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HomeMy WebLinkAboutStaff Report 260-09TO: ATTN: FROM: DATE: HONORABLE CITY COUNCIL FINANCE COMMITTEE CITY MANAGER MAY 26, 2009 DEPARTMENT: ADMINISTRATIVE SERVICES CMR:260:09 SUBJECT: Recommendation to City Council to Change the Methodology Used to Calculate the Equity Transfer from Utilities Funds to the General Fund EXECUTIVE SUMMARY On March 31, 2009, staff presented to the Finance Committee recommendations for changes to the calculation methodology for the Utilities Equity Transfer to the General Fund (CMR: 190:09, Attachment 1).The Finance Committee had additional questions regarding the rationales for the tax and risk adjustments and requested that staff retm'n with the responses during the FY 20 1 0 and 2011 Proposed Budget hearings. RECOMMENDATION Staff recommends that the Finance Committee recommend that the Council approve the proposed Utility Enterprise Methodology (UEM) that bases the Equity Transfers from the Gas and Electric Funds upon a rate of return on the asset base. The UEM is proposed for implementation in Fiscal Year (FY) 2010. DISCUSSION During the Finance Committee's review of the UEM on March 31, 2009, questions arose regarding the comparison of the City of Palo Alto's transfer amount to those of other municipalities, and the rationale behind the two adjustment factors that the proposed UEM relies on: the 30 percent adjustment to account for being a tax -free entity and the 15 percent adjustment to account for reduced risk. Comparison to Other Municipalities Information on comparisons of General Fund transfers from other municipalIy-owned utilities was provided by the 2009 annual survey conducted by the Northern California Power Agency (NCPA). This information was for transfers from electric funds only, since there are only two other municipally-owned gas utilities besides Palo Alto in the state. Showing as dollar amount and as a percentage of annual electric sales revenues, the data is as follows: o City of Alameda -$2.8 million (6 percent) CMR:260:09 Page 1 of 5 o City of Briggs • $150,000 (6 percent) o City of Gridley . $800,000 (14 percent) o City of Lompoc • $1.3 million (7 percent) o City of Roseville -$6.5 million (4 percent) o City of Santa Clara -$13.4 million (5 percent) o City of Ukiah -$1.1 million (7 percent) By comparison, the Electric Fund Equity Transfer for Palo Alto in FY 2009 is $9.3 million, (8 percent). In FY 20 I 0, the proposed Electric Fund Equity Transfer for Palo Alto is $11.1 million, or 9 percent ofthc budgeted sales revenue. Compared to the other cities listed above, Palo Alto's Equity transfer of $Il.l million (9 percent) for FY 2010 is on the upper end of the range. Tax and Risk Ad instment Factors The City's consultant for the equity transfer methodology, R.W. Beck, has recommended thatthe City use PG&E's approved rate of return on equity as a base, with two adjustments to aeCOtUlt for differences between an investor owned utility and a municipally owned utility. An investor in City bonds compared to an investor in PG&E bonds is not taxed on interest earnings and will not experience the risk of default associated with PG&E's lower-rated bonds. It is appropriate, due to the tax exempt status of City bonds as well as the City's high rating on its utility revenue bonds (AAA), to adjust the PG&E rate of return with a tax adjustment and a risk adjustment. The recommended tax rate adjustment of 30 percent is used as a proxy for the marginal tax rate that an investor in municipal bonds would avoid paying compared to a corporate bond holder. Because the difference in yield between a corporate and municipal bond cannot solely be explained by the tax adjustment, R.W. Beck also advised that a risk adjustment be included in the UEM. An investment in a City of Palo Alto utilityrevenue bond provides a degree of security or risk avoidance that a PG&E bond would not. The recent increase of the City's utility revenue bond to a triple A rating informs an investor that their investment bears a minimum of risk or that the issuer is most unlikely to default. The graph below illustrates the past 90 days of PG&E' s (current S&P rating A-) Expected Default Frequency (EDF) and the City of Palo Alto Utilities (CPAU) EDF based on the recently upgraded ratings from AA-(0.1 0%) and AA+ (0.7%) to AAA. The equivalent median EDF credit measure as defined by Moody's KMV for an A-rating is 0.26% and the same measure for an AAA rating is 0.06%. The difference is 0.20%, illustrating the higher risk that an investor in PG&E faces, and the consequent higher rate of return on their investment. Therefore, some adj ustment to the equity transfer calculation is reasonable. Staff is recommending a 15 percent risk adjustment as reasonable artd one CMR: 260:09 Page 2 of5 and one that keeps the equity transfer at a steady level compared to prior years, Chart Builder PG&E CORP [PCG] EOf 11 r Vo/JV'I~ VL r r\'-rd ---' V - IG -, ..... - J'J : ... _- .27 24 21 18 A2 PGE '. I .15 -, --c-' n. 12 09 : 1<12 CPA 06 Aaa 31-0'::0-09 14Jan.