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HomeMy WebLinkAboutStaff Report 439-08City of Palo Alto City Manager’s Report TO:HONORABLE CITY COUNCIL FROM:CITY MANAGER DEPARTMENT: .ADMINISTRATIVE ¯SERVICES DATE:NOVEMBER 17, 2008 CMR.’439:08 REPORT TYPE: Information SUBJECT:City of Palo Alto’s Energy Risk Management Report for the First Quarter, Fiscal Year 2008-2009 This is an information report and no Council action is required. EXECUTIVE SUMMARY Staff has continued to purchase electricity and gas in compliance with the City’s Energy Risk Management Policies and Procedures. Despite the current volatility in the credit and financial markets, and a decline in credit quality for a few of the City’s counterparties, the City’s credit exposure in the commodity purchasing area is minimal. The market value of the City’s fixed price electricity purchases is $1.9 million less than the City’s contract price. The market value of the City’s gas purchases is $2.6 million less than the contract price. The relative value of these commodities declined during the quarter as market prices for energy dropped and results in minimal overall credit exposure to the City and no exposure to financially-based counterparties. The market value of purchases of renewable power is $1.f million less than the City’s costs based on forward prices of wholesale power. The mark to market value of electricity from Western hydro is $6.3 million, while the value for Cataveras hydro is negative $4.0 million. There are no exceptions to report. CMR:439:08 Page 1 of 10 BACKGROUND The purpose of this report is to inform the City Council of the status of the City’s energy portfolio and transactions executed with energy suppliers as of the end of the first quarter of Fiscal Year 2008-09 (July - September). The City’s Energy Risk Management Policy requires that staff report on a quarterly basis to Council on: 1) the City’s energy portfolio; 2) the City’s credit and market risk profile; 3) portfolio performance; and 4) other key market and risk information. Appendices A and B summarize the current position and exposure of the City with the electricity and gas commodity portfolios, respectively. Appendix 1 summarizes the electric portfolio in terms of forward purchase volumes, headroom (volume limit less current purchases volumes), and mark to market value (current market price less purchase price). Appendix 2 summarizes the gas portfolio in terms of transaction volume, market value, mark to market value and limits. DISCUSSION The City obtains electricity from hydro electric resources (referred to as Western and Calaveras), renewable landfill gas contracts, wind generation contracts, and fixed priced forward market purchase contracts. Electricity Purchases. The City currently has purchased supplies of electricity totaling 416,225 MWh for delivery between October 1, 2008 and March 31, 2010. The average price for all of the fixed-price purchases was $69.82 per MWh, based on transactions with three approved counterparties: Shell Energy North America (SENA), Powerex, and Sempra Energy. Figure 1 below illustrates the sources of electricity supplies by month for the next 36 months in terms of megawatt hours (MWh). The Mark to Market (MTM) value of the City’s forward transactions for wholesale power was negative $1.9 million at the end of the quarter. Figure 2 presents the forward volumes and MTM positions for each electric supplier by month of delivery. The reduced value of the contracts, as compared to last quarter, is a result of the recent decline in energy prices. CMR:439:08 Page 2 of 10 120,000 Figure 1. Load Resource Balance 100,000 80,000 60,000 40,000 20,000 Western ~ Calaveras ~ Wind Landfill ~ Purchases + Load Non-Carbon Emitting Electricity. The City estimates that it will utilize non-carbon emitting electricity sources, including hydro power, for approximately 62% of the total annual electric load over the next 12 months. The MTM value of the City’s forward positions for non-hydro renewable power is negative $1.1 million, based on a wholesale power forward curve. The reduced value is the result of the rapid decline in wholesale energy prices during the quarter. With regard to the hydro electric purchases, the MTM value of Western hydro is $6.3 million, while the MTM value of Calaveras hydro is negative $4.0 million. This negative number for Calaveras means that the costs are greater than the value of electricity for the next 12 months. Note that the Calaveras project provides other benefits to the City which have not ben included in the market value. Therefore, the total value of the Calaveras project is not fully reflected in the MTM value. CMR:439:08 