HomeMy WebLinkAboutStaff Report 2427City of Palo Alto (ID # 2427)
Finance Committee Staff Report
Report Type:Meeting Date: 2/7/2012
February 07, 2012 Page 1 of 4
(ID # 2427)
Summary T itle: Gas Supply Rate T imeline
Title: Timeline to Implement Gas Supply Rate Change to Monthly-Varying,
Market-Based Rates
From:City Manager
Lead Department: Utilities
Recommendation
This is an informational report and requires no Council action.
Executive Summary
This report outlines the steps that need to be completed and the timeline for implementing
market price-based, monthly-adjusted gas supply rates. The proposed schedule would allow for
full implementation of the plan, including the required rate adjustments, by July 1, 2012. The
schedule allows time for reviews by the Utilities Advisory Commission (UAC), the Council
Finance Committee, and the Council.
Background
At its November 1, 2011 meeting, the City Council approved staff ’s recommendation to
transition to market price-based, monthly-adjusted gas supply rates (Staff Report #2106).
Council also directed staff to return to the F inance Committee by January 2012 with a timeline
for implementation of the new gas supply rate. Since no F inance Committee meetings occurred
in January 2012, this report was scheduled for February 2012.
Discussion
The figure below shows the fixed-price purchases that have been completed compared to the
pool customer1 load for the next three years as of January 10, 2012. Although gas purchases
have been suspended for months, the pool load is partially hedged with fixed-price gas through
October 2013.
1 Pool customers include residential customers and small and medium commercial customers. Large commercial
customers have been on a monthly-varying, market-based gas supply rate since July 2001.
February 07, 2012 Page 2 of 4
(ID # 2427)
Gas Supply Procurement Program for Pool Customers
January 10, 2012
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
Feb-12 Aug-12 Feb-13 Aug-13 Feb-14 Aug-14
MMBtu/month
57%
hedged
for FY12
Expected Pool
Customer Load
Completed
Purchases
24% hedged for FY13 5% hedged for FY14
As of January 10, 2012, fixed-price purchases have been completed for 57% of the expected
pool load for the remaining months in Fiscal Year (FY) 2012. Fixed-price purchases comprise
approximately 24% of the expected pool load for FY 2013. For FY 2014, fixed-price purchases
account for approximately 5% of the expected pool load.
Even though fixed-price purchases have been completed for FY 2013 and FY 2014, staff has
developed a plan to implement the new gas supply pricing direction starting in FY 2013. The
following are the major steps for implementing market price-based, monthly-adjusted gas
supply rates by July 1, 2012.
Revisions to the Gas Utility Long-term Plan (GULP)
In the staff report recommending the change to market price-based, monthly-adjusted gas
supply rates, staff identified the need to revise some sections in the Council-approved Gas
Utility Long-term Plan (GULP) Objectives, Strategies and Implementation Plan. The UAC
recommended that Council approve those changes at its December 7, 2011 meeting, and the
revisions are presented to the Finance Committee in a separate report (Staff Report #2440).
Financial Projections and Revenue Requirement
As part of the budget process, staff produces a five-year financial projection and revenue
requirement. This projection will consider the new market-based pass-through supply rate as
well as the distribution rate, which must recover costs including the capital improvement
project needs, operations and other expenses.
February 07, 2012 Page 3 of 4
(ID # 2427)
Proposed Changes to Rates and Reserve Guidelines
Based on the distribution-related costs to serve each customer class, staff will propose changes
that align the distribution rates with the associated cost of service. At the same time, staff will
also propose a methodology for calculating the monthly supply rate. If needed, revisions to the
supply and distribution Gas Rate Stabilization Reserve guidelines will be recommended that take
into account existing bond covenants and debt coverage ratios for favorable bond rating,
minimum cash reserves to manage cash flow risk, and unanticipated cost contingencies.
