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HomeMy WebLinkAboutStaff Report 215-06N a ager s TO:HONORABLE CITY COUNCIL FROM:CITY MANAGER DEPARTMENT: ADMINISTRATIVE ¯ SERVICES DATE:MAY 8, 2006 CMR:215:06 SUBJECT:CITY OF PALO ALTO’S ENERGY RISK MANAGEMENT REPORT FOR THE THIRD QUARTER, FISCAL YEAR 2005-2006 This is an information report and no Council action is required. OVERVIEW Staff has continued to purchase electricity and gas in full accordance with the City’s Energy Risk Management Policies and Procedures. There have been no exceptions to report. Continued decreases in prices for both electricity and gas have reduced the exposure of the City’s positions. The current Mark to Market (MTM) value of the City’s fixed price purchases is $15.6 million for electricity, down from $26.3 million at the end of last quarter; and $7.9 million for gas, down from $16.9 million at the end of last quarter. The current Mark to Market value of the City’s wind power contracts for the next 12 months has decreased from $0.1 million to negative $1.2 million. The value of the hydro contracts with Western and NCPA has decreased in value from $50 million to $33.8 million. The electricity Value at Risk (VaR) measure is 0.9% and remains well below maximum limits. The VaR of the gas portfolio remains above the 10% benchmark, though the value did decline from 16% to 11% during the quarter. Corresponding to the changes in portfolio market value, the total credit exposure of the City has decreased overall from $43.2 million to $23.5 million. Gas and electricity supply reserves .are adequate for the current risk profile, although the gas reserves are below those set by current policy. 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 second quarter of Fiscal Year 2005-06. 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. Table 1 and Table 2 below summarize the current position and exposure of the City with the electricity and gas commodity portfolios. Table 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). Table 2 summarizes the gas portfolio in terms of transaction volume, market value, mark to market value and limits. CMR:215:06 Page 1 of 17 DISCUSSION Open Transactions as of March 31, 2006 Open transactions are commitments that the City has made to purchase either electricity or gas, but for which supplies have not yet been delivered. The analysis presented here is restricted to forward fixed price purchases with corporate counterparties, and, except where specifically stated, does not include purchases from Western Area Power Administration (Western) or the Calaveras Project operated by NCPA. Additionally, the electricity analysis separates standard bulk power purchases from tong-term wind contracts which the City has recently implemented. Electrici_ty. As of March 31, 2006 the electric portfolio consisted of 56 open transactions (transactions for which commitments have been made but electricity remains to be delivered) througsh December 2009. Fig~Lre 1 illustrates the sources of electricity supplies by month for the next 36 months. The City currently has purchased supplies of electricity totaling 0.66 million MWh for delivery between April 1, 2006 and April 30, 2009. The average price for all of the fixed-price purchases was $46.94 per MWh, significantly down from $48.22 last quarter. The forward purchases have been transacted with four approved counterparties: Coral Energy, Duke Energy, Sempra Energy and British Petroleum. Note that in Figure 1, the Seattle City Light (SCL) volumes represent a "swap" whereby Pa!o Alto supplies power to Seattle City Lig~ht in the winter months and Seattle provides power to Pa!o Alto during the summer months. Figure 1. Load Supply Balance for Electrici~ 140 000 ~. 120 000 ~100 000 80 000 ~ 60 ,,5 40 20 000 000 000 (20,000 (40,000) ! Western ~ SCL Wind Gen I~ Spot Market r--q Calaveras I Landfill Gas Gen ~ Forward Market Purchases -~- Total Load The distribution of purchases by month and by counterparty is presented in Figure 2. CMR:215:06 Page 4 of !7 Figure 2. 70,000 ~,60,000 5o,ooo .... 