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HomeMy WebLinkAbout2004-08-03 City Council (4)City of Palo Alto C ty Manager’s Report TO:HONORABLE CITY COUNCIL FROM:CITY MANAGER DEPARTMENT: AMINISTRATIVE SERVICES DATE: SUBJECT: AUGUST 2, 2004 CMR: 373:04 CITY OF PALO ALTO’S ENERGY TRANSACTION ACTIVITY REPORT FOR THE FOURTH QUARTER, FISCAL YEAR 2003-04 This is an information report and no action is required. BACKGROUND The purpose of this report is to inform the City Council of the status of the City’s energy portfolio as of the end of the fourth quarter of Fiscal Year 2003-04 as it relates to transactions executed with energy suppliers. The City’s Energy Risk Management policy requires that staff report to Council on: 1) the City’s energy portfolio composition compared to Council-adopted policy, 2) the City’s credit and market risk profile, 3) portfolio performance, and 4) other key market information. DISCUSSION Open Transactions as of June 30, 2003 Open transactions are commitments that the City has made to purchase either electricity or gas, but for which supplies have not been delivered. Electrici _ty. Since the last quarterly report, CPAU has continued diversified purchases of blocks of forward supplies under the Council-approved Electricity Master Agreements (CMR 510:03). While approximately 55% of annual electricity supplies are expected to be supplied by the Western Area Power Authority (WAPA) and the Calaveras Hydroelectric Project for Calendar Year 2005, the City increasingly will purchase supplies from private sector entities. Figure 1 illustrates the sources of electricity supplies by month for the next 36 months. CMR:373:04 Page 1 of 13 Figure 1. Electric Load Resource Balance 110,000 ................................................................................................................................................ 90,000 ~70,000 m 00,000 ~30,000 I0,000 -10,000 dul-04 Sep-04 Nov-04 Jan-05 Mar-05 May-05 Jul-05 Sep-05 Nov-05 Jan-08 Mar-06 May-06 dul-06 Sep-06 Nov-08 Jan-07 Mar-07 May-07 [] Western [] Calaveras [] Fo~ard PurchaselSales Planned Wind[][]Planned Landf~ll 8pot Market Exposure Figure 2 presents the current purchases (i.e. open positions) by the City by monthly delivery by volume (GWh) and dollar value. Dollar Value $2,500,000 $2,000,000 $1,500,000 $1,ooo,ooo $500,000 $- Figure 2. Electricity Forward Purchases ~Dollars Delivery Month GwH 40,000 35,000 30,000 25,00O 20,000 15,000 10,000 5,000 CMR:373:04 Page 2 of 13 The City currently holds open positions in the energy market with four private sector power providers: Coral, British Petroleum, Sempra and Duke. The total Mark to Market (MTM) value of these transactions has increased by nearly 70% from $5.2 million to $8.8 million as a result of an increase in forward prices. Figure 3 presents the mark to market positions for each supplier by month. Figure 3. $700 $600 $500 $400 $300 $200 $100 $- $(100) $(200) Electric Mark to Market Value of Forward Positions [] Sempra" E! Duke [] Coral Power DBP Delivery Month Forward prices for calendar year strips of 6 by 16 (6 days a week, 16 hours a day) electricity delivered at NP15 are presented in Figure 4. CPAU open transactions are scheduled for delivery either at the California Oregon Border (COB) or North Path 15 (NP15). CMR:373:04 Page 3 of 13 Figure 4. Forward Electricity Prices During Quarter 66.00 64.00 62.00~60.00 58.00 56.00 54.00 52.00 50.00 Forward Electricity Prices for Delivery at NP15 (Prices of forwards during Quarter) + Cal 05 + Cal ’06 Cal ’07 x Cal ’08 Date of Price As noted in previous reports, 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. A positive MTM value 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 higher. A negative MTM represents the supplier’s credit exposure with the City. Natural Gas. The Council approved Gas Master Agreements (CMR:482:03) has allowed staff to expand the number of approved suppliers from two to five and diversify counterparty risks. The current gas portfolio consists of 120 open transactions (transactions for which commitments have been made but gas has yet to be delivered) over the next 36 months as of June 30, 2004. The contract volume of these transactions is 4.04 