HomeMy WebLinkAboutStaff Report 2106
City of Palo Alto (ID # 2106)
City Council Staff Report
Report Type: Action Items Meeting Date: 11/1/2011
City of Palo Alto Page 1
Summary Title: Gas Purchasing Strategy
Title: Finance Committee Recommendation to Change the Gas Purchasing
Strategy to Implement Market-Based, Monthly-Adjusted Gas Supply Rates
From: City Manager
Lead Department: Utilities
Recommendation
Staff and the Finance Committee recommend the City Council direct staff to develop market
price-based, monthly-adjusted gas supply rates.
As an alternative, the Utilities Advisory Commission (UAC) recommends that the City Council
adopt a rate objective of annually-adjusted gas supply rates limited to a maximum rate change
of 20% per year.
Executive Summary
Palo Alto’s gas retail rates consist of a gas supply component and a gas distribution component.
Revenue from the gas supply portion of the retail rate is currently about 55% of the total
revenue from gas customers.
For 10 years a portion of Palo Alto’s residential and small commercial customer gas supply
needs have been met through purchases of gas at fixed and capped prices. While this
“laddering” strategy was successful in achieving relatively stable gas supply costs, the downside
is that, during times of declining market prices, Palo Alto’s costs and resulting rates are higher
than Pacific Gas and Electric’s (PG&E’s) gas supply rates, which change on a monthly basis
mirroring the fluctuating market price of gas. Staff now proposes to change to a monthly
market price-based gas supply rate. Gas distribution rates will continue to remain stable
month-to-month and will change as needed (typically, no more than annually) as in the past.
The change may reduce the need for financial reserves, eliminates the current gas purchasing
strategy, and saves on staff time.
Committee Review and Recommendations
On July 20, 2011, staff recommended the UAC recommend changing from “stable” gas rates to
market price-based, monthly-adjusted gas supply rates for Palo Alto’s residential and small
City of Palo Alto Page 2
commercial customers. The UAC, instead, unanimously recommends an annual, not monthly,
gas supply rate change with a goal that the supply component of gas retail rates change by no
more than 20% annually. The distribution component of the gas retail rates would continue to
change as before.
Staff presented both recommendations to the Finance Committee at its September 20, 2011
meeting (Attachment A, Staff Report #1992). A representative from the UAC was present at the
meeting and stated that it was the sense of both staff and the UAC that the current three-year
laddering purchasing strategy should be shortened or eliminated, but that the UAC stopped
short of supporting having rates change on a monthly basis.
Finance Committee members asked if there were programs to assist low- and fixed-income
customers if rates spiked upwards significantly. Staff replied that programs exist to help low-
income customers. Council Member Scharff stated that he believed buying gas on a forward
basis as in the laddering strategy inherently costs some premium and that overall costs would
be lower with no forward purchases. Vice Mayor Yeh noted that the amount of money held in
rate stabilization reserves could be reduced if the costs were passed through to customers on a
monthly basis. He asked if there would be any impact on the City’s bond rating if reserve levels
were lowered. Staff replied that if the recommendation was approved by Council, staff would
return to the UAC, Finance Committee and Council with changes to policies, reserve guidelines
and rate schedules to implement the recommendation. The evaluation of the reserve
requirements will include an assessment of the impact on the City’s bond rating.
The Finance Committee agreed with staff’s recommendation and voted unanimously to
recommend that the Council direct staff to develop market price-based, monthly-adjusted gas
supply rates. Minutes of the September 20, 2011 meeting are provided as Attachment B.
Resource Impact
In the short term, staff resources will be required for implementation of the new gas
commodity purchasing and rate strategy. Long-term, approximately 0.4 FTE are expected to be
redeployed from gas portfolio management activities to other projects.
Policy Implications
The proposed gas commodity rate objective is a change to past practice and changes to several
policy documents such as the Gas Utility Long-term Plan and the rate stabilization reserve
guidelines will be required. If Council supports staff’s and the Finance Committee’s
recommendation, staff will return to Council for consideration of changes to those policies and
to the gas rate schedules.
Environmental Review
Approval of the gas purchasing strategy and implementation of market price-based, monthly-
adjusted gas supply rates does not meet the definition of a project pursuant to Public
Resources Code Section 21065, thus no California Environmental Quality Act review is required.
City of Palo Alto Page 3
Attachments:
Attachment A: Finance Committee Staff Report #1992: Proposed Change to the Gas
Purchasing Strategy to Implement a Market-based, Monthly-adjusted Gas Supply Rate
(PDF)
Attachment B: Excerpt Draft Finance Committee Minutes of 9-20-11 (PDF)
City of Palo Alto (ID # 1992)
Finance Committee Staff Report
Report Type:Meeting Date: 9/20/2011
September 20, 2011 Page 1 of 10
(ID # 1992)
Summary Title: Gas Purchasing Strategy
Title: Proposed Change to the Gas Purchasing Strategy to Implement a Market-
based, Monthly-adjusted Gas Supply Rate
From:City Manager
Lead Department: Utilities
Recommendation
Staff recommends that the Finance Committee recommend the City Council direct staff to
develop market price-based, monthly-adjusted gas supply rates.
The Utilities Advisory Commission (UAC) did not support staff’s recommendation and, instead,
recommends that the City Council adopt a rate objective of annually-adjusted gas supply rates
limited to a maximum rate change of 20% per year.
Executive Summary
For 10 years, a portion of Palo Alto’s residential and small commercial customer gas needs have
been met through purchases at fixed and capped prices. While this strategy was successful in
achieving relatively stable gas supply costs, the downside is that, during times of declining
market prices, Palo Alto’s costs and resulting rates are higher than Pacific Gas and Electric’s
(PG&E’s) gas supply rates, which change on a monthly basis mirroring the fluctuating market
price of gas. Staff now proposes to change to a monthly market-based gas supply rate. Gas
distribution rates will continue to remain stable month-to-month and will change only as
needed (at most annually) as in the past. The change will reduce the need for financial reserves,
eliminate the current gas purchasing strategy, and save on staff time.
Staff asked the UAC to recommend to Council market-based, monthly-adjusted gas supply rates
for Palo Alto. The UAC, instead, recommends an annual, not monthly, gas supply rate change
with a goal that supply rates would change by no more than 20% annually.
Background
History of Palo Alto Gas Supply Rate Stabilization
Prior to the 2001 energy crisis, the City of Palo Alto Utilities (CPAU) engaged in very little, and
only short-term, gas commodity hedging. Hedging is a risk management strategy used to
achieve a level of cost stability despite fluctuations in commodity prices. The energy crisis sent
market prices soaring, and CPAU’s largely unhedged gas portfolio experienced soaring gas
September 20, 2011 Page 2 of 10
(ID # 1992)
supply costs that drained $9 million from the Gas Supply Rate Stabilization Reserve (G-SRSR) and
required four retail rate increases in fiscal year (FY) 2001 (15%, 25%, 35% and 67%).
In direct response to the financial pain caused by gas rate increases experienced during and
after the energy crisis, staff developed a hedging strategy known as the gas laddering strategy in
April 2001 whereby a portion of CPAU’s gas needs would be purchased at fixed-and capped-
prices over a 36-month time horizon. The goal of this purchasing strategy was to smooth or
stabilize gas supply costs relative to the extremely volatile spot market. The laddering strategy
was revisited with the UAC and with the City Council in 2004 and again in 2008. The gas
laddering strategy has been used to manage the volatility of gas costs for the “pool”, residential
and small commercial customers. CPAU’s eight largest customers manage their own gas supply
costs by electing either a monthly spot-market-based supply rate, a fixed rate for 12 or 24
months, or a custom rate. All of these large customers are currently on the spot-market-based
supply rate, which changes on a monthly basis.
