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HomeMy WebLinkAbout1999-07-26 City Council (16)of PMo Alto TO:HONORABLE CITY COUNCIL FROM:CITY MANAGER DEPARTMENT: UTILITIES DATE:JULY 26, 1999 CMR:315:99 SUBJECT:STATUS REPORT ON REVIEW OF ISSUES RELATED TO COUNCIL OVERSIGHT OF THE ELECTRIC AND GAS UTILITIES IN THE NEW COMPETITIVE ENVIRONMENT This is an informational report and no Council action is required. BACKGROUND Deregulation has resulted in new market structures for the electric and gas industries and an increase in risk for the City of Palo Alto Utilities Department (CPAU). Such increases in risk result from: 1) potential loss of sales revenue to competition on the retail side; 2) extremely volatile energy prices on the wholesale side; 3) the introduction of new market players, thus increasing supplier credit risk; 4) complexity of forecasting future energy prices; 5) availability of tools to manage risk, which may increase risk; and 6) a mismatch in the terms for which CPAU acquires and prices energy. In an attempt to minimize some of these risks, staff has utilized various strategies including hedging its supply purchases by buying forward contracts and locking in revenue on the retail side through long term sales contracts. The Council has concerns regarding some of these activities and at the Council meeting of January 11, 1999, the Council directed staff and the City Attorney to respond to ten issues regarding Council oversight of the Electric and Gas Utilities activities in the new competitive environment. Staff was directed to address the following issues: CMR:315:99 Page 1 of 7 Submit guidelines for entering into long-term sales contracts to the Utilities Advisory Commission (UAC) and Council for review and approval. o Establish a procedure for senior management to provide oversight to ensure that long- term contract guidelines are being followed. Provide the UAC and Council with a periodic review of the economics of existing long- term contracts. o Report on the issues involved in making long-term contracts available for examination by the Council. Submit guidelines for engaging in risk management transactions to the UAC and Council for review and approval. Establish a procedure for senior management to provide oversight of risk management activities to ensure that guidelines are being followed. Provide the UAC and Council with a periodic review of the success of risk management activities relative to an a~eed-on standard. o Report on any legal issues related to entering into "hedge" transactions as a part of risk management activities. Recommend changes to the Municipal Code to make clear that the duties of the UAC include advising the Council on both long-term sales contracts and risk management activities. 10.Address the apparent inconsistency between entering into long-term sales contracts and the Charter provision that Council will set utility rates. Staff was directed to consider alternative approaches associated with risk management and long-term contracts as long as staff keeps the UAC and Council informed. Additionally, staff was to consider the long-range issue of whether the existing governance process was a serious handicap to doing business in a competitive market, but not at the expense of addressing the above issues. Staff was to report back to the Council in six months on these issues. CMR:315:99 Page 2 of 7 DISCUSSION The response to Council’s issues will come in the form of an energy risk management program. An energy risk management program will define CPAU’s risk management objectives and establish clear policies and guidelines for achieving its objectives. Essentially, an energy risk management program has six fundamental components: policies, procedures, practices, oversight, reporting and education. The following is a brief description of the different elements. 1. Policies provide the guiding principles in the development of pro~am procedures and practices. Besides the policies, the establishment of risk measure(s) is necessary to provide a basis on which staff can implement the pro~am and manage the supply and retail portfolio. 2. Procedures must be established in accordance with the approved policies to allow implementation of an energy risk management program. Examples of procedures that need to be established include: 1) a list of approved risk management products that can be used; 2) a list of approved counterparties; and 3) limitations and authorities for each person involved in an energy risk management program. 3. Practices are operational in nature and must be developed to ensure implementation of an energy risk management program is in line with approved policies and procedures. Examples of practices that must be instituted include: 1) how the risk measure will be calculated; 2) how the portfolio will be evaluated and recommendations made to justify each transaction; 3) how transactions will be tracked; 4) how to calculate each commodity rate components; and 5) how performance will be evaluated. 4. Oversight, a major component of the an energy risk management program, involves instituting procedures to ensure that all established and approved policies and procedures are being appropriately followed. 