():g 2e·Jan-09 11·Feb·OQ :to·Feb·OIl 11·M1r·OO: U·Mar·Qg oe·JI1ir·Oo;, 12·JIpr-OQ lime: Plot: Values Period: Last 90 Trading Days From: December 30,2008 Currency. U.S. DOLLAR[U8D] To: May 4,2009 Description -PG&E CORP [P.CG] EDF Value As Of 0,26 04-May-09 The calculations using the proposed UEM for the electric and gas rate base on which the equity transfer is calculated is as follows: Electric Rate Base for Equity Transfer -Proposed Utilities Enterprise Methodology (UEM) In Thousands: $ 151,044 -Net asset value as of June 30, 2008 from the FY 2008 CAFR + 5,669 -Supply working capital (supply purchases divided by 12) + 5,141 -Operating expense working capita (operating expense divided by 8) + 8,074 -FY 2009 budgeted CIP less customer funded improvements =--"'''''''''' -FY 2009 depreciation $ 164,542 -Total electric rate base Gas Rate Base for Equity Transfer -Proposed Utilities Enterprise Methodology (UEM) CMR: 260:09 Page 3 of 5 In Thousands: $ 69,525 Net asset value as of June 30, 2008 from the FY 2008 CAFR + 2,238 -Supply working capital (supply purchases divided by 12) + 1,580 Operating expense working capita (operating expense divided by 8) + 6,747 -FY 2009 budgeted CIP less customer funded improvements 1,5 52 -FY 2009 depreciation $ 78,538 Total electric rate base The calculation of the rate of return on equity appropriate for Palo Alto and as recommended by staff is equal to PG&E's approved return on equity multiplied by 0.70 (I ·.30, the tax adjustment) multiplied by 0.85 (1-.15, the risk adjustment). This rate of return percentage approximates the difference that an investor could expect to experience when investing in a municipal bond as opposed to a corporate bond. Using PG&E's current approved return on equity of 11.35 percent as example, the total return for Palo Alto would be equal to 11.35 percent times 0.70 times 0.85, or 6.75 percent. An alternate risk adj ustment of 10 percent discount would result in a 7.15 percent rate of return and a risk factor of 20 percent discount would result in a 6.36 percent rate of retUln. The table below shows the change in the equity transfer for 0, 10, 15 and 20 percent risk discounts. Staff has recommended a risk adjustment of 15 percent, as reasonable and one that keeps the equity transfer at a steady level compared to prior years. RESOURCE IMPACT SECTION The cun'ent FY 2009 equity transfers equal $15.07 million. The staff recommended Electric and Gas transfers in FY 2010 with a tax adjustment of30 percent al1d a risk adjustmel1t of 15 percent result in a transfer of$16.42 million, an increase of$I.35 million. Changing for the alternative risk adjustment to 20 percent results in a decrease of $1 million in total equity transfers and the alternative risk adjustment of 10 percent results in an increase 0[$1 million in total equity transfers when compared to the 15 percent risk adjustment. POLICY IMPLICATIONS The recommended action changes the equity transfer methodology for the Electric and Gas Funds to the General Fund. ENVIRONMENTAL REVIEW Changing the equity transfer methodology does not meet the definition of a "project" pursuant to Section 21065 of the Public Resources Code, thus no enviromnental assessment under the California Environmental Quality Act (CEQA) is required. CMR: 260:09 Page40fS PREPARED BY: APPROVED BY: CITY MANAGER APPROV AL: ATTACHMENTS Attachment 1 -CMR: 190:09 LALO Director, Administrative Services Attaehment 2 -EDF Equivalent Median EDF eredit measures from CreditEdge CMR:260:09 Page S ofS TO: FROM: ATTENTION: DATE: SUBJECT: ATTACHMENT 1 BUDGET FY 201O-FY 2011 HONORABLE CITY COUNCIL II LJ CITY MANAGER DEPARTMENT: UTILITIES AND ADMIN ISTRA TIVE SERVICES FINANCE COMMITTEE MARCH 31, 2009 CMR: 190:09 Recommendation to City Council to Cbange tbe Methodology Used to Calculate tbe Equity Transfer from Utilities Funds to the Genera) Fund EXECUTIVE SUMMARY Staff regularly reviews the methodology used to calculate the equity transfer to the General Fund from certain Utilities Funds. The last time a change was made to the methodology was for FY 2002. Staff's reconunendation is to return to the Utility Enterprise Methodology that the City used starting in 1983. The proposed methodology is recommended for the Electric and Gas Funds to take effect for FY 20 I O. The City will cease making an equity transfer from the Water Fund in FY 2010. The Utilities Advisory Commission (UAC) recommended changes to the staffs recommendation at its March 4, 200!i meeting. Staff has slightly modified its reconunended equity transfer method, but does not recommend adoption of all of the changes in the UAC's proposal .. Both staffs and the UAC's proposals are described in this report for consideration by the Finance Committee. RECOMMENDATION Staff reconunends that the Finance Committee tentatively recommend that the Council approve the proposed Utility Enterprise Methodology (UEM) that bases the equity transfers from the Gas and. Electric Funds upon a rate of return on the asset base. This UEM is proposed to be implemented beginning in Fiscal Year (FY) 2010. The Finance Committee will make