Page 3 of 10 Figure 2. Electric Forward Volumes and Mark to Market Values 80,000 70,000 60,000 o,ooo 40,000 30,000 20,000 10,000 Electric Forward Volumes $1,500,000 $1,000,000 $500,000 $- $(500,0( $0 ,ooo,ooo) $0,5oo,ooo) $(2,000,000) $(2,500,000) Electric Mark to Market E]Shell [] Sempra [] Powerex Natural Gas. The City currently has purchased supplies of gas totaling 4.6 million MMBtu for delivery between October 1, 2008 and June 2011. The average price for all of the fixed-price purchases was $7.80 per MMBtu, down from $8.32 last quarter. The forward purchases have been transacted with four approved counterparties: Shell Energy, Sempra, Powerex and British Petroleum. The forward volumes and MTM values by month and by counterparty are presented in Figure 3. CMR:439:08 Page 4 of 10 Figure 3. Gas Forward Volumes and Mark to Market Values 400,000 Gas Forward Volumes 350,000 ~300,000 250,000 ’ 200,000 - - ~ 150,000 100,000 50,000 0 $100,000 Gas Forward Mark to Market $(100,000 $(200,000) $(300,000) $(400,000) ElShell [] Sempra [] Powerex ¯BP $(5oo,ooo) Figure 4 presents the Mark to Market history for both gas and electricity. It shows how the recent sharp decline in energy prices has altered the value of the City’s electricity and gas portfolios. CMR:439:08 Page 5 of 10 Figure 4. Mark to Market Value of Gas and Electric Portfolio History Mark to Market History 25 2O 15 5 Credit Risk To manage credit risk, staff reports on major credit rating agency’s (S&P and Moody’s) scores, and, in addition, the "expected default frequency" (EDF) using the Moody’s KMV CreditEdge© and RiskCalc© analytical tools. The EDF is an estimated probability that a counterparty will default in the next 12 months. The KMV tools allow staff to carry out "real-time" credit evaluations which include equity pricing and asset value changes that are not reflected in the static and annually-conducted credit rating agencies reports. Credit risk has been of particular focus in recent months due to the extreme volatility in the credit markets, and the potential impact on Palo Alto’s electricity and gas counterparties. It is important to note at the outset that the City has no exposure to any financially-based counterparty and that the City’s exposure in both the gas and electric positions has significantly reduced in the quarter. Under the City’s current Risk Management Policy, the City is not permitted to transact with any counterparty which has an S&P rating below BBB-. Some exceptions to this prohibition are made on a case-by-case basis, largely for suppliers of renewable energy. Figure 5 shows how the Moody’s KMV expected default frequency (EDF) ratings correspond to S&P credit categories. To be equivalent to a BBB- or better rating, any counterparty should have an EDF measure of 0.15% or lower. CMR:439:08 Page 6 of 10 Figure 5. Expected Default Rates Equivalent Median Bound Range and the Equivalent S&P Credit Equivalent Median Category Bound Range Credit EDF credit Credit EDF credit Category measure Lower Upper Category measure Lower Upper AAA 0.01%0.01%0.01%B6 0.25%0.2"1%0.33% AA+0.02%0.01%0.02%BB-0.45%0.33%0.6"1% AA 0.02%0.02%0.02%B+0.83%0.61%1.12% AA-0.03%0.02%0.03%B 1.52%1o12%2.32% A+0.04%0.03%0.05%B-3.55%2.32%5.42% A 0.05%0.05%0.06%CCC+8.28%5.42%12.66% A-0.06%0.06%0.07%CCC 19.35%12.66%19.99% BBB+0.07%0.07%0.08%CCC-20.66%19.99%22.07% BBB 0.09%0.08%0.10%CC 23.57%22.07%26.02% BBB-0.12%0.10%0.15% I C 28.72%26.02%35.00% BB+0.17%0.15%0.21%D 35.00%35.00%35.00% The volatility in the credit markets has significantly impacted the creditworthiness of some of the City’s counterparties, especially in regard to those counterparties which are primarily financial institutions, notably Sumitomo, JP Morgan Chase, and Royal Bank of Scotland (RBS). RBS provides credit support to the City’s trades with Sempra. Figure 6 p~esents analysis of the changes in default rates in Palo Alto’s publically traded counterparties in the last 90 days of trading as of September 30, 2008. It shows the expected default rates of the City’s financially-based counterparties. As can be seen in Figure 6, Sumitomo Corporation default rates have increased by 86 basis points, while those of Royal Bank of Scotland have increased by 6 basis points. The default rates of JP Morgan Chase, the last of the City’s financially-based counterparties, did not change during the period. While the changes in the credit quality are significant, the City has no current transactions with Sumitomo and no current exposure with Royal Bank of Scotland or JP Morgan Chase. Overall, the City’s credit exposure declined significantly during the quarter as a result of the decline in energy prices. CMR:439:08 Page 7 of 