HomeMy WebLinkAboutStaff Report 130-07City of Palo Alto
City.Manager’s Report
14
TO:HONORABLE CITY COUNCIL
FROM:CITY MANAGER DEPARTMENT: UTILITIES
DATE:
SUBJECT:
FEBRUARY 12, 2007 CMR:130:07
ADOPTION OF ORDINANCE OF THE COUNCIL OF THE CITY OF
PALO ALTO AUTHORIZING THE CITY MANAGER TO PURCHASE A
PORTION OF THE CITY’S NATURAL GAS REQUIREMENTS FROM
CERTAIN PREQUALIFIED NATURAL GAS SUPPLIERS UNDER
SPECIFIED TERMS AND CONDITIONS DURING CALENDAR YEARS
2007 THROUGH 2022, INCLUSIVE
RECOMMENDATION
Staffrecommends that Council approve the following:
Authorize the City Manager to negotiate and sign new, amended, or restated NAESB
contracts with the following suppliers: ,
a. ConocoPhillips Company;
b. Coral Energy Resources, L.P.;
c. Sempra Energy Trading Corporation;
d. BP Energy Company;
e~ ’JP Morgan Ventures Energy Corporation; and
f. Powerex Corporation
o Authorize the City Manager or his designee, the Director of Utilities, to execute multiple
transactions under the Master Agreements with one or more of the above suppliers to
procure natural gas supplies sufficient to meet the City’s forecasted natural gas load, with
the date for delivery of the gas for each transaction not to exceed 36 months from the date
the transaction is executed. The delivery date for any transaction will not extend beyond
December 2022, and the maximum aggregate transaction limit under each Master
Agreement shall be $65 million.
CMR: 130:07 Page 1 of 7
BACKGROUND
Prior to July 2001, the City contracted with a single supplier to supply the entire natural gas load
of the City over the period of the agreement. This approach had the merits of operational ease
and lower overhead for the City. However, the City had only one supplier with whom to fix the
price of a portion of the gas supply. This gas purchasing approach did not provide sufficient
incentive to the sole supplier, once selected, to provide the best prices for gas supplies that the
City wanted to buy at a fixed price. In addition, the sole supplier approach did not provide the
City any credit risk diversity.
The City’s Natural Gas Procurement Plan, designed to meet Palo Alto’s gas loads at low and
stable retail rates, calls for procuring gas supplies in a diversified, systematic fashion over a
rolling 3-year period [CMR:196:01]. To implement the "laddering strategy" and to facilitate
obtaining price quotes from each supplier each time the City decided to procure gas, the City
sought to establish Master Agreements with multiple suppliers, awarding each specific
transaction to the qualified supplier offering the best price. This approach was implemented to
meet the City’s credit diversification and cost stabilization risk management strategies. The City
currently procures natural gas supplies from four suppliers (BP Energy, Coral Energy,
ConocoPhillips and Sempra) under Master Agreements that were approved by Council in 2003
[Ordinance #4810]. An additional Master Agreement with Duke Energy Marketing, LLC was
approved in 2003 but that counterparty has since exited the Western energy markets and is,
therefore, no longer transacting with the City.
The July 2002 Assessment of Utility Risk Management Procedures by the City Auditor made
recommendations to improve the City of Palo Alto Utilities’ (CPAU) energy procurement
process. The Auditor’s report recommended that Master Agreements with suppliers be approved
by the Council with clearly defined dollar, volume and duration limits and with clear definition
of the types of transactions staff is authorized to execute under the agreements (recommendation
#4). The Auditor’s report also recommended that the process of securing Master Agreements be
undertaken in an open and competitive manner (recommendation #6).