a final· reconunendation to the Council when it reviews the entire budget proposal later this spring. The Utilities Advisory Conunisslon (UAC) reconunends that Council adopt an alternate UEM with modifications including that the equity transfers from the Electric and Gas Funds neither increase nor decrease by more than five pereent from the preceding year's transfer. BACKGROUND As a result of the initial investment made by the City and its citizens, Palo Alto's residents and businesses have enjoyed favorable rates and utility services provided by the City's municipal utility. The services provided by the Gas, Water and Electric Funds provide a return on investment to the General Fund in the form of Utility Fund transfers, as established in the City's Charter. Article VII, Section 2 -Public utilities revenue, of the City Charter states: The revenue of each public utility shall be kept in a separate fund from all other receipts and shall be used for the purposes and in the order as follows: (a) For the payment of the operating and maintenance expenses of such utility, including the necessary contribution to retirement of its employees. (b) For the payment of interest on the bonded debt incurred for the construction or acquisition of such utility. (c) For the payment of the principal of said debt, as it may become due. (d) For capital expenditures of such utility. (e) For the annual payment into a reserve fund for contingencies, of an amount not to exceed ten percent of the expenditure for capital outlay for the year, exclusive of bond fund expenditures. The total accumulated in this reserve for contingencies shall at no time exceed five percent of the book value' of the utility's capital in service. This reserve fund shall be available for use by the utility, only for replllcements or emergency repairs and after special appropriation by the council. (f) The remainder shall be paid into the general fund by quartedy allotments. The historical transfers to the General Fund from the Gas, Water and Electric Funds from FY 1982 to FY 2009 are shown in Attachment A to this report. ·1982 Price Waterhouse Study In July 1982, the City executed a contraCt with Price Waterhouse to evaluate and determine the appropriateness of the method utilized for determining the transfer from the Utilities Funds to the General Fund. Price Waterhouse confirmed that the wastewater and refuse funds are considered "governmental functions" and no transfers to the General Fund are made, so the study focused on the "proprietary" utilities -gas, water and electricity. The Price Waterhouse study noted that the City had a practice for its 82-year history of generating net income based on the provisions of the City Charter cited above. As part of the study, Price Waterhouse conducted a survey of how cities determine an appropriate transfer to their General Funds. This survey concluded that many methods were in use, but that cash transfers from proprietary funds to. the General Fund are a common and accepted practice for cities in Califurnia and other states. The most common method was based on a percentage of revenues. The most common method for investor-owned utilities was the UEM. The City wanted to ensure that it would have a method that was in-line with the practice of other cities. The study, which was completed in December 1982, noted that the City's ratemaking methods varied for each utility at the time. The gas utility set retail rates equal to retail rates in Pacific Gas and Electric Company's (PG&E) service area that surrounds Palo Alto. The equity transfer -==-=:--:c-:-::-::-:::-------------------------:::--.. ----CMR: 190:09 Page 2 of 1 J method for the gas utility was equal to the total revenues minus total costs for the gas utility. This formula could result in a negative transfer in the event that total costs exceeded total revenues. For the water utility, a "return on ratebase" method (also known as the Utility Enterprise Method, or UEM) was used to calculate the transfer to the General Fund. Price Waterhouse noted that the UEM is used by investor-owned utilities, such as PG&E, in California. The method links the transfer to the total investment made in the utility. For the electric utility, the transfer method was based on a Utilities Department ratemaking goal to include "a reasonable transfer to the City'S General Fund." In January 1983, Council was provided with the Transfers to the General Fund Study completed by Price Waterhouse (CMR: 143:3). The study recommended the use of the UEM in which the three proprietary enterprises (water, gas and electric) are viewed as taxpayers' assets that should yield a reasonable return on the assets dedicated to the systems. Using the UEM, the transfer to the General Fund is calculated by multiplying the net plant assets of each utility by the rate of return. The study also recommended the City Council consider a "range of reasonableness" in determining the appropriate transfer to the General Fund. The recommended "range of reasonableness" included a lower and upper boundary on the rate of return to be used in the UEM calculation. The lower end of the range used a rate of return equal to the current rate on Treasury bonds, a long-term, risk-free investment. The upper end of the range would be based on the rate equal to that used by the California Public Utilities Commission for investor-owned utilities, such as PG&E. 122ZCQ.