4o,ooo 30,000 20,000 10,000 Forward Electric Purchases by Volume [] Sempra ~ [] Coral Power/~ 1-- The mark to market (MTM) value represents the difference in price between the current market value of the contracted supply and the original contracted price. A positive MTM value indicates an increase in the value of the purchase, which would be realized only if the transaction was liquidated. While a positive MTM value represents an increase in value to the City, it also represents the City’s credit exposure with the supplier. In other words, should a counterparty default on delivery of supply, the City would need to purchase replacement energy on the open market when prices could be higcher. A negative MTM represents the supplier’s credit exposure with the City. The MTM value is based on the current forward prices, that is, the prices at the end of the quarter for deliveries in the future. Prices during the quarter continued in the downward trend noted last quarter following the sharp increases immediately after Hurricane Katrina. As shown in figure 3, prices during the quarter for deliveries in Calendar Year (CY) 2007 declined by 10%, while those of 2008, 2009, and 2010 decreased marginally (less than 5%). CMR:215:06 Page 5 of 17 Figure 3. 100.00 ~90.00 80.00 70.00 Electricity Forward Prices at NP15 --*-- Cai ’07 ~ Cal ’08 Cal ’09 60.00 Date of Price Note: NP15 refers to North Path 15 which serves as the key delivery and market point for Northern California. As such it represents an aggregated price for the region. Because of this price decline, the total MTM value of the City’s forward transactions dropped during the quarter from $26.3 million to $15.6 million. Figure 4 presents the MTM positions for each supplier by month. $1,300 $1,1oo $900 $700 $500 $300 $100 $(100) $(300) $(500) Figure 4.Forward MTM by Month CMR:215:06 Page 6 of 17 Hydro Power. Based on forecasts provided by Western and the Calaveras Project and forward market projections, staff has calculated values for CPAU’s hydro contracts, it should be noted that for both Western and Calaveras, values are based on the expected volumes of delivery for the next 12 months. These values will change as actual volumes will differ from those predicted at this moment in time. At present, the 12-month value for Western through March 31, 2006 is $24.6 million, down from $33.3 million last quarter. For Calaveras, the 12-month value is $9.2 million, significantly down from the previous quarter results of $16.8 million. Seasonal Exchange Contracts. The sole seasonal exchange transaction in which Palo Alto is engaged involves Seattle City Light. Under this contract, which was signed in 1992, Palo Alto receives 9 MW from November through March, and sends 10 MW from June through October. The 12-month MTM value of this contract is $514,694. Wind Power. The City has entered into a 23.5-year contract with Pacificorp Power Marketing (PPM) for supplies of wind energy. Wind power has different characteristics from a normal power purchase because it is not volumetrically firm. The amount Palo Alto receives directly relates to how strongly the wind blows. Based on historic meteorological conditions, Palo Alto expects to receive approximately 58,000 Megawatt hours per year. Based on this data the current MTM of the wind power contracts is a negative $1.2 million. CMR:215:06 Page 7 of 17 Natural Gas. As of December 31, 2005 the gas portfolio consisted of 167 open transactions (transactions for which commitments have been made but gas remains to be delivered) through December 2008. The City currently has purchased supplies of gas totaling 4.83 million MMBtu for delivery between April 1, 2006 and February 28, 2009. The average price for all of the fixed- price purchases was $6.78 per MMBtu, up from $6.26 last quarter. The forward purchases have been transacted with five approved counterparties: Coral Energy, Duke Energy, Sempra Energy, ConocoPhillips and British Petroleum. This data is presented in Figure 5. 350,000 300,000 250,000 200,000 150,000 100,000 50,000 Figure 5.Forward Gas Purchase Volurnes [] Sempra El Duke [] Coral Energy NBP Month Forward prices for gas decreased by 10% over the quarter for delivery in Calendar Year 2007 (CY 06), and decreased slightly for delivery in Calendar Year 2008 (Figare 6). The current MTM value of these transactions is $16.9 million, a decrease of 44% from last quarter. The MTM value by month and by counterparty is presented in Figure 7. CMR:215:06 Page 8 of 17 Figure 6. Forward Calendar Year Gas Prices 10.00 =9.50 ~9.00 ~8.50 "-8.00 7.50 Figure 7. Gas Mark to Market by Month $1,ooo $800 $600 $400 $200 $- [] Sempra [] Duke [] Coral Energy NBP Month CMR:215:06 Page 9 of 17 Figure 8 below presents the pool purchases made for each month over the next three years compared to estimated pool load. It illustrates the gas laddering purchasing strategy in relation to the total estimated load, showing the amount of volumes purchased (hedged volumes), the volume to be used by market rate customers, and the amount of the pool to be purchased on the short-term market (pool exposed to market). Under the laddering strategy, CPAU purchases up to 100% of forecasted load for the upcoming 18 months, up to 75% of load for 19 to 27 months out, and up to 50% of load for 28 to 36 months out. As a result, the amount of pool exposure to the market is low in the near term, but increases further out in the future. 