Proposed Changes to the Energy Risk Management Policy
The Energy Risk Management Policy applies to financial commitments made today for delivery
of energy and gas in the future and describes the controls needed to manage the risks for these
types of transactions. These risks do not exist for the spot market purchases, which will
comprise the gas portfolio under the new gas purchasing /gas rate policy. Therefore, the Energy
Risk Management Policy, as it applies to the gas utility, will require some revisions.
Customer Education and Outreach
A critical task in the transition to a new gas supply rate structure is customer outreach. The goal
is to prepare customers for a gas supply rate that will change each month, something Palo Alto’s
residential and small commercial customers have not experienced in the past. Utilities will
develop and implement a plan to reach customers with a clear and concise message about the
change.
Timeline
The table below summarizes the schedule to complete the tasks outlined above. The UAC and
Finance Committee will provide recommendations on the implementation steps and the
Council will consider action at several points prior to final adoption of the new gas rates. The
timeline shows that staff intends to follow the normal budgeting and rate setting process and
will strive to have new rates in place by July 1, 2012, at the beginning of F iscal Year 2013.
February 07, 2012 Page 4 of 4
(ID # 2427)
Task Oversight Date
UAC Dec 2011
Finance Feb 2012
GULP Revision
Council Mar 2012
UAC Apr 2012Gas Utility F inancial Projections/Revenue Requirement
F inance Apr 2012
UAC May 2012
Finance May 2012
Proposed Changes to Rates and Reserve Guidelines
Council Jun 2012
UAC May 2012
Finance Jun 2012
Proposed Changes to Energy Risk Management Policy
Council Jun 2012
Customer Education and Outreach Staff May-Jul 2012
New Effective Gas Supply Rate Staff Jul 2012
Resource Impact
In the short-term, staff resources will be required for implementation of the new gas commodity
purchasing and rate strategy. Long-term, 0.4 FTE are expected to be redeployed from gas
portfolio management to other projects. This savings include small amounts of time spread
across multiple individuals in Utilities and Administrative Services.
Policy Implications
Revisions to the Council-approved GULP are presented in Staff Report #2440. Potential
revisions to the Gas Rate Stabilization Reserve Guidelines will occur according to the timeline
above.
Environmental Review
The development of a timeline to implement the new gas purchasing strategy and gas rates
does not meet the definition of a project pursuant to Section 21065 of the California
Environmental Quality Act (CEQ A). Thus, no environmental review is required.
Attachments:
·Attachment A: Draft Excerpt Minutes 11.01.11 (PDF)
Prepared By:Karla Dailey, Sr. Resource Planner
Department Head:Valerie Fong, Director
City Manager Approval: ____________________________________
James Keene, City Manager
DRAFT EXCERPT MINUTES
Special Meeting
November 1, 2011
The City Council of the City of Palo Alto met on this date in the Council Chambers at 7:03
P.M.
Present: Burt, Espinosa, Holman, Klein, Scharff, Schmid, Shepherd, Yeh
Absent: Price
7. Finance Committee Recommendation to Change the Gas Purchasing Strategy to
Implement Market‐based, Monthly Adjusted Gas Supply Rates.
Mr. Keene explained that Staff had been discussing the gas purchasing strategy for a
number of years. Staff planned to explain their process for working through different
gas purchasing alternatives and their proposal to move away from the ten‐year strategy
of laddering gas purchases to a market competition model.
Karla Dailey, Senior Resource Planner, explained that the Gas Utility Long‐Term Plan
(GULP) provided direction on gas purchasing, energy efficiency, regulatory advocacy,
and climate protection. The Utilities Strategic Plan provided direction on reliability and
safety, customer satisfaction, cost management, and environmental sustainability.