\illcii Action In 1996, a landmark electric utility deregulation bill (AB 1890) was passed by the California legislature. It allowed, as of March 31, 1998, customers to choose their electric commodity supplier. In addition, the Utility Infrastructure Improvement Program (UIIP), which began in FY 1991, had led to increased funding of Capital Improvement Program (CIP) projects, increasing the asset bases of the Water, Gas, and Electric Funds. Since the UEM is based on the asset base, the UIIP led to an increase in the level of transfers to the General Fund. The combined effect of customers potentially "leaving" the Palo Alto system in order to be served by an alternate commodity supplier and the upward pressure on rates caused by rapidly increasing transfers to the General Fund led staff to review the equity transfer methodology. Responding to these conditions, in 1997, the City Council froze transfers from the Gas, Water and Electric Funds to the General Fund at FY 1997 levels of $11.835 million annually. 2000 R. W. Beck Sruc:l! In 1999, the City selected R. W. Beck to evaluate methodologies for Utility Fund transfers to the General Fund. The study's scope included the review of existing transfer methodologies, identification of alternative methodologies, and the development of recommendations. The R. W. Beck Utility Funds Transfer Study was completed in March 2000. The study concluded that the current UEM transfer methodology is viable if it undergoes certain modifications to recognize the risk associated with the electric and gas supply business. The analysis performed in 2000 resulted in a recommendation that the City adopt an equity transfer .... -- CMR: 190:09 Page 3 of 11 policy aTound the Utility Enterprise Method that had been adopted by the City after a 1982 study by Price Waterhouse. The Utility Enterprise Method is based on a Rate of Return on Rate Base methodology. The final recommendation contained in R. W. Beck's 2000 report was not ultimately adopted by the City. The UAC reviewed the R. W. Beck Utility Funds Transfer Study in MaTch 2000 and concurred with staff's recommendation to change the transfer methodology as follows: • For the Water Fund, increase the transfer at an annual rate of 3 percent per year from the initial level of $2.044 million for FY 2000. • Foi the Electric Fund, calculate the transfer based on 14.5 percent of Adjusted Sales Revenue (ASR), where ASR is defined as the metered sales revenue less the Capital Improvement PrograIn (CIP) expenditures. • For the Gas Fund, use the SaIne basic methodology, but use 15 percent of ASR in the calculation. • Include in the methodology a sharing arrangement in case of a loss faced by one of the utility funds. In April 2000, the City Council approved the recommended methodology for the equity transfers (CMR: 223:00) beginning in FY 2001. Change in Fiscal Year 2002 In the FY 2002 budget, staff recommended that the equity transfer from the Electric and Gas Funds change so that inereases to the transfers are capped at 3 percent per year due to volatility of electric and gas commodity costs. Since FY 2002, the equity transfers have increased by 3% from the previous year's transfer amounts. DISCUSSION More recently, the City decided to conduct a review of the methodologies for the water, gas and electric equity transfers. The City hired the firm of Black and Veatch in 2008 to review the water fund equity transfer. After eJ{aInining the water equity transfer methodology study and the practices of other public agencies, staff decided to cease the equity transfer to the General Fund from the Water Fund beginning in FY 2010. In addition, R. W. Beck was engaged in eaxly 2009 to review its recommendations from 2000· and to again evaluate alternate equity transfer methodologies. R. W. Beck completed its review of the electric and gas equity transfers in Febl1laIY 2009, identifying alternative methodologies and recommending a methodology for the future that is fair and reasonable. R" W. Beck's Recommendation R. W. Beck's letter report (Attachment B) identified some of the common methods used by municipally-owned utilities to determine an equity transfer to the general fund of the city. These methods are described in the report and include: . CMR: 190:09 Page 4 of 11 ~ Return on Rate Base ~ essentially the UEM " Percent of Gross Revenue ~ based on retail revenues .. Percent of Net Revenue ~ based on retail revenues less certain identified expenses " Rate per Unit Delivered ~ a fixed amount per kilowatt-hour delivered ~ Fixed Amount _. predetermined amount independent of operational costs or revenues R W. Beck recommends that the City employ a Return on Rate Base method similar to the UEM utilized in the past by Palo Alto. The