In late 2007, market prices again spiked, more than doubling in eight months. In the summer of
2008 the credit crisis combined with increased gas supply from new shale developments sent
market prices plummeting. As anticipated in a falling market, CPAU’s average gas supply cost
remained stable and was higher than wholesale market prices, and CPAU’s supply rates did not
fall as fast as PG&E’s comparable rates because some fixed-price gas was purchased prior to the
market price decline.
As part of the development of the Utilities Strategic Plan, staff conducted interviews with 26
influential community members. The interviews took place in August and September 2010, and
interviewees included current and former UAC and Council members. Staff asked interviewees
about the value of stable versus competitive gas rates, and all of those asked were either
indifferent to, or supportive of, gas rate stability.
Recent UAC/Finance/Council Review and Actions
In September 2009 staff presented to the UAC a gas purchasing strategy review emphasizing the
relationship between the stable rate objective, the gas commodity purchasing strategy, and the
reserve guidelines. This was followed by a discussion in June 2010 during the development of
the Gas Utility Long-term Plan (GULP).Staff presented information comparing variable market-
based versus stable rate objectives. The UAC asked whether market-based rates would have a
positive influence on encouraging energy efficiency (EE). The UAC also asked about evidence
indicating customers’ attitudes toward rate stability.
In July 2010 staff returned to the UAC with draft GULP Objectives and Strategies and additional
information regarding stable rates. Staff reported finding no statistical support for fluctuating
market rates impacting EE. Also cited was the most recent customer satisfaction survey which
did not reveal an issue with gas rates although the stable versus competitive rate question was
not asked directly of customers in that survey. Staff presented additional analysis of a laddered
purchasing strategy versus buying gas on the spot market, showing the trade-offs between the
September 20, 2011 Page 3 of 10
(ID # 1992)
two purchasing strategies, and promised a review of the gas rate objective as part of the Utilities
Strategic Plan.
In October 2010 the UAC recommended the proposed GULP Objectives, Strategies, and
Implementation Plan for Council approval, and in November 2010 staff sought Finance
Committee approval of the same (CMR:400:10). The Finance Committee requested more
explicit language regarding review of laddering strategy, and in December 2010 staff returned to
the Finance Committee (CMR:432:10) with an additional explicit GULP implementation step to
review the laddering strategy with the UAC. In March 2011, Council approved GULP (Staff
Report 1313) including the initiative to review the gas laddering strategy.
The Council-approved portfolio management-related GULP objective and implementation plan
initiatives are:
Objective #1: Balancing Stability and Competitiveness
GULP Strategy #1: Balance supply cost stability with market exposure by:
a.Diversifying energy purchases for the pool across commitment date, delivery date,
duration, suppliers, pricing terms and delivery points;
b.Leaving some fraction of the forecasted gas pool needs exposed to near-term market
prices; and
c.Avoiding long-term (>10 years) fixed-price commodity contracts.
Implementation Plan Tasks:
1.Continue to implement a laddered commodity purchasing strategy for the pool.
2.Review the laddering strategy and rate stability with the UAC and recommend changes,
if appropriate.
Meanwhile, staff presented the Utilities Strategic Plan to the UAC in January 2011. The retail
gas rate objective was questioned by the UAC since the gas laddering strategy review under
GULP had not yet occurred. Staff returned to the UAC in February with an initiative to “reassess
the gas portfolio laddering purchasing strategy” in lieu of specifying a retail gas rate objective.
At that meeting, the UAC recommended Council approve the Strategic Plan. The Utilities
Strategic Plan was approved by Council on July 25, 2011.
The Utilities Strategic Plan contains the following strategic initiative related to the gas laddering
strategy:
Reassess the gas laddering purchasing strategy and develop a rate change
performance measure for gas service.
Discussion
Gas Commodity Market Prices and Volatility
Energy market prices are inherently unpredictable and volatile. Prices move to balance supply
and demand. Market prices reflect market participants’ short-and long-term views. Many
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fundamental changes can drive natural gas prices higher including, but not limited to, factors
such as global economic recovery, a dramatic switch from coal-fired and/or nuclear to gas-fired
electric generation driven by Federal greenhouse gas (GHG) regulation, a determination that
shale gas produced from hydraulic fracturing is environmentally troublesome, significant
development of liquefied natural gas export capacity, and a shift in drilling from low-priced gas
to high-priced oil. Conversely, a sluggish global economy, stagnated Federal GHG regulation, or
continued aggressive shale drilling may result in weaker natural gas market prices.
Completely unpredictable events can drastically change the market outlook in a very short
period of time. Extreme temperatures can have a short-term impact on prices. Events like
hurricanes can have a short-or long-term impact on prices depending on the disruption of
natural gas production and/or the destruction of demand such as the shut down of refineries or
other large industrial gas users. Other events, like the rapid increase in supply from shale
production and overall economic activity, can have a long-term impact on market prices.
Gas Supply Rate Objective
The pertinent question that needs to be answered is not whether market prices will go up or
down. The pertinent question is, “What is CPAU’s gas supply rate objective?”Staff
recommends a market-based gas supply rate objective. To meet that objective, implementation
will include new purchasing strategies, financial reserve management guidelines and supply
rate-setting methodologies. Specifically, the change calls for the following to occur:
1.The commodity purchasing strategy will be to purchase all pool gas needs in the monthly
and daily spot markets instead of buying gas in the forward market;
2.Implementation of monthly-adjusted gas supply rates for the pool; and
3.Revision of the G-SRSR guidelines.
There are several reasons for staff’s recommended policy and strategy change:
1.CPAU’s gas costs, over the long-run, will be approximately equal to the market cost
regardless of the hedging strategy;
2.CPAU’s gas supply rates will closely compare to PG&E’s floating gas supply rates;
3.Gas bills vary dramatically seasonally due to gas usage much more than they vary due to
the gas supply rate;
4.Market-based gas rates are more likely to complement the state of the overall economy;
5.The need for financial reserves will be reduced;
6.Staff time can be saved by eliminating the laddering strategy.
Because Palo Alto does not own any natural gas reserves or production, all of CPAU’s gas needs
must be met though purchases on the open market. While it is possible to smooth out the
peaks and valleys of the volatile spot market using a hedging strategy, and it is possible to use
reserves to keep rates more stable, the average portfolio cost over the long-run will be
approximately equal to the market price. From July 2001 through June 2011, the monthly
market price for gas ranged from $1.80 to $12.57 per million British Thermal Units (MMBtu,
which is equal to 10 therms) with an average price of $5.65 per MMBtu. Over that same period,
September 20, 2011 Page 5 of 10
(ID # 1992)
CPAU’s monthly gas cost ranged from $3.52 to $10.45 per MMBtu with an average cost of $6.32
per MMBtu. While the range of costs was narrowed by hedging, the average cost was within
about 12% of the average market price. Attachment A provides additional analysis of hedging
strategies.
If CPAU ceases gas commodity hedging and no longer uses reserves to stabilize rates, customers
would bear the full brunt of market price increases and receive the full enjoyment of market
price dips, and CPAU’s rates will never be out of step with the natural gas market. The market
price signals will be passed immediately on to the customers.
Second, customers and policy makers inevitably compare CPAU’s gas supply rates and PG&E’s
gas supply rates. PG&E’s gas supply rates are based on a monthly weighted average cost of gas
which closely follows the monthly spot market. Since PG&E’s gas costs fell below CPAU’s stable
gas costs, the gas laddering strategy has received increased attention from the UAC, the Council,
and the community. Although GULP does not include an objective to be competitive with
PG&E’s gas supply rates, having gas supply costs higher than PG&E’s is clearly problematic for
the community.
Third, while it is true the laddering strategy smoothes out the cost of gas over time and results
in relatively more stable gas supply rates, the average monthly customer bill is anything but
stable. The main driver for the customer bill is weather which results in high or low gas usage.
