity from and who are we selling it to. Bechtel: Okay, I understand. Another item that’s maybe not under the UAC purview is wastewater. I assume that because it’s in there, so we ask questions. It’s another question about financing. I’m looking at Page 290 which is the summary by the various funds. Under wastewater collection, there is line that says “Purchase.” Then I’m reminded under the treatment plant though we have a regional water quality improvement plant. So there’s another question. How does money move from there to there, because I Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 37 of 65 see purchases -- we must be reimbursing ourselves in this area? Can someone explain how that works? Baldschun: The treatment plant, the regional water quality improvement plant I think serves 5 cities, one of which is Palo Alto. Palo Alto staff operate it , manage it. But the costs associated with that treatment plant, both capital and financing costs, and staffing and materials cost, all get split between the 5 cities based on formulas. In our budget, in the wastewater collection fund, you’ll see a cost allocation for treatment that is our share of the treatment cost. Bechtel: Is that under the Purchases line item? Is that what that means? Baldschun: Yes. It’s not, of course, purchases. But that’s where it’s shown. Bechtel: I was seeing line item, 6.1 million for Purchases. I was wondering, was that chemicals? So, that’s purchasing services from the waste treatment. OK? Baldschun: Correct. Bechtel: The other is, I was looking at the reserve percentages -- that’s Pages 291 and 292 -- in terms of what they are. If I recall the numbers in electric and gas, the reserves as a percentage of expenditures are running about 40% or so, which seems healthy. Ulrich: I realize they’re too low. Bechtel: But I looked at water and water is awfully low. I mean, if you look at a reserve as a function of that, it seems way out of balance. Particularly if we have an earthquake or some real disaster, we’re going to have some real trouble there. I was wondering why the reserves on the water side seemed to be so much lower. Not that I’m advocating raising them this year, but already our rates are going way way up. Baldschun: You’re absolutely right that the water fund reserves is very low. Let me just add a comment on all the reserves. We’re probably going to come to the UAC with a new updated reserve analysis -- for the rate stabilization reserves for the water, gas and electric -- in the next fiscal year. Time to time, we do update these reserve policies, and they’re based on cost contingencies. Now back to the water fund reserve. It doesn’t matter what analysis we did, there’s no question it’s low. But it’s purposely low because of the huge hit that the water fund’s experiencing with this very large CIP. This financial strategy to deal with this was 3 parts: bond financing, rate increases and withdrawing reserves. What you see is a proposed water rate increase for 03-04. There will be another one in 04-05, and we’ll be building that reserve back up. Am I comfortable with it that low? At this point, no. But Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 38 of 65 given the amount of the rate increase to be required to bring that up to the minimum level, at this point in this recession and given the fact that we have a very supportive Council when it comes to building up our reserves, as you saw on the gas fund, I think we can get by this upcoming fiscal year. We do not, on an ongoing basis, have our reserves this low in the water fund. Bechtel: As I recall, next year 04-05 the reserves will go to 20% of expenditures. That’s still half of what it is in the other two funds that we look at. Seems to me it’s going to take some years to bump that up, if we ever get there. Baldschun: And there’s a big question mark, too. Scott mentioned the CIP with regard to the El Camino Reservoir. The CIP itself in 03-04 is 11.6 million, and that’s an increase from a prior year level of around 4 or 5 million. The actual expenditure to the CIPs, as they come into play, become the actuals -- they will be above and below 11.6. As we get more information on this particularly large huge project, we’ll be taking that into consideration with our rate and reserve recommendations. Right now, this is just a projection. They haven’t even started digging up the ground at some of these big ticket item sites. But once they start doing that, some expenses may come in lower and some may come it higher. That’s just the way it is. We’ll get a better handle on how that’s going to impact the reserves, and we’ll make our recommendations to make sure that the reserves get built back up. Bechtel: Thanks, Randy. One last question, then I’ll turn it over to my colleagues. I’m looking at Page 313. This applies to the other funds as well. It’s “functional areas” the list of all the positions, total positions, which is really helpful in looking at it. How many of those positions are really filled? In other words, how many openings do we have? That’s another way of looking at it. Bradshaw: Unless someone else has a better guess, I just looked at it, we have about 111 positions filled, and it’s a little less than 13 vacancies. Bechtel: In all the utilities… Ulrich: Correct. Bechtel: … Or in all of the enterprises? Just utilities? Ulrich: Oh, thank you. Our total budget shows 228. As you know we’ve added positions to the enterprise fund -- at a loss to the General Fund -- so there’s no net difference. Scott’s correct that we have about 11 or 12 positions that are vacant. Bechtel: Is it your plan, given the pressure on budget and expenditures, to actually fill those positions? Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 39 of 65 Ulrich: I don’t think so. There’s a couple of those positions because of turnover that will be replaced, but not all 12 of them. Actually in our budget, if you excluded these added positions from the general fund, we’re actually going down ½ position in our budget. Bechtel: ½ a position authorized, right? Ulrich: Yes. Bechtel: But what you’re actually saying is that you’re 11 under that already? Ulrich: Yes. Bechtel: OK, thank you. Rosenbaum: Other questions on the operating budget? Dexter? Dawes: Basically, I focused on the reserves, that’s where everything sort of comes together. Kind of where the P&L ends up. I’m having trouble understanding what the charts mean on page 292, specifically the first 3 columns. You have the “03-04 project beginning balance, and then you have “03-04 changes,” then “03-04 projected beginning balance” and then sneaking up looking at our quarterly reports, you know there’s another set of numbers which projects our beginning balance as well. In integrating all these numbers, I get lost. Baldschun: Let me point out a typo right away. On that page, you’ll notice 2 columns that are identical. One of them is 2003-04 is says “project beginning balance,” then two columns over it says “2003-04 projected beginning balance.” The latter should read “2004-05 projected beginning balance,” instead of 03-04. So there’s a typo there. Dawes: So the change is that that second column is the increase or decrease during the year? Baldschun: The second column is the change 2003-04. Dawes: I don’t know if it’s appropriate here to ask about the differences between the numbers shown on the quarterly report and these [budget] numbers. On the quarterly report it started out with the initial budgeted beginning balance, running balance, same number and then decrements, then ended up with another set of numbers. I think there’s something also called an adjusted budget that happens in mid-year. That number seems to have vanished from the quarterly reports. I’m not sure that it’s on here -- whether this beginning first column is the actual budget, the adjusted budget. It’s sure not the forecast, because I wrote those in myself. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 40 of 65 Baldschun: On Page 292 that is the 2003-04 beginning balance, I believe. ASD can correct me if I’m wrong, but that number is based on their adjusted budget which would include any mid-year adjustments that were able to be reflected before this went to print. Maybe some didn’t. The quarterly report is done by utilities staff. We start from the same numbers, but we have some more information that is a little bit different, and more timely perhaps. Dawes: Actually you start with the beginning budget, not the adjusted budget? Baldschun: We start with the beginning. There are things that have happened since January of this year that we’re reflecting in the quarterly report -- for example, the impact on our margin. We do a lot more detailed analysis for the quarterly report than is done in the actual accounting system, the City’s financial accounting system. So there are two different projections. Now, we can explain. I knew this question was going to come up, so I’ve got Lucy to explain any differences, if you really want to talk about the differences. The big difference -- in my sense -- is in the electric fund, the electric supply reserve. That gets to the timing of recognizing a payment that was made, I believe to NCPA on 7/9 or so. That number was in one number but not necessarily in the other. There was also some wholesale sales revenue. These kinds of things we can go into if you want to go into them. Dawes: I tend to look at them and get a feel for the adequacy. What it looked like -- just penciling in those numbers from the quarterly report -- is that the electric fund is in remarkably good shape. Where it had appeared