DISCUSSION
The cun’ent Master Agreements were approved by Council for transactions with delivery no later
than December 31, 2009. Given the City’s 36-month laddering strategy, it is now necessary to
make purchases beyond that time horizon. In addition, the exit of Duke Energy Marketing, LLC
increased the need for additional counterparties to ensure competitive pricing and diversifying
purchases across multiple creditworthy suppliers. To that end, an RFP was issued in June 2006
to solicit interest from suppliers to sign Master Agreements with the City to enable future
procurement of natural gas supplies required to meet the City’s natural gas needs. The supplier
selection process for the RFP is provided in Attachment A. The six proposed Master
Agreements were negotiated under terms and conditions acceptable to the City. The Master
Agreements with Coral and Sempra approved under Ordinance 4810 remain valid and do not
require re-execution at this time. Due tothe size of each agreement, staff has elected not to
attach copies to this CMR in an effort to save paper. However, the Master Agreements are
available for review in the Office of the City Clerk.
CMR: 130:07 Page 2 of 7
Description of a Master Agreement
The proposed Master Agreements are based on the 2002 North American Energy Standards
Board, Inc. (NAESB) Standard 6.3.1 dated April 19, 2002. A Master Agreement is similar but
not identical to a blanket purchase order. A Master Agreement details all of the contractual
terms that govern transactions that are completed under the Master Agreements. The Master
Agreement consists of a Base Contract, Special Provisions, and a Credit Support Addendum.
Executing a Master Agreement does not commit the City to any transaction. Each transaction for
part of the City’s monthly, annual, or multi-year gas requirements is completed through
subsequent competitive bidding, as evidenced by a completed Transaction Confirmation
document. Executing a Master Agreement is not a promise of business by the City or by the
supplier. It serves only to qualify suppliers to bid on individual transactions solicited by the
City.
Each Master Agreement 1ylay be terminated at any time by either party according to the terms of
the agreement. Termination of the Master Agreement cancels the supplier’s ability to bid on
further transactions until a new Master Agreement is executed. Any transaction executed under
the Master Agreement prior to termination will remain in place until the final gas delivery date,
unless an event of default has transpired. In the event of default by a supplier, the City has the
option to terminate the remaining transactions that were executed under the Master Agreement.
The City may suspend the privilege of solicitation to bid on individual transactions with any
supplier due to counterparty credit limits or transaction limits, a supplier credit downgrade event,
supplier default or suspected default, or where inclusion in the solicitation would not comply
with the law or City policies, guidelines, rules or procedures. If the number of eligible suppliers
dwindles to an unacceptable level, the City reserves the right to conduct an RFP for new Master
Agreements.
Staff does intend to conduct another RFP within 5 years, well before the 2022 term limit on these
Master Agreements. The 2022 end date provides the City the flexibility to execute one or more
long-term transactions with Council approval if the ladder.ing strategy is revised to include
longer-term purchases. If such a recommendation is made, the transaction(s) will have a specific
cost limit and transaction time limit to be approved by Council at that time. That cost may be in
addition to the $65 million per supplier limit in the attached Ordinance.
All transactions under the Master Agreements will be executed by staff in accordance with the
Energy Risk Management Policies, Guidelines, and Procedures. These procedures are monitored
by the Energy Risk Manager and the Utilities Risk Oversight and Coordination Committee.
They ensm’e that risks inherent in the energy industry are managed prudently. Staff will provide
Council with an update of all executed transactions under the Master Agreements as part of
energy risk management reporting.
Limits of Authorization
The proposed limits and parameters for Council’s authorization to the City Manager
following:
include the
CMR:130:07 Page 3 of 7
4.
5.
6.
Delegation of authority, in accordance with the Palo Alto Municipal Code, to the City
Manager to purchase and, incidental to purchase, sell gas to meet the City’s retail load
requirements within a 3-year period from the date the transaction is executed. "
Requirement that all transactions are consistent with Council-approved Energy Risk
Management Policies (CMR: 128:06) and internal energy risk management guidelines and
procedures.
Reporting of all transactions in excess of $65,000 to Council as part of regular reporting
(per the Energy Risk Management Policies and Guidelines).