Figure 1 shows an average CPAU residential customer monthly bill and a bill for the same usage
using PG&E’s residential rates1. Despite CPAU’s stable rate and PG&E’s rate that changes on a
monthly basis, the average customer’s bill is not stable at all in either service area. In both
areas, residential bills are substantially higher in the winter months when gas use is high. Figure
2 shows the differences between the annual bills for average residential gas usage using CPAU’s
and PG&E’s residential retail gas rates.
1 Average bills are calculated using the monthly average gas usage for the period from July 2009 through June
2011.
September 20, 2011 Page 6 of 10
(ID # 1992)
Figure 1
Monthly Bill for Average Residential (G-1) Usage
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September 20, 2011 Page 7 of 10
(ID # 1992)
Figure 2
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Fourth, market-based gas rates are more likely to complement the state of the overall economy.
During and in the period after an economic recession, when consumers have less money to
spend, natural gas prices tend to be lower. When the economy is booming and consumers have
more money to spend, natural gas prices tend to be higher. With a hedged portfolio, the
opposite is true making higher rates more painful because those higher rates are likely to occur
during economic downturns and when the economy is struggling to recover. Figure 3 shows
monthly spot gas prices from 1995 through May 2010 and when the last two economic
recessions occurred.
September 20, 2011 Page 8 of 10
(ID # 1992)
Figure 3
PG&E Citygate Monthly Bidweek Index Prices Since 1995
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Fifth, eliminating the stable rate objective will greatly reduce the need for financial reserves.
Funds are withdrawn from the Gas Supply Rate Stabilization Reserve (G-SRSR) to mitigate gas
costs increases, and the reserve is replenished during low gas cost periods. If CPAU changes to
monthly varying market-based rates, reserves will be needed only for short-term revenue and
cost balancing. Modification to the G-SRSR guidelines would be appropriate. The current
reserve guidelines are to maintain between 25% and 50% of the supply purchase cost in the G-
SRSR. More information regarding the use of reserves for rate stabilization is provided in
Attachment A.
Lastly, the estimated staff time required to implement the laddering strategy is about 0.4 full-
time equivalents (FTEs) that could be redeployed in the long-term. However, in the short-term,
resources would be needed to implement the new purchasing and rate strategies including
implementing procedures to update the gas supply rate on a monthly basis, revising the rate
schedules, revising the reserve policy, revising GULP, and communicating the rate changes to
customers.
Alternatives
Two parameters can be used to measure rate stability: (1) the frequency of rate changes (e.g.
monthly, annually,every two years) and (2) the magnitude of the rate change (e.g. 10%, 50%, no
limit). The desired level of overall rate stability defines how the supply portfolio should be
managed. Staff’s proposal reflects the least stable alternative: monthly rate changes in line
September 20, 2011 Page 9 of 10
(ID # 1992)
with spot market prices. There is a continuum of alternatives with less frequent rate changes
and/or a specified cap on rate change magnitude. Greater rate stability will require more
aggressive hedging and/or larger reserves.
Commission Review and Recommendations
On July 20, 2011 staff asked the UAC to recommend the City Council direct staff to develop
market price-based, monthly adjusted gas supply rates. The UAC commissioners engaged in a
lengthy discussion covering topics such as staff time saved by eliminating the laddered hedging
strategy, the relationship between rate stability and energy efficiency, bill payment plans for
low income customers, and the advisability of being competitive with PG&E’s supply rates.
In general, the UAC was uncomfortable with monthly changing gas supply rates and indicated
that customers value rate stability. The UAC did, however, also acknowledge the downside of a
portfolio that is out of synch with economic cycles and PG&E’s gas supply rates which closely
mimic the monthly spot market. Several commissioners expressed support for a gas hedging
ladder shorter than 36 months. Rather than specifying a laddering period, staff urged the UAC
to propose a gas supply rate objective and explained that staff would then be able to design a
purchasing and reserve strategy to meet that objective.
A motion made to reject staff’s recommendation and instead recommend an objective of
adjusting gas supply rates once per year and by no more than 20% at a time, with the mix
between laddering and reserve levels to be determined by staff. The motion passed
unanimously (6-0 with Commissioner Cook absent). An analysis and potential implementation
plan for the UAC recommendation is provided in Attachment B. Draft excerpted notes from
the UAC’s July 20, 2011 meeting are provided as Attachment C.
Next Steps
If Council approves the proposed change in policy, staff will develop an implementation plan
and timeline. Steps will include:
1.Develop systems to implement monthly market-based supply rates;
2.Revise the G-SRSR guidelines;
3.Develop a new gas commodity purchasing plan;
4.Update relevant sections of GULP;
5.Establish timeline for rate roll-out; and
6.Conduct customer outreach and communication.
To implement the change, staff will return to the UAC requesting recommendations to Council
for changes to the gas retail rates, changes to the G-SRSR guidelines and changes to GULP.
Resource Impact
Short-term resources will be required for implementation of the new gas commodity purchasing
and rate strategy. Long-term, 0.4 FTE are expected to be redeployed from gas portfolio
September 20, 2011 Page 10 of 10
(ID # 1992)
management to other projects. This savings includes small amounts of time spread across
multiple individuals in Utilities and Administrative Services.
Policy Implications
Approval of staff’s recommendation or the UAC’s recommendation would result in a change in
practice and would necessitate future changes to Council-approved Gas Supply Rate
Stabilization Reserve guidelines.
Environmental Review
Changes to the gas supply objective or gas purchasing strategy does not meet the definition of a
project pursuant to Section 21065 of the California Environmental Quality Act (CEQA). Thus, no
environmental review is required.
Attachments:
·Attachment A: Gas Laddering Strategy Analysis (PDF)
·Attachment B: Utilities Advisory Commission Recommendation Implementation (PDF)
·Attachment C: Excerpted Final Special Minutes of July 20, 2011 UAC Meeting (PDF)
Prepared By:Karla Dailey, Sr. Resource Planner
Department Head:Valerie Fong, Director
City Manager Approval: James Keene, City Manager
Attachment A
Page 1 of 12
Gas Laddering Strategy Analysis
Laddering Strategy Parameters and Current Status
Since its inception in 2001, the City of Palo Alto Utilities (CPAU’s) gas laddering strategy structure
has remained largely unchanged. While the time horizon was extended from 36 months to 5 years
in 2009, hedging targets beyond 36 months have always remained at 0%. The portfolio planning
periods within the 36‐month ladder have numbered from 3 to 4 and have ranged in length from 9 to
18 months. The most recent minimum and maximum hedge targets are shown in Table 1 below.
Table 1
Gas Commodity Purchasing Plan
Portfolio Planning Period 1 2 3 4
Months from Present 1-18 19-27 28-36 37-60
Minimum Hedge 60%40% 20%0%
Maximum Hedge 10%75% 50% 35%
Actual Hedge 53%23%3%0%
The laddering strategy was suspended in December 2010 as the strategy was being reviewed, and
since then the actual hedged amounts are below the minimum guideline. Figure 1 shows the first
36 months of the purchasing strategy; no gas has been purchased for delivery beyond October
2013.
Figure 1
Gas Supply Procurement Program for Pool Customers
June 14, 2011
0
50000
100000
150000
200000
250000
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350000
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450000Jul-11Sep-11Nov-11Jan-12Mar-12May-12Jul-12Sep-12Nov-12Jan-13Mar-13May-13Jul-13Sep-13Nov-13Jan-14Mar-14May-14MM
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Actual 49%
Min/Max = 50/90%
Actual 23%
Min/Max = 25/60%
Actual 1%
Completed
Purchases
Min/Max = 0/30%
Expected Pool
Customer Load
Shaded area indicates hedge limits
Attachment A
Example of Laddered Gas Purchases
Figure 2 and Figure 3 show how gas was actually purchased in a laddered fashion for two months in
the past. Figure 2 shows fixed‐price commitments for April 2008 in the three years prior to delivery
of the gas. As illustrated, the forward gas price ranged from a little above $6/MMBtu to almost
$10/MMBtu with the bidweek index price at delivery of $9.33/MMBtu. In this case, market prices
were flat or increased during the three‐year laddering period. This meant that the average cost for
the gas delivered in April 2008 was much lower than the bidweek index price for the month as
fixed‐price commitments were made prior to delivery.