there would be a dipping into the reserves this fiscal year 02-03, in fact we will end up with an increase in our reserves, which is basically very good news. It looked as though that non-recurring item was the principal reason for it, the 7 million dollar rebate, whatever it was. It leads me to think certainly of the rate increase in 04-05, which is laid out in the schedules. It might have a “may” in front of it, rather than a more certain estimate that we now face. Obviously, your research into adequacy of reserves, given the higher beta that we face in our purchase costs, may impact that and make it desirable under any set of circumstances. But it seems to me that we’re really in excellent shape when it comes to reserves. Baldschun: Based on the current reserve guidelines, we are. But again, those reserve guidelines are going to be updated next year and you’ll get a sense of whether the reserves are where we want to them to be or not. Again, on the 10% proposed next year, that number could change because we’re always updating those rate projections, We’ll probably update that one as well as the water and the sewer. I want to focus on the ones to be effective in a couple of months. I do want to talk a little bit later about the gas. Dawes: Another general comment. In each fund there is an item called salary adjustments. There are huge increases in salaries and benefits, and then a sort of offset Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 41 of 65 called something like a salary adjustment. I assume this is the open positions that were eliminated from the budget, nobody’s really taking a hit in the electric fund of $683,000 dollars? Ulrich: I think these are the positions that are moved. We are reducing our cost allocation to the general fund for the positions that were in the general fund. Dawes: I though they were coming to us, rather than vice versa? Ulrich: That’s correct. They’re coming to us, but on the other hand, our costs for that service in the general fund has gone down. Bechtel: In other words, it moves from an expense item to a salary item. Is that what’s happening? Ulrich: I believe so. Dawes: Although it’s listed under salaries and benefits rather than operating expenses. This is on Page 308 , each fund has the same entry to it. Ulrich: Let me talk a minute to ASD on the accounting, the way it’s defined, but the idea is that we pay this as an expense, not as a salary expense, we pay it as an operation expense to have this work accomplished in ASD. They in turn use that money to pay the salaries of the employees that do the work. Now those employees have been moved over to our head count and our budget. Dawes: Which suggests to me that our payroll expenses would go up. This says the opposite. Ulrich: Right, but our allocated costs would go down. Dawes: My guess is that it’s the elimination of the head count. Ferguson: Isn’t it just the allocated charge, the negative number at the bottom of the expense list? Dawes: That’s in the wrong category. That would be under non-salary if it was the allocated costs. It’s listed under salary. Is $683,000 negative there? Pretty big number. Ulrich: As we’re talking, I realize there is total silence in the rest of the room. If you don’t mind, why don’t you go ahead and ask some more questions, until I can give you some more details. But it’s basically what I’m describing to you. So how about another question? Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 42 of 65 Dawes: While we’re on the same page, it really relates to a thing that Commissioner Bechtel raised, this is in 04, which again is this O&M and capital thing for street lights and traffic signals. It looks to me as those utilities absorbing 1.3 million in cost, which they had previously billed out. My question is, was there any discussion with ASD about netting those costs out, the dividend, out of the electric fund? Otherwise, it amounts to about a 15% increase in the dividend. It’s a cost we used to bill out, but we now absorb. Baldschun: You mean reducing the transfer to the general fund by the corresponding 1.3 million? Dawes: Yes. Baldschun: No we didn’t talk about that. We did talk about the figure, the 1.3 million and there were some questions we had about, first we thought it was a million then it was 1.3 million because there are some cost allocations that are part of that that we didn’t include earlier. So, the 1.3 million is really the impact of the proposal. We did not want to touch the transfer general fund. In terms of reducing it or increasing it. Dawes: This is just another way of increasing the general fund. I also want to ask the same questions about rentals, because I see rentals in all the funds are heading upwards. We’ve over the years visited the rental situation from time to time. It’s one of Commissioner Ferguson’s favorite subjects, as is mine. The Holy Grail is the Stanford Avenue site for the reservoir that just got a new roof, which is classified as land available for an office building, and it’s like a half-million dollar rental charge. I’m exaggerating, maybe it’s $300,000. But prices have basically come down dramatically for rental space in Palo Alto, and yet I see no corresponding reductions in the costs assessed to utilities. Could you describe what process is gone through to make that evaluation? Who does it, and whether it’s fair between the utilities and the owner of the asset which is the City? Ulrich: I think about this all the time, particularly once a year when you bring it up. The process is that it’s based on an evaluation of what the rental market is for the value of the land. Dawes: Who makes it? Ulrich: The real estate department of the City of Palo Alto. Dawes: Thank you. Rosenbaum: Rick, do you have more questions? Ferguson: No. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 43 of 65 Ulrich: I always have to remind you of who owns the utility. Dawes: If they really want big money, we could buy it from them. Ulrich: We’re looking at a few things like that. Rosenbaum: I did have a question on telecommunications, which I sent ahead. If we look at Page 317, it surely looks as if we’re losing money, and Blake has assured me time after time, that we’re making money. Indeed the quarterly report suggests we’re making money. So I’m trying to figure out how to put this together. Ulrich: Blake is ready to answer those questions. Rosenbaum: He’s got a lot of paper in his hand. Heitzman: I can’t give you a 100% complete answer but I can kind of give you some background to alleviate some of your concerns. The 3 pages you have in the Quarterly Report are put together statements by one of the people in ASD, one of the accountants. It’s an income statement, a balance sheet, and a cash flow statement. Although they have some of the same data in the budget, there’s some different data and organized differently. In a few minutes we can talk about this more, but this is a very good document and very reliable document. It’s all very historical. There is no projections. It’s the facts, basically. When you look at the budget, you have one column there that’s the facts, and that’s the 01-02 actuals. Then everything else is projections. To talk about the first column, 01-02, this whole budget area reflects what’s called [account] 260 which is my area of budget. It includes the dark fiber and the fiber to the home. The 01-02 numbers include $537,000 of fiber to the home. If you pull that out, then you’ll see [for dark fiber alone] the balance between the expenditures and the revenues -- we made somewhere around $700,000 dollars in profit. That explains, at least what has happened in this budget, confirms that we are making money. Now when you look at 02-03, and 04 there are a couple of things that I still need to research. But I know that my projection for revenues is low. I’ve already looked at the actuals for 02-03 up to date through March, and I have revenues already on the books of 1.6 million. So my revenues were low here by about $400,000 in my [budget] projection. That comes from underestimating what I think I’m going to get, because I don’t want to project too high. And I probably overestimate what my expenditures are. That’s an inconsistency which I need to correct. I’m going to look back at these numbers and try to make them more consistent. I’m going to project the revenue and expenditures to match each other instead of being too conservative one way or the other. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 44 of 65 In any case, the actuals for 02-03 again show that we’re making money at this point. The expenditures are about ¾ of the year, they are about ½ of what was projected, so the actuals that are coming in for 02-03 again show that we’re making money. Another difference between the 3 sheets that the accountant made in the quarterly report, and the budget, is that we bill annually. He takes this annual bill, and allocates ½ of it to one fiscal year and ½ to the other. In the budget, you just see when it was billed, it goes into that fiscal year. So there would be a little bit of discrepancy between 01-02 in the budget and 01-02 in his other sheets. There are some issues I need to explore a little further, like why do I have 8.5 FTE against me. Is that what I have budgeted or is that what’s really being expended? I have a position that hasn’t been filled for over ½ year. How is that represented in there? So there’s some issues I need to check into a little further. My expenditures look like kind of hefty there in planning. I want to make sure I haven’t over-projected some costs that really aren’t necessary to be there. Basically, Mr. Rosenbaum asking about that has made me look a little closer at it. But as far as are we making money, the actuals show that we still are. Hopefully, that answers your question. Dawes: Does that include the capital expenditure portion? Because the budget does have cap ex assessed, and the other is on a GAAP basis. Heitzman: Yes, there’s a different way of managing capital. Here’s it’s just a straight out expense. He has included depreciation and other expenses over here, so there is a difference there. If you look at 01-02, the design-and-capital there is $938,000, about ½ of that is fiber to the home and ½ of that is dark fiber. When I say that, there is $280,000 of overhead distributed between the two. The actual field costs are about a little over $300,000 each, and there’s another $280,000 of overhead that’s tossed in there on top of them. You split that between each of them equally and that’s the way you allocate that. Have I answered the question or is there more to be answered? Rosenbaum: I’m always glad to hear you say that we’re making money on the dark fiber system. I keep waiting for a report which a layman can understand which proves that in a definitive manner. Heitzman: I’m doing the best I can on that. These sheets here we have in the quarterly report, I think they’re very nice. I don’t say I understand them 100% myself. An accountant put them together and I sat down and we talked over the different issues as he put it together. I don’t know how to cut this pie to make it easier to understand. He’s convinced me that we’re doing OK. And when I look at my actual expenditures my actual revenues, it looks like we’re doing OK, by $700,000 to a million dollars a year. Maybe we can talk about how to cut this differently so it’s a little easier to understand. But I keep trying to come up with a solution. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 45 of 65 Rosenbaum: You can understand, from at least my perspective, I hear you saying we’re making $700,000 a year. I look at the budget and it shows we’re going to lose $700,000 in this coming year. That’s just too great a discrepancy for a $2 million dollar a year operation. Heitzman: This 02-03 is basically a projection. I do have the printouts of the actuals. I’ve already underestimated – part of the reason I underestimated we estimated the revenue from annual fees. But we did not include the full estimation for the capital -- in our minds, when we do a capital project we pay for it $1.00 and the customer pays us back $1.00. So in our minds, OK, that really balances out to $0 revenue. But when you put it on this sheet, you really need to show the full capitalization because it’s an expense there. There are probably some shortcomings in our thinking and how we gave these numbers to ASD for the budget. And as I said we’ll rethink that and work with them to make it more correct. Rosenbaum: Thank you. Bechtel: One thing, Blake. I have a comment to you. The most pleasing part is, you still have 50 customers. There are some of us out there who have no customers. Rosenbaum: Do we have any further comments on the operating budget? Bechtel: I have one more question, on Page 318, on public benefits. I noticed there that the head count went up but the expenses are way way down. I’m just curious, are we really adding people to the public benefit program? To help plan programs or expend or so on? Auzenne: I’m sorry, where are you looking, sir? Bechtel: On page 318. I don’t have the book but I have the note that says public benefit. The head count was up for that particular group, but the expenses were down, total expenditures were down, for example, from previous year. The question is I’m assuming that if the head count went up and it’s proposing to go to 5 people and so on. Auzenne: I understand. What we do on an annualized basis is we try and budget people’s time according to what they are going to be working on. Some years, in fact, you will have less people working on certain programs and projects and other people working on different ones. What you’re seeing here is probably a reallocation of time spent from people working, typically, on key accounts or account services, moving back into efficiency services. Last year, we were still playing in the energy crisis so we were having more and more people working on that type of activity. Now, with the advent or the relegation of the energy crisis, a more stable part, those people that were doing that Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 46 of 65 stuff, are coming back to this stuff. When I got here in 1993, I had 14 FTE plus two agency people. I now have a staff of 8 FTE. Dawes: Tom, there’s a big reduction in contract services and basically an increase in salaries. Is there any switch between bringing people on to do things which previously have been contracted? Auzenne: There’s not really any increase in any new bodies, per se. We have sharpened our pencil and reduced the contractor and consultant expenses where we can, where we feel we can, we made some significant gains there. There are some other things we’re not going to be doing. As a result, I believe of some of the discussion that this commission had in September of last year, we’re phasing out of a lot of our power- quality types of activities, so we’re able to drop some consulting expense in those areas to correlate with the new improved utility strategic plan. Rosenbaum: Any other comments or questions on the operating budget? Ulrich: I’d like to go back and answer Mr. Dawes’ question. I’ll try in my non-technical way. I talked with ASD and the manager and he assures me. Every general fund is done exactly the same. What is shown as salary adjustment is moving a portion of the salary that is benefits related out of the salary and moving it over into the “personnel benefits.” The number to look at, the key number is the total salary and benefit changes, which is account 598. That reflects the increase in salary and benefits from the previous year. The numbers above it are a breakdown of that. Sorry -- page 308. Rosenbaum: I just have one final comment. Dexter did bring up this item of the utility picking up the expenses for the street lights and traffic signals. I don’t really think that transfer should be made. As Dexter mentioned, we do have a very healthy transfer from the electric utility to the general fund. But I think this is more a political issue rather than a utility issue. The staff and the Council have come under considerable criticism for the way in which they have been handling city finances, whether justified or not. To attempt to solve at least a portion of the budget problem by transferring expenses from the general fund to the utility, I suspect is only going to incense or make the critics even more angry, perhaps with good reason. I assume the Council understands what they’re being asked to do here. If they’re willing to do it, I guess they’ll accept the political heat. Every now and then, I like to offer them a little gratuitous advice: I think it’s a poor decision. Alright, with that, I think we’re ready for a motion on the operating budget. Ferguson: I move that we recommend the operating budget to Council. Bechtel: I second. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 47 of 65 Rosenbaum: We have a motion by Ferguson and a second by Bechtel to recommend to the Council that they approve the operating budget. Any further discussion? Let’s vote. All in favor? Group: Aye. Rosenbaum: That passes unanimously with Commissioner Carlson absent. Let’s go on to the gas rate proposal. Gas Rate Proposal Ulrich: You have in front of you Item 3C which is the proposed gas rate decrease, with recommendation based on our analysis of the market and prices. We do have some discussion we’d like to have with you about the actual decrease and our concerns and comments about the actual amount of decrease that’s in the recommendation. Baldschun: It’s a projected 15% gas rate decrease we propose to be effective July 1, 2003. Between now and June 15th or 16th, Council will rule on rate proposals. We may come back to the Council with a revised proposal on the gas, but we may not. There is still some uncertainty regarding the 25% of our load that is for all 3 or 4 that is not been fixed. It’s based on our assumptions about what that price is going to be for that portion of load and how that impacts reserves and some other factors. So we’re going to be having internal discussions about whether or not we should go forward with the 15%, or go forward with something less than that, or no rate decrease. I just wanted to give you a heads up on the gas rate proposal, that it could change. Dawes: That statement of no rate decrease is fairly major item. This is big dollars we’re talking about. It was by virtue of this 15% decline that the overall 4-utility billing change looked very accommodating. It sounds as though you are very apprehensive that that 25% balance is going to be at unfavorable pricing. Or is it simply that the best alternative would be to wait? We don’t have to cut rates June 30th, we can cut them October 1st or whatever. We once made 4 changes in a year. Ulrich: I think this certainty or what we thought was more certainty about the rate decrease, the actual number is 15%. We’re clearly waffling in that area because as Randy pointed out, we have a fairly significant amount of gas we have not fixed the price on, because of our laddering strategy that we have in place. With the amount that has not been fixed, there is the uncertainty of what that price