HomeMy WebLinkAboutStaff Report 263:93-
HONORABLE CITY COUNCIL
Palo Alto, California
Attention: Finance committee
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U1ILrfIBS RESERVE poLICY RECOKMENDATIQ~
Members of the Council:
Report ill Brie;
Staff recomzne11ds that the Council adopt the attached. resolution
establishing the Utilities Reserve Pelley described in this report
effective FOi 1993-94. The recommendation is that a Rate
Stabilization Reserve, with ne~ reserve level guidelines, be
establisbed to replace and incorporate t~e existing System
Improvement Reserve and Trar.sfe.r stabilization Reserve in funds
where applicable. A Rate Stabilization Reserve ~ould be created
for the water~ Ga:$., Electric, Refuse, storm Drain, wastewater
'IrE:at-ment and Waste'Water Collection Funds. NeW' reserve level
qudelines would be established for all utility funds except the
Storm Crain Fund. No other changes to reserve titles or purposes
are propose.d.
Backqroun4
By Charter or by Council action, a number of Util itie$ reserves
have been established for various purposes. A..."il.ong these reserves
are the:
• E:tlergency Plant Replacement Reserve,
• System Improvement Reserve
• Transfer Stabilization Reserve
• Calaveras Reserve, and
• Gas Supplemental Supply Reserve
All uti! ity funds have, as a minimum, an EIl'_el."gency Plant
Replacement Reserve (except Refuse and storm Drain) and a System
Improvement Rese-rve, whil€ somoe reserves are unique to a given
fund. 'l'his fiscal year the Utilities Advisory commission indicated
an interest in reviewing the Utilities reserve policies. To
accomplish this revie~, staff ~ompleted a comprehensive fin~nci~l
review of the Palo Alto Utilities, inclu~ing reserves.
A review-of reserve policies for-other municip~l utilities -,,'as also
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cond'..!cted. Not surp.i:isingly, policies varied and W'ere largely
influenced by local conditions. A number of fac:tor-s contrit.'ute to
a diversit)· of reserves and reserve level measure:inents. 'l'he~e
include the locale (exposure to storms), political cli~ate,
competitive rates. system relia~ility, infrastructure status, bond
rat.irlgs, legal requirements, etc. Res~rvE. le ..... els are set using
s~veral approaches. These include: as a percent of undepreciated
fixed assets, to achieve debt service coverage, based on a nurrJ:er
of days cash requirement, based on a ce~tain n4mber of months {2-12
months) of gross sales re .... enue • .or as a percent {5-25 percent) of
operating expenditures. 'I"he approaches are tailored to meet local
requirem~nts and necessarily involve ~ncertai~ties that they toee.
The approach tak~n by Palo Alto involved a prospective analysis of
the financial exposure of each utility fund O'l,.'er the next ten
years. Staff evaluated those exper.ditu~es ~hich should
appropriately be funded through rates snQ those which are better
suited to reserve funding. By identi f:fing events 'Which could
impact the reserves, the ade~~acy of reserve level guidelines could
be tested. Based C~1: this quaTltitative and q'ualitative analysis.
staff considered co!"..bining r deletin<j, and/or creating reserves
which would result in the lOlJest possible stable rates to the
consUlUer, .. hil~ allowing the Utilitie:s:. to meet the financial
challenges in the future.
Discuss-ion
The following narrative reflects the recommended r-eserve pol icy on
which the proposed changes are founded upon:
Generally speaking, reserves should be established to finance
extraordinary one-time contingencies. Reserves should net be used
to solve long-term financial pro~lems. Rates should be established
to finance cuz-rent operating, cap1.tal, and financial obligatior.s
ill'hich are of an ongoing nat' .. re. l'hus; cw.rrent operations are
fUnded from current revenues. }I,lso, reserves should ncot be funded
to cove.r !!l.ajor catastrophic disasters. ThE! City has insurar.ce
covera.ge at certai.n levels an;;l other goverrunental resources can be
made available in disaster situations. In the event currenl:
operatinq C~$ts exceed current revenues, reserves should be used to
cover increased operati~g costs in the short-run, ~hile allowing
rates to gradually increase over a reasonable period to meet such
cost levf!ls.