There were references to the gas purchasing strategy in both the gas purchasing section
of the GULP and the customer satisfaction section of the Utilities Strategic Plan. She
stated the current laddering strategy was developed in response to the energy crisis. In
2000, gas prices increased dramatically. As a result, the City was forced to impose
several very large rate increases and to nearly exhaust their reserves. The City reacted
to that situation by implementing a laddered gas purchasing approach, rather than
subjecting themselves to open market gas prices. In June 2010, Staff made a
presentation to the Utilities Advisory Commission (UAC), in which they reviewed all of
the high‐level alternatives for the GULP guidelines. They discussed the advantages and
disadvantages of reliance on the open market versus fixed rate gas prices. In October
2010, the UAC approved the GULP. The GULP specified that the City would continue
with the laddering strategy, but that Staff would conduct further review. In December
2010, the Finance Committee approved the GULP and asked that explicit language be
added directing Staff to review the gas laddering strategy. In February 2011, the UAC
approved Utilities Strategic Plan, which included language similar to that in the GULP.
Having received a clear directive to review the gas laddering strategy, Staff took a
ground‐up approach to their analysis. In September 2011, Staff presented a
recommendation to move to a market price based supply rate to the Finance
Committee. The Finance Committee supported the recommendation. Over the course of
their analysis, Staff considered alterations to laddering periods, laddering targets,
financial reserves, and rates. The criteria used to evaluate each of the alternatives
included the implementation cost, the impact to customer bills, the value of rate
stability, the relationship between energy price and the economy, and the gas rates as
compared to neighboring cities. Staff avoided making predictions regarding future gas
prices, as the prices tended to be extremely unpredictable. She noted that while the
cost of a laddered portfolio was less volatile than the spot market approach, when the
prices were about the same when averaged over time. A consequence of the laddered
approach was that the City’s gas rates lagged behind the market rate, however, they
eventually caught up. The nature of a laddered approach was that one would always
pay less than the market price as it increased and more than the market price as it
decreased. She emphasized that the long run costs equaled the market, regardless of
purchasing strategy. While Pacific Gas and Electric (PG&E) benchmarking hadn’t been
included as an official criteria in their analysis, it was an important factor to the
community. Staff felt there was a good chance that market based rates would
compliment what was happening in the economy. Their analysis had clearly shown that
stable rates, such as those produced by the laddering method, did not result in stable
bills for customers. A market rate approach could reduce the need for reserves by
passing on the market costs to the customers, and could result in an overall savings. In
order to move to a new gas purchasing strategy, the City would need to design monthly
market‐based supply rates, develop a new gas commodity purchasing plan, update
relevant sections of the GULP, establish a timeline for rate rollout, and conduct
customer outreach. If the City were to move to a market‐based gas purchasing strategy,
customer outreach would need to be a very large part of the process. She noted that in
July 2001, the UAC had disagreed with Staff’s recommendation for a change in gas
purchasing strategy. The UAC was not comfortable transitioning to a completely market‐
based supply rate. They felt there was value in the stabilization of rates, but expressed a
desire for a shorter laddering period. The UAC’s alternative recommendation was that
the City set a gas supply rate objective at a maximum change of 20 percent per year.
When Staff presented the alternative recommendation to the Finance Committee, they
suggested the proposal be accompanied by a laddering period of 18 months. Staff also
estimated that in order to enact the UAC recommendation, the City would need to
maintain $12 million in reserves. Notwithstanding the UAC recommendation, the
Finance Committee and Staff unanimously recommended that Council approve the
development of a market price‐based, monthly‐adjusted gas supply rate.
William Berry, UAC Commissioner, explained that the UAC had been uncomfortable with
the idea of moving completely from the cost stability of the laddering approach to a
market‐based approach. He stated Ms. Dailey’s presentation had included some
information that had not been presented to the UAC.
Council Member Scharff stated that as a Member of the Finance Committee, he was
struck by the fact that the slight rate stabilization received from the laddered approach
had not resulted in more stability for customer bills. Although the laddered approach
delayed market fluctuations, the graphs presented by Staff clearly demonstrated that
the bills for City customers went just as high as, and often higher, than those of PG&E
customers. The fact that market‐based rates would complement the economy was an
important factor, which the UAC had not considered. He stated that both the UAC and
the Finance Committee had considered the current strategy to be no longer appropriate
and felt that changes had to be made.
