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HomeMy WebLinkAboutStaff Report 2868 City of Palo Alto (ID # 2868) City Council Informational Report Report Type: Informational Report Meeting Date: 6/4/2012 June 04, 2012 Page 1 of 9 (ID # 2868) Title: Energy Risk Management Quarterly Report Q2 FY 2012 Subject: City of Palo Alto’s Energy Risk Management Report for the Second Quarter, Fiscal Year 2012 From: City Manager Lead Department: Administrative Services Executive Summary Staff has continued to purchase electricity and gas in compliance with the City’s Energy Risk Management Policies and Procedures. This report is based on market prices and load and supply data as of December 31, 2011. The credit quality for the City’s counterparties improved during the quarter and the City’s credit exposure in the commodity purchasing area is minimal. The 36-month mark-to-market (MTM) value of the City’s fixed price electricity purchases is negative $3.2 million. The MTM value represents the difference between the current market price and the contract price. The 36-month MTM value of the City’s gas purchases is negative $4.1 million. Market prices for energy remained low during the quarter and the overall credit exposure to the City is low. The 12-month MTM value of renewable power purchases is negative $8.1 million and positive $6.4 million when marked against the renewable energy Market Price Referent. The 12-month MTM value of electricity from Western hydro is positive $3.6 million and the value for Calaveras hydro is negative $6.8 million. Changing market dynamics, international events, and other factors 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. Staff monitors these factors as well as the financial condition of the City’s counterparties on an ongoing basis. When the Full-time Energy Risk Manager retired, it provided an opportunity to reassess this position and its responsibilities. A 0.50 Senior Financial Analyst has assumed the risk management function, creating salary and benefit savings of $152,000 for the Electric and Gas Funds in FY 2012. Two exceptions are being reporting during this period and are discussed later in this report. June 04, 2012 Page 2 of 9 (ID # 2868) 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 2012. 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. Discussion To meet the expected load demands, the City obtains electricity from: hydroelectric resources (referred to as Western and Calaveras); renewable landfill gas converted to energy; wind generation contracts; and fixed priced forward market purchase contracts to meet its expected load demands. Staff projects that carbon neutral resources, including hydroelectric, will be 74% of the load over the next 12 months. Figure 1 below illustrates the sources of electricity supplies by month for the next 36 months in terms of megawatt hours (MWh). Fixed Price Forward Electricity Purchases The City currently has purchased supplies of electricity totaling 186,120 MWh for delivery between January 1, 2012 and February 28, 2013. The average price for all of the fixed-price purchases is $49.97 per MWh. The City contracted with six approved counterparties: Shell Energy North America (SENA), Powerex, British Petroleum Energy (BP), JP Morgan Chase, Sumitomo, and ConocoPhillips. The 12-month Mark to market (MTM) value of the City’s forward transactions for wholesale power was a negative $3.2 million at the end of the quarter. In other words, the contract price was higher than the market price. Figures 2 and 3 represent the Electric forward volumes and June 04, 2012 Page 3 of 9 (ID # 2868) MTM positions for each electric supplier by month of delivery for all forward fixed price electricity contracts. The data is shown by delivery month for all forward fixed price electricity contracts. Renewable Portfolio Standard To date the City has nine Council-approved power purchase agreements for landfill gas and wind renewable resources to meet the City’s renewable portfolio standard of 33% by 2015. The 12-month MTM value of the City’s forward positions for existing, committed landfill gas and wind renewable power is positive $6.4 million when marked against the California Public Utilities Commission’s (CPUC) Market Price Referent (MPR). The MPR represents the cost of comparable long-term contracts with a combined cycle gas turbine facility plus a carbon adder. The MPR is currently the only publicly available approximation of expected long-term renewable energy prices. As an alternative, staff estimates a long-term forward price for renewables based on the most attractive proposals it receives when it issues a request for proposals (RFP). Hydroelectricity The 12-month MTM is positive at $3.6 million for Western and is negative $6.8 million for Calaveras. This negative number for Calaveras means that the costs for Calaveras power are greater than the expected market value of electricity for the next 12 months. Note that the Calaveras project provides other benefits e.g., it provides ancillary services including the ability to crank up and down fast, so if the grid needs additional energy it can provide it and it is also an additional revenue source to the City when excess power is available. Therefore, the total value of the Calaveras project is not fully reflected in the MTM value. Figure 2. Electric Forward Volumes as of 12/31/11 June 04, 2012 Page 4 of 9 (ID # 2868) Figure 3. Electric Forward Mark-to-Market Values as of 12/31/11 Fixed Price Forward Natural Gas The City has purchased gas supplies totaling 1.7 million MMBtu for delivery between January 1, 2012 and October 2013. The average price for these fixed-price purchases is $5.37 per MMBtu. The forward purchases have been transacted with five approved counterparties: SENA (Shell Energy), Powerex, JP Morgan Chase, ConocoPhillips and BP. The gas forward volumes are shown in Figure 4 and the gas MTM values of all fixed price forward natural gas contracts by month and by counterparty are presented in Figure 5. Figure 4. Gas Forward Volumes as of 12/31/11 June 04, 2012 Page 5 of 9 (ID # 2868) Figure 5. Gas Forward Mark-to-Market Values as of 12/31/11 There is a negative MTM for gas forward contracts. Effective 7/1/12, the laddering strategy for gas purchases will no longer be in effect. Previously committed fixed price contracts will disappear over time. Ongoing gas purchases will be made based on the monthly and daily market index prices. Credit Risk Staff monitors and reports on credit risk using the major credit rating agencies (S&P and