million MMBtu with total commitments of $18.5 million and an average price of $4.58 per MMBtu. The open commitments for natural gas by month and by supplier are presented in Figure 5. CMR:373:04 Page 4 of 13 Volume (MMBTu) 350,000 300,000 250,000 200,000 150,000 100,000 50,000 Figure 5. Forward Natural Gas Purchases Volume I"1Sempra ¯ ! Coral Energy [] ConocoPhillips DBP Delivery Month The current MTM value of these transactions is $3.7 million. The current MTM represents a 50% increase over last quarter as a result of significant increases in forward prices. The forward prices for gas delivery in the next 4 years are presented in Figure 6. $6.50 Figure 6. Forward Gas Prices (NYMEX) ~2005 Strip ~2006 Strip ~2007 Strip 2008 Strip $6.00 $5.50 $5.00 $4.50 $4.00 $3.50 $3.00 CMR:373:04 Page 5 of 14 $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $- $(5o,ooo ~ Figure 7. Gas Mark to Market (by month and counterparty) []BP [] ConocoPhillips [] Coral Energy [] Sempra Delivery Month Figure 8 below present the pool purchases made for each month over the next three years compared to estimated pool load. The figure illustrates the gas "laddering" purchasing strategy in relation to the total estimated load. CMR:373:04 Page 6 of 13 Figure 8. Gas Load-Resource Balance 500,000 450,000 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 Month 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 charged to ratepayers. Specifically, VaR measures how much projected 12 month net revenue could change in one-week, due to a potential market change. In compliance with the Risk Management Guidelines, the Utilities’ staff and the Energy Risk Manager monitor the VaR and ensure that its value remains below 10% of the projected end of year supply rate stabilization reserve levels for both electricity and gas. Currently, the VaR for the electricity portfolio is 0.5%, a decline of 0.6% from last quarter. This decline is due to the City purchasing a greater portion of its load in fixed price, long term contracts. The VaR for the gas portfolio is 5.7% compared to 5.4% VaR figure from the previous quarter. The historic levels of the VaR values for electricity and gas are presented in the Figures 8 and 9 respectively. Please note that in Figure 9, gaps in the graph indicate missing data. CMR:373:04 Page 7 of 13 12% 10% 8% 6% 0% Figure 9. Gas Value at Risk 12% Figure 10. Electric Value at Risk History 10% 8% 6% 4% 2% 0% Month CMR:373:04 Page 8 of 13 Credit Risk As part of an ongoing effort to enhance the City’s credit management, the risk management staff is implementing improved credit oversight policies and procedures. As part of this process, staff will regularly report on major credit rating agency’s (S&P and Moody’s) scores, as in past reports, and, in addition, report an "estimated default frequency" using the Moody’s KMV CreditEdge© system. The EDF is an estimated probability that a counterparty will default in the next 12 months (e.g., 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. A more detailed explanation of the EDF value, and how it is calculated, is presented in Appendix III. For simple comparisons, the table below compares EDF values with credit rating scores of S&P. Note that this comparison is an estimate only, and is regularly adjusted by CreditEdge. CPAU’s Risk Management procedures outline the actions required in the event of a change in the EDF value. A change in the EDF of a supplier can result in lowered credit limits, even if its credit rating is unchanged. CMR:373:04 Page 9 of 13 AAA ,, 0.02%0.02%0.02% AA+0.02%0.02%0.02% AA 0.02%0.02%0.02% AA-0.03%0.03%0.04% A+0.05%0.05%0.06% A 0.08%0.07%0.09% )k-0.10%0.10%0.11% BBB+0.12%0.12%0.13% BBB 0.15%0.14%0.18% BBB-0.22%0.19%0.27% BB 0.46%0.39%0.57% BB-0.71%0.58%0.88% B+1.10%0.89%1.36% B 1.69%1.37%2.40% B-3.42%2.41%4.86% CCC+6.92%4.87%9.84% CCC 14.00%9.85%14.46% CCC-14.94%14.47%15.94% CC 17.00%15.95%17.61% C 18.25%17.62%19.10% D 20.00%19.11%20.00% Electricity. Currently, the City purchases most of its electricity load from the Western Area Power Administration (WAPA). WAPA is a Federal Agency and operates under the full faith and credit of the United States Government, minimizing the City’s credit risk. The City’s