MOTION: Council Member Scharff moved, seconded by Council Member Schmid to
direct Staff to develop market price‐based, monthly‐adjusted gas supply rates.
Council Member Schmid explained that the laddering strategy was more costly than the
market‐based strategy. He quoted information from the Staff Report, which stated that
over the last ten years the average monthly market price per MMBtu for gas had been
$5.65, whereas the City had paid an average of $6.32. Thus, the City had paid 12 percent
more than they would have had they paid a market‐based price, which he described as a
price premium for risk avoidance. He remarked that offering clear signals to consumers
regarding the cost of gas would likely help the City’s efficiency programs.
Mayor Espinosa asked why, in light of the fact that new information became available
after the initial UAC review, the Finance Committee had not returned the Item to the
UAC for a second review.
Council Member Scharff stated that the Finance Committee did not feel it necessary to
return the Item to the UAC for a second review.
Vice Mayor Yeh stated that he had remaining concerns regarding the reserve funds. He
inquired as to the value proposition of the City’s utilities and asked how City utilities
differed in that respect from investor owned utilities.
Jane Ratchye, Assistant Director of Utilities, explained that under the Staff proposal, any
spikes to the market rate would be passed directly to the customer and the City would
not insulate those market fluctuations with reserve funds. The market‐based strategy
was already in effect for the City’s largest gas customers, and had been for quite some
time. As with PG&E, Staff had not proposed any consumer protections against market
fluctuations.
Vice Mayor Yeh replied that his understanding from the Finance Committee discussions
was that Staff planned to present additional information to Council regarding the
reserve funds. He felt that it was possible for Staff to implement a policy whereby
reserve funds were made available when the market spiked beyond a certain point. That
type of policy would help mitigate a catastrophic spike in gas prices and protect
residential customers.
Ms. Ratchye stated that in order to pursue that policy direction, Staff would first need to
determine how much of an impact an extreme market spike would have on an average
residential bill. Staff could return with an analysis of those potential impacts and of the
various alternatives available for developing reserve fund price protection.
Vice Mayor Yeh observed that Council could only approve the Item in concept at that
time, as many of the important details had yet to be finalized.
Ms. Ratchye replied that Staff had only presented an overall policy direction and that
many of the implementation pieces would need to come back at a later date for UAC
and Council approval. She noted that laddered gas purchasing had been frozen for the
duration of the purchasing strategy consideration process.
Vice Mayor Yeh commented that it would be helpful if Staff provided a clear timeline for
the various implementation phases. Some implementation steps, such as the freezing of
gas purchasing, had already been taken, and emphasized that it was important for
Council to understand exactly where the Item was in the process. He did not feel
comfortable freezing gas purchases until a comprehensive and fully fleshed‐out gas
purchasing plan had been approved. The data showed that the gas laddering strategy
failed to decrease volatility to customer bills. He emphasized that it was very important
to determine exactly why that strategy failed to achieve its intended objective.
Ms. Ratchye replied that the laddering strategy did achieve the objective of stabilizing
the City’s costs, and therefore their rates. When Staff analyzed the strategy further, they
noticed that stable rates did not prevent extreme customer bill volatility. The primary
driver in determining the amount of a bill was usage, and the fact that people used so
much more energy in the winter than in the summer overshadowed the effect of a
stable rate.
Vice Mayor Yeh asked what Staff proposed in terms of customer outreach.
Ms. Ratchye replied that Staff considered customer outreach to be extremely important,
but had not yet discussed that aspect of the proposal. A timeline for implementation
still needed to be developed.
Council Member Burt stated he was one of the Council Members who had initially urged
Staff to reexamine the laddering purchasing strategy, based that on the fact that there
had been several years of declining rates and long‐term projections reflected a
continuing strong supply. The strategy’s main objective was to balance stability and
competitiveness.