will be when actually purchase it. And the way the market prices are now, they’re higher than we’d like to see them. Now obviously, over time, those prices are going to go down. That seems to be the trend in the short run, but without having that certainty of locking in the price of that gas, that makes this recommendation of a 15% decrease less certain than we’d like to have it. Now you can always have a rate decrease and lock it in if that’s what we want to do. But Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 48 of 65 that would impact the reserves by taking more money from the reserves that what we might feel is appropriate to do. You can hear all this kind of waffling sort of discussion. I think it’s prudent for us as a staff to keep working on this and finalize this as we get closer to the date we have in the CMR or in our report. Dawes: Looking at the quarterly reports, Girish had locked in about a 1% decline from 4.63 this year to 4.59 next year for the 75% that you’ve locked in. Are we looking at gas prices in the winter timeframe, or do we still have our pool at current prices being over that number, Girish? Balachandran: Prices are higher than what we projected before and the 70-75% number we have locked in for the full load anyway, it’s not for the large customers. Dawes: I thought that whenever a large customer locked in an individual number we committed for gas at that time. Are you saying that we have outstanding contracts for these other customers that we haven’t yet purchased gas for? Balachandran: Those contracts which customers have, customers who are on a fixed term rate, some of them are presently on the monthly varying rate and there are other customers who are still on the fixed term rate and their contracts will be expiring end of June and end of July. They will either move to the G3 rate, which is a monthly rate or they may decide to renew their fixed term rate. If they decide to renew their fixed term rate, then we go ahead and lock in purchases at the current market price at that time. Dawes: You’re quoting pricing now for those customers for the terms that they are interested in? I guess if they come into pool then, instead of being 75% bought, we may be 60 or 50% bought, is that the idea? Balachandran: That’s correct. Dawes: So that’s the major uncertainty there. Balachandran: That’s one of the uncertainties. Rosenbaum: Then you’re saying you don’t have a rate proposal to present to us then? Ulrich: The rate proposal as written shows the alternatives and it shows our recommendation, but you can tell the recommendation has a waffle factor in it. Baldschun: We want you to recommend to the Council our recommendation which is to go forward with a 15% rate decrease. So that is on the table, and that is the action we want you to take. All I’m saying is that there are some uncertainties that we need to evaluate in the next week or two, some risk factors. I feel confident we can address some Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 49 of 65 of this stuff, and go forward with a rate decrease. I don’t want to give the impression that – I guess I don’t want you to be surprised if you find out a week before the Council meeting that staff has changed the rate proposal. I am not saying we will, I’m not saying we’re not. It’s just that we don’t know as we speak tonight. Dawes: Why is it so important to have a rate proposal at this time, given this level of uncertainty? It’s been more or less traditional that there be one rate change at the beginning of the FY. But as we all know, there were 3 or 4 of them back in 01 or whenever it was. Again, why don’t we just defer this until September? Baldschun: That’s certainly an option. We could do that. We could tell the Council we want to take it off the table and defer it. That’s an option. There’s a couple of options. Frankly, we could stage in two rate decrease proposals. We could go propose one, say 7%, and the other 8% would be contingent on some other factors coming into play. The big unknown in my mind right now is if these G7 customers, if these fixed term contract customers decide to come back on their G7 rate, at that time, we’re going to have to pay the market price. The market price today is around $0.52 a therm. Our weighted average cost of gas for all our pool customers is about $0.45 a term. As John said before, if that happens, that would have to come out of reserves. We just have to do some more analysis. We’re also going to be looking at some language to add to these rate schedules to try to, this gets to the legality, to try to keep all the other rate peers whole if this in fact happens. There are some things we want to look into on that regard too. Dawes: It seems to me that this is basically pretty unfair. What we’ve done is given our big customers, who now have an option -- they can see what good work has happened for a large purchase of gas and they know that the amount we purchased is probably less than what they would have to pay if they renewed their bulk contract, and it really gives them a leg up. A bit of uncertainty resolved for them. I really question whether or not it’s appropriate to offer them the benefits of what we have for people who were in the pool. By them now joining the pool, it’s going to drive up the rates for everybody. It just doesn’t seem right to me. I think that’s another reason for saying maybe this is premature and we should just shelve it. Or take a very modest slice out of it at this time. Ulrich: Regardless if you change the rate or not, the financial impact will be there, either to the reserves or to what you’re doing with the rate. I don’t want to leave with the rate schedule we have in place. You can always make the decision to do the 15%, that’s what is in here. We stand by it. But I thought it was important to point out the last sentence in that “Alternatives” area -- that if new and relevant information becomes evident before Council approval, staff may revise this rate proposal upward or downward. I just want to call that to your attention. This is not the same old utility rate making business as it was in the past. It is a lot more dynamic and we point this out to everybody. We’re not going to lose a penny here. It’s going to be done in a very thoughtful and business like manner. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 50 of 65 Dawes: It seems to me we could lose a penny, though, if we … Baldschun: Let me clarify one thing. Rate reduction before these fixed term people … Ulrich: It’s a matter of how it gets paid. Baldschun: If in fact these customers did come back on the G7, what they would forfeit would be Direct Access and fixed term contracts. And what we’re hearing from most of the 11 customers is that the most important thing to them is fixed term rates, these one or two year contracts. That’s what they really care about for the businesses. They don’t care about the exact price, but they want the fixed term rates. Well, if they come back on G7 they are no longer eligible for these fixed term rates. They’re not real comfortable going back to G7 because they know the City Council can raise those G7 rates anytime that we make the recommendation. So I don’t expect to see a big exodus of customers to the G7. But it is something we have to look at. Rosenbaum: Could I suggest that we delay in taking action on the gas rates until you feel comfortable in projecting in what’s going to happen next year? It seems as Dexter indicated there is something basically amiss. At this point in the year you don’t feel comfortable making a rate projection because some large customers can still take action which might adversely affect us. Suppose you came back to us next month with a gas rate proposal, and that could go to the Council, not as part of the budget process, and the rate change could start a month later. Ulrich: We’ve done that before. As you recall we’ve had several rate changes in mid- stream. I’m just suggesting that the thought processes is to move the way we recommend. We’ll come back to you and communicate with you between now and when it has to be firmed up with the Council, and you could give us some advice on that or not. Rosenbaum: Staff has indicated to us they’d like us to act on this recommendation. Would someone make a motion.? Ferguson: I move the staff recommendation with special emphasis on the implication of the alternative. Rosenbaum: Do we have a second? I don’t hear a second, so I think the feeling of the UAC is that you should come back to us when you feel confident when you can make a rate proposal that reflects the actual situation. And that doesn’t seem to be the case today. [The Commission returns to this topic at the end of the evening and takes action after treating the other budget topics. See below.] Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 51 of 65 Water Rate Proposal Rosenbaum: Shall we move on to the next item? The water rate proposal. Dawes: This proposal has been on the table for well over a year. It’s been discussed a little bit earlier today. It’s a combination of large cap ex funded by bonds, digging into the reserves and a rate increase and was in our 10 year plan previously. With the permission of the chairman I’ll make a motion that we recommend to the Council that the 15% be initiated. Rosenbaum: We have a motion by Dawes, do we have a second? Bechtel: Second. Rosenbaum: We have a motion by Dawes and a second by Bechtel to recommend to the Council the staff recommended 15% increase in water rates. Any discussion? If not, let’s vote. All in favor? Group: Aye Rosenbaum: That passes unanimously with Commission Carlson absent. The next item the wastewater collection rate proposal. Wastewater Rate Proposal Dawes: Basically we spent very time on waste water matters and I have very little background in it other than what’s in the budget so forth. It appears to be a sound proposal based on the activities at the processing plant. Basically this recovers the share of the increased costs of the processing the pooled amount between the various cities, so again I’ll put a motion on the table that staff’s proposal for a 15% be recommend to the City Council. Rosenbaum: Do we have a second? Bechtel: Second. Rosenbaum: Motion by Dawes and a second by Bechtel to recommend to the City Council the 15% increase in the waste water charges. Bechtel: I have one question. Basically, it has to do with Page 2 of the Wastewater -- 3E, comparing our rates to the surrounding cities. The last comment hopefully justifies it, but do we know, do we have a real strong sense that our neighbors are really going to Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 52 of 65 raise their residential rates? We’re all part of the same system, at least the same environment. As low as inflation is in the rest of the United States, the inflation in our utility bills seems to be outpacing any thing else I can see. So I sure would like to see other indications that people are in the same boat, with respect to wastewater. [Inaudible staff response] Bechtel: So the basis is really actual people to people head to head talk about what’s going on. That’s satisfies me. Thanks very much: Rosenbaum: I think we’re ready to vote on the motion to recommend to the City Council the approval of the 15% wastewater collection rate increase, effective July 1st. All in favor? Group: Aye Rosenbaum: That passes unanimously with Commissioner Carlson absent. Dawes: Actually one question – in the regular budget there was a stapled page which revises the estimated average residential monthly bill, but wastewater is not on that. Why is that? I mean we just voted on recommending a change in the rate, but yet it doesn’t show that it’s on the bill. This is on Page 297. Baldschun: That would be sewer. Dawes: So that would be under the sewer. Baldschun: Correct. Ulrich: We have a different name, depending on where it’s at in the budget. Dawes: Got it. Rosenbaum: That completes action on approval of the budget items. Shall we go on to gas utility long-term plan or GULP? Energy Risk Management Ulrich: Well, my notes show that was an item we agreed to drop at the beginning of the meeting. When we recast everything we left the energy risk management report and the utilities quarterly report on the agenda. Rosenbaum: Pardon me, I thought you had indicated that you did want us to take action on the GULP? Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 53 of 65 Ulrich: But I thought subsequently we agreed that we would… Rosenbaum: We will not do that. Ulrich: I need to refresh my memory. I am just reading my notes. So we’re ready to do Risk Management if you’d like. Rosenbaum: The energy risk management report, right down to the end. Go right ahead. Ulrich: I think you’ve all met our new energy risk manager, Karl Van Orsdol, who will walk us through the report. The reason that this is an important report is 1) it’s the beginning of many that you’ll see and 2) this moves on to a report that goes to the city council, and is a reflection of the changes we’ve made in our risk management policies. You’ll hear an executive summary and more details about the risk management plan. Dawes: While they’re dealing with setting up there, John, has there been any change in the risk manager’s assignment? Clearly when the concept of having this function come in house, the idea was under deregulation and ability of customers to contract directly and so forth, that there was vastly heightened risks for us and other utilities. Times have changed a lot. There is still a great deal of volatility in the supply pricing and our ability to deal with different sources and so forth, and of course, the bankruptcy business with electricity. Because of this, has there been any change in the expected functions of our risk manager? Has that evolved? Ulrich: I guess I would say we probably didn’t realize all the benefits that we could extract from Karl. You notice that the last couple meetings that we had some extensive discussions about the Western contract and some of the ways to extract benefits out of it, and there is a level of risk in the hedging that’s goes along with that so he’s been very instrumental in helping us do that. I don’t think that was … the Western contract was not one we expected that that would be a lot of risk management involvement. Also, with the new LEAP, we’re going into some extensive long-term contracts both on renewables, the RFP for the renewables and the contracts, the master contracts that we’re negotiating for, these larger purchases. So he has added value. How about doing this next? If you’re going to ask me about the computer skills and all that, that’s another area. Bechtel: Why don’t we just use an oral …? John, may I suggest, or Karl, we have the material you have here in the book. Why don’t you just use the material that’s here, and we just not do the PowerPoint slides? Ulrich: That’ll be fine. People that do not have copies of it are welcome to come up and take a look at the few copies that we do have. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 54 of 65 Van Orsdol: How’s this? First of all, just to reiterate what John said, my name is Karl van Orsdol. I joined City of Palo Alto as the Energy Risk Manager on the 3rd of March of this year and I report directly to Carl Yeats, in ASD. This really is a report that is joint report between Utilities and ASD. The materials that I have given you here really are in support of the text you received in the memorandums in your package. So if you turn to Slide 3 we can begin. Why am I giving you this report and why now? The risk management policy that was approved by the City Council does require timely and accurate information to be reported to both the UAC, the City Council and the public. The risk management guidelines that have been approved also require semi-annual summary reports. The energy risk manager, as you know, his role is to establish a separate risk review and management program and provide independent reporting to the public on the risks taken by the wholesale energy and gas transaction of the utilities. If you turn to Page 4, you’ll just see the structure that you’ve seen before, with Utilities actually carrying out the transactions, I’m sorry it’s a little small, and the administrative services serving as the independent risk oversight body. Slide 5 summarizes some of the accomplishments that the City has made in terms of risk management over the past year or so. The City Council has approved the new risk management policies. There’s been a risk oversight committee that’s been formalized, that consists of Carl Yeats, John Ulrich, and Emily Harrison, with Sharon Erickson and Grant Kolling as advisors. You have hired a full-time energy risk manager. We’ve been in the process of revising key guidelines and policies related to trade capture and other key aspects of the wholesale trading business and making sure that Palo Alto meets the industry standards. We have detailed responsibilities for the front, middle, and back office. We are in the process of developing an improved oversight reports, of which, this presentation is the first. Now, Slide 6 really goes over the oversight report contents and really are the key components of the risk assessment that I’d like to present. Those five element of the risk assessment are low resource balance, the actual risk assessments, compliance and exception reporting, program status, and then some information on the master agreements and the contracting status, which are actually key to our risk portfolio. Now the low resource balance is actually a risk management activity or concern because we want to make sure that the balance is within the guidelines that have been established and it is within what would be considered appropriate and prudent risk management guidelines. Slide 8 shows the gas supply with the top line being the estimated _________, and the darker line below that being the purchase load. According to the gas purchasing guidelines, approximately 75% of the load is purchased for the next 12 months, 50% approximately for months 13 through 24, and about 25% for months 25 to 36 looking outward. And currently those goals are being met and the gas procurement strategy and Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 55 of 65 implementation is in a line with this idea of managing the risks. And the price forecast is also consistent with this strategy. If you look at Slide 10, you’ll see the long-term gas prices of the future prices are on a downward trend after December of this year. Of course, this is NYNEX prices which are not completely correlated with California gas prices, but they are a good indicator. B Bechtel: Karl, do you look at the prices yourself or your assistant? Do you independently verify these numbers? Van Orsdol: I don’t actually have an assistant, but we basically receive them from an outside party, TFS. Actually, one of activities I’ve been looking at is whether they’re the most appropriate vendor for us to receive long term price quotes, whether we need to find some alternative sources. In fact, we had a meeting today with another vendor about the possibility of getting long-term