HomeMy WebLinkAbout2001-04-17 City CouncilTO:
City of Palo Alto
City Manager’s Re ort
ATTENTION:
DATE:
TITLE:
HONORABLE CITy COUNCIL
FROM:CITY MANAGER FROM: UTILITIES
FINANCE COMMITTEE
APRIL 17, 2001
NATURAL GAS SUPPLY PROCUREMENT PLAN
CMR:196:01
This is an informational report and no Council action is required.
BACKGROUND
Natural gas prices have increased to unprecedented levels over the past year. Due to this
extreme volatility, the purpose of this report is to inform the Council of the Utilities gas
supply purchase plan. Though the details and implementation of this plan are operational in
nature, the potential fiscal impact of the purchase plan merits keeping the Council informed.
The City Manager has the authority to enter into contracts for the purchase and sale of natural
gas commodity for terms of three years or less. The City has not entered into a contract for
natural gas commodity of longer duration in many years. Recent practice has been to
contract with a single supplier for terms of three years or less. This supplier has been selected
using a competitive Request For Proposal process. Besides supplYing all the gas needs of
the City, this supplier also performs, other operational tasks such as daily balancing of the
City’s usage with its gas purchases.
The City’s contract with its current gas supplier/daily gas manager expires on June 30, 2001.
Staff is in the process of evaluating using other suppliers (besides the default supplier/daily
gas manager) to hedge against higher gas prices.
CMR:196:01 Page 1 of 5
DISCUSSION
The current supplier provides for the City to purchase up to all its gas.needs at a price based
on a monthly index known as the "bidweek index". The bidweek index price changes every
month and is not known..until just before the month begins. The contract also allows the City
to lock in fixed prices for any portion of its load with the supplier prior to the beginning of
the month. The bidweek price could turn out to be higher or lower than this fixed price.
Prior to a year ago, Palo Alto purchased some of its anticipated volumes based on the
bidweek index and locked in prices for the balance, but the difference between the prices was
not significant. In the last year, however, natural gas market prices have exhibited extreme
volatility. Figure 1 below shows historical and projected bidweek prices at Palo Aito’s
receipt point, PG&E Citygate. Exposure to these prices prompted a re-examination of the
gas procurement strategy pursued by Palo Alto.
$1.60
$1.40
$1.20
$1.00
so.so
$0.6O
$0.40
$0.2O
$0.00
Figure 1 - Monthly Wholesale Gas Prices at Citygate
Actual ~--* Projections
For fiscal year 2000-01 gas needs, staff fixed prices with its default supplier/daily gas
manager during the spring and summer of 2000. The prices paid were much higher than
CMR: 196:01 Page 2 of 5
anticipated at the time of budget development, but significantly lower than the bidweek
prices were. Thus, the hedging had a positive outcome.
As market prices rose dramatically in fiscal year 2000-01,
approved retail rateincreases effective August 1, 2000
2001(CMR:399:00), and April 1, 2001(CMR: 144:01).
staff requested and Council
(CMR:333:00), January-1,
Cognizant of customers’ desire and expectation of stable prices, staff developed a plan to
hedge gas prices for periods longer than one fiscal year. Conceptually, the gas supply
purchase plan is to purchase defined fractions of each month’s load in increments over a
three-year period. The plan consists of dividing the load into pieces and purchasing each
piece at different times. Figure 2 below shows the fraction of load that will be purchased at
a fixed price. This is explained in more detail below:
o
Purchase a fraction (- 20-30 percent) of the month’s load approximately three years
in .advance of the month;
Purchase a fraction (- 20’30 percent) of the month’s load approximately two years in
advance of the month;
Purchase a fraction (- 20-30 percent) of the month’s load approximately one year in
advance of the month; and
Purchase the balance of the month’s load sometime during the year prior to the start
of the month or during the month.
6
.Figure 2 - Gas Purchase Plan as of July 2001
FY 01-02 through FY 03-04
,Load
0
Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04
As Figure 2 shows, this "laddering" approach results in locking in the price of the cost of gas
CMR: 196:01 Page 3 of 5
at different points in time. The objective of this plan is to provide cost stability while still
maintaining some exposure to market prices. When fully implemented, the plan would result
in hedging, gas costs for about 75 percent of the load for the first fiscal year, about 50 percent
for the second fiscal year, and about 25 percent of the third fiscal year at any time.
Risks of the Three-year Gas Purchasing Plan
While the plan provides retail rate stability to improve customer satisfaction, there are risks
to the implementation of this strategy. As with any strategy that involves purchasing gas at
fixed prices, there is a possibility that market prices will decrease. Figure 3 below shows a
range of future gas prices.
$2.00
Figure 3: Gas Price Forecasts
(for next three fiscal years)
$1.80
$1.60
$1.40
$1.20
$1.00
$0.80
$0.60
$o.4o
$0.20
$o.oo
Jul-01
High Forecast --..~"~~’~
Base Forecast
Low Forecast
Jan-02 Jul-02 Jan-03 Jul-03 Jan-04
For example, as of mid-March 2001., the gas supply costs for fiscal year-2001-02 were
estimated to cost about $33 million. If the utilities relied on the spot market and no gas were
purchased in advance to lock in the gas cost; actual costs could range between $20 million
and $55 million. If the gas supply purchase plan were implemented locking in about 75
percent of the gas costs, then the range of possible gas costs would shrink considerably to
between $30 million and $38 million. Thus, the risk of increased cost is reduced
substantially by hedging. However, if gas market prices fall to near the low forecast, then
the cost of the hedged portfolio would be above market costs.
CMR: 196:01 Page 4 of 5
Although the risk of gas market prices collapsing exists, Utilities will implement the gas
supply procurement plan because of its benefits of cost stability resulting in greater retail
rate stability for its customers.
PREPARED BY:Jane Ratchye, Senior Resource Planner
DEPARTMENT HEAD APPROVAL:
ULRICH
of Utilities
CITY MANAGER APPROVAL:MI~L~s0~-
Assistant City Manager
CMR: 196:01 Page 5 of 5