recommended method requires the annual calculation of the "rate base" for the Electric and Gas Funds. The rate base contains the following components that are added together: .. Net asset value of the utility assets as of the latest audited fiscal year. This is calculated every year by the Administrative Services Department. The net asset value is adjusted every year by that year '8 capital additions and reductions for depreciation, which is based on the life of each asset. The latest audited net asset value will be found in the City's Comprehensive Annual Financial Report (CAFR); .. Working capital for the supply purchases for the upcoming fiscal year. This is calculated by mUltiplying the budgeted cost for supply purchases by 1112 since the City needs to reserve sufficient funds for one month of these costs; .. Working capital for the non-energy supply operating costs for the upcoming fiscal year. This is calculated by multiplying these costs by 118 since there is approximately a 4S-day lag from customer usage of the energy deliveries and payment received for the energy deliveries; .. Additional capital projects budgeted during the current fiscal year. This is equal to the additional budgeted capital improvements minus the expected customer funded improvements; .. Depreciation for the current fiscal year. This is the estimated depreciation on the utility assets for the current fiscal year, which will result in a reduction of the asset base; and ". Additional capital projects planned to be added during the upcoming fiscal year. This is equal to the additional budgeted capital improvements minus the expected customer funded improvements. This total amount is divided by two to approximate the average CIP and customer funded improvements during the fiscal year. The rate base is then multiplied by an appr()priate return on equity to calculate the equity transfer. R. W. Beck recommends using an adjusted return on equity based on the return on equity allowed by the California Public Utilities Commission for PG&E. R. W. Beck recommended methodology has two adjustments to PG&E's allowed return on equity to accoUllt for differences between an investor oWlled utility (IOU) like PG&E, and a municipally owned utility. The first adjustment is a tax adjustment and the second is a risk adjustment. The tax adjustment compensates for the fact that the City of Palo Alto Utilities is a tax-exempt entity and the City does not pay taxes on its collected return. The tax adjustment is 30%, which is reflective of the total tax rate for taxable entities. The risk adjustment is based on the concept that an investment in a municipal utility is less risky than an investment in an IOU. R. W. Beck advised thai the difference in yield between corporate bonds and municipal bonds cannot be C.MR: 190:09 Pa 5 of 11 entirely explained by the tax adjustment alone. R. W. Beck recommends a 15% factor for this risk adjustment. The calculation of the return on equity appropriate for Palo Alto, then is equal to PG&E's approved return on equity multiplied by 0.70 (1-.30, the tax adjustment) multiplied by 0.85 (l- .15, the risk adjustment). As an example, using PG&E's current approved return on equity of 11.35%, the total return for Palo Alto would be equal to 11.35% times 0.7 times 0.85, or 6.75%. When this return on equity is multiplied by the rate base, calculated as described above, the answer is the equity transfer for the Electric and Gas Funds. The chart below shows the equity transfers to the General Fund for FY 2009. Fiscal Year 2009 Equity Transfer Fiscal Year Water Fund Electric Fund Gas Fund Total Increase (%/year) 2009 $2,666,956 $9,267,688 $3,135,256 $15,069,901 +3.0% IfR. W. Beck's methodology were in place for FY 2009, the calculation would be as follows for the Electric and Gas Funds: Electric Equity Transfer: $143,377,000 -net asset value as of June 30,2007 from the FY 2007 CAFRi + 6,393,000 -supply working capital (supply purchases divided by 12) + 5,241,000 -operating expenses working capital (operating expenses divided by 8) + 9,260,000 -FY 2008 budgeted CIP less customer funded improvements 5,387,000 -FY 2008 depreciation + . 4,037,000 -FY 2009 budgeted CIP less customer funded improvements divided by 2 $162,921,000 -total electric rate base Electric Equity Transfer = $162,921,000 * 0.0675 = $10,997,000 Gas Equity Transfer: $ 65,471,000 -net asset value as of June 30, 2007 from the FY 2007 CAFR + 2,324,000 -supply working capital (supply purchases divided by 12) . + 1,534,000 -operating expenses working capital (operating expenses divided by 8) + 6,365,000 -FY 2008 budgeted CIP less customer funded improvements 1,552,000 -FY 2008 depreciation + 3,355,000 -FY 2009 budgeted CIP less customer funded improvements divided by 2 $ 77,497,000 -total gas rate base Gas Equity Transfer = $77,497,000 * 0.0675 = $5,231,000 R. W. Beck's recommended method results in estimated equity transfers to the General Fund for FY 2010 of $11,400,000 from the Electric Fund and $5,367,000 from the Gas Fund for a total I Adjusted for fiber optic net asset value CMR: 190:09 Page 6 of 11 equity transfer of $16,767,000. The table below shows the projected transfers using the proposed method for the next five fiscal years given the projected crp expenditures for each fund. Estimated Equity Transfer Usin2 RW Beck Recommended Methodology ($million) f-I -:;;;:;-E::oquity Transfer FY 2010 FY 2011 FY 2012 FY 2013 IT 2014 I . Electric Fund 11.40 11.80 12.00 12.17 12.41 I r Gas Fund --~-~-5.37! 