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HomeMy WebLinkAboutStaff Report 161-09TO: FROM: DATE: SUBJECT: BUDGET FY 2010 -FY 2011 FINANCE COMMITTEE CITY MANAGER MARCH 31, 2009 DEPARTMENT: UTILITIES CMR: 161:09 Recommendation to City Council on Proposed Changes to the Electric Fund's Calaveras Reserve Guidelines EXECUTIVE SUMMARY The Calaveras Reserve is used to provide funds to the Electric Fund's operating budget to cover costs that are above the value of certain assets (known as stranded cost). Since completing the assignment of a transmission asset and an energy exchange contract whose costs were higher than their benefits, staff reassessed the level of funding necessary in the Calaveras Reserve. Staff's current assessment is that, under many scenarios, the Calaveras Reserve may have funds in excess of what is needed to cover stranded cost. However, the stranded cost needs are highly sensitive to changes in wholesale electric market prices and hydroelectric generation conditions. Over the past few months, staff has met with the UAC, Finance Committee and Council to discuss alternatives for managing the Calaveras Reserve going forward including the use of excess funds for other purposes within certain parameters. After evaluating several alternatives, on January 12, 2009, the Council provided direction to staff on how to manage the Calaveras Reserve. Staff's recommended changes to the existing Calaveras Reserve Target and Guidelines are necessary to implement Council's direction and to provide for a dynamic and transparent methodology to assess the Electric Fund's stranded cost and potential excess funds. RECOMMENDATION The Utilities Advisory Commission (UAC) and staff recommend that the Finance Committee recommend that the City Council adopt new guidelines to manage the Calaveras Reserve through changes to the existing Calaveras Reserve Target and Guidelines as follows: • Eliminate the existing Calaveras Reserve drawdown schedule; • Require the calculation of the stranded costs for the electric supply portfolio during the annual budget process for the upcoming budget year(s) and set the minimum transfer from the Calaveras Reserve to the Electric Supply Operating Budget equal to this amount; • Require the calculation of the stranded costs for the long-term (until 2032 when Calaveras debt is paid off) of the electric supply portfolio during the annual budget CMR: 161:09 Page 1 of 6 process and ensure that the Calaveras Reserve balance will be sufficient to cover this amount; • Calculate stranded cost based on the above market cost of the Calaveras Hydroelectric Project and the California Oregon Transmission Project; and • To the extent that there are funds available in excess of long-term stranded cost needs, staff will work with the UAC to identify and recommend projects for Council consideration and approval. Such projects shall be to the benefit of electric ratepayers. BACKGROUND In 1983, the City Council established the Calaveras Reserve in the Electric Fund to help defray a portion of the annual debt service costs associated with the Calaveras Hydroelectric Project, which was put in service at that time. As originally established, the Calaveras Reserve policy did not provide for a target balance and depletion of the reserve was anticipated by 2002. California Assembly Bill 1890 was adopted in 1996, which provided for the deregulation of California's electric industry effective January 1, 1998. A key element of deregulation was the provision for Direct Access, which would allow electric customers to choose their electric commodity supplier. The City of Palo Alto Utilities (City), along with other California utilities, were faced with the prospect of losing customers and load to Direct Access and being saddled with expensive generation assets purchased or built to serve these customers. In response to such risk, Pacific Gas and Electric Company and other investor- and municipally -owned utilities established stranded cost surcharges to collect funds from ratepayers to cover the amount that these uneconomic assets were projected to cost above their market value in the future (i.e., "stranded cost"). Council changed the purpose of the Calaveras Reserve in 1996 (CMR: 214:96) and authorized collections from electric ratepayers to cover the amount that certain electric assets' costs were projected to be higher than their market value in the future (i.e., stranded cost). In addition, Council approved a new Calaveras Reserve policy linking the reserve balance to an amount sufficient to cover potential stranded costs. The assets identified as stranded included the Seattle City Light Exchange contract, the Calaveras Hydroelectric Project, and the California -Oregon Transmission Project (COTP). In 1999, Council ceased collecting funds for these stranded costs and established the Calaveras Reserve Target and Guidelines with a schedule to draw down the funds and manage electric rates through the end of FY 2032-33 (Attachment A). In May 1997, Council revised the reserve target level to cover above -market, or "stranded," costs to $93 million by December 31, 2001 to be collected from a stranded cost surcharge imposed on electric rates (CMR:219:97). When the Calaveras Reserve balance reached $71 million in 1999, stranded costs were deemed fully collected. At that time, Council authorized the cessation of the collection of the stranded cost surcharge and