500,000 450,000 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 (50,00( Figure 8. Market Exposure [] Pool Exposed to Market N Market-Rate Customers [] Hedged Vo umes (MR:215:06 Page 10 of 17 Value at Risk The °°riskiness" of the energy portfolio is measured through the °’value at risk" (or VaR). The VaR measures the risk that adverse market conditions could force CPAU to use reserves to cover costs on future purchases over what is reflected in current rates. Specifically, VaR measures how much projected !2-month net revenue could change in one week due to a potential market change. Staff use the VaR as one of the key measures of risk to CPAU. In compliance with the Risk Management Guidelines, the Utilities staff and the Energy Risk Manager monitor the VaR level relative to the projected end of year supply Rate Stabilization Reserve (RSR) levels for both electricity and gas. Currently, the VaR for the electricity portfolio is 0.08% of the RSR, a reduction from 0.13% last quarter. The VaR for gas remained above the 10% benchmark value, although it declined to 11%, down from 16.0% at the end of last quarter. The historic levels of the VaR values for electricity and gas are presented in Figure 9. Figure 9. History of Gas and l~ectri¢ Value at Risk 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -~- Gas VaR I+ Electric VaR Date The 10% VaR limit set by the Risk Manager in conjunction with the Risk Oversight Committee represents a benchmark to monitor the potential risk to which the City is exposed as a result of possible variability in the cost of supplies not yet purchased. In some instances, exceeding the 10% benchmark would indicate the need for the City to purchase additional forward supplies. The risk represented by the VaR number is solely the result of the increases in energy prices during last fall and winter as opposed to the City holding large unhedged positions. At this time, when prices are in decline from near historic highs and when over 90% of the City’s expected gas load has been purchased, staff does not recommend additional purchases in order to reduce VaR levels. Rather, staff will continue to monitor VaR levels and make recommendations to limit risk exposure when appropriate. CMR:215:06 Page 11 of 17 Credit Risk As part of enhancing the City’s credit oversight policies and procedures, staff now regularly reports on major credit rating agency’s (S&P and Moody’s) scores, and, in addition, the "estimated default frequency" (EDF) using the Moody’s KMV CreditEdge© system. The EDF is an estimated probability that a counterparty will default in the next 12 months. For example, a 0.2 EDF indicates a chance of 2 in 1000 that the firm will be in default in the time period. Thus a higher EDF represents a higher credit risk for the City. While the current risk management practices do not set a specific EDF upper limit, any counterparty with a value over 0.50 warrants careful and regular monitoring of its financial condition and outlook. Electricity. CPAU’s electric supplier counterparty credit exposure and the supplier credit ratings are presented below. CPAU’s largest exposure, in excess of $14.2 million, is with Coral, a company rated A- by Standard and Poor’s. Coral is a wholly owed subsidiary of Royal Dutch Shell which is rated AAA, the highest rating given. Table 1. Electricity Suppliers - Credit Exposure and Credit Ratings as of March 31, 2006. Counter party BP Corat1 Duke Sempra Total 1 Coral i Credit Exposure $817,941 $14,183,480 $0 $592,390 $15,593,812 S&P Ranking A- BBB BBB+ wholly owned by Shell PLC Previous Quarter Expected Default Frequency .O2 .053 .08 .!1 Current Expected Default Frequency .O2 .O5 .O5 .O8 Expected ~Loss"2 $ 163 $1,418 $0 $474 $2.055 2 Expected loss represents theproduct of the default rate in the next 12 months and credit exposure. As such it provides an estimate of the 12-month average risk being carried by CPAU as a result of its forward contracts. Default frequencies are independently calculated, and cross-default probabilities (that chance the one firm ’s default will increase the chances of another firm defaulting) are not included. 