price data from other sources as well. Bechtel: Well, the reason I asked the question is that there’s been quite a scandal in terms of traders, gas traders actually, submitting false date to the index providers, so I’m hoping that we have reputable indexes or sources. Van Orsdol: I think the source that we are using right now is quite reputable. But I do think that there are opportunities to get different sources and to make sure that the prices are consistent between vendors. When they are not, that gives us a heads up that there may be some price manipulation going on. Dawes: Going back to Slide 9, do I understand that you agree that this laddering approach is the most effective way to balance risk and pricing for our procurement activities and gas? Van Orsdol: To a certain extent. Actually when I get to the market risk section, I will talk about some of the risks that are inherent with that current strategy. Dawes: And you’ll have some recommendations for standing pat or making changes? Van Orsdol: I would like to do some further analysis before I make a recommendation on changing the gas procurement strategy. One of the thing I would like to look at is really the variation in load use at peak months. We’ll talk a little bit about that. And we’ll talk about volume risk and market risk. I think there may be some opportunities to improve that. But I’d like to look at the data and do some more technical analysis before I would want to make a recommendation based on that. Once again, we’re consistent with the policy that we’re expecting these to be at least semi-annual, if not quarterly reports. So those can be things we will be following up in subsequent meetings. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 56 of 65 Let’s turn to Slide 11. On the electricity side of the load balance, as you’re all aware, supplies have been purchased and meet expected load until December 31, 2004. On that date, actually on January 1st, the integration agreement 2948A between Western and PG&E is terminated. As a result of that, Palo Alto finds itself initially in 175 megawatt hole starting that day. The Utility is now in the process of securing new supplies from a variety of different counterparties. One of them is the Western base resource contract that you’ve seen before. There are a number of other activities that will be needing to take place within the next 12 months, to ensure that that hole is filled prior to the end of the year 2004. We see long term foreign prices on a downward movement now, so it is a good opportunity in the next 12 months or so to purchase some more additional supplies. Dawes: That chart does include the …. we have made one 25 megawatt purchase. Yes? Van Orsdol: If you’ll just give me one moment, I’ll get this up. It will be easier for you to see actually the next points. This again shows you what we’ve procured, this is really the Western contract. This is January 1, ’05 and this shows you this blue, this large hole we’ll need to fill. As I said, long term prices are slightly downward for the years July’03 and beyond. In terms of this first initial risk assessment, I looked at 3 main characteristics, or 3 main categories of risk, Market Risk, Volume Risk, and Credit Risk. In terms of market risk, the analysis that we’ve done here is carried out on yet to be delivered supplies. There are 2 key measures I’ve looked at, and I think are most important for our risk assessment activities. The first is the level of the supply reserves for both gas and electricity, and that’s because this level provides a buffer to market changes and protects the consumer from rate changes with unexpected changes in market prices. The second key measure we use in assessing risk is what we call really the net revenue value at risk. That is the risk that an adverse market change would require CPAU to use the supply reserves to cover their costs over what is charged to rate payers. I’ve used net revenue value of risk, for a number of different reasons. One of them it is universally reported within the industry. If you read any of the energy industry texts, you might know it as cash flow at risk, but it’s a definitely a key parameter in assessing risk. It’s clearly one of the many risk measure that we use, but it’s very indicative of where the portfolio stands in relationship to the market. We really only focus on adverse changes. That is changes in prices which would then cause the utility to have to withdraw from the reserve fund. If they make additional funds their reserve fund, that’s really not obviously a risk issue. I define net revenue value at risk as the amount of money, the amount of funds CPAU would be required to take out of the reserves due to adverse market changes, assuming that the worst outcome would only occur one in 20 times over the 12 month horizon. That is sort of a standard confidence limit interval. So we’re really looking at the tail of the distribution. There may be many outcomes that are less worse than what the VAR figure is, but there would only be 1 out of 20 times or so. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 57 of 65 First let’s look at the gas. Let’s look at the two measures of the gas reserve level, and the value of risk of the gas reserve. As you are all aware, in the start of the energy crises, the commodity gas budget was set at approximately $5.00 gas and increases occurred really in the end of ’99 and ’00, when gas prices increased up to $14.00. CPAU chose not to raise the consumer rates to fully compensate for this, and so money was taken out of the reserves. As a result, by mid-01,the reserves were nearly depleted and at that time, in fiscal year ’02 the utilities did raise rates to help replenish the supply fund. Subsequently, the supply fund has gone back up to about 11 million dollars. The second measure is how risky is the portfolio in relationship to the existing gas reserve level, and the guidelines state that the limit is 10%, that is when the value at risk is such that 10% of the reserves could be eliminated due to adverse market changes, and that’s a warning sign to us that we need to look at the portfolio structure in relationship to the market. And this shows you the weekly net revenue VAR over the past 3 years, and I think it’s a good indication of really where you are. Please remember that this is a logarithmic scale and it’s really the only way you could put the VAR as well as the revenue on the same graph. But we’re about ½ up to the limit. So we are well within the range that we require. I think the value of VAR can be seen in this graph. This is again the reserve level, and this the VAR of the gas portfolio, and you can see as the VAR got over the limit, the gas portfolio lessened in value, and then once the increase occurred and the gas market became more stable, then the reserve was able to go up and the value at risk of the gas portfolio was able to stay the below the limit. So this is a very good indicator of how vulnerable your gas portfolio is to market changes. Let’s look quickly at the electricity. Electricity stabilization reserve has gone from about 20 million to about 37 million in the last 3 years. For the value at risk of the portfolio, again the limit is about 10%. The portfolio’s kept the VAR well below the limit down at about 1.85% now. Dawes: Is that less scale 4.0 or 40? Van Orsdol: The less scale, this is millions of dollars. Dawes: So it’s 4.0, roughly 10% of the 40 million reserve. Van Orsdol: Yes, in summary I’ve gone through this fairly quickly, because of the late hour, but in summary the key points are, in terms of market risk, both the gas reserves and the electricity’s reserves are at the appropriate level from the risk management perspective. The risk to the portfolios to adverse market changes is well balanced. Now let’s look very briefly at volumetric risk. Just sort of a definition, it’s really the risk at the volume of a contractor position changes from current expectations, and a volumetric risk could be caused by a major counterparty defaulting , weather conditions being different from what you expect, causing excessive demand or less demand that you Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 58 of 65 predict, or perhaps a lack of rainfall causing your expected hydro generation to be reduced. In terms of gas, the volumetric risk really changes very much according to the season. This shows you basically the volumetric risk here, this is what’s been purchased in September and this is what is expected demand is going to be. So the distance between the purchase and the expected demand is very small. But in December, January, February where gas use is much higher, the potential volumetric risk is much greater. I should point out, one of the things I mentioned earlier is that we have not yet be able to do an analysis of the variability of demand during the winter months, and that’s something that needs to be taken care of I think if we’re going to try manage volumetric risk. Dawes: Would you include in that analysis the appropriateness of Palo Alto actually acquiring it’s own ability to store gas, so we would not be in this looking to suppliers to supply that peak demand, but in fact, be able to have an inventory of gas that we could put in. It certainly is something I have been thinking we should be looking very seriously at and wondered if that was part of your risk analysis. Van Orsdol: It is certainly something I would be involved with and I would lend some advice on in terms of looking at the value of that option. But it’s not something I have done to date. So we do