Figure 2
April 2008 PG&E Citygate Trading History
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April '08 bidweek price = $9.33/MMBtu
Average of daily prices = $10.18/MMBtu
6/1/05
buy 1000/day
3/25/08
buy 1600/day
@bidweek index
8/3/05
buy 1000/day
4/11/06
buy 1000/day
9/14/05
buy 1000/day
1/17/07
buy 1000/day
7/11/07
buy 970/day
Figure 3 shows fixed‐price commitments for February 2011 in the three years prior to delivery of
the gas. As shown, the forward gas price ranged from a high of $11.60/MMBtu in July 2008 to a low
of $4/25/MMBtu shortly before delivery. The bidweek index price for February 2011 was
$4.34/MMBtu. In this case, as market prices were falling throughout the laddering period, the
average cost for the gas delivered in February 2011 was much higher than the bidweek index price
for the month.
Page 2 of 12
Attachment A
Page 3 of 12
Figure 3
Laddering Strategy Objectives
Figure 4 shows historical monthly market costs (as expressed by the monthly “bidweek” index),
forward prices, and high and low price scenarios. The high and low prices are derived from the
market price volatility embedded in the premium cost to purchase capped price products1. Hedging
reduces the cost impact to the portfolio should the high market price scenario occur. The decision
to hedge, or not to hedge, should be based on the amount of cost increase the organization is
prepared to accept. Hedging should not be considered to have been a bad decision if actual prices
do not turn out to be high. In fact, hedging is expected to result in costs higher than the market at
least some of the time.
1 Capped price products are priced to float up and down with the market, but have a maximum price. For example,
the forward fixed price as of June 14, 2011 for gas deliveries in December 2012 was $5.77/MMBtu. One could also
buy a capped price product for December 2012 gas that would float with the market, but with a maximum price of
$6.25/MMBtu. However, the premium for the capped price product was $0.50/MMBtu. When December 2012
arrives, the price for the gas would be the bidweek index up to the $6.25 maximum price plus $0.50/MMBtu. If the
bidweek price for December 2012 is $4.00, then the total price paid will be $4.50/MMBtu (bidweek price plus the
$0.50/MMBtu premium). If the bidweek price for December 2012 is $8.00/MMBtu, then the total price paid will
be $6.75/MMBtu (maximum price plus the $0.50/MMBtu premium).
February 2011 PG&E Citygate Trading History
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2/1/08 8/1/08 2/1/09 8/1/09 2/1/10 8/1/10 2/1/11
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t
u
February '11 bidweek price = $4.34/MMBtu
Average of daily prices = $4.16/MMBtu
1/24/11
buy 3200/day
@bidweek index
5/8/09
buy 1000/day
1/14/09
buy 970/day
5/8/08
buy 1000/day
4/2/08
buy 1000/day 11/13/08
buy 1000/day
10/14/10
buy 1000/day
11/9/10
buy 1000/day
7/9/08
buy 1000/day
2/26/09
buy 1000/day
Attachment A
Figure 4
Natural Gas Wholesale Prices at PG&E Citygate
as of June 14, 2011
$0
$2
$4
$6
$8
$10
$12
$14Nov-06Feb-07May-07Aug-07Nov-07Feb-08May-08Aug-08Nov-08Feb-09May-09Aug-09Nov-09Feb-10May-10Aug-10Nov-10Feb-11May-11Aug-11Nov-11Feb-12May-12Aug-12Nov-12Feb-13May-13Aug-13Nov-13Feb-14May-14Pr
i
c
e
s
(
$
/
M
M
B
t
u
)
Actual
Projected
High
Low
* High and low prices in the 75th and 25th
percentile projected using Black Scholes model
Implementation of the laddering strategy smoothed out the supply portfolio cost increases and
decreases relative to the monthly spot market. Figure 5 shows CPAU’s Weighted Cost of Gas
(WACOG) compared to the spot market prices over the period from July 2001 through May 2011.
Page 4 of 12
Attachment A
Figure 5
Pool WACOG versus the Monthly Bidweek at PG&E Citygate
$0
$2
$4
$6
$8
$10
$12
$14Jul-01Jan-02Jul-02Jan-03Jul-03Jan-04Jul-04Jan-05Jul-05Jan-06Jul-06Jan-07Jul-07Jan-08Jul-08Jan-09Jul-09Jan-10Jul-10Jan-11$/
M
M
B
t
u
CPAU's Cost of Gas
PG&E Citygate
Monthly Bidweek
Impact of Various Laddering Strategy Time Horizons
Making commitments to buy gas in advance of its delivery at fixed‐prices means that the average
portfolio cost will always be different from the spot market, either higher or lower. The hedged gas
will be less expensive than the market when market prices are increasing and more expensive than
the market when market prices are decreasing. In effect, the cost of a laddered portfolio lags a spot
portfolio in time.
Figure 6 shows hypothetical annual portfolio costs for five different laddering time horizons using
actual historical prices. These costs are compared to the costs of a portfolio, in which all gas was
purchased at the monthly spot price. The figure illustrates that longer laddering horizons will result
in the greatest differential between portfolio cost and market. That means greater discounts when
the market is increasing and greater premiums when the market is decreasing for longer hedging
horizons. As shown, the spot market portfolio would have cost the most in times of rising prices (FY
2004 through FY 2006) and the least in times of falling prices (FY 2007 through FY 2010). The
difference in cost between the hedged and unhedged portfolios was most dramatic in FY 2009,
during which prices fell precipitously.
Page 5 of 12
Attachment A
Figure 6
Cost of Portfolio vs. Different Laddering Periods
$10
$12
$14
$16
$18
$20
$22
$24
$26
FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010
Co
s
t
t
o
M
e
e
t
P
o
o
l
L
o
a
d
(
$
m
i
l
l
i
o
n
/
y
e
a
r
)
Bidweek
36-mo
30-mo
24-mo
18-mo
12-mo
Bidweek
12-mo
12-mo
30-mo
24-mo
18-mo
36-mo
Bidweek
18-mo
24-mo30-mo36-mo
Relationship Between Commodity Rate Objective, Laddering Period and Reserves
In addition to hedging, financial reserves are an important tool for achieving rate stability. Even
with no hedging at all, a large reserve can mitigate the rate impact of oscillating market prices.
Alternatively, aggressive hedging can mitigate the rate impact of oscillating market price without
the need for large financial reserve funds.
Staff conducted a preliminary analysis of three different supply rate stability objectives – annual
maximum supply rate adjustments of 10%, 20%, and 40%.
Figure 7 shows three different potential laddered hedging strategies. One is an aggressive laddering
plan that hedges a part of the portfolio needs for three years ahead of delivery. A moderate two‐
year laddering strategy and a minimal, one‐year laddering strategy are also depicted. Each of those
strategies can be combined with a reserve guideline to achieve a specific gas supply rate stability
objective.
Page 6 of 12
Attachment A
Figure 7
Conceptual Pool Laddering Options
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000Jul-11Sep-11Nov-11Jan-12Mar-12May-12Jul-12Sep-12Nov-12Jan-13Mar-13May-13Jul-13Sep-13Nov-13Jan-14Mar-14May-14Jul-14Expected Load
Aggressive
Moderate Minimal
MMBtu
Table 2 below shows the combination of Gas Supply Rate Stabilization Reserve (G‐SRSR)
requirements and hedging strategies that can be used to achieve three alternative gas supply rate
stability objectives. While there are many other combinations of laddering horizon lengths,
laddering targets and G‐ SRSR levels that work together to meet a supply rate objective, the table
shows only three of those possible scenarios for each of three different gas supply rate objectives.