current exposure continues to increase due to changes in forward prices, greater quantities for forward purchases made to fill the post 2004 energy deficit, and the resulting change in the Mark to Market Value. In summary, CPA’s counterparty exposure is as follows: CMR:373:04 Page 10 of 13 Electricity Suppliers Counterparty Credit Exposure - Credit BP ($’240,520) Coral $8,400,658 Duke $420,963 Sempra $204,461 Total $8,785,562 *Coral is owned by Shell (70%) and Bechtel (50%). Exposure and Credit Ratings S&P Ranking AA+ A- BBB BBB+ Moody’s Ranking N/A N/A Baal Baal Expected Default Frequency and Intergen (30%). .02 .05* .82 .38 Intergen is owned by Shell (50%) Natural Gas. The City has exposure to four counterparties totaling $3.7 million over the next 36 months. The highest exposure is $2.6 million with a BBB+ company, with the remainder of the exposure distributed among three other counterparties. Gas Supplier Credit Exposure and Credit Rating Counterparty Sempra BP ConocoPhillips Coral Total Credit Exposure S&P Ranking Moody’s Ranking $2,673,408 $ 74O,O35 $ 57,181 $ 258,346 $3,728,973 *Coral is owned by Shell (70%) and Bechtel (50%). BBB+ AA+ A- A- Baal N/A A3 N/A Expected Default Frequency .38 .02 .02 .05* and Intergen (30%). Intergen is owned by Shell (50%) Credit Quali _ty of Suppliers. Overall, the City has continued toimprove the credit quality of its suppliers. Figure 10 shows how the EDF of CPA’s current suppliers have declined (i.e. improved credit) over the past three years, and that the EDF scores for CPA suppliers are well below (i.e. better credit rating) industry averages. As a group CPA suppliers are lower credit risks than the average energy supplier for gas or electricity in the United States. CMR:373:04 Page 11 of 13 Figure 11 Median Expected Default Rate of CPAU Suppliers a~ainst Utility Indices in last 6 months. EDF ~, US Energy Group :=k~.~,~:_n ~Util!ties ~__,~ USElec-t~r’-~- " -: --~ ------- ~- -"-" - US Gas .00 .86 ,72 ,58 0,44 .30 0.16 e+Worst Credit ~ Best Credit ATTACHMENTS: A) Consolidated Mark to Market Report of All. Open Gas Transactions as of June 30, 2004 B) Consolidated Mark to Market Report of All .Open Electric Transactions as of June 30, 2004 C) Detailed Explanation of CreditEdge Expected Default Frequency calculations. CMR:373:04 Page 12 of 13 PREPARED BY: DEPARTMENT HEAD APPROVAL: CITY MANAGER APPROVAL: KARL G. 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LLZ ZG~ ,~8~ ~oooooooo!ooooo~ E!E E E E!E E E!E oo o ~ Appendix III CreditEdge© and Credit Scoring The CreditEdge system provides "real time" credit scoring methodologies that enable staffto: o Evaluate risk with greater degree of accuracy; ¯Quantify the to improve the performance of the portfolio; ¯Focus fundamental analysis where resources add the most value; ¯Actively monitor for early warning of serious credit deterioration. Staff evaluation demonstrated that this system is more accurate and rapid than relying solely on agencies scoring. The output of the model is based on three primary financial parameters: Value of Assets - the market value .of the firm’s assets, present value of future free cash flows; Asset Risk - the uncertainty or risk of the firm’s asset value, business and industry risk; Leverage - the extent of the firm’s contractual liabilities (book value), the amount the firm must pay. Using this data an Expected Default Frequency (EDF)is calculated to estimate the probability of default by the counterparty in the next 12 months. This estimate is arrived at by: 1.Estimating asset value and asset volatility Equity value is considered a call option on asset value Solve for implied asset value and volatility 2.Calculating Distance to Default Contractual obligations determine Default Point Number of standard deviations from default 3.Scaling Distance to Default to EDF Assign EDF using actual historical default rates Using this information, the EDF methodology operates on the following equation: BV Assets = BV Liabilities + BV Equity The approach then uses the Black Scholes’ options valuation to estimate the value of the assets in 12 months, and thus the expected default probability. This approach is summarized in the following graph. ooo oooo oooo