Ms. Ratchye stated that another of the listed objectives was to continue the laddering
strategy, but that Staff had received direction from both the Finance Committee and the
Strategic Plan to reevaluate that strategy.
Council Member Burt indicated that the reevaluation was to have been completed
within the context of the stated objective, which was to balance stability and
competitiveness. Instead, the current Staff proposal represented a complete change in
course and recommended the City’s gas purchasing strategy focus exclusively on
competitiveness. He expressed concern regarding Staff’s process for developing the
proposal, but suggested that he was still undecided as to its merit. He explained that
Staff was directed by a vote of Council to complete a review of the laddering strategy
within the given objective. Instead, Staff approached the UAC with a new proposal,
which did not coincide with the Council determined objective. He felt Staff should have
offered their current proposal in addition to that which was requested. He expressed
displeasure that the UAC and the Finance Committee had not been presented with the
original Council commissioned analysis. Rates had been decreasing over the previous
several years and because of the laddering program the City was paying a higher price
than the market rate. PG&E projected moderate future rate increases. He expressed
concern that the City might abandon their rate stabilization strategy at the very moment
that the rates began to increase and the laddering strategy would be of most benefit. He
emphasized the importance of balancing stability and competitiveness. He agreed with
Staff’s observation that stable rates did not result in stable bills for customers, but did
not feel that was a justification for assuming that greater rate stability did not result in
greater stability to customer bills. He noted that although one of Staff’s reasons for
making their current recommendation was that it could reduce the need for reserves,
the interest earned from the current reserve funds was used to maintain the City’s bond
rating. He inquired as to the benefit of full time equivalent savings.
Ms. Ratchye stated that full time equivalent savings referred to the savings received
from making small monthly purchases of gas rather than fewer large purchases. She
explained that Staff had created a good deal of risk management infrastructure to
accommodate the long‐term fixed price purchasing strategy. Staff reviewed the City’s
portfolio on a weekly basis and the market rate changed daily. The proposed strategy
would eliminate all of the forward purchases and instead, Staff would make very short‐
term purchases.
Council Member Burt asked whether it was true that staff had frozen all laddered gas
purchases. If so, how long it had been since the last new laddered purchases.
Ms. Ratchye stated that Staff had not made any new gas purchases for almost a year.
Council Member Burt asked how often laddered gas purchases were typically made,
prior to the decision to stop.
Ms. Ratchye replied that the purchases had previously been made on a monthly basis.
Council Member Burt inquired as to whether Council had given Staff direction to freeze
the laddered purchases.
Kara Dailey, Senior Utilities Resource Planner, stated that the objective approved by
Council was to balance stability with market exposure. The Director of Utilities approved
the amount of gas purchased and the frequency with which it was purchased, via a bi‐
annually Staff developed procurement plan.
Council Member Burt replied that there had been a failure to communicate. He stated
Council had not been consulted regarding the decision to freeze laddered purchases and
expressed concern that the existing policy had been disregarded without proper
communication.
SUBSTITUTE MOTION: Council Member Burt moved, seconded by Vice Mayor Yeh to
have this agenda item return to the Utilities Advisory Commission for Staff to present
two alternatives; 1) balancing stability and competitiveness, and 2) Staff’s
recommendation for a competitiveness proposal to return to Finance Committee for
discussion and Council for approval.
Vice Mayor Yeh stated that it was an incredibly complex issue, but that he was open to
Staff’s proposal to shift to a market‐based purchasing strategy. He indicated a lack of
urgency to move away from the current strategy, which he explained would allow Staff
time to fully develop the proposal. He felt that the proposal development process
would resolve many of Council’s outstanding questions and provide ample opportunities
for discussion at the committee level.