5.18 .~._5.88 6.18 ··--6.41"l Total E:quity Transfer 16.77 I 16.98 +-_!~8f1~ __ --.!8~1-. __ !8.8~1 Annual Rate of Change I NJA_!._1.3%.L 5.3% .• 2.7% ·~2_.7_% __ . Staff's Recommendation Staff proposed the R.W. Beck's recommended methodology to the UAC at its March 4, 2009 meeting. Based on discussions by the Commissioners, staff has modified its recommendation slightly from the methodology recommended by R. W. Beck. Staff now recommends removing the utilization of one half of the additional capital projects planned to be added during the upcoming fiscal year. This part ofR. W. Beck's recommendation is meant to base the upcoming fiscal years rate base on the estimated net assets as of the mid-point of the fiscal year. Staff has decided that calculating the rate base for the upcoming fiscal year at the start of the fiscal year improves the method and limits the amount of future estimates required for the calculation. If staff's recommended methodology were in place for FY 2009, the calculation would be as follows for the Electric and Gas Funds: Electric Equity Transfer: $143,377,000 -net asset value as of June 30, 2007 from the FY 2007 CAFR2 + 6,393,000 -supply working capital (supply purchases divided by 12) . + 5,241,000 -operating expenses working capital (operating expenses divided by 8) + 9,260,000 -FY 2008 budgeted elP less customer funded improvemeuts 5,387,000 --FY 2008 depreciation . $158,884,000 -total electric rate base Electric Equity Transfer = $158,884,000 • 0.0675 = $10,725,000 Gas Equity Transfer: $ 65,471,000 -net asset value as of June 30, 2007 from the FY 2007 CAFR + 2,324,000 supply workiug capital (supply purchases divided by 12) + 1,534,QOO -operating expenses working capital (operating expenses divided by 8) + 6,365,000 -FY 2008 budgeted ClP less customer funded improvements -1,552,000 -FY 2008 depreciatiou $ 74,142,000~total gas rate base Gas Equity Transfer = $74,142,000· 0.0675 = $5,004,000 Staff's recommended method results in estimated equity transfers to the General Fund for FY 2010 of $11,112,000 from the Electric Fund and $5,304,000 from the Gas Fund for a total equity , Adjusted for tiber optic net asset value transfer of $16,416,000. The table below shows the projected transfers using the proposed method for the next five fiscal years given the projected CIP expenditures for each fund. Estimated Equity Transfer Using Staff's Recommended MethodololO' (Smillion) Equity Transfer FY2010 FY2011 FY20n FY2013 FY2014 .. _. Electric Fund 11.11 i 11.53 11.74 11.91 12.15 . Gas Fund 5.30 4.93 5.64 5.94 6.29 Total E'lliity Transfer 16,42 16.46 17.38 17.84 18.43 Annual Rate of Change N/A 1.3% 5.3% 2.7% I 2.7% ..... _ .. COMMISSION REVIEW AND RECOMMENDATIONS The method proposed by RW. Beck for the equity transfer methodology was presented to the UAC at its March 4, 2009 meeting. The UAC noted that the rnethod must take into account assets that are added to the system that are debt-financed. There were also questions as to why the rate base formula includes one-half year of the future fiscal year's capital additions. Staff also clarified for the UAC that property for which Utilities pays rent to the General Fund is not included in the Utilities net asset base. Commissioner Rosenbaum provided staff and the UAC a perspective from the last time there waS a change in the equity transfer method in 2000. Rosenbaum felt that the discussion about the change this time was not adequate and that staff did not prepare the UAC for the sudden increase in the proposed transfer amount. He also expressed dismay that the additional funds appeared to be proposed coincident with the City's announcement of a budget deficit. Other commissioners generally supported the Utilities Enterprise Methodology, calling it reasonable and based on non-arbitrary information, but made some suggestions for modifications. . Commissioner Melton made a motion that .the UAC recommend that Council approve the methodology proposed by staff modified by removal of 50% of the future year's budgetedCIP and by an appropriate asset base in the event of debt issulUlce. Chair Dawes proposed that the motion be amended so that the UAC recommend that Council approve the methodology proposed by staff modified by; 1. Removal of50% of the future year's budgeted CIP; 2. Removal of the operating eXPense working capital; 3. Require that the annual transfer cannot change by more than plus or minus 5%; and 4. Require debt-funded assets to be appropriately characterized in the rate base recognizing that a rate of return is being paid to bond holders on such assets. . Chair Dawes seconded the motion. The motion carried 3 -1-1 