5. Reporting on the performance of achieving risk management goals and use of strategies to achieve such goals such as, long-term sales contracts and hedging instruments. 6. Education of all involved in an energy risk management program is needed to ensure success. All parts of the organization involved in risk management will need a level of training appropriate for their part in the program. Staff involved in implementing the program will need ongoing ,training to stay current with risk management developments. Senior management, decision-makers, and policymaker will need sufficient education to feel comfortable with the decisions they must make. CMR:315:99 Page 3 of 7 CPAU activities in Risk Management Staff has already begun the process of implementing an energy risk management pro~am for CPAU. Staff’s early efforts have concentrated on evaluating and reporting existing energy portfolio management procedures and practices and assessing risk exposures. In Spring 1997, staff calculated the risk exposure to electric and gas portfolios to market price changes. In Summer 1997, staff reviewed existing purchasing procedures and practices. This resulted in the development of new procedures and forms to enhance existing processes. Additionally, new supply portfolio models and performance reporting formats were developed. In February 1998, staff retained Teknecon, a risk management consulting firm, to examine CPAU’s existing procedures and make recommendations for enhancements to the existing process and future changes. In Fall 1998, staff enlisted the support of senior management in developing policies, procedures and to review existing practices. The Risk Oversight Committee (ROC) was formed to provide direction and review staff’s progress. The ROC meets monthly and is comprised of senior management from Utilities, Administrative Services, and the City Manager’s and City Attorney’s offices. In Winter 1998, staff provided the ROC with a first draft of a policies, procedures, and practice document. The document is intended for staff engaging in risk management and energy procurement activities. Currently, the document contains existing practices only. The document will be updated to reflect approved policies and procedures and necessary practices to implement an energy risk management program. In Spring 1999, staff retained the services of Deloitte and Touche, a business consulting firm, to assist in the development and implementation of an energy risk management prog-ram. Deloitte and Touche augrnents staff’s capabilities by providing an industry perspective of best management practices and providing training to policy makers, senior management, and staff. In addition to developing an energy risk management program for CPAU, staff is assisting the Northern California Power Agency (NCPA) in developing a risk management pro~am. NCPA operates the Calaveras hydro plant and augments CPAU staff’ s electricity purchasing and sales activities. NCPA’s risk management pro~am is expected to be developed by the end of 1999 with implementation scheduled to be completed by Summer 2000. NCPA also established a risk oversight committee and CPAU is represented on the committee. CMR:315:99 Page 4 of 7 Future Risk Management Activities Staffplans to formalize a risk management program and provide a complete response to all of Council’s issues by the Spring of 2000, through a series of information and/or action reports that are described below. This schedule may change depending on staff’s progress and the reports from Deloitte and Touche. The attached table, Exhibit A, is a summary of how and when each of the issues will be addressed. 1. Energy Risk Management Program: An energy risk management program will be presented to Council in two reports. The first report will recommend risk management objectives and measures to be used to guide staff in implementing risk management strategies. This report will also contain policies necessary to engage in risk management transactions, including a counterparty credit policy and an approved product policy. Additionally, an assessment by the City Attorney’s office on the legality of entering into hedge transactions will be included within this first report. The second report will recommend an oversight structure to ensure staff is following approved guidelines when engaging in the use of risk management transactions; guidelines for reporting performance of risk management activities to the UAC and Council; and identification of procedures necessary to ensure implementation of approved policies. Currently, staff is working with the ROC to identify needed policies and procedures and to establish risk measures. Additionally, Deloitte and Touche is reviewing staff’s activities and assessing the associated risks and will recommend an approach for developing an energy risk management program. The first energy risk management program report will come to Council in Fall 1999, and the second part will come in Winter 1999. 