Reserve level guidelines shculd be set to al:ow reserves to float
up or down without unduly falling belo....-the minimum or above the
maxin'.'..l.:m; and thereby trigger a r1<Harr.ing siren". Reserve targets
should not be construed as a rigidly defined standard that dictates
the level of financial resources to be maintained for
contingencies,. The decision to set aside Itore money or less lr',oney
than the target should be basec on an assessment of the
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uncertainties and financial risk facing the utilities. The
recommended reser¥·e lavel guidelines 3re identified later in L,is
report .
current reserve po] icy regarding procedures of Council notificatior.
and disposition of '" surplus ",ill continue. Council ",ill be
informed in the Midyear Financial Feport, as well as in the Fourth
Quarter Financial Report, of an.y existing or potential issues known
at that time involving the reserves. In the absence of direction
from the Council to immediately address disposition of a reserve
surplus, the disposition ...... i 11 be addressed in the following year
budget cycle. Disposition mey include a rate reduction, customer
rebate, applying the surplus towards a financial obligation, or if
justifiea, allowing the reserve to remain in a surplus for a stated
period of time4 Existing policy requiring Council authorization
of the use of the reserve is continued. Thus, the mere fact of
the existence of a reserve ~s a rescurce to fund expenditures ...... ill
not guarantee t.hat. such expen..:!i tures "will be fundt.!d unless the
Council authoriZes s-.tch action. In t.his mannGr, utilities
management is held accountable for operating efficiently and t.he
council makes the decision regarding the use of reserves.
As a matter of public policy, it is desirable th~t annual revehue
requirements (rates) be driven primarily by real or known cost
factors rather than by planning assumptions. Each year in. the
budget formulation process, reasonable assumption.s (both favorable
and unfavorable) Wiill be put forth. The primary assumptions
affecti~9 the validity of the utilities Budget include: wholesale
co~odity costs including e~~ected weather and stream flow
conditions, the level ~~ capital improvement activity and general
fund transfer, debt service obligations, and sales forecasts. To
insure long-term financial stability, assumptions should be based
on base case scenarios taking into account those contingencies
which favorably impact the utilities as well as those which do net.
Decisions related to appropriate reserve and rate levels should ~e
made in the context of a fiVE: to ten yedr financial planning
horizon.
The follo~ing recommendations apply to the applicable reserves in
the Water, Gas, Electric, Retu~e, Waste*ater Collection, Wastewat~r
Treatment Funds, and St.orm Drain Funds:
• continue the E!I1ergenc'j Plant Replacement Reserve .... ith no
changes.
• Cantinue the calaveras Reser.re with no changes.
• continue the Gas Supplement21l supply Reserve with no
changes.
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• Continue the Gas conservation Lo~r. Rp-serve with no chang~s .
• Create a Rst~ Btabili.atioD R6serve (RBR) to replace and
incorporate the e~i6ting s:':"stem ImproveIllent Reserve (SIR}
and Transfer Stabiliz~tion Reserve (TSR) in the applicable
funds. An RSR ~ould be created ter the _ater, gas,
electric, refu.~e I 'Waste ..... 'ater collection, 'Waste .... ater
treatment, and storm drain funds. An operating su~lu$
~ould be deposited into the RSR while operating deficits
would be ~ade up from the RSR.
There are three reasons for consclidating the Transfer
Stabilization Reserve and system Improvement Rezerve. The first
reason is that the uncertainty and fluctuation related to the
Utilities Transfer to the General Fund has substantially dimir.ished
~ince adoption of the Utility Enterprise Method. Since FY Be-81
the utilities have been acle to make whateve.r Transfer to the
Gene.ral Fund that has been adopt.ed. 'l'he se_cond reason is that
rates have already, or will be, rising to finance the
Infrastructure Projects for the 1990's. This reduces the need to
have a specific System Improvement Reserve to address these largest
of Capital Improvement-Projects. The third reason is to revise
utility policies to more accurately reflect current practice. The
'l'SR and SIR az.'e presently being used priJt.arily to stabilize rates
and are therefore rate stabilization re3er'es.
Recommended R.eserv. Level Gui4_",lin,.a for Rate Btab1-_Jil._ation lteserY4!
The proposed Rate Stabilization Reserve level guidelines are
designed to serve as warning sirens, ..... ·hile allowing reserves to
float within these guidelines without creating a deficit/surplus
situation. When a reserve level falls below a minimum level or
exceeds a maximum level, it triggers a management response.
Guidelines which are set too 10\11 can place the utility in a
financially vulnera~le condition while too generous a gu id'Sline can
a110·. a reser"e surplus to accumulate unintentionally. Sinc02
selecting a guideline involves a degree of judgement and
uT'-::ertaint:;~, the adequacy and pn.ldency of these guidelines .... ill bf;
reviewed internally each year and; if appropriate, revised
guidelines will be recommended.