with Commissioner Rosenbaum voting no with a comment that the method is a blatant attempt for the General Fund to take more dollars from Utilities. Commissioner Keller abstained saying that she did not understand the method. The notes from the UAC meeting are provided as Attaclunent C. CMR: 190:09 Page 8 of II 1,Jt\C's Recommcl1dation The UAC's recommendation includes modifications to the methodology recommended by R, W. Beck. If the UAC's recommended methodology were in place for FY 2009, the caleulation would be as follows for the Electric and Gas Funds: Electric Equity Transfer: $143,377,000 -net asset value as of June 30, 2007 from the FY 2007 CAFR3 + 6,393,000 -supply working capital (supply purchases divided by 12) + 9,260,000 -FY 2008 budgeted CIP less customer funded improvements _-_ 5,387,000 -FY 2008 depreciation $153,643,000 -total electric rate base Electric Equity Transfer = $153,643,000 * 0,0675 = $10,371,000 Gas Equity Transfer: $ 65,471,000 -net asset value as of June 30, 2007 from the FY 2007 CAFR + 2,324,000 -supply working capital (supply purchases divided by 12) + 6,365,000 -' FY 2008 budgeted CIP less customer funded improvements :, 1,552,000 -FY 2008 depreciation $ 72,608,000 -total gas rate base Gas Equity Transfer = $72,608,000 * 0.0675 = $4,901,000 In addition the 5% maximum annual increased transfer is part of the UAC's recommended 'method, The table below shows the resulting equity transfers to the General Fund where the transfers from each fund do not change by more than 5 percent up or down from year to year. Using the method, the transfers in FY 2010 would be 5% more than they are in FY 2009, or $9,731,000 from the Electric Fund and $3,292,000 from the Gas Fund for a total equity transfer of $13,023,000, The table below shows the projected transfers using the proposed method for the next five fiscal years given the projected CIP expenditures for each fund. Estimated Equity Transfer Using UAC's Recommended Methodology ($million) Equity Transfer ' , FY1OO9,' .11"),2010. "FY20',~ ,.FY201f,' , FY2013 , FV 2014 , • ;'" ,. -" ·(¢ur~n~t . -" i' -.' : " ." '" . .' .. /. . I' ··:::·:;W·:' :-..... ,- Electric Fund 9.27 10.77 11.16 11.36 11.52. 1~ Gas Fund 3,14 5.20 4.81 5,53 5.82 6.16 Total Equity Transfer. 12.41 15.96 15.98 16.89 17.33 17.91 -• Annual. Rate of Change, 28.7% 0.1 % 5.7% 2.6% 3,3% ~~8ferlflimited by 5% maximum annual chanll.e for each fund Electric Fund . 9.27 9.73 10.22 I 10.73 11.26 11.75 Gas Fund 3.14 3.29 3.46 I 3.63 3.81 ;,.-4·2.2-TotalEquity Transfer 12.41 13.02 13.67 14.36 • 15.08 15.75 Annual Rate of Change 5% 5% , 5% J 5% 4.5"/0 , Adjusted fur fiber optic net asset value The table below summarizes staff's and the (JAC's recommendations for the equity transfers for the next five fiscal years. RESOURCE IMPACT The total equity transfer from Utilities Funds for FY 2009 is $15.07 million. If the current method of increasing the equity transfer by 3% per year were used for FY 2010, the equity transfer would be $15.52 million. Staff's recommended equity transfer method will increase the total equity transfer from Utilities for FY 2010 to $16.42 million, or an increase of approximately $900,000. The equity transfers are part of the Utilities revenue requirement and the costs will be recovered from gas and electric ratepayers . .. . Since the equity transfer from the Water Fund will cease in FY 2010, the Water Fund revenue requirement is reduced by the amount of the transfer amount, or approximately $2.75 million. Staff's recommended equity transfer method will increase the equity transfer from the Gas Fund by about $2.1 million for FY 2010 compared to what it would have been if the current method continued. Staff's recommended equity transfer method will increase the equity transfer from the Electric Fund by about $1.57 million for FY 2010 compared to what it would have been If the current method continued. The current FY 2009 equity transfers from the Electric, Gas, and Water Funds total $15.07 million compared to the staff recommended Electric and Gas transfers in FY 2010 of $16.42 million, or an increase of $1.35 million in equity transfers to the General Fund. If the UAC's recommended methodology were to be adopted, then the equity transfers for FY 2010 from the Electric Fund and the Gas Fund would be $9.73 million and $3.29 miIHon for a total equity transfer of $13.02 million. This is $2.05 million less than the FY 2009 total equity transfer to the General Fund from Utilities and $3.4 million less than staff's recommendation for FY20l0. Staff agrees with the UAC's recommendation to exclude any impact to the operating expense as a result of the issuance of debt. However, any assets created as a resillt of the debt issue will be included in the rate bese calculation as part of the net asset value as per the CAFR. The City Attorney's office has also advised that the UAC recommendation to require that any decrease in the annual transfer be limited to a maximum of 5% is legally impermissible. CMR: 190:09 ~~~~~~~~ ....... --~ Page 10 of 11 POLlCY IMPLICATIONS The recommended