Authorization of transactions to be executed under Council-approved Master
Agreements.
A maximum total dollar amount of $65 million for aggregated gas transactions for any
single Master Agreement.
Requirement that commodity products allowed for purchase or sale incidental to purchase
must be "authorized transacting products" as defined in the Council-approved Energy
Risk Management Policies.
All other transactions lie outside of the authority delegated to the City Manager and will require
Council approval, including:
Any transactions with a term ending beyond 3 years from the date of transaction;
Any transaction with volumes in excess of the limitations listed above; or
Any transactions costing more than the limits specified above.
Additional limitations on transactions with the suppliers are imposed under intemal guidelines.
These intemal guidelines include counterparty credit limits that limit transaction term and risk
exposure depending upon the creditworthiness of the supplier. For example, the guidelines
provide transaction limits in terms of annual volume, annual cost, and transaction term for each
supplier. Thus, staff is constrained by these guidelines regarding transacting with each approved
supplier. These guidelines act as an additional level of control beyond those that staff
recommends Council impose under the Master Agreements.
Collateral
Of the six Master Agreements, five require the City to post collateral in the form of cash or a
Letter of Credit as a form of collateral assurance. Such a circumstance would occur in the very
rare event that the City purchases a high portion of its forward gas supply with one of the
counterparties after which forward prices fall by over 50% for an extended period of time. Much
of the risk of this occurrence can be managed through sound counterparty diversity practices.
The other event when the City could be required to post collateral would be through a downgrade
event whereby the City’s credit rating is downgraded by either Standard and Poor’s or Moody’s
Investor Services. While neither of these events is likely, the obligations of the contract require
that the City be prepared to offer credit collateral assurances. A separate City Manager’s Report
(CMR) detailing these issues recommends a plan for implementing a credit facility for posting
Letters of Credit (CMR: 108:07). The costs associated with developing this facility will be
covered by the relevant enterprise funds.
CMR: 130:07 Page 4 of 7
ALTERNATIVES
Council could elect not to approve one or more of the proposed contracts. However, doing so
would limit the ability of staff to competitively bid and diversify gas supplies.
Council could elect to approve the contracts with different contract limits. Lower limits would
reduce the ability of staff to competitively bid and diversify gas supplies or would require staff to
return to Council to increase the limits on certain Master Agreements within the terms of the
Master Agreements. Staff does not recommend higher limits. Should higher limits be necessary
due to unforeseen circumstances, staff believes that there would be adequate time to request a
change in contract limits from Council.
RESOURCE IMPACT
Currently, natural gas can be purchased for between $7 and $9 per million British thermal units
(MMBtu) for deliveries during the next several years. Since the City’s load is about 3.3 million
MMBtu per year, this translates to an annual commodity cost of about $26 million. However,
prices could increase dramatically as during the 2001 energy crisis. Since natural gas prices can
be volatile, it is conceivable that the prices could double from current levels over the term of the
Master Agreements.
The following table summarizes CPAU’s historical gas purchase costs and projected costs for the
next several years as well as commitments as of November 3, 2006 with each of the four existing
suppliers.
Gas Procurement Summary - Cost ($) and Volumes (MMBtus)
BP Energy Company
Sempra Energy Trading Corp.
Coral Energy Resources, LP
ConocoPhillips, Inc.
TOTAL
$3,618,000
$4,775,000
$4,672,000
$715,000
$13,066,000
$0
$5,o61,000
$10,014,oo0
$o
$15,075,000
$0
$3,916,000
$5,950,000
$0
$9,866,000
BP Energy Company
Sempra Energy Trading Corp.
Coral Energy Resources, LP
ConocoPhillips, Inc.