Council Member Klein stated that a common investing mistake was shifting from one
system to another, which often resulted in a loss at both ends of the equation. He felt
the City would likely shift to a market‐based purchasing strategy and cautioned future
Council’s on the dangers of repeating the actions taken in 2001, when Council approved
the move to a laddered strategy. He noted that he was not a Council Member in 2001
when the laddered purchasing strategy was adopted and that he had no part in the
decision. He felt that a market‐based approach made the most sense and that the City
was not equipped to be successful at hedging. The market‐based approach was the
most transparent and straightforward way to deal with the City’s customer base. He felt
that Council should display discipline by strictly adhering to the market approach, once
adopted. In doing so, they should avoid placing limitations of the price of gas. He
inquired as to the possibility of offering a one‐time customer savings through the use of
reserve funds and asked whether that action would negatively impact the City’s bond
rating.
Ms. Ratchye stated that it would not negatively impact the City’s bond rating.
Council Member Klein asked Staff to present a more precise recommendation regarding
how much of the reserve fund could be used for one‐time customer savings.
Ms. Ratchye replied that Staff would return with that information.
Council Member Klein stated that he understood Council Member Burt’s concerns, but
also felt that Council should move forward on the issue.
Mayor Espinosa was surprised that when the Finance Committee came to a different
conclusion than the UAC, based upon new information regarding the Item that had not
been previously considered, the Item was not then returned to the UAC for additional
analysis and recommendation. He stated that Staff’s supporting data was compelling,
but expressed confusion at the process by which the proposal was developed. He was
comfortable supporting the Motion, if the current proposal was then used as a broader
framework from which to return the Item to both the UAC and the Finance Committee
for refinement.
Council Member Holman asked for clarification regarding Council Member Burt’s
reasons for sending the Item back to the UAC.
Council Member Burt replied that Council would benefit from an in‐depth analysis by
both the UAC and the Finance Committee of the two alternatives. Approval of the
proposal included in the Motion would constitute a clear Council decision to shift to a
market‐based purchasing strategy. If Staff were to return both the current proposal and
a new one, which balanced stability and competitiveness, to the committee level, the
UAC would have much more latitude in their decision‐making.
Council Member Holman she favored the Substitute Motion because it would allow the
UAC to weigh all of the options. She felt that the Motion was too narrow.
Council Member Burt stated that it was exceedingly rare to receive a unanimous
proposal from any commission, especially the UAC. He acknowledged that the UAC had
not been afforded the opportunity to evaluate a fully vetted blended system alternative.
SUBSTITUTE MOTION FAILED: 3‐5 Burt, Holman, Yeh yes, Price Absent
Vice Mayor Yeh noted that the freezing of laddered gas purchases was in fact a de‐facto
progression towards a market‐based strategy. He asked what Staff’s intentions were in
terms of a timeline for moving forward with the new strategy, if the Motion were to
pass.
Ms. Ratchye responded that Staff had not yet developed a timeline, but that she
guessed it would be at least a year before implementation could occur. Staff had
identified several other changes that would need to be worked into the timeline if
Council were to approve the Motion.
Vice Mayor Yeh asked what Staff felt would be a reasonable timeframe in which to
develop a timeline for implementation. He expressed concern that in the absence of a
solid timeline, the public would receive misinformation regarding how the shift in
purchasing strategy would affect their utility bills.
Ms. Ratchye agreed that customer communication was extremely important and that a
timeline would be vital to the success of those communication efforts. She stated the
creation of a timeline would necessitate UAC involvement, which would take at least a
couple of months.
INCORPORATED INTO THE MOTION WITH CONSENT OF THE MAKER AND SECONDER
for Staff to return to the Finance Committee with a clear timeline within two months.
Vice Mayor Yeh emphasized the importance of proceeding with caution with regards to
the way the item was presented to the public.
Council Member Burt observed that the November 20, 2011 Finance Committee
minutes did not reflect an acknowledgement of the fact that the Staff proposal being
considered was inconsistent with Council approved policy objectives. He suggested that
it may have been an unconscious oversight, but emphasized the need for increased
awareness of how Council functioned at a committee level to ensure strict adherence to
Council directives in the future.
MOTION PASSED: 6‐2 Burt, Holman no, Price Absent