The RSR level guidelines are based on an identical formula for the
Water, Gas, and Wastewater Collection Funds. Similar formulas are
suggested for F.efuse and. Waste",'ater Treatment. Howe .... er, because of
some major, outstanding contingencies ~hich could impact electric
purchases cost, a different formula is used tor the Electric Fund
RSR to better recognize this potential cost burden. At this time,
the staff recommends that an RSR be created in the Storm Drain Fund
in title only, while retaining the current system improvement
reserve guideline for the RSR. The app~opriateness of adopting new
reserve level guidelines for the Storm Drain Fund will be
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evaluated, pending completion of two st.udies under.,-ay dealing with
the. existing infrastructure and a ne .. master plan.
ill ReCQlIIJI.8D~e~ water, Gas, WII.stewater Collecti.on, -.. astewater
Tr.atment &n~ Refuse Rese~~. Level Gui~eli~e8-
Reserve Balar.ce Mini.;:n~rn Guidel ine-The sum of:
1) 15 percent (10 percent for Refuse) of sales revenue
for that year; plu3
2) Estimated annual net sales revenue decline due to
abnormal irfe<lther. (This second component does not
apply to Refuse cr waste· .... ater Treatment:).
Reserve Level Tarqet Guideline-Midpoint of minimum and maximum
gUideline.
P.es?r ... e Balance MaxiJ:r1.um n ,Guidel ine-T¥lice the minimum guidel ine.
1) Fifteen percent of sales revenue is recommended ~s one of the
two elements for this guideline. This element is intended to cover
~ormal operating budget variances, as ~ell as current operating anc
capital costs not covered by C:.lrl-ent rates. since budgets are
prospective by nature, er.d of the year variances often result, are
identified, and 'With council approval, are funded by a reserve to
balance the budget. In addition, any expenditure reay rise from
year to year between rate adju~tments. To finance such budgeted
expenses and to help stabilize rates, reserves are .... ithdrawn. such
financial fle~ibility allows rate increasi?!s of the six utilities to
be planned and staggered, in order to minimize the bill iffipact on
our customers.
Given the above objectives for the RSR, a review of the nature,
timing. and magnitude of expenditures which could dra~ dOwn on the
reser,;e indicates that a resulting g'uideline level based 0;'1 15
percent of sales revenue ...... ·ill be adequate and p:-udent for most
utilities. However_ the Refuse Fund P£R guideline is recomme~ded
at 10 percent beca'Use this fund is not as capital intensive as aI.'e
the other utilities and, unlike other utility funds, the Refuse
Fun:j is required to DlCllintain separat.e reserves to fund long teno
environmental care and impac'ts. Such additional reserves diminish
the need to fund the Refuse Fund RSR aC the same level as other
.... tilities. The guideline range recommended is reasonably
consistent with the current General Fund Reserve Policy, \o'hich is
based on a 10 percen't. minimum and J 0 percent :rr.aximum of annual
budgeted General Fund operating exp~ndjtures.
2) rn addition, there is a need for some utilities to have funds
available to cover fixed cost.s during abnormal W'eatrler periods such
as a drought or \o'~r.:m 'Weather. i·his (sales revenue erosion) is
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applicC!.ble to the ;,tater I gas, 2Ind ~""aste\o,'ate:r funds and is net
applicable to the refuse fund. The amount is calculated for the
respective tund based on the impact of on~ year abnormal ~eather en
net sales reven~e.
These two items l .... hen added, should ordin<::rily be s ... fficient to
also cover extraordinary ene-time contJngencies. The JIlBx:imum level
could provide additional reSO'lrces for unforeseen contingencies in
the future •
• Electric Reserve Level Guidelines-The recommended minimum reserve
level guideline is a~ amount based on 35 percent of next year's
pcwer purchases cost~ Th~ maximum reserve level guideline is an
amount based on 70 pez.-cent of next year's paver purchases cosi:..
The target is halfway between the minimum and maximum. The
percentages were derived by correlating the expected ~ost of
approximately 12 contingencies with ar,r.ual power purchases cost
ties a measurable yardsticlc tW over the next five years. Alnong these
contingencies is an a!l1ount necessary to cover ongoing budget
variances, the impact of poor hydro conditioros on power costs, and
a number of contingencies such as an energy tax which could cause
the western Area Po~er Administration to charge more for
electricity.
Impaet _QL~tilitiils Reserve po1iey A~_<?gendaticD'
For :most funds, the impact. of implementing the reserve pol icy
reconunendations is not expected to be significant relative to
current reserve policy. A comparison