3 This estimate is based on the credit ratings, and not the KMV model results. The City’s current exposure to Coral is a reflection of a 5 year contract for electricity supplies at a cost of $37 per MWh. The current appreciation in prices due to weather factors renders this contract very valuable, and therefore a credit risk. However, this risk has moderated significantly with the recent reduction in forward prices as well as on-going deliveries; the previous u ’q arter s credit exposure with Coral was $21.3 million as compared to $14.1 million this quarter. CMR:215:06 Page 12 of 17 Renewable Electricity. Palo Alto’s contracts for renewable "geen" energy include both wind contracts with Pacificorp Power Marketing (PPM), discussed above, as well as contracts to convert landfill gas to electricity with Ameresco, Inc. Neither PPM (owned by Scottish Power) nor Ameresco are publicly traded and therefore KMV Credit Edge does not include them in its default reporting. The Risk Manager has used financial information provided confidentially by each of the two counterparties to estimate an Expected Default Frequency, which is statistically comparable to the EDFs reported for the other counterparties. The Credit Exposure and EDF ratings for these counterparties are presented below. Table 2. Green Energy Credit Exposure and Credit Ratings as of March 31, 2006. Counterparty Ameresco, Inc. Pacificorp Power Marketing Credit Exposure $0 $0 Previous Quarter Calculated Expected Default Frequency N/A 0.58 Current Calculated Expected Default Frequency 0.85 0.58 Note: Since the current MTM of this contract is negative, the City has no credit Rather PPM has a credit exposure to the City. Expected "Loss" $0 $o exposure. Natural Gas. As the Table 3 shows, the City has exposure to five counterparties totaling $16.9 million over the next 36 months, a decrease of over 45% since the last quarter and a decline of over 50% in the last six months. As with electricity, this large jump in market exposure is the result of the rapid rise in the forward energy prices. The highest exposure with a single supplier is $4.6 million with Sempra, a BBB+ company, with the second highest exposure being with A- rated Coral at $1.5 m_illion. The remainder of the exposure is distributed between two other counterparties. The 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 Estimated Default Frequency and the MTM value. CMR:215:06 Page 13 of 17 Table 3. Credit Exposure and Default Ratings of Natural Gas Suppliers (March 31, 2006) Counter party BP ConocoPhillips CoralI Duke Sempra Total Credit Exposure $703,556 $ 0 1,519,756 S&P Ranking AA+ Previous Expected Default Frequency .02 .02 Current Expected Default Frequency .02 .02 Expected Loss2 $140 $760 $5071,015,313 BBB ¯ 053 .08 .053 .05 $3,737 $5,144 $4,670,658 $7,909,283 BBB+.11 .08 1 Coral is wholly owned by Shell PLC 2 Expected loss represents theproduct of the default rate in the next 12 months and credit exposure. Itprovides an estimate of the 12-month average risk being carried by CPA U as a result of its froward contracts. Default frequencies are independently calculated, and cross-default probabilities(that change the one firm ’s default will increase the chances of another firm defaulting) are not included. 3 This estimate is basedfinancial analysis of confidential data, and not the KMV model results. Credit Oualitv of Suppliers. Overal!, the City’s suppliers have continued to improve their credit quality. Figure 10 shows how the expected default frequency of CPAU’s current suppliers has declined (i.e., improved credit) over the past three years. As mentioned previously, Pacificorp Power Marketers is privately held and therefore an EDF is not issued by Moody’s KMV. The firm’s sole owner, Scottish Power, is used as a surrogate EDF. Similarly, Coral is the wholly owned subsidiary of Shell. The Coral EDF is calculated manually on a quarterly basis based on confidential financial information provided by the company. The estimate is also adjusted after consultation with credit analysts at Standard and Poors and Moody’s Investor Services. The staff-calculated EDF point estimates for Pacificorp Power Marketers, Coral and Ameresco are included on the Figure 10. Council should be aware of changes in the guarantor for the Pacificorp Power Marketer’s wind power purchase. While the guarantor is currently Pacificorp Holdings Inc. (PHI), purchases of portions of PHI by Mid-American are necessitating changes in the guarantor. The new guarantor will be Scottish Power Financial (SPFUS) an A- rated company. Staff is currently in the process CMR:215:06 Page 14 of 17 of negotiating a new guarantee with SPFUS but this was not consummated by the end of the quarter. Figure 10. Expected Default Frequencies for CPAU Counterparties over last 6 months 0.90 ~0.