have volumetric risk during the winter. I should also note, as you would expect, volume risk and price risk are very related in this because the winter months are when there are the highest prices. Now volumetric risk is really mitigated for the city in two different ways. The first is that the tariff rules under which a city purchases gas, it’s allowed to take an additional 5% or leave off up to 5% on a monthly basis. For example, if February is a particularly cold month, it’s able to borrow from March. Likewise, it’s there extra left over in January, it’s able to borrow from that. Bechtel: Is that usually at the same price, the contract price? Van Orsdol: Yes. As a second measure of managing volumetric risk, the city has secured several swing contracts, which are really contracts that are volume variable. It allows the city to purchase additional supplies up to within 2 days of demand at a set price which is based on market conditions. So the city has these existing contracts if they foresee a cold snap coming on, they don’t have sufficient supplies, they can purchase additional gas very quickly under these swing contracts. With regard to electricity, there really is very little volumetric risk because up until December 31, 2004 we have this agreement where our largely hydro generation is firmed up by PG&E. However, after 2004 volumetric risk is going to be become quite significant unless it is addressed through the activities that are being currently carried out under the LEAP program. Dawes: Do our distribution problems -- lack of carriage into the Bay Area -- enter into this volumetric risk analysis, or is this simply not part of it? Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 59 of 65 Van Orsdol: Not so much to the volumetric risk in terms of electricity but it will enter into the fact that PG&E of course is going to be charging new transportation and transmission tariffs once 2005 begins. And they only now have just started to release some of the data as to what their charges are going to be. Palo Alto has a less vulnerable position than many other cities or many other load-bearing entities. It doesn’t specifically deal with volumetric risk, but it will deal with how we deal with price changes. Let’s look at the final major risk item -- and that’s credit risk. In electricity, we have essentially no credit risk exposure because Western is a federal agency. With regard to gas, our credit exposure is really limited to two counterparties. And in this our credit exposure is our Accounts Receivable, plus the market value of our portfolio, minus the costs for what we paid for that portfolio. And you can see, our two counterparties -- 18% of our credit exposure which totals about 11 million dollars currently -- 18% is covered by one counterparty and it’s double A rated, and by 82% by a second party that’s triple B+ rated. Just sort of reference, the City policy prohibits purchasing of wholesale commodities from companies that are rated below tripe B – I leveled there here as junk but from our perspective we won’t be dealing with those. So our portfolio is really quite safe from the credit perspective given that we have focused very much on finding counterparties with good credit ratings. I should add that as part of the long term gas purchasing we will be finding more counterparties and reducing our counterparty concentration list. Ok, exception reports. One of things the policy requests is that I do a report on exception that have occurred to policies, guidelines or procedures. Really , this exception report is any occurrence that conflicts with policy guidelines or the limits. In the 2 months that I’ve been here, there have been 2 exception reports issued. The first was really a pro- active credit limit adjustment that occurred because of two instances. The first is the risk manager coming on board. The guidelines had outlined stricter credit limits to be implemented when the risk manager came on board. When I started on the 3rd of March, actually, our credit limits automatically became tighter with my arrival. Simultaneous with that, one of our two gas counterparties was slightly downgraded to Triple B+. Utilities was faced with a situation where they only had two counterparties, they wanted to get additional purchases from different counterparties, and there was a need to raise the credit limit in order to allow for that to occur. The second exception was a contract execution exception by NCPA. In an agreement where Palo Alto had been working with NCPA to carry out this transaction. The Utilities understood the terms and conditions of the contract but had now formally approved the execution before it was carried out. I should note the NCPA notified us of the exception, and there was no financial impact of that decision. However, I would add that based on that exception I’ve been working with NCPA to review their risk management policy and procedures to insure that this doesn’t happen again, because while this exception was in itself was minor, we want to make sure there are no further executions that are carried out without our explicit permission. I Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 60 of 65 want to report just a little bit about the progress of the risk management process. I talked earlier about many of thinks I think we have accomplished, not just in the last two months, but really over about the past year. And there are a number of items in progress that we’re working on, that includes enhancing our analytical capabilities, refining specific procedures for front, middle and back office. We are acquiring recorded phone lines for transaction execution which is an industry standard and really needs to be done for our protection, and we’re improving really our database management and security procedures by developing a transaction database, and improving our sheets that the traders fill out in terms of executing the deal. We’re doing some other work and all of this is based on the priorities of the city auditor’s report as well as the consultants who worked for Palo Alto , Deloitte and Touche. Finally, because of the shortage of electricity in 2005, I wanted to just talk a little about where we stand in terms of future purchases. There are three block purchases that were anticipated to fill some of the post-’04 shortage. Block 3 is a purchase that has been approved by city council, through NCPA, but I wanted to note that we have worked with NCPA to insure that they meet our credit limits and well as our volume limits and now theirs, which tend to be looser. We have several other blocks, two other blocks that will be purchased within about the next 9 months, and we expect that they will be done through the master agreements. Dawes: Western is evidently to work up some proposals for ancillary agreements. If they came up with something that was appealing, they would fill one of these open blocks, is that the idea? Van Orsdol: Well, no. There are three blocks, Blocks 1, 2, and 3, which are very specific purchases that the Utilities has been developing. Block 3 is calendar year ’05 6 x 16 purchase peak power. Blocks 1 and 2 I’m sure Girish knows the exact terms by heart. Ulrich:Those are the ones that are listed in the LEAP. Dawes: I’m a little unclear. I guess we don’t know what Western is coming up with. Balachandran: The answer is no, we’re not looking at Western. Dawes: We’re not going to do business no matter with what they come up with. Balachandran: They’re not coming up with products with which these are meant to satisfy. These are just standard block on-peak and off-peak products and as part of the base resource contract, Western is not going to come up with this. The custom product there’s an option for customers to elect for Western to buy stuff for them. At this point, it’s only going to be very small customers who would do it and the whole process of the custom product, it’s only going to get finalized sometime in June ’04. So in terms of one Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 61 of 65 of our objectives is to diversify our supply across time, the laddering strategy, so these first 3 blocks we plan to complete the purchase of these blocks by June ’04. So just about the time that Western would come out with custom product contract, which is mostly suited for very small customers, we’d be done with this phase. Van Orsdol: We have been talking very extensively with Western about the custom products and staff and utilities and I have gone to Western meetings to make sure the contracting arrangements are to our liking as much as possible, and to start trying to hammer out what the specifics are that custom contracting’s going to be. Ferguson: I’m fascinated by the “value at risk(VAR)” charts at the beginning here. One of the things that we’ve always assumed here in the multiple-utility businesses is that there is advantage to the diversification. Maybe there is efficiency, in that we have shared management dividing its time in cost allocated across 3 or 4 different utilities. But it looks like you’re a step or two away from being able to demonstrate with some numbers that there is or there is not a benefit from having four utilities operating. In the sense that there’s a value to the City, a bottom line. Maybe it’s a sum total of all the reserves, and the risk to that sum total overall is lower because we’re operating four utilities -- one ebbs while the other flows. It would be interesting to see how that kind of grand calculation of risk might come out using these techniques. As a corollary to that, it might be interesting