2. Commodity Pricing Policy: Provides a commodity pricing methodology applicable to all electric and gas rate schedules, including long-term sales contracts. The purpose of the policy is to ensure that, when developing rates, all customers within a customer class are treated in an equitable manner, all costs are recovered, risks are minimized and rates are competitive. The policy will contain principles for establishing rates, components of commodity rates, and procedures for establishing rates. The report also establishes guidelines for oversight by senior management and perforn~ance reporting to the UAC and Council. Long-term sales contract pricing will follow the same pricing policies applicable to retail tariffs, however, special guidelines will be recommended to ensure equity. The policy will be presented to Council in the Fall of 1999. Following Council approval, staff will return within three months to Council with appropriate rates, CMR:315:99 Page 5 of 7 3. Long-Term Sales Contract Policy and Rate Schedules: Establishes guidelines for entering into long-term sales contracts. Specifically, this report will provide guidelines to: 1) negotiate commodity prices, in accordance with the Commodity Pricing Policy; 2) set distribution rates and other charges for services; 3) review and authorize contracts; and 4) address contract confidentiality. The report will also recommend guidelines for oversight by senior management and performance reporting to the UAC and Council. Additionally, the report will include the City Attorney’s assessment of Council’s issues regarding: 1) making long-term sales contracts available for examination by the Council; and 2) the apparent inconsistency between entering into long-term sales contracts and the Charter provision that Council will set rates. Accompanying this report, will be a proposal for new fixed price term contract rate schedules. These rate schedules will be developed in accordance with the proposed policies on commodity pricing and long-term sales contracts. Staff will begin to develop long-term sales contract procedures once Council has reviewed the Commodity Pricing Policy and Procedures and the City Attorney’s legal analysis and recommendations regarding long-term sales contracts. Staff will bring these reports to Council near the end of 1999. 4. The UAC’s Role: The report will provide a review of issues of oversight and confidentiality as they relate to the UAC, and propose alternatives for addressing these concerns procedurally, as well as, through clarification of the Municipal Code language regarding the UAC’s cope of responsibilities. The report will be presented to Council in the Fall of 1999. 5. Utilities Governance Structure Report: This report will respond to Council’s longer range request that staff evaluate the existing governance structure in light of the new competitive market. The report will compare the existing structure and alternative governance structures. This report is scheduled to come to the Council in Spring 2000. RESOURCE IMPACT This report is informational only, therefore there are no resource impacts. POLICY IMPLICATIONS This report is informational only, therefore there are no policy implications. CMR:315:99 Page 6 of 7 Attachment:Exhibit A PREPARED BY:Monica V. Padilla, Utilities Resource Planner Girish Balachandran, Supply Resource Group Manager DEPARTMENT HEAD APPROVAL: CITY MANAGER APPROVAL: H ’ector of Utilities EMILY ~IARRISON ---- Assistant Ci~ Manager ATTACHMENT(S): Exhibit A: Summary of staff’s plans to address Council’s issues CMR:315:99 Page 7 of 7 Exhibit A Summary of Staff’s plan to address Council’s issues 10 11 Issue Report When Submit guidelines for entering into long-term sales contracts to the Utilities Advisory Commission (UAC) and Council for review and approval Establish a procedure for senior management to provide oversight to ensure that long-term contract guidelines are being followed Provide the UAC and Council with a periodic review of the economic of existing long-term contracts, Report on the issues involved in making long- term contracts available for examination by the Council. Submit guidelines for engaging in "risk management" transactions to the UAC and Council for review and approval. Establish a procedure for senior management to provide oversight of "risk management" activities to ensure that guidelines are being followed. Provide the UAC and Council with a periodic review of the success of "risk management" activities relative to an agreed-on standard Report on any legal issues related to entering into "hedge" transactions as a part of"risk management" activities. Recommend changes to the UAC ordinance to make clear that the duties of the UAC include advising the Council on both long-term sales contracts and risk management activities. Address the apparent inconsistency between entering into long-term sales contracts and the Charter provision that Council will set rates. Evaluate appropriateness of existing Utility governance process. Energy Risk Management Progam Policies Fall/Winter 1999 X X X X Commodity Pricing Policy, Fall 1999 X Long term Sales Contract Policy, & Procedures Winter 1999 X X X X X The UAC’s Role Fall 1999 X Utilities’ Governance Structure Spring 2000 X