10 Figure 6.Changes in Expected Default Rates of Counterparties in the Last 90 Days Define Current: 9/30108 Define Previous: Three Mont Companies per page: 10 EDF Credit Category Company Name Currellt Previotls Amt. Change % Change Current Previous 1 SUMITOMO CORPORATION 1.37%0.51%+86 bp +168.63%Caal B2 r- ROYAL BANK OF SCOTLAND GROUP2 PLC (T 0.10%0.04%+6 bp +150.00%Baa2 A2 [- 3 JPMORGAN CHASE & CO 0.09%0.09%Baa2 Baa2 4 CONOCOPHILLIPS 0.09%0.05%+4 bp +80.00%Baa2 A2 [- 5 IBERDROLA S.A.0.06%0.03%+3 bp +100.00%A3 A1 r- 6 ROYAL DUTCH SHELL PLC 0.06%0.04%+2 bp +50.00%A3 A1 i’-- 7 BP PLC 0.04%0.02%+2 bp +’100.00%A1 Aa2 8 SEMPRA ENERGY 0.03%0.06%-3 bp -50.00%Aa3 A3 [- 9 SCOTTISH POWER PLC 0.01%0.02%-! bp -50.00%Aaa Aa’l CopyrigN ,:~2007, Moody’s KMV Company. All rights rese[ved. Moody’s KMV, CreditEdge, CreditEdge Plus, the Moody’s KMV logo, Expected Default Frequency, and EDF are trademarks of MIS Quality Managemeat Corp. Electricity. CPAU’s electric supplier counterparty credit exposure and the supplier credit ratings are presented below. CPAU’s largest exposure, in excess of $3,089,861 is with Shell Energy North America (SENA), a company rated A- by Standard and Poor’s. Shell is a wholly owned subsidiary of Royal Dutch Shell which is rated AAA, the highest rating given, although the credit support is provided directly by SENA. Table 1. Electricity Suppliers - Credit Exposure and Credit Ratings as of September 30, 2008 Counterparty Shell Powerex Sempra1 Total Total Credit Exposure S&P Ranking $ 3,089,861 $ -4,041,777 $ - 949,382 $ -1,901,299 Current Expected Default Frequency 1, Sempra credit supported by Royal Bank of Scotland AAA AA- 0.06 0.01 0.10 Expected "Loss" (Exposure x Expected Default Frequency) 1,854 $ 0 $ 0 $1,854 Renewable Electricity. Palo Alto’s contracts for renewable "green" energy include both wind contracts with Pacificorp Power Marketing (PPM) as well as contracts to convert landfill gas to electricity with Ameresco, Inc. The credit exposure and EDF ratings for these counterparties are presented below. CMR:439:08 Page 8 of 10 Table 2. 12 Month Renewable Energy Credit Exposure and Credit Ratings as of September 30, 2008 Counterparty Ameresco, Inc. Pacificorp Power Marketing~ Total Total Credit Exposure $ 77,884 $ -1,035,210 $1,113,094 Current Calculated Expected Default Frequency 0.25 0.01 I. Pacificorp Power Marketing credit is supported by Scottish Power, PLC. Expected "Loss" (Exposure x Expected Default Frequency) $ o $0 $0 As Table 2 shows, the City does have contracts for renewable power with a counterparty whose EDF score is significantly higher than the 0.15% BBB- equivalent. This counterparty is Ameresco, a renewable power developer with whom the City has three existing and one pending long term power contracts. The City currently receives approximately 51,000 MWh of electricity from these projects annually. Ameresco is not publically traded and is not rated by any of the major credit rating agencies; the EDF score listed in Table 2 is based on staff’s analysis of Ameresco’s confidential financial reporting. While Ameresco’s EDF score is below the BBB- equivalent, the City currently has no exposure to Ameresco. In addition, the City has additional protections in these contracts which would allow the City to continue receiving the renewable power in the event of an Ameresco default. Natural Gas. As Table 3 shows, the City has no credit exposure to any of the five counterparties. Table 3 below calculates the loss which the City would suffer should one of its gas counterparties default. This loss is calculated as the product of expected default frequency and the MTM value. Because the current portfolio is valued less than the contract price, the City has no potential loss at present. Table 3, Credit Exposure and Default Ratings of Natural Gas Suppliers (September 30, 2008) Counter party BP Shell Powerex Sempra1 Total Total Credit Exposure $ -533,218 $ -1,338,994 $ -224,352 $ -474,255 $-2,570,819 S&P Ranking Current Expected Default Frequency Expected Loss (Exposure x Expected Default Frequency) AA+.04 .06 .01 .10 $0 $o $o $o 1. Sernpra credit support from Royal Bank of Scotland CMR:439:08 Page 9 of 10 Exceptions /No exceptions were noted during the Quarter. _,~t DEPAP~TMENT HEAD APPROVAL:~~ Director, Administrative Services CITY MANAGER APPROVAL: Appendix A. Electric Portfolio Summary Appendix B. Gas Portfolio Summary CMR:439:08 Page !0 of 10 c 0 t: 0O_ O 00000000000 00000000000 00000000000 00000000000 0 0 0 0 E O000001NO~000000~0~O00000NO~ 000000~0~00000~00~ 0 0000000000 ~ 0000000000~.-qqqqqqqqqq 0000000000 ~di4ddddd~d 000000~0~000000~0~:O00000NO~J dd4~dd~d~ ,g 00:00000000 0000000000 00000~0000