established the Calaveras Reserve Target and Guidelines (CMR 222:99) with a schedule to drawdown the funds and manage electric rates through transfers from the Calaveras Reserve to the Electric Supply Rate Stabilization Reserve (E-SRSR) through the end of Fiscal Year (FY) 2032-33, when the Calaveras Reserve would be exhausted. In 2001, the California electric industry faced an energy crisis triggering wholesale power price spikes and rolling blackouts throughout the state. The crisis was blamed on poor deregulation CMR: 161:09 Page 2 of 6 market design and market manipulation by energy suppliers. As a result, Direct Access was suspended in California for the investor -owned utilities and subsequently, the City suspended its Direct Access program. Further, as a result of changing market conditions and the assignment of certain electric assets, the estimate of the City's stranded cost is lower now than when stranded cost collections stopped in 1999. Since then, electric market prices have increased significantly, reducing the stranded cost associated with the Calaveras Hydroelectric Project. In June 2008, the City permanently assigned away its share in the Seattle City Light Exchange. Further, a long- term assignment of the City's share in the COTP has been executed. The assignments of the COTP and Seattle City Light Exchange effectively eliminate stranded costs associated with these two electric assets. At the December 2007 and February 2008 UAC meetings, staff discussed the background and rationale for developing the Calaveras Reserve, provided an assessment of the current need for the Calaveras Reserve and options for managing the Calaveras Reserve in the future. In November 2008, staff presented a proposal to the UAC for the use of the Calaveras Reserve funds including allocating $10 million to return to the Rate Stabilization Reserve and provided an estimate of future stranded costs from Calaveras and COTP. At that time, the estimate for the potential need for funds for stranded costs was $32.5 million. Since the balance of the Calaveras Reserve will be $64.5 million as of the end of FY 2009, the Calaveras Reserve would have about $32 million (by the end of FY 2009) that may be no longer needed to cover future stranded costs. At its November 2008 meeting, the UAC provided the following general feedback on staff's proposal: • Agreement with staff's assessment that the current estimate of stranded cost is likely lower than the $64.5 million in the Calaveras Reserve and recognition that staff's stranded cost estimate of $32.5 million is a prudent amount of funds to reserve for stranded cost. • Recognition that the Calaveras Reserve has about $32 million more than is needed to cover stranded cost. • No support for transferring funds to the Electric Supply Rate Stabilization Reserve (E-SRSR) because such a strategy sends the wrong price signal to customers and only defers the need to raise electric rates to cover cost. The UAC noted that E-SRSR funds were drawn down in FY 2007-08 and are planned to be drawn down in FY 2008-09 resulting in retail rates that do not fully cover operating costs. An additional transfer would continue to defer the alignment of retail rate revenues with costs. • Support of the use of funds in the Calaveras Reserve that may not be needed for stranded costs to pay for capital improvement projects to the benefit of electric rate payers and identification of several types of projects which may be funded. However, the UAC did not support the idea of creating a new fund to do so. • Recognition of market price and hydroelectric generation uncertainty as reason for careful deliberation of the use of the Calaveras Reserve. • Support of use of funds in the Calaveras Reserve that may not be needed for stranded costs for capital project development only after reviewing and concurring with a specific project recommendation by staff. As a result of the UAC's input, staff revised its preliminary proposal and decided not to recommend an immediate transfer of some of the excess funds to the Electric Supply Rate CMR: 161:09 Page 3 of 6 Stabilization Reserve and not to create a new reserve for potential capital projects that benefit electric ratepayers. At its December 2, 2008 meeting, the Finance Committee reviewed the recommendations from the UAC and staff's revised proposal (CMR: 449:08). The Finance Committee generally agreed with staff's revised proposal to retain some funds in the Calaveras Reserve for stranded costs and to begin a thorough review of potential capital projects that could benefit electric ratepayers. These project ideas would be considered for at least partial funding from Calaveras Reserve funds. The Committee agreed with the UAC that potential projects for the funding might include: • Development of local and/or distributed generation to reduce transmission charges and losses and save costs of local capacity requirements; • Upgrade of transmission voltage from PG&E to the City's distribution system to reduce transmission system losses; • Development of smart grid elements and purchase of smart meters to optimize the distribution system; • Purchase of land from the City which the electric utility currently rents to reduce the cost exposure to changing property values; and • Loans to other Utilities funds and/or the General Fund in order to save financing costs related to issuing bonds for capital projects. On January 12, 2009, Council