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HomeMy WebLinkAbout1999-12-13 City Council (24)City of Palo Alto City Manager’s Report TO:HONORABLE CITY COUNCIL FROM:CITY MANAGER DEPARTMENT: UTILITIES DATE: SUBJECT: DECEMBER 13, 1999 CMR:448:99 STATUS REPORT ON THE DEVELOPMENT OF AN ENERGY RISK MANAGEMENT PROGRAM This is an informational report. No Council action is required. BACKGROUND Deregulation in the gas and electric industries has resulted in an increase in risk for the City of Palo Alto Utilities Depa~ment (CPAU). At its January 11, 1999 meeting, the Council raised concerns regarding potential risk management activities and directed staff and the City Attorney to respond to issues regarding Council oversight of Electric and Gas Utilities activities in the new competitive environment. In July 1999, staff provided Council with a timeline and plan on how and when staff would respond to Council’s issues (CMR:315:99). Staff’s plan was to respond to.Council’s issues by the spring of 2000 with energy risk management program goals, risk measures, policies and procedures and with recommendations on how to change the existing governance structure so that the City could compete effectively in a deregulated environment. DISCUSSION In Spring 1999, staff retained the services of Deloitte and Touche, a business consulting firm, to further assist in the development and implementation of an energy risk management program. To date, Deloitte and Touche has produced a detailed risk assessment and identification document and an inventory and evaluation of current technical applications (models, methods, and calculations). Based on its evaluation, Deloitte and Touche recommends that CPAU take a comprehensive approach to respond to the competitive CMR:448:99 Page 1 of 6 environment~ The first step in a comprehensive approach is for CPAU to define what role, or business direction, it should take fn the competitive environment. The selection of the appropriate business direction depends to a large degree on the level of risk that the City is comfortable assuming. When this is determined, CPAU can develop an energy risk management program to support that direction. The strategic planning effort to evaluate alternative business directions is well underway. In October, CPAU presented issues and alternatives to the UAC for its comment. At its November meeting, the UAC received training in risk management fundamentals and CPAU’s risk exposures. Plans are for a final recommendation to go to the UAC in March, followed by the Finance Committee, and, to the City Council in April. Risk management activities are dependent upon completion of the strategic plan. After the approval of a strategic direction, a comprehensive energy risk management program can be developed. The elements of such a program include: policies, guidelines, procedures, oversight, reporting and education. Policies provide the guiding principles in the development of program procedures and practices. Guidelines must be established in accordance with the approved policies to allow implementation of an energy risk management program. Procedures are operational in nature and must be developed to ensure implementation of an energy risk management program is in line with approved policies and guidelines. Oversight involves instituting procedures to ensure that all established and approved policies and guidelines are being appropriately followed. Reporting on the performance of achieving risk management goals and use of strategies to achieve such goals is essential. Finally, 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 policymakers will need sufficient education to feel comfortable with the decisions they must make. This comprehensive energy risk management program will provide a complete response to all of Council’s issues through a series of information and/or action reports that are described below. The attached table, Exhibit A, is a summary of how and when each of the issues will be addressed. Approach to Energy Risk Management. This report will support the strategic business direction and general risk management objectives. It will establish the underlying risk attitude of CPAU. CMR:448:99 Page 2 of 6 Energy Risk Management Policies: This report will contain policies necessary to engage in risk management transactions, including a counterparty credit policy and an approved product policy. An assessment by the City Attorney’s office on the legality of entering into hedge transactions will be included. This report will also include appropriate risk measures to guide staff in implementing risk management strategies. Energy Risk Management Guidelines: This report will recommend guidelines which support the previously approved policies. It will describe the roles and responsibilities of all personnel involved in measuring, monitoring, and mitigating risk. Included will be a recommended oversight structure to ensure staff is following approved guidelines when engaging in the use of risk management transactions and guidelines for reporting performance of risk management activities to the UAC and Council. Utilities Governance Structure and the UAC’s Role. 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. The report will also provide a review of issues of oversight and confidentiality as they relate to the UAC and Council, and propose alternatives for addressing these concerns procedurally, as well as through the Municipal Code. Completed Interim Risk Management Activities Until the long-term strategic direction is selected and a comprehensive program can be developed, staff has proceeded to prudently monitor and mitigate risks. The City Manager approved interim policies and procedures related to the management of the wholesale supply portfolios of the gas and electric utilities. These policies and procedures formalize existing practice and take a very conservative approach to managing risks. Tile five policies included in that document are described below. Business Objective: The primary business objective in developing and implementing an Energy Risk Management Program is to benefit Palo Alto’s retail customers and to be risk averse at the same time. Therefore, CPAU will reduce exposure to risks, by using its assets to enhance revenues and offer competitively. priced services that address customer needs. Anti-Speculation: Speculative buying and selling of energy products is prohibited. Speculation is defined as buying energy not needed for meeting load or selling energy that is not owned. In no event should transactions be entered into to speculate on market conditions. 3.Authority and Responsibility:Until the City Council has approved comprehensive risk CMR:448:99 Page 3 of 6 management policies, the City Manager will assure that the Utilities Department is acting prudently in mitigating’risks that are inherent in operating in a competitive environment. Separation of Duties to Preserve the Integrity of the Market Transaction Process: The person who makes an approved transaction must not be the same person who confn’ms the transaction or the same person who monitors and reports on performance of that transaction. Operational Policy:CPAU will be responsible for all electric and gas transactions for a month before the month begins. After the beginning of the month, the Northern California Power Agency (NCPA) will have responsibility for electric transactions and CPAU’s gas supplier (currently, Texas Utilities) will have responsibility for gas transactions that are completed on CPAU’s behalf. Presently, no use of fmancial instruments (e.g., futures contracts, financial call or put options etc.) allowed in the interim policies and procedures. Financial instruments are used to shift and/or mitigate risk without being tied to the physical delivery of energy. The City Manager has delegated authority to purchase commodity to the Utilities Director in order to enhance the efficiency with which CPAU purchases commodities in the wholesale markets. In addition to these interim policies and procedures, staff has identified some risks that need to be managed prior to implementation of the comprehensive approach. These risks are relatively straightforward and easy to manage and will likely need to be addressed in any future CPAU business direction. They include establishment of a commodity pricing policy (CMR:387:99); establishing guidelines for entering into long-term retail sales contracts; the introduction of new fixed price rates which require customers to commit to staying on the rate for a set term. Staff also plans to request approval from Council for the use of financial call options and financial forward purchases for the gas utility in clearly and narrowly defined situations. CMR:448:99 Page 4 of 6 ATTACHMENTS Exhibit A: Summary of staff’s plans to address Council’s issues PREPARED BY: Jane Ratchye, Senior Resource Planner Girish Balachandran, Supply Resource Group Manager DEPARTMENT HEAD APPROVAL: .es Director CITY MANAGER APPROVAL: HARR!SON Assistant City Manager CMR:448:99 Page 5 of 6 Exhibit A 10 11 Summary of Staff’s plan to address Council’s issues Report ¯ Issue 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 Counci! 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 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. Commodity Long term Pricing Sa~e_s ContractPohcyGuidelines December February 13, 1999 2000 X X X X X X Strategic Business Direction April 2000 X X Approach to Energy Risk Manage- ment June 2000 X Risk Manage- ment Policies August 2000 X X Risk Manage- ment Guidelines October 2000 X X X