Moody’s) scores. The “expected default frequency” (EDF) is an analytical tool from Moody’s. Two of these analytical tool softwares are KMV CreditEdge Plus© and RiskCalc©. The EDF is an estimated probability established by combining information from the equity markets along with the company’s debt structure as reported on their financial statements. This will provide information on the probability of a counterparty defaulting in the next 12 months. It also provides frequent updates along with early warning of changes in credit quality. The KMV tools allow staff to carry out “real-time” credit evaluations that include equity pricing and asset value changes that are not reflected in the static and annually-conducted credit issuer rating agencies’ reports. Credit risk continues to be a focus due to the volatility in the credit markets, and the potential impact on Palo Alto’s electricity and gas counterparties. The City has two financially-based counterparties which are JP Morgan Chase and Sumitomo. The banking industry has seen extreme volatility this past year. Both of these companies currently have been trending downward in their expected default frequencies which are indicators of their financial health. There are outstanding contracts with JP Morgan Chase. June 04, 2012 Page 6 of 9 (ID # 2868) Under the City’s current Risk Management Policy and the City’s Purchasing Ordinance, the City is not permitted to transact with any counterparty which has an S&P rating below BBB-, unless approved by City Council. Some exceptions are made on a case-by-case basis, mainly for renewable energy suppliers. Moody’s KMV EDF numeric ratings correspond to S&P credit categories. For example see Table 1 below, the EDF measure of the counterparties must be 0.15% or lower which equals a BBB- rating. Table 1. Expected Default Rates and the Equivalent S&P Credit Category The City has Electric Master Agreements signed with six counterparties: Sumitomo, JP Morgan Chase, ConocoPhillips, SENA, Powerex, and BP. In addition, the City has renewable electricity contracts with Ibedrola Renewables, LLC (formerly Pacificorp Power Marketing) and Ameresco. Of this group, the City currently has outstanding contracts with three counterparties, as listed in Table 2 below. Electricity and Gas City of Palo Alto Utilities’ electric and gas supplier counterparty credit exposure and supplier credit ratings are presented in Tables 2 and 3 below. Note the City has a credit exposure only when the MTM value is positive. There are currently no contracts with a positive forward MTM value this quarter meaning the contract values are greater than the market value. June 04, 2012 Page 7 of 9 (ID # 2868) Table 2. Credit Exposure and Expected Default Frequency of Electricity Suppliers as of December 31, 2011 Table 3. Credit Exposure and Expected Default Frequency of Natural Gas Suppliers as of December 31, 2011 * The EDF for JP Morgan Chase was at 0.51 on 12/31/11 and at 4/19/12; their EDF is currently at 0.12 which is a BBB implied rating above the BBB- minimum guideline level. Supply Rate Stabilization Reserve Adequacy A key premise to the City’s risk management practices centers on ensuring the adequacy of supply reserves with respect to the risks associated with serving the gas and electric customers. Table 4 below summarizes the current, unaudited supply rate stabilization reserve levels for gas and electricity as of December 31, 2011 based on the City’s SAP financial system. Table 4. Supply Rate Stabilization Reserve Levels for Electricity and Gas for FY 2012 (Preliminary unaudited figures from City’s Financial System) June 04, 2012 Page 8 of 9 (ID # 2868) *Accounting activity to date reflects what has been booked into the City’s financial system. These figures are preliminary until outside auditors have completed their review and the Comprehensive Annual Financial Report is produced. There could be significant changes to the RSR balances based on year end adjustments that have not been booked yet. The data presented in Table 4 and discussed below, is based on unaudited preliminary financial reports. The projected reserve balances listed above for gas and electricity are impacted by differences in accounting methodologies for the two reserves. All contracts and commitments for purchases of gas for the fiscal year have been entered into the City’s SAP accounting system when the commitment is made, and therefore are included in the projected end of year balance. However, electricity commitments for the remainder of the fiscal year are not entered into the financial system until the month of delivery. The current reserves for electricity are well above the minimum guideline level, and are also above credit, regulatory, and other risks for the next 12 months. Total risks associated with the electric supply reserve for the next 12 months include: $2.0 million for credit reserves; $2.5 million for hydro risk; and $0.3 million for market risk of the yet-to-be-purchased positions in the next 12 months. These risks total $4.8 million. Electric Supply Rate Stabilization reserve unaudited balance at 12/31/11 is $65.4 million, which is $3.4 million above the reserve maximum guideline level. The unaudited gas reserve balance at 12/31/11 is $3.2 million which is below the minimum guideline. Total 12-month risks to the gas supply reserve are estimated at $4.8 million mainly for the market risk of yet-to-be- purchased positions in the next 12 months. Exceptions There are two exceptions to policy and procedures to call to Council’s attention. First, with the retirement and long-term vacancy of the City’s Energy Risk Manager, required quarterly energy risk management reports, were ceased. Administrative Services and Utilities staff reassessed the need to have a full-time Risk Manager and decided to devote a 0.50 Senior Financial Analyst to the risk oversight function. This change generated total salary and benefit savings of $152,000 in FY 2012. Training is underway and the resumption of the quarterly reports has begun. It should be noted, that the UROCC continued to meet during the absence of the Risk Manager to discuss and review all substantive issues. During the prior quarter, there was also an exception to procedures in the trading area. Utility Management and the UROCC reviewed this exception and it was thoroughly addressed with the responsible employee. Prepared By: Mary Figone, Senior Financial Analyst June 04, 2012 Page 9 of 9 (ID # 2868) Department Head: Lalo Perez, Chief Financial Officer City Manager Approval: James Keene, City Manager