Table 2
Gas Supply Rate Stabilization Reserve Requirement to Meet Rate Objective
Gas Supply Rate Objective
Minimal
hedging
(1‐year ladder)
Moderate
hedging
(2‐year ladder)
Aggressive
hedging
(3‐year ladder)
Maximum Annual Rate Increase of 10% $18 million $15 million $6 million
Maximum Annual Rate Increase of 20% $14 million $11 million $2 million
Maximum Annual Rate Increase of 40% $5 million $2 million $0
For example, as shown in the table, a three‐year, aggressive laddering plan would require about $6
million in the G‐SRSR, while a moderate two‐year laddering plan requires a G‐SRSR balance of about
$15 million, and a one‐year laddering plan with small amounts of hedging requires an $18 million G‐
SRSR balance to maintain a supply rate objective of a increasing rates by a maximum of 10% per
year.
Is There a Premium for Fixed‐price Gas?
The UAC raised the question regarding whether or not there is a cost, or premium, for purchasing
gas on a forward basis compared to purchasing gas on the spot market. There is no definitive
Page 7 of 12
Attachment A
evidence that the forward market inherently carries a premium. Every transaction requires two
counterparties, one with a desire to guard against rising prices and the other with a desire to guard
against falling prices. Depending on the overall market sentiment, the premium can go in either
direction.
Figure 8 shows monthly bidweek prices and the highest and lowest prices the forward market
traded during the 36 months prior to delivery for each of those months. The figure shows that the
final trading price (the bidweek price) was equal to the historical high price during periods of
increasing prices, equal to the historical low price during periods of decreasing prices, and in
between when prices did not have a sustained direction. For example, the forward price for gas
delivered in December 2006 ranged from a low of $4.92/MMBtu to a high of $11.59/MMBtu during
the three years prior to delivery. The bidweek price for December 2006 was $7.56/MMBtu.
Figure 8
PG&E Citygate Prices
Actual Bidweek Index and Forward Prices as of May 31, 2011
$0
$2
$4
$6
$8
$10
$12
$14
$16
$18
$20
$22
D ec-9 7
D ec-98
D ec-9 9
D ec-00
D ec-0 1
D ec-02
D ec-0 3
D ec-04
D ec-0 5
D ec-06
D ec-07
D ec-08
D ec-09
D ec-1 0
Delivery Month
$/
M
M
B
t
u
Bidweek Price
Low
High
There is less competition among sellers the farther into the future the delivery date is, so it is
important to strike a balance between achieving stability and being able to buy at competitive
prices. Staff researched the relationship between the time lapse to delivery month for the gas and
the difference between the forward price for buying gas and the forward price for selling gas (called
the bid/ask spread). Staff found that the bid/ask spread increases from about 1.3% of the
underlying purchase price for delivery one year from now to 2.9% of the underlying purchase price
nine years from now. The bid/ask spread is less than 2% of the underlying purchase price within the
Page 8 of 12
Attachment A
current 36‐month planning horizon. Table 3 shows the bid/ask spread as a percent of the forward
price as of May 2011.
Table 3
Delivery Year Bid/Ask Forward Price Bid/Ask
$/MMBtu $/MMBtu % of Forward Price
2012 0.07 5.27 1.3%
2013 0.07 5.57 1.3%
2014 0.10 5.77 1.7%
2015 0.11 6.18 1.8%
2016 0.14 6.53 2.1%
2018 0.18 7.11 2.5%
2020 0.22 7.71 2.9%
CPAU’s Gas Rates compared to PG&E’s Gas Rates
When comparing CPAU’s gas rates to PG&E’s gas rates, it is important to recognize that the rate
usage tiers are not the same. Figure 9 shows two years of average monthly gas usage for residential
customers on the G‐1 rate schedule in Palo Alto as well as CPAU’s and PG&E’s first tier use limits.
Because CPAU’s Tier 1 limit is relatively high, the average residential customer rarely pays rates in
higher tier brackets.
Figure 9
Average Residential (G-1) Gas Usage
0
20
40
60
80
100
120Jul-09Aug-09Sep-09Oct-09Nov-09Dec-09Jan-10Feb-10Mar-10Apr-10May-10Jun-10Jul-10Aug-10Sep-10Oct-10Nov-10Dec-10Jan-11Feb-11Mar-11Apr-11May-11Jun-11th
e
r
m
s
p
e
r
m
o
n
t
h
PG&E Tier 1
usage limit
Palo Alto Tier 1
usage limit
Page 9 of 12
Attachment A
Figure 10 shows the total gas rates (supply plus distribution) for CPAU and PG&E by month over the
past 14 years. As expected, CPAU’s gas laddering strategy results in a cost lag compared to the spot
market and PG&E’s rates.
Figure 10
Residential Bundled rates
$0.00
$0.50
$1.00
$1.50
$2.00
$2.50
Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
$/
t
h
e
r
m
PG&E tier 1 rate
PG&E tier 2 rate
CPAU tier 1 rate
CPAU tier 2 rate
PG&E purchases gas on the monthly spot market and passes those costs on to customers through
monthly‐adjusted supply rates. Therefore, PG&E’s gas supply rates closely mimic the monthly spot
market price (the “bidweek” index). Figure 11 shows the gas supply portion of both PG&E’s and
CPAU’s gas rates. CPAU did not separate the supply rate from the distribution rate until July 2006.
The figure shows the relative stability of CPAU’s gas supply rate.
Page 10 of 12
Attachment A
Figure 11
Monthly Supply Rate and Spot Price
$0.00
$0.20
$0.40
$0.60
$0.80
$1.00
$1.20
$1.40
$1.60
$1.80
Jan-9 8
Jan-9 9
Jan-00
Ja n-01
Jan-02
Jan-0 3
Jan-0 4
Ja n-05
Jan-06
Jan-0 7
Jan-0 8
Jan-09
Ja n-10
Jan-11
$/
t
h
e
r
m
bidweek index
PG&E residential supply rate
CPAU G-3 supply rate
CPAU G-1 tier 1 supply rate
CPAU G-1 tier 2 supply rate
Gas Supply Bill = $55
for 50 therms
Gas Supply Bill = $15
for 50 therms
CPAU’s versus PG&E’s Gas Customer Bills
While it is true the laddering strategy smoothes out the cost of gas over time and results in
relatively more stable gas supply rates, the average monthly customer bill is anything but stable.
The main driver for the customer bill is weather which results in high or low gas usage. Figure 12
shows an average CPAU residential customer monthly bill and a bill for the same usage using PG&E’s
residential rates. Despite CPAU’s stable rate and PG&E’s rate that changes on a monthly basis, the
average customer’s bill is not stable at all in either service areas. In both areas, residential bills are
substantially higher in the winter months when gas use is high. Figure 13 shows the differences
between the annual bills for residents in CPAU and PG&E’s service areas.