approved the Finance Committee's recommendation (CMR:110:09) to direct staff to: 1. Continue using the Calaveras Reserve to cover stranded cost, which is currently calculated to be $32.5 million; 2. Continue the annual transfer from the Calaveras Reserve to the Electric Supply Rate Stabilization Reserve as budgeted for Fiscal Year (FY) 2009; and 3. Work with the Utilities Advisory Commission (UAC) to review possible projects that would benefit electric ratepayers for consideration of funding from the calculated "excess" Calaveras Reserve funds and to return to the Finance Committee with staff's and the UAC's recommendations for use by the Finance Committee to formulate a recommendation for Council action. DISCUSSION The current Calaveras Reserve guideline consists of a schedule for the target reserve balance until the reserve is completely exhausted by the end of FY 2033 (Attachment A). Changes to the guidelines must be made in order to implement the Council direction. Staff has identified two alternatives that could be considered for changing the Calaveras Reserve guidelines. The first sets a new target reserve balance schedule so that $32 million is reserved for capital projects that are identified and selected for funding. This alternative provides certainty for long-term financial planning for the electric utility because the amount that can be expected to be transferred from the Calaveras Reserve is known. CMR: 161:09 Page 4 of 6 The second alternative is a more dynamic guideline that establishes a minimum transfer from the Calaveras Reserve based on the stranded cost estimate updated in the annual budget process. In this alternative, the amount transferred from the Calaveras Reserve would be determined annually and could take into account the five-year financial plan measures such as reserve levels, projected rate adjustments, and updated stranded cost estimates. Staff recommends the second alternative, which requires an annual recalculation of the electric utility stranded cost estimates during the budget approval and rate setting process. Staff's proposal contains several aspects: 1. Annually, during the budget approval and rate setting process, the stranded costs for the upcoming budget year and for the long-term would be estimated. The calculation would be based on the updated cost and generation estimates for the Calaveras Hydroelectric Project and the California -Oregon Transmission Project (COTP) and electric market price projections. 2. The minimum transfer from the Calaveras Reserve to the Electric Supply Operating Budget for the upcoming budget year would be equal to the stranded cost estimate for that budget year. An additional amount could be transferred depending on the overall financial circumstances of the Electric Fund. 3. The updated long-term stranded cost estimate would be used to establish the amount that should remain in the Calaveras Reserve to cover these costs. The amount of money available for an alternate use would be equal to the Calaveras Reserve balance minus these updated long-term stranded cost estimates. 4. The use of any funds available in the Calaveras Reserve that are in addition to the funds needed for the long-term stranded cost as calculated in the annual budget process would require Council approval. 5. Staff will work with the UAC to identify and recommend projects to Council that benefit electric ratepayers to use funds from the Calaveras Reserve. If the proposed method were used for FY 2010, then the minimum transfer from the Calaveras Reserve would be $2.6 million for FY 2010. This is based on the assumptions and market prices used to develop the FY 2010 budget. Using these assumptions and an estimate of long-term contingencies, the long-term stranded cost estimate would be $48 million. This would be the amount that should remain in the Calaveras Reserve to cover these potential stranded costs. Therefore, if the Calaveras Reserve balance was $64.5 million, then $16.5 million could be used for an alternate use. Depending on how much of the funds in the Calaveras Reserve remain after being used for projects, the Calaveras Reserve could be insufficient to cover stranded costs as determined by the annual recalculation. In this case, the remaining balance in the Calaveras Reserve may not have funds available for new projects. COMMISSION REVIEW AND RECOMMENDATIONS The proposed changes to the Calaveras Reserve guidelines were presented to the UAC at its February 4, 2009 meeting along with an update of short- and long-term stranded cost and potential excess funds. The UAC discussed whether there were risks of the proposed changes whereby cumulative transfers from the reserve would result in inadequate reserves to cover CMR: 161:09 Page 5 of 6 stranded costs. The Commission agreed with staff's explanation that, although this could happen, the real risk exists only if Direct Access were reinstated. The UAC voted unanimously to recommend that the Council approve staff's recommendation. The notes from the UAC meeting are provided as Attachment B. RESOURCE IMPACT Implementation of the proposed changes to the Calaveras Reserve Target and Guidelines does not impact FY 2009. The changes, if approved, will be incorporated in the FY 2010 and FY 2011 Operating Budgets and FY 2010 electric rates for Council's review and approval. POLICY IMPLICATIONS This recommendation is consistent with the Council -approved Utilities