to put whatever the fiber-to-the-home proposal is going to look like, bracket the magnitude of that risk, as part of the overall utility value-at-risk portfolio. Van Orsdol: Well, obviously in my value risk I’m looking very specifically at the portfolio and looking at market changes. I mean certainly one of the risks Palo Alto does face is that it’s not very diverse in terms of its fuel or electricity or water. And one of the ways to diversify your portfolio would be to enter into more, for example, tolling agreements, where the price of electricity is really determined by the price of gas. There’s a number of options that some of these people at these staff utilities are looking at -- to try to come up with fuel diversity, because that’s clearly one of the areas Utilities could find ways to leverage their multi-commodity approach. Ferguson: Thanks. Van Orsdol: This is just my last slide, just to bring you up to date on both the gas and the electricity master agreements. In terms of gas, and RFP was issued. We had nine creditworthy respondents replying. We’re currently reviewing and evaluating six of those. We anticipate presenting multiple contracts to the city council for approval by the fall of about 2003. As I showed you before, in the credit risk area, we only have two counterparties, and so doing these gas master agreements will help us significantly in lowering our counterparty credit risk and our counterparty concentration risk. In terms of electricity, the electricity master agreements, we actually yesterday finalized the language for the RFP, so we expect that to be issued next week. Given to the timetable, we are Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 62 of 65 hoping to present to the city council by October, November of this year, the most successful bids on those master agreements. And again, this will lower our post ’04 market and credit risk. We anticipate we may actually get some tolling counterparties submitting, so it also reduces our fuel risk. That in brief is the first of what I hope will be regular risk oversight reports to this group. I certainly would welcome any comments and suggestions you have on the approach, the depth, the breadth of what we’ve looked at. There’s many other risks that we haven’t talked about -- operational risk, regulatory risks -- other risks that we might be looking at down the road. I certainly welcome your comments and thank you for your time at this late hour of the night. Rosenbaum: Thank you very much, particularly at this late hour. Colleagues, questions? Ferguson: I jumped the gun with my global question. Rosenbaum: Thank you very much and hopefully next time you appear before us, it’ll be a little earlier and we’ll be in a better position to ask questions. Ulrich: Mr. Chairman, our City Auditor, Sharon Erickson would like to make some comments. Rosenbaum: Go right ahead. Erickson: Thank you very much and it’s very late. I just wanted on behalf of the City Auditors office to acknowledge the joint efforts of Administrative Services and the Utilities Department in preparing this first energy risk management report. The establishment of the independent middle office, the issuance of these types of reports, and the hiring of a risk manager, an energy risk manager, demonstrates , well they are major milestones to me in the city’s move towards our continuing commitment to industries best practices in this area. I think the staff deserves a big round of applause for that. Thank you. Ulrich: Thank you Sharon. Rosenbaum: Thank you. Gas Rate Proposal (concluded) Ulrich: If it’s appropriate to return to a subject that we didn’t finish and that is further discussions and hopeful conclusion on Items 3C the proposed gas rate decrease. In the last few minutes staff has been spending some time thinking about how to resolve this in Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 63 of 65 a way that would give comfort to you on what an appropriate rate of change would be. It turns out to be a rather simple solution. A lot of brain power went into this, to come up with a simple solution. And that is to change our recommendation. The recommendation change would be to have the 15% rate decrease for all classes of gas customers with the exception of G7, which is the schedule that a customer on a current contract could choose to have at the conclusion of their contract. If they do that, then that’s where the price risk becomes a problem for the rest of the customers. So we change our proposal to say that the current G7 rate schedule would stay exactly as it is, and the other rate schedules would have the 15% reduction. The price volatility and impact on the costs, therefore -- either our customers bills or reserves -- would be quite minimal. I request that you approve that recommendation. Rosenbaum: Commissioners, any thoughts? Ferguson:: So moved. Rosenbaum: Do we have a second? Bechtel: Second. Rosenbaum: The motion is to approve the staff recommendation except for the G7 rate schedule which would stay as currently is. Any discussion? Dawes: Referring to table 1 on page 305, it lists various types of customers. To which of these customers does G7 apply? Just to the last one or the last two? Or is it to those particular classes that have elected that? Baldschun: G7 is not shown, because we don’t have any customers that are on G7 right now. This is the schedule we’re at risk for. This is the schedule our customers left during the energy crisis, to go to the fixed term rates. Since these customers were not on the rate during the energy crisis, they did not participate in building up the reserve -- that’s why it’s appropriate not to have a decrease on the G7, next month or next July. Dawes: But I thought that you said that if these guys migrated -- and it is not clear that they would but if they did and we had to buy a lot more gas as a height, at a higher price - - then instead of having a 15% decrease, we could be looking at a 10%, a 5%, or no decrease. I’m a little unclear. Ulrich: The beauty of this simple approach is that, if you don’t have a rate decrease, when the customer looks at his alternatives -- either buy gas again under contract or what rate schedule could he apply for -- it would be the one that is currently in place, which is 15% higher than what we were proposing to give. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 64 of 65 Baldschun: Let me give you the exact rate, the current G7 rate today is 46.8 cents a therm. That’s the commodity charge. The rate proposal with the 15% reduction, that 15% is on the overall rate, not just a commodity rate, but the commodity rate would have gone from 46.8 down to 33.1 cents -- about 13% drop. Now by taking that off the table, that really removes the incentive for customers to move from the fixed term rates to the G7 rates because now the commodity rate is 46.8 cents. The risk exposure is dramatically reduced. Dawes: So all of these customers would go into G7, they wouldn’t go into these other classifications? Ulrich: Well, they would get a choice to go into G7, but when they looked at the price, they’d say, “Whoops, I don’t want to do that.” Dawes: So they would continue their fixed term. Balachandran: Or G3, the monthly rate. The point that Randy made is that there is no customer on G7 right now. Everyone is on G11 or G3, and they’ll continue as per their own risk profile. Dawes: Part of the problem is that I’m looking on the wrong page. Ulrich: So G7-1, is the very last page. Dawes: I think I have it, but at 11:15 pm I’m not as sure as I am at 8:15 pm. Ulrich: Oh, come on. We can keep going. Rosenbaum: It looks as if the staff come up with a fine solution and that’s very good. We have the motion by Ferguson with a second by Bechtel to approve the staff recommended decrease in gas rates for all classes except for G7. All those in favor? Group: Aye Rosenbaum: Opposed? That passes unanimously with Commissioner Carlson absent. Is there anything else to do tonight? Next Meeting Ulrich: Well, we have a couple of other items. Do you want to go through those or would you like to put those off? Rosenbaum: I think if we can put them off, we’ll put them off. Approved UAC 2003May7 Minutes Approved on 6/4/03 Page 65 of 65 Ulrich: One idea might be is to take the utility quarterly report, since it’s information, and accept it as filed, if you’d like to do that? Dawes: You’ll have to answer one question from me and least give me an indication. There’s a short discussion about Western and Enron working out a situation. Is this a straw in the wind with respect to Palo Alto, or is this something you can’t comment on? Ulrich: I can’t comment on it. Dawes: Does it have any relation to our reserve position? Can’t comment? Ulrich: Can’t comment on that. Rosenbaum: Anybody else have any questions on the quarterly report? Ferguson: Not the quarterly, just the scope of the June agenda. Rosenbaum: We’ve received the quarterly report and it will not be necessary to bring it back on next month’s agenda. Rick, your question? Ferguson: Do we have a June agenda, since you slipped FTTH to July and August? Ulrich: Yes, we would do GULP and also the groundwater feasibility study. Ferguson: The reason that I ask is that I’ve elected not to re-up for a third appointment to the Commission. So I hope we can save a little time for some parting comments, if we have a June meeting. That will be my last meeting with my colleagues here on the Commission. Ulrich: The meeting will be June 4th. Adjournment Rosenbaum: If there is no further business, this meeting is adjourned. Thank you all very much.