Page 11 of 12
Attachment A
Page 12 of 12
Figure 12
Monthly Bill for Average Residential (G-1) Usage
$0
$20
$40
$60
$80
$100
$120
$140
Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
Ga
s
B
i
l
l
(
$
/
m
o
n
t
h
)
PG&E
CPAU
Figure 13
Residential Gas Bill for Average G-1 Customer
$0
$100
$200
$300
$400
$500
$600
$700
$800
$900
$1,000
FY
1999
FY
2000
FY
2001
FY
2002
FY
2003
FY
2004
FY
2005
FY
2006
FY
2007
FY
2008
FY
2009
FY
2010
FY
2011
Ga
s
B
i
l
l
(
$
/
y
e
a
r
)
PG&E
CPAU
Attachment B
Illustration of Implementation of the Utilities Advisory Commission’s
Recommendation for a Gas Supply Rate Objective
Utilities Advisory Commission (UAC) Recommendation
On July 20, 2011, the UAC did not support staff’s recommendation to develop monthly‐adjusted
market‐based gas supply rates. The UAC, instead, recommends an annual gas commodity rate
change with an objective of 20% maximum gas supply rate change per year. If the UAC
recommendation is approved by Palo Alto City Council, staff will implement a portfolio
management plan including a gas purchasing strategy and utilization of the Gas Supply Rate
Stabilization Reserve (G‐SRSR) to meet that supply rate objective.
Price Uncertainty
The market price for gas in the future is uncertain. Figure 1 shows the current market price for
gas purchased today to be delivered in future months as well as the high and low market price
scenarios used in this analysis.
Figure 1
Natural Gas Market Scenarios
$0
$2
$4
$6
$8
$10
$12Jul-11Sep-11Nov-11Jan-12Mar-12May-12Jul-12Sep-12Nov-12Jan-13Mar-13May-13Jul-13Sep-13Nov-13Jan-14Mar-14May-14Jul-14$
p
e
r
M
M
B
t
u
High Market Price Scenario
Forward Market
Low Market Price Scenario
Potential Implementation of UAC Recommendation
Although the UAC recommendation for annual gas supply rate changes with a 20% maximum
increase per year did not specify a laddering planning horizon, the UAC was generally supportive
of a shorter horizon so that market prices would be passed on sooner, rather than later, to
customers (but on an annual, not monthly, basis). If the UAC’s supply rate stability objective
Page 1 of 2
Attachment B
Page 2 of 2
recommendation is adopted by Council, staff would shorten the laddering horizon from 36
months to 12‐18 months and implement a moderate hedging strategy.
Figure 2 illustrates one such scenario. In this example, hedging targets are 50% of expected
pool load for the first 12 months and 30% of expected pool load for the following 6 months.
Based on current market conditions and this hedging target, the G‐SRSR balance required to
accommodate a 20% maximum annual rate change objective is $12 million. The G‐SRSR balance
is currently projected to be $9 million at the end of FY 2012.
Figure 2
Pool Laddering Implementation
with Maximum Annual Commodity Rate Increase = 20%
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
Jul-11
Se
p
-
1
1
Nov-
1
1
Jan-12
Mar-
1
2
Ma
y
-12
Jul
-
1
2
Se
p
-12
Nov-12
Jan
-
1
3
Ma
r-1
3
Ma
y-13
Jul
-
1
3
Se
p
-13
Nov-13
Jan
-
1
4
Ma
r-14
Ma
y-14
Reserve Reqt =
$12M
Expected Load
Because market prices and market price volatility are constantly changing, the portfolio plan
would be updated at least twice per year. Specific hedging targets and G‐SRSR levels would be
reassessed as part of that planning process. For illustrative purposes, the implementation plan
shown here begins in July 2011. Assuming a rate objective is adopted by Council in October
2011, staff would reassess the adequacy of the current G‐SRSR guidelines and potentially
recommend changes. Implementation of a new gas portfolio purchasing plan could begin
immediately thereafter.
Council may adopt a different supply rate objective (different frequency of rate change and/or
different maximum rate change). In that case, staff will develop a different portfolio
management plan using gas purchasing and the G‐SRSR to meet that objective.
_______________________________________ City of Palo Alto
Final
UTILITIES ADVISORY COMMISSION – SPECIAL MEETING
EXCERPTED MINUTES OF JULY 20, 2011
ITEM 2: ACTION: Recommend Proposed Change to the Gas Purchasing Strategy to Implement a Market-
Based, Monthly Adjusted Gas Supply Rate
Senior Resource Planner Karla Dailey presented staff’s recommendation to develop a market price-based,
monthly adjusted gas supply rate for Pool customers. The presentation included analysis showing that
longer laddering horizon result in greater deviation from market prices, as well as the lack of evidence of
forward price premium. Dailey also presented comparisons of CPAU gas rates with PG&E rates and spot
market prices since 1998 and explained that the main bill driver is usage, with high gas bills during the
winter months. An alternative to the proposed market price rate is setting a stable rate objective that limits
the rate change frequency as well as the rate increase each time. The reserve level and laddering strategy
work together to meet the specific rate objective. For example, an objective of maximum annual supply rate
increase of 10% can be met by aggressively laddering over a 36-month period, or moderately laddering
over a 24-month period, or minimal laddering over a 12-month period. The reserve requirement will differ
depending on the laddering strategy – the longer and more aggressive the laddering strategy, the lower the
reserve requirement. As the maximum annual supply rate increase goes up, the reserve requirement
lowers.
Commissioner Eglash asked about the staff savings under a market rate strategy. Dailey explained that
initially there will be none, but over the long term, she estimated savings of 0.4 FTE (full-time equivalents.)
Commission Eglash questioned the staff time required to implement monthly rate adjustments. Utilities
Assistant Director Jane Ratchye indicated that the monthly rates will be similar to the current rate schedule
for the G3 customers (large commercial customers), and that it would take to minimal time to also adjust
the monthly rate for Pool customers.
Commissioner Eglash commented that gas prices are likely to stay at relatively low prices for a long time
and asked if that is relevant. Dailey pointed out that market views are not relevant to the discussion.
Commissioner Keller asked whether the projected FTE reduction accounts for additional staff time to
manage customer questions related to the fluctuating monthly gas rate. Dailey clarified that staff did not
consider customer service resources. Usage is the primary bill driver, not so much the rate. The gas bill is
also just a portion of the total utility bill, so even if the gas bill may be higher in the winter, it may not be
significantly out of line because the water portion would be lower.
Commissioner Melton asked whether CPAU can level out the winter bill for low income customers,
regardless of the laddering strategy. Dailey pointed out such a billing option is already currently available to
customers.
Utilities Advisory Commission Minutes Approved on: Page 1 of 3
Commissioner Melton also questioned the reasons behind the staff recommendation to swing to the
opposite end instead of some intermediate position, such as shortening the ladder. Utilities Director Fong
indicated that PG&E is the benchmark, and that unless CPAU adopts a market price rate, we will never
compare favorably with PG&E. Commissioner Melton commented that the proposal is too big a move. His
impression is that PG&E is a comparator, but he is not convinced that we should emulate PG&E. The City’s
customer base values some amount of steadiness. Extreme variability of PG&E model is not what majority
of customers want.
Director Fong commented that whatever gas purchasing strategy the City decides to adopt, we should stick
to that strategy. Dailey emphasized that rather than focusing on the ladder, a supply rate objective more
relevant. Once we have a supply rate objective, then staff can manage the portfolio to meet the objective.
Defining the rate objective is the most valuable thing.
Commissioner Waldfogel referred to a slide in the presentation and commented on the long-term trend with
short-term random events. The current laddering strategy creates a 2 to 3 years lagging trend. He also
commented on the need to expose customers to second year trends trend while simultaneously shielding
customers from short-term spikes.
Commissioner Keller expressed that she is in favor of stability. Predictable rates are more conducive to
investing in conservation measures, as customers are more inclined to make investments when they can
predict future savings. She added that CPAU has the benefit of focusing on customers, unlike PG&E,
which focuses on shareholders. People value the service of having stable and predictable rates.
Commissioner Eglash also expressed his support for annual rate adjustment for Pool customers, rather
than monthly rate adjustments. Laddering would be a separate issue, as the utility can adopt annual rates,
but still forego laddering.