TOTAL
524,271
896,800
655,530
131,719
2,208,320
0
705,000
1,259,540
0
1,964,540
0
468,140
716,000
0
644,140
Cost ($)$17,915,000 $20,292,000 $26,024,000 $27,649,000 $ 26,882,000
Load (MMBtu)3,342,000 3,267,000 3,305,000 3,318,000 3,306,000
CMR: 130:07 Page 5 of 7
As shown in the chart, the expected gas commodity cost for the next several years is between
$26 and $28 million!year. The cost estimates are relatively certain for the cun’ent fiscal year
since a large portion of the gas has already been purchased at fixed prices. Costs for FY 07-08
and FY 08-09 are less certain than for FY 06-07 as less gas has been purchased in advance, and
future gas prices could rise above expectations.
While the City has selected six suppliers to sign Master Agreements, it is conceivable that only a
few suppliers may ultimately provide the most competitive prices, and some may merge or leave
the industry, resulting in most transactions being concentrated among fewer qualified suppliers.
Staff recommends a maximum transaction limit of $65 million for the term of each Master
Agreement. This limit gives staff the flexibility it needs in case gas costs increase above
expectations or if some of the suppliers are unable to continue to do business with the City or do
not offer the best prices. It also sets a monetary limit on the transactions that is less than the total
anticipated tba’ee-year purchase cost.
Approval of the recommendation will not impact the FY 06-07 budget. Transactions with
deliveries extending beyond the approved budget horizon are contractual commitments,
supported by natural gas retail revenues with retail rates determined by Council.
POLICY IMPLICATIONS
Authorizing the City Manager to buy and sell natural gas to meet City load under these Master
Agreements conforms to existing Council-approved Energy Risk Management Policies
[CMR:128:06]. These Master Agreements are required for staff to conform to the approved
policies.
This recolnmendation is consistent with the Council-approved Utilities Strategic Plan to 1)
preserve a supply cost advantage compared to the market price; and 2) streamline and manage
the business process to allow the City of Palo Alto Utilities to work efficiently and cost-
effectively.
Further, the recommendation supports the Council-approved Utilities’ Natural Gas Supply
Portfolio Planning and Management Objectives and Guidelines .for the Gas Utility Long-term
Plan (GULP) [August 2003 CMR:355:03]. These include the following Objectives and
Guidelines relevant to Master Agreements:
Objective 1:
Objective 2:
Guideline 1:
Ensure low and stable gas supply rates for pool customers
Provide superior financial performance to customers and to the City by
managing the supply portfolio cost in a competitive manner compared to
market cost and a retail supply rate advantage compared to PG&E.
Market Risk Management - Manage market risk by adopting a portfolio
strategy for gas supply procurement by:
A. Diversifying energy purchases for the pool across co~rnnitment date,
delivery date, duration, suppliers, pricing terms and delivery points;
B. Maintaining a prudent exposure to changing market prices by leaving
some fraction of the forecasted gas pool needs exposed to near-term
market prices; and
CMR: 130:07 Page 6 of 7
C. Avoiding long-term (>10 years) fixed-price commodity contracts.
ENVIRONMENTAL REVIEW
Adoption of the ordinances approving Master Agreements and delegating gas procurement to the
City Manager under certain limitations does not constitute a project for the purposes of the
California Enviromnental Quality Act.
ATTACHMENTS
A: RFP Evaluation Process
B: Ordinance of the Council of the City of Palo Alto Authorizing the City Manager to Purchase
a Portion of the City’s Natural Gas Requirements from Certain Prequalified Natural Gas
Suppliers Under Specified Terms and Conditions During Calendar Years 2007 through 2022,
Inclusive
PREPARED BY:
KARLA DAILEY
Resource Planner
DEPARTMENT HEAD:
VALE~ONG
Director of Utilities
CITY MANAGER APPROVAL:
CMR:130:07 Page 7 of 7
CMR: 130:07 - ATTACHMENT A
ATTACHMENT A: Gas Master Agreement RFP Selection Process Summary
The City of Palo Alto issued RFP # 118075 on June 8, 2006 to solicit and execute Master
Agreements with multiple suppliers to enable future procurement of natural gas supplies
required to meet the City’s natural gas load needs. Bid packages were mailed to 24
potential suppliers. The nine suppliers responding to the RFP were evaluated by a team
comprised of staff from Utilities, Purchasing, Administrative Services and the City
Attorney’s Office. The selection was based on supplier ability to competitively and
reliably transact with the City and supplier responsiveness in agreeing to meet City’s
contractual provisions. The responses were evaluated biased on four broad criteria
categories.