-l-Jan-06 o 15-Feb.06 Time Plot: Values Perio~t: Last 90 Trading Days From: December 2, 2005 Currency:. U.S. DOLLAR[USD] Io: April 6, 2006 Description --DUKE ENERGY CORP [DU[q EDF --SEMPRA ENERGY [SRE] EDF SOOTTISH POWER PLO [£PV~] EDF --CONOCOPHILLIPS [COP] EDF ~BP PLO [BPfJ EDF --OPAU PORTFOLIO [..MYPORTJ EDF- Median Value As Of 0.05 05-Apr-06 0.08 05-Apt-06 0.06 06-Apr-06 0.02 05-Apt:06 0.02 06-Apt-06 0.04 06-Apt-06 Note: The Pacificorp, Coral and Ameresco EDF values shown above are point estimates calculated by staff from confidential financial information. As such, tracking is done on a "point in time" basis and is not continuous. CMR:215:06 Page 15 of 17 Rese~ A key premise to the City’s risk management practices centers on the adequacy of supply reserves with respect to the risks undertaken as a result of purchases of gas and electricity commodities. Table 4 below summarizes the current and project supply reserve levels for gas and electricity as of March 31, 2006. The methodologies for calculating minimum and maximum reserve levels were approved by Council in 2003 (CMR 483:03). The current formula for calculating maximum reserve balances are 103% and 75% of purchase costs for electric and gas respectively. The minimum reserve levels are 50% of the maximum levels for both gas and electricity. Table 4. Supply Reserve Levels for Electricity and Gas ($ Millions) Beginning Reserve Balance as of 6/30/05 FY 04/05 Budgeted Reserve Guideline Range for FY 05/06 Current Projected Reserve Balance as of 03/31/06 FY (05-06)* Budgeted Reserve Guideline Range for FY 06/07 Min t Max Electricity___ $ 44.2 $27.4 $54.8 $ 44.1Gas$ 3.8 $ 7.6 $15.2 $ 4.5* Projected reserve balances subject to change as a result of changes events, and budget alterations. Min Max $27.1 $ 54.3 $ 7.8 $15.6 Projected Reserve Balance (based on Budget as of 03/31/06) for FY 06-07* 30.5 3.2 in prices, meteorological The current reserves for electricity are well above the minimum and well above credit, regulatory and other risks for the 12 months moving forward. Total risks associated with the electric supply reserve for the next 12 months is $20.6 million, and includes $7.0 million for credit reserves (using best practice of 50% of largest single exposure), $11.9 million for hydro risk, $234,000 for market risk of the short positions in the next 12 months, and $1.5 million for possible regulatory and other risks. With regard to gas, the current reserve levels of $4.5 million are below the minimum level of $7.8 million as set by current policy. Despite this, current reserve levels are viewed as adequate. Total risks associated with the gas supply reserve include $2.3 million for credit reserves, $0.6 million for unhedged commodities in the next 12 months, and $0.5 million for possible regulatory and other risks. This total of $3.4 million is below the current reserve levels. It should be noted that changing market dynamics, international politics and other factors fully outside the City’s control can have a significant and adverse impact on the adequacy of reserves for both gas and electricity over a short timeframe. As a result, formal reserve adequacy assessments will be a regular component of the risk management quarterly reports from this time forward. CMR:215:06 Page 16 of 17 PREPARED BY: DEPARTMENT HEAD APPROVAL: CITY MANAGER APPROVAL: KARL VAN ORSDQ~ Energy~,P~sk i~¢f~n~ ~// C"ARL YEATS/" Director, Adm~nis ative Services EM HARRISON Assistant City Manager ATTACHMENTS A) Consolidated Mark to Market Report of Al! Open Gas Transactions as of March 31, 2006 B) Consolidated Mark to Market Report of All Open Electric Transactions as of March 31, 2006 CMR:215:06 Page 17 of 17 o ~ ~ e ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ xe x x x x x xxx x x x xe xeXX X X X XX X X X X X X X XL~. ...............................XXXXX x xl x x x x ~ x ~L ~ x x x x x x x x x x O0 o o o ~ ~ o o o oi~io o ~i°~° § o o o~o o o oo,o o o o o oooooooo~oooo oooo,oo ~oo~ ooo ~ o 0 ..~ o o ooooo ooo o~ooooo oooo Nioooooo~ x x x x x x x x × x!x ~x~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~xxxxxxxxxx xxxxx ww w w w w w wl ~ w w "~ ~0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 ~,~o~oo~ooooooo~oo,.oooo,oooooloooo~,~,~ 0 0 O 0 ZZ~ZZZ ZZZZ