Assistant Director Ratchye explained that rate stability within the year does not address rate stability year-
to-year. There will also be the question of the reserve level. Ratchye posed the idea of monthly changes
within a band to dampen the spikes. Commissioner Waldfogel responded that customers might prefer a
published set of rates in July for the next 12 months. Customers can’t respond to shorter term price signals
in a meaningful way.
Commissioner Melton noted that by allowing rate change only once per year, there is a risk of big annual
increase. There would need to be a huge reserve or accept huge changes between years. An alternative is
semi-annual or quarterly changes. Allowing mid-year rate adjustment could dampen the risk of big change
on July 1.
Chair Foster pointed out that in the slide showing a 10% maximum annual supply rate increase, under a 1
year ladder, the reserve requirement is $18 million.
Commissioner Eglash moved to shorten the laddering period to a one-year ladder and set rates annually.
This could be achieved with a reasonably-sized reserve. No rate objective is recommended. Commissioner
Berry seconded the motion.
Assistant Director Ratchye noted the desire to pass on price signals more quickly. That will result in bigger
annual rate changes than the past.
Utilities Advisory Commission Minutes Approved on: Page 2 of 3
Utilities Advisory Commission Minutes Approved on: Page 3 of 3
Commissioner Eglash agreed that by fixing annual rates but allowing year-to-year adjustments to respond
to price changes can be a dual-edged sword. He pointed out that to meet the objective of annual rate
change with no ladder requires bigger reserves. His sense is that getting rid of laddering altogether is an
overreaction, but rather should find a common ground that is likely to be accepted by Finance Committee or
Council.
Council Member Scharff commented that the UAC should not attempt to second guess what FC or Council
will think, but rather should go with what they think is the right approach.
Commissioner Keller commented that there was an advantage to buying when we want rather than at the
fluctuating market price. For example, by buying ahead of the delivery month, we can avoid buying gas
during a natural disaster such as a hurricane that disrupts prices. Fong responded that there is never
certainty that market prices will be short spikes or sustained. Many of the price spikes are sustained for
some period and a laddered strategy cannot protect against these price spikes.
Commissioner Melton expressed his support for annual rate increases and that there are two ways of
reaching the goal: one is laddering, and the other is reserves. These two trade off against each other. He
then moved to amend the motion by asking staff to return with analyses with the objective of setting rates
annually and either shortens or eliminates the ladder and increases the reserve to accomplish that.
Dailey pointed that if the goal is to change rates annually, then we need minimal reserves but that a large
annual rate change is possible.
Commissioner Eglash deferred to staff to determine the optimal level of reserve requirement and laddering.
Dailey explained that if there is no cap on the annual rate change, then there is not a need to do much
more. The rates from one year to the next could be doubled or halved, and there is no need to put in place
a laddering strategy.
Commissioner Eglash asked whether the UAC need to provide an explicit rate objective. Dailey responded
that if the rate objective is 10%, then staff can design a strategy around that rate objective.
ACTION: Commissioner Eglash commented that a 20% cap on annual supply rate change is reasonable,
as that would translate to a 10% annual gas rate change which exposes ratepayers to market prices, and
yet provides some stability for customers’ planning purposes.
Chair Foster made a substitute motion, that the UAC reject staff’s recommendation and instead
recommend an objective of one-year rate adjustments with 20% maximum annual supply rate change, with
the mix between laddering and RSR to be determined by staff.
Commissioner Eglash seconded the motion.
The amended motion passed unanimously (6-0).
FINANCE COMMITTEE
DRAFT EXCERPT
Regular Meeting
September 20, 2011
Proposed Change to the Gas Purchasing Strategy to Implement a Market-based,
Monthly-adjusted Gas Supply Rate.
Assistant Director of Utilities, Jane Ratchye explained the price hike began
during the energy crisis in 2000 to 2001. This was when Palo Alto started the
gas laddering strategy which continued until 2010. Staff was proposing to
purchase gas on a monthly and daily market as was the practice for gas utilities
throughout the State and with Palo Alto’s larger customers. The proposal would
extend to the residential and smaller commercial customers rather than just the
larger customers.
Senior Resource Planner, Karla Dailey stated the gas market prices had
collapsed over the past two years. Palo Alto’s gas costs had been higher than
the market and Pacific Gas & Electric (PG&E) costs. Gas prices were
unpredictable and there was nothing that could be forecast to change the
uncertainty. She noted the stability of the rate varied but had no influence on the
stability of the bill; consumers’ bills changed dramatically during colder months
versus in warmer months. The synergy that occurred between the state of the
economy and the cost of gas had a tendency to be higher when the economy
was booming where it was less costly when the economy was in recession. Staff
was recommending deviating from past history and moving ahead with a market
pass-through rate structure. She clarified there were action steps that involved
the Utilities Advisory Commission (UAC) and the City Council in order to
implement the policy. The UAC had made alterations to the Staff
recommendations including the implementation of a gas commodity rate
objective of the rates not changing any more than 20 percent in a single year and
only changing rates once per year.
Utilities Advisory Commissioner, Steve Eglash stated it would be helpful to
distinguish between laddering; which was about purchasing gas, and how often
rates were adjusted. The City had been laddering their purchases over three
years. He noted rate payers tended to compare their rates to PG&E. The
consequences of a three-year ladder in a time of rising costs were that Palo Alto
citizens were paying less than a PG&E customer but in a time of falling prices
they were paying more. The overall sense was to eliminate or dramatically
shorten the term of the ladder. With respect to rate adjustments the UAC felt
setting annual gas rates was more beneficial to the rate payers.
Ms. Dailey clarified Palo Alto had a stable rate objective for ten years without
defining the term stable. The UAC recommendation was a flat rate of 20 percent
annually.
Council Member Shepherd asked whether Staff had proposed volatility on the
spot market.
Ms. Ratchye replied no.
Council Member Shepherd felt a 20 percent shift in the rate would be a large
jump.
Ms. Dailey clarified the total rate was made up of the supply and distribution
portions, the current discussion was only on the supply portion.
Mr. Eglash noted the use of the expression 20 percent was actually a 10 percent
increase to the consumer. The Committee or Council could place the cap at any
amount they saw fit and Staff would accommodate it through a combination of
laddering and reserves.
Ms. Dailey explained with the lower cap there would be a combination of more
money available in reserves or there needed to be a more aggressive ladder put
into place.
Mr. Eglash said it would be difficult to imagine an event in the world that would
cause such a mass change in gas prices that it was not something that should be
shielded to your consumers. PG&E tells their consumers that the cost was
passed to them through the prices they paid.
Council Member Shepherd stated that was easier to handle than an annual
increase.
Vice Mayor Yeh said if the consumer was asked what stability was the majority of
them would say predictable bills. In comparing the bills between City of Palo Alto
Utilities (CPU) and PG&E it was eye opening. His concern with shifting away
from a laddering system was the impact on low or fixed income households.
Ms. Dailey informed the Committee there were programs in place for low and
fixed income families to spread their payments out evenly over the twelve month
period.
Vice Mayor Yeh asked what types of programs PG&E had in place for low or
fixed income households.
Ms. Dailey confirmed PG&E carried the same programs as CPU in terms of low
and fixed income rate payers.
Director of Utilities, Valerie Fong stated two of the public benefit programs were
Rate Assistance Program (RAP) which provided a 25 percent discount on gas
and electric rates for eligible customers and Residential Energy Assistance
Program (REAP) which could permanently reduce energy and water costs
through home energy efficiency.
Vice Mayor Yeh asked what the savings would be in terms of the administrative
operations.
Ms. Dailey confirmed the calculations had been a savings of .4 Full Time
Employees (FTE) which equaled less than half of a person. She noted it was not
a simple calculation to manage since there were multiple departments involved
outside of CPU that had activities correlated to the inner workings.
Vice Mayor Yeh asked what the maximum exposure would be in terms of impact
on bills. He understood the concept was to provide a level of protection for the
consumers.