Financial: Financial strength, clarity of financial statements, organizational
transparency of the supplier/entity providing credit support, overall future
outlook, expected longevity in the industry were ranked by top, middle, and
bottom third (A, B, C).
Credit: A minimum requirement is the supplier must be investment grade. Quality,
nature, and extent of credit support, rating agencies credit ratings, credit
contractual provisions, risk limits based on proposed terms, and magnitude of
credit risk were ranked by top, middle, and bottom third (A, B, C).
Contract Provisions: Several terms must be met as a minimum requirement: (1)
Choice of law is California; Venue of dispute is Santa Clara County; and One-
way termination applies. Overall contractual provisions beyond the minimum
required in addition to flexibility/ease of .negotiation were ranked top, middle
and bottom third (A, B, C).
Performance/Capabilities: Experience in California, relevant physical assets and
capabilities, and past performance with Palo Alto or other municipal entities
were ranked by top, middle, and bottom third (A, B, C).
Two suppliers, Merrill Lynch Commodities, Inc, and .Morgan Stanley Capital Group,
Inc., did not meet the City’s mininmm contract requirements (namely one-way
termination) and were eliminated from the process. A third supplier, Wasatch Energy,
LLC, did not meet the City’s minimum credit requirement and was eliminated from the
process.
Two of the City’s four existing suppliers, Coral Energy Resources, LP and Sempra
Energy Trading, elected to extend the Master Agreements currently in place. One
existing supplier, BP Energy Company; requested one force majeure-related clause to be
added to the contract. ConocoPhillips, although an existing supplier, negotiated a new
CMR:130:07 Page 1 of 2
CMR:130:07 - ATTACHMENT A
contract based on the version issued by the City in the RFP process. These four suppliers
meet the City’s minimum credit and contractual criteria.
Composite results of the team’s evaluation are summarized in Table 1 below.
Table 1. Gas Master Agreement RFP Evaluation Summary
Performance/Financials Credit Contract Provisions Reference Average
BP Energy Corporation A B A A A
ConocoPhillips A A A A A
Coral Energy Resources A B A A A
JP Morgan A B B A A-
Powerex A 13 B A A-
Sempra Energy Trading B B A A
Staff strives to ensure that the City has at least three qualified bidders to obtain
competitive pricing and to diversify suppliers, some counterparties do not offer all of the
natural gas products that the City needs, and the industry regularly experiences vendors
exiting the business or consolidating. These characteristics dictate securing a set of three
to seven agreements. Managing more than seven contracts becomes unduly burdensome.
All six qualifying suppliers were able to negotiate final agreements acceptable to the
City.
CMR:130:07 Page 2 of 2
NOT YET APPROVED
ATTACHMENT B
ORDINANCE NO.
ORDINANCE OF THE COUNCIL OF THE CITY OF PALO ALTO
AUTHORIZING THE CITY MANAGER TO PURCHASE A PORTION
OF THE CITY’S NATURAL GAS REQUIREMENTS FROM
CERTAIN PREQUALIFIED NATURAL GAS SUPPLIERS UNDER
SPECIFIED TERMS AND CONDITIONS DURING CALENDAR
YEARS 2007 THROUGH 2022, INCLUSIVE
The Council of the City of Palo Alto ~does ORDAIN as
follows:
SECTION I. The City Council finds, as follows:
A.Between August 2003 and August 2004, the Council by
minute orders approved the. following: (i) the gas utility long-
term plan management objectives and guidelines ("GULP
Guidelines"), noted in staff report CMR:355:03, which requires the
diversification of energy purchases based on factors such as dates
and terms of commitment, suppliers, prices and fuel sources; and
(3) the GULP Implementation Plan, noted in staff report
CMR:335:04, which deals with asset management and acquisition
strategies.