action changes the equity transfer methodology. This recommendation is consistent with the Council-approved Utilities Strategic Plan with regard to I) 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 equity transfer methodology does not meet the definition of a "project" pursuant to Section 21065 of the Public Resources Code, thus no environmental assessment under the California Environmental Quality Act (CEQA) is required. ATTACHMENTS A. Historical Equity Transfers from Electric, Gas, and Water Funds B. March 3, 2009 letter from R. W. Beck to the Director of Administrative Services regarding the equity transfer C. Draft Notes from the March 4, 2009 UAC meeting PREPARED BY: JANE O. RATCHYECW' DEPARTMENT APPROVAL: CITY MANAGER APPROVAL: Utilities Assistant Direc,:j. Resource Management SHARON BOZMAN Manager,Budget~ VAL~NG Director Qf . tilities L z Director of Administrative Services -j!'r> 4/ JA E KEENE Ci ger Attachment A: Historical Equity Transfers to the General Fund Historical Equity Transfers to the General Fund C-=--:C:-~C-=-C-----=--"'-'---=~' --:---r--:~=----c--,----:=--"'::----.-=---I Fiscal Year Water Fund Electric Gas Fund Total Increase (%/year) Fund 1--;-;:-;:-;:--t---:-:-:-::---,;:-;;c::+-~'5-=_+_-:-=~::+--;::-;-;:-::-;:::-::-+"'~"~:-;:-;C;;-;---1 1-~1~98~2_-f-~I~,1~3~3,~0~00::+_~7~,8~2~9,~0~00~r-~1~3~9,~00~0~~9~,1701~,0~0~0-f-__ +~4~0~.87%~--1 1-~19=-=8::;-3 _+--_~4c;-87:-,,~00~0-f-_-::7~,6789:-,-'0~0~0+--568,000 8,744,000 -3.9% 1984 811,000 5,845,000 1,003,000 7,659,000-12.4% ...... -t----,:;.;-;,~~-~=~_+_...::2.~~~__;;~~~ .. ~ i--' ---:1'798;::.:;5;---l ... ~ ... _7~1;-::0"-:;,0,;;.0;;.-0 +-----=5:-'-,5;:-;0;-;;0Z;;,0:;;-00;;.+_-;8:;;;6;-;;4,Z;;0~00~__;;7~,0~77'4,:;;._00;;_;0~-___,-_;c7._=;_6";;-;VO_-----i 1986 726,000 5,500,000 875,Q-:OO:::-+---:7:,,:,1:-::0-?1,,-:-00:;-:0:-+-__ +c=:0.40/,=-c0 ----c 1987 910,000 5,500,000 2,309,000 8,719,000 +22.8% c .. --.l;c;9~88::---+_~9.:,;;09:-,-,9::.;9~6-1---::6',-=,44-;.:5;.'-,6::-:;2~0+ 1,594,992 8,~?.o~,6:;;-0;;.-8 +-__ +:..:2::.;;.7'+%;:-0_---c 1989 1,453,000 • 6,011,000 1,103,000 8,567,000 -4.3%----1 1990 1,460,000 6,098,O~0:-70-f-~1 ,::;;.21;:.:5:.z.,O;:.:0.;:-0-t-_8::z,7-,:-:7:-=3.z-::,0..:c0-c-0 +-__ +.,:;2:,:...4:.c:% . I 1991 11,112 6,126,600 1,383,'-:-50:;-:0:-+---;:7_'=:,5,:;-27'1,-c-21""2+-----:-1,.::4":.3_::'%:-···-· _' 1992 1,703,000 6,498,000 1,444,000 9645,000 +28.2% 1993 1,123,000 6,165,000 1;713,000 9,001,000 ·6.7% 1997 2,044,000 7316,000 2,475,000 11,835,000 +9.7% 1998 2,044,000 7,316,000 2,475,000 11,835,000 0% 1999 2,044,000 7,316,000 2,475,000 11,835,000 0% '--::2~0.;:.;00:--_+__....:;:2"-:,O.,:44?-,0~0~0-t,-_7',;;;',3;;-:1~.6z;;,0i;;00~____:;;2.z.,;,4_;;.75;f'0~0~O.1---:171,~83~5;r;'0:;;;0~0+----;;0"';%~---ji ---c~2~0:-::0~1--t-~2~,1~05~32;:.:8+--~7_'=:,3T157'),~;99:_::2+-._?2,~4_::'75~,0~0:-::0-f-~1~1,~896~,3~20:::-+----+~0~.5~%~ __ ~ i 2002 2,168,480 7,535,480 2,549,250.1:2,253,210 +3.0% 1-~2:::0c::0-73-+_---=2~,27337!,;:53;..;4Ci---_=7'i:,7.;c67'1,::c54:_::4+~2,S62;:5:;.z.,7::-;2::;:8 .. 1--'1:.;:2~,6:::'2~0,;:80o.;6~-......:.+73.:::-00~VO'---~ ... ---'2;;;:0c::0-::-4-+---:?2,730;.;:0~,5=-=4.:;-0.\-___;7:'::,9"'".9-7'4,:;;.;39:_:0:_l .. -?2,':::c70;.,:4:z:5;;:;:0-:;-0r-;:12::',9:-:9"'"9'i:,4.:;.:30::+-----'-+-::;-3 . .;c00/':, .... -.. ---c 2005 2,369,556 • 8,234,222 2,785,635 13,389,413 + 3.0% 2006 . 2,440,643 8,481,248 2,869,204: 13,791,09",,5_+_! __ +:-:;;3.:.;:.0'j/._ 2007 2,513,86? 8,735,686 2,955,280 14,204,828 +3.0% ... _ 2008 2,589,278 8,997,756 3,043,938 14,630,972 +3.0% ---~:-::-~--.,:;z~~7r--~~~:::-+~~~~~~~~-f-----~~--~ ,--~2=..:0:...:O:c...9 __ ..L---=2=,6~6,956 9,267,688 3,135,256 15,069,901 +...-"3:.:..,0=-0/,;:...0 _--' CREDITEDGE'" • Moody's I K' M • V ATTACHMENT 2 Credit Category -----------------....... -.. -~---- The following table displays the correlation between Credit Categories and Median EDF credit measures. These values are updated.on a monthly basis. S·yr Median: Median of spot medians over a 5-year period, Spot EDF: The EDF median calculated for companies grouped by their agency ratings, compiled at the end of each month. Source; ED!" Median Calculation: Credit Category: Export I Return To S&P SpotEDf 1 Year ~;i~ Previous Page Equivalent Equivalent Median Bound Range Median Bound Flange Credit EDf credit Credit EOF c",dit Category measure Lower Upper Category measure Lower Upper MA 0,06% 0.01% 0.07% BB 2.38% 1,89% 3.28% M+ 0.07% 0.07% 0.07% BB· 4.51% 3.28% 6,21% M 0.07% 0.07% 0.08% B+ 8.54% 6.21% 11.75% M· 0.10% 0,08% 0.11% B 16.16% 11.75% 18.11% A+ 0.13% 0.11% 0.15% B· 20.29% 18.11% 22.74% A 0.17% 0.15% 0.21% CCC+ 25.48% 22.74% 28.56% A· 0.26% 0.21% 0.32% CCC 32.00% 2B.56% 32,16% BBB+ 0.39% 0.32% 0,48% CCC· 32.32% 32.16% 32,64% BBB 0.59% 0.48% 0.74% CC 32.97% 32.64% 33.47% BBB· 0.94% 0.74% 1.18% C 33.97% 33.47% 35.00% BB+ 1.49% 1.18% 1.89% D 35.00% 35.00% 35.00% ·Last Updated: March 31, 2009 Copyright ©2007, Moody's KMV Company. All righls reserved. Moody's KMV, CreditEdge, CreditEdge Plus, the Moody's KMV logo, Expeeled Default Frequency, and EDF are trademarks of MIS Quamy Management Corp. ..