Strategic Plan with regard to 1) managing supply portfolio risk to preserve a supply cost advantage; and 2) to provide low and stable rates, adequate reserves, and budgeted transfers to the General Fund. ENVIRONMENTAL REVIEW Changing the Calaveras Reserve guidelines does not constitute a "project" pursuant to Section 21065 of the Public Resources Code, thus no environmental review under the California Environmental Quality Act is required. ATTACHMENTS A. 1999 Council -Approved Calaveras Reserve Target and Guidelines B. Excerpts — Final Minutes from the February 4, 2009 UAC meeting PREPARED BY: REVIEWED BY: DEPARTMENT APPROVAL: CITY MANAGER APPROVAL: MONICA PADILLA Senior_ Resource Planaer E O. RATCHYE lities Assistant Director, Resource Management vi it( VALERIE O. FANG Director of Utilities S Mana ger KEEN CMR: 161:09 Page 6 of 6 ATTACHMENT A 1999 Council Approved Calaveras Reserve Target & Guideline Ending Reserve Target (M$) Minimum (M$) Maximum (M$) FY 06-07 71.8 64.6 89.8 FY 07-08 70.3 63.3 87.9 FY 08-09 68.9 62.0 86.1 FY 09-10 67.4 60.7 84.3 FY 10-11 65.1 58.6 81.4 FY 11-12 62.0 55.8 77.5 FY 12-13 58.8 52.9 73.5 FY 13-14 55.5 49.9 69.4 FY 14-15 52.0 46.8 65.0 FY 15-16 48.4 43.5 60.5 FY 16-17 44.6 40.1 55.7 FY 17-18 40.6 36.5 50.8 FY 18-19 36.5 32.8 45.6 FY 19-20 32.2 28.9 40.2 FY 20-21 27.6 24.9 34.6 FY 21-22 22.9 20.6 28.7 FY 22-23 18.0 16.2 22.5 FY 23-24 12.9 11.6 16.1 FY 24-25 9.8 8.8 12.3 FY 25-26 8.6 7.7 10.7 FY 26-27 7.3 6.6 9.2 FY 27-28 6.1 5.5 7.6 FY 28-29 4.9 4.4 6.1 FY 29-30 3.6 3.3 4.5 FY 30-31 2.4 2.2 3.0 FY 31-32 1.2 1.1 1.5 ATTACHMENT B EXCERPTS from Final Minutes of UAC Meeting of February 4, 2009 ITEM 2: ACTION ITEM: Proposed Changes to the Calaveras Reserve Guidelines Utilities Director Valerie Fong presented staff's proposed changes to the Calaveras Reserve Target and Guidelines and requested that the UAC recommend to Council the adoption of the proposed changes. The recommended changes as presented included: • Eliminate the existing Calaveras Reserve drawdown schedule; • Require the calculation of the stranded costs for the electric supply portfolio during the annual budget process for the upcoming budget year(s) and set the minimum transfer from the Calaveras Reserve to the Electric Supply Operating Budget equal to this amount; • Require the calculation of the stranded costs for the long-term of the electric supply portfolio during the annual budget process and ensure that the Calaveras Reserve balance will be sufficient to cover this amount; • Calculate stranded cost based on the above market cost of the Calaveras Hydroelectric Project and the California Oregon Transmission Project; and • To the extent that there are funds available in excess of long-term stranded cost needs, staff will work with the UAC to identify and recommend projects for Council consideration and approval. Such projects shall be to the benefit of electric ratepayers. Fong also presented an update of stranded cost and possible excess Calaveras Reserve funds in a manner consistent with the proposed changes to the guidelines, including: • Stranded cost equal to minimum transfer requirement for FY 2010 and FY 2011 at $2.63 and $1.99 million, respectively based on market value and cost assumed for FY 2010 budget development; • a range of long-term stranded cost scenarios which are dependent on market price and hydroelectric generation of $31.5 to $52.5 million; and • a potential Calaveras Reserve excess in the range of $12 to $33 million, given the range of long-term stranded cost and the projected ending FY 2009 Calaveras Reserve balance of $64.5 million. Assistant Utilities Director, Jane Ratchye added that in the event a project is identified for possible funding with excess Calaveras Reserve funds, the long-term stranded cost calculation would be updated prior to expending the funds to ensure adequacy of the Calaveras Reserve. Ratchye also clarified that the stranded cost transfer calculated for FY 2010 is the minimum amount recommended and that it is Council's discretion to approve greater transfers from the Calaveras Reserve. Commissioner Waldfogel expressed concern that the short-term calculation did not look at contingencies for low hydroelectric output for which Ratchye clarified that such contingencies would be included in the long-term calculation. Chair Dawes expressed his desire to annually true -up the transfer from the Calaveras Reserve based on actual performance of the stranded assets, however none of the other commissioners expressed their support for this idea as it would not add to rate stability and could be administratively burdensome. Commissioner Melton asked what staff would do if the Calaveras Reserve is used to fund projects and stranded cost increases above the amount available in the Calaveras Reserve. Fong explained that staff's response would depend on whether or not Direct Access was available to customers and that any recommendation would be provided in the context of overall rates. Action on this item was deferred until after Item Number 6 — Long -Term Financial Projections and Revenue Adjustment Targets for the Electric Fund. RETURN TO ITEM 2 FOR ACTION: Proposed Changes to the Calaveras Reserve Guidelines Commissioner Melton motioned to recommend to Council the adoption of the changes to the Calaveras Reserve Target and Guidelines as presented by staff. Commissioner Rosenbaum seconded the motion. The motion passed unanimously (5-0).