Ms. Dailey clarified at the end of the day, there was no protection. She noted if
the cost of gas rose the City could possibly use their reserve to make up the
difference.
Council Member Schmid acknowledged since CPU had been doing laddering
there was a benefit during the mid 2000’s but the lagging had been substantially
greater and that would imply the CPU was paying extra for insurance.
Ms. Dailey explained the graph showed the market had been going down over
the past few months and that the CPU had risen above it.
Council Member Schmid stated the amount above was greater than the amount
that used to be below.
Ms. Ratchye explained the rates being addressed on the graphs were the total
bundled rates which encompassed the supply and distribution components. CPU
had a higher distribution rate and cost than PG&E.
Council Member Schmid said in consideration of the UAC recommendation of the
20 percent increase, from the year 2001 there was a jump of about 57 percent
from PG&E gas bills. His concern with placing a cap on the increase was the
financial impact on the reserve if the cap was below the cost increase.
Ms. Dailey clarified CPU started the laddering system after 2001 had no
guarantee the 20 percent objective would always be met. The market was in
constant flux and while CPU attempts to make its most educated estimate of
what the portfolio would look like would provide reasonable assurance that the
CPU would be able to stay under the 20 percent cap.
Council Member Schmid felt placing a cap on the increase was inviting problems.
Ms. Dailey stated having a cap provided a framework for Staff to make portfolio
management decisions.
Ms. Fong noted were the CPU to exceed the cap the Council would know
because Staff would return to request a larger increase.
Council Member Schmid struggled with the increase in the market of 60 percent
while the CPU had an increase of 160 percent. The slide clearly showed the CPU
rate was higher than the market in the 2000- 2001 time frame.
Ms. Dailey stated that was when the laddering program began.
Council Member Scharff asked if the supply was normalized, what would the
difference be between the CPU and PG&E rates.
Ms. Dailey stated the Palo Alto and PG&E residential averages were similar; it
was the distribution rate that was higher with CPU by approximately $40.00.
Mr. Eglash noted slide 5 showed less volatility if laddering was in place
compared to a spot market approach.
Ms. Ratchye clarified that was a reflection of supply only.
Mr. Eglash stated if the question was what the cheapest thing was, nothing
discussed had any effect on the average cost overall of what the rate payers
paid.
Council Member Scharff indicated there was a cost to the laddering strategy and
it appeared to be slightly more expensive.
Mr. Eglash noted the UAC had discussed that fact and Staff had assured them
they did not time the market. The laddering system was blind to the market
fluctuation.
Council Member Schmid asked whether there was a small insurance premium.
Mr. Eglash stated there was a small laddering penalty which came from the fact
that when you were buying a forward contract there needed to be some way in
which the person selling the contract handled the risk and uncertainty.
Ms. Dailey said an insurance policy was not an accurate way to describe the
situation. There was a party on one side who was in fear of rising costs and a
party on the opposite side who was afraid of falling prices and in the middle of
the two parties was a marketer who was making money.
Council Member Scharff asked what was gained by adding the 20 percent cap.
He asked why the reserves were needed without the laddering system.
Ms. Daily stated with the UAC recommendation of shortening the laddering
system from three years and with today’s current market conditions, the CPU
estimated the need for a $12 million reserve but currently it was at $9 to $10
million.
Council Member Scharff confirmed with the UAC recommendation there was a
need for more funds in the reserves.
Ms. Dailey noted with the change to an 18 month laddering system, yes.
Council Member Scharff asked without a laddering structure in place what would
the need be in reserves.
Ms. Daily stated Staff had not calculated the necessary reserve amount but it
would be approximately $3 million.
Council Member Shepherd asked what the UAC thought about the difference in
financial need.
Mr. Eglash clarified it was certainly appealing to eliminate the need for a reserve.
He continued to explain a scenario of setting the rate at the beginning of the
year, eliminating laddering, and review the findings at the end of the year where
there would either be too much or not enough funds collected. He suggested
they evaluate how much was off and incorporate the difference into the rate for
the upcoming year. That way each year the CPU was correcting the prior years
error. His understanding was the reserve was the financial instrument the City
used for handling the over or under.
Council Member Scharff asked for clarification on the 20 percent cap. He said in
2000 the costs spiked then returned but Palo Alto maintained their prices
artificially low and ran through their reserves causing a spike in prices. If they
had just let the market work itself out the prices would have been at a normal rise
and fall; as was PG&E.
Mr. Eglash noted that was Staff’s recommendation, to eliminate laddering and to
have monthly adjusted rates. He asked if there was a reserve necessary in the
recommended scenario.
Ms. Dailey replied there was a small reserve of $3 million necessary.
Ms. Fong clarified there would continue to be a distribution reserve.
Vice Mayor Yeh felt the term reserve meant emergency, what if there was a year
where there was a 100 percent spike. As a small publicly owned utility there was
some level of protection with added value that PG&E did not have.
Ms. Fong stated part of the value returned by the CPU was the General Fund
transfer. Regardless of how the rates may fluctuate there was a transfer which
was not insignificant on its own.
Vice Mayor Yeh asked how the transfer would be impacted if the City were to go
from a laddering structure to a spot market.
Ms. Fong noted there would be no affect.
Council Member Scharff understood the impulse to shield the rate payers but that
was what was attempted in 2000 and it ended up being worse for them.
Vice Mayor Yeh understood the reason behind the aggressive increase once the
reserve had depleted below the necessary level. He asked if having a reserve
served as a benefit when it came to bonding.
Ms. Fong acknowledged all of the reserves had helped tremendously.
Director of Administrative Services, Lalo Perez confirmed the benefits to securing
a bond needed to be included when addressing the state of the reserves.
Currently the funds sitting in the reserves were earning a 2.9 percent interest and
with the governmental agencies the rate of return was guaranteed.
Vice Mayor Yeh reiterated the need to ensure eliminating any of the reserves
would not be negatively impacting other financial aspects.
Ms. Dailey agreed there needed to be conversations between the CPU and the
Administrative Services Department (ASD) to determine what amounts were
necessary to maintain in reserves. She explained the reduction of the reserve
was the reason for the laddering system; it was not the laddering system that
caused the reduction in the reserve.
MOTION: Council Member Schmid moved, seconded by Council Member Scharff
that the Finance Committee accept Staff recommendation to recommend the City
Council direct Staff to develop market price-based, monthly-adjusted gas supply
rates.
Council Member Schmid stated PG&E customers were adapting to the market
rate and he felt Palo Alto’s larger customers were choosing to go with market
prices. Market prices had strong conservation impacts with customers and he
agreed it was appropriate to move in that direction.
Council Member Scharff agreed moving in the direction of market prices was
beneficial and would be easier to explain the ebbs and flows of the prices. He
understood the need for reserves with sensitivity to the bond rating and agreed
there would be discussions between the necessary departments.
Vice Mayor Yeh requested determining the reserve amount be brought before
the full Council.
Council Member Scharff agreed and requested Staff bring the reserve amount
discussion back to the Finance Committee prior to the Council.
Vice Mayor Yeh stated the current policy pre-dated any of the Council Members,
except Council Member Klein, and the suggested change would be a significant
shift in how reserves were dealt with.
Ms. Ratchye acknowledged Staff would return to the Committee with Supply
Rate Guidelines which would need to be changed and at that time the Committee
could review the reserve distribution rate stabilization.
Vice Mayor Yeh was in support of the Motion with Staff returning to the Finance
Committee for approval prior to being sent to Council.
Ms. Ratchye said the goal for Staff was to receive direction on new Rates and
Reserve Guidelines and return to the Finance Committee before implementation.
Ms. Dailey added the Gas Utility Long Term Plan (GULP) needed to be updated
and brought back for approval.
MOTION PASSED: 4-0