B.In accordance with the GULP Guidelines and
implementation of the City’s natural gas purchase laddering
strategy, noted in staff report CMR:167:04, the City must annually
purchase and, incidental to purchases, sell gas to meet the needs
of its gas customers by contracting for terms varying from less
than one month to three years. The City’s Energy Risk Management
Policies, noted in staff report CMR:128:06, provide that the City
will purchase only that quantity of gas meeting its load
requirements at the time a transaction is executed.
C.By Ordinance No. 4810, adopted November i0, 2003,
the City has .entered into one or more purchase transactions,
costing in the aggregate $34" million, which are scheduled for.
delivery in the 2007 - 2009 period. These transactions will be
governed by the new, amended, or restated North American Energy
Standards Board, Inc. contracts (each a "NAESB Contract").
D.In June 2006, the City conducted an RFP process for
natural purchases, and BP Energy Company, Coral Energy Resources}
L.P., Sempra Energy Trading Corporation, ConocoPhillips Company,
J.P. Morgan Ventures Energy Corporation, and Powerex Corporation
have been determined to possess the minimum financial and legal
070113 syn 0072802
qualifications and business experience required of suppiiers
eligible to do business with the City.
E.The City intends to purchase natural gas from one or
more of these pre-qualified suppliers for delivery during calendar
years 2007 through 2022, inclusive, so long as the supplier with
whom the City negotiates a specific purchase transaction continues
to be qualified and otherwise eligible to transact with the City.
SECTION 2. The Council hereby authorizes the City Manager
to negotiate and sign new, amended, or restated NAESB contracts
with the suppliers referred to in Section I.D above, and further
authorizes the City Manager or his designee, the Director of
Utilities, to negotiate one or more individual transactions,
including, but not limited to, negotiating contracts, addenda,
confirmations and transactions. The authorization shall extend to
individual transactions executed under any number of NAESB
Contracts with~the referenced suppliers; provided, however, (a) the
maximum expenditure under any NAESB Contract and related
transactions shall not exceed $65 million in the aggregate and,
with respect to outstanding transactions for $34 million referred
to in Section I.C, the respective amounts will not be applied
against the maximum expenditure established herein; and (b) the
maximum term of any transaction shall not exceed three years,
commencing on the delivery date of the transaction. The sentence ~
preceding notwithstanding, the City may enter into a transaction.
greater than three years, if the Council grants prior approval to
such transaction.
’ SECTION 3. No NAESB Contract and any related transaction
entered into with any qualified supplier, executed by the City
Manager or his designated representative and approved as to form by
the City Attorney, under the authority of this ordinance, shall
extend beyond December 31, 2022.
SECTION 4. The Council hereby finds that this ordinance is
exempt from the provisions of the CaliforniaEnvironmental Quality
Act pursuant to Section 15061(b) (3) of the California Environmental
Quality Act Guidelines, because it can be seen with certainty that
there is no possibility of significant environmental effects
occurring as a result of the adoption of this ordinance.
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061219 syn 0072802
SECTION 5. This ordinance shall be effective on the
thirtY-first day after the date of its adoption.
INTRODUCED:
PASSED:
AYES:
NOES:
ABSTENTIONS:
ABSENT:
ATTEST:
City Clerk
APPROVED AS TO FOR!~:
Mayor
APPROVED:
Senior Asst. City Attorney City Manager
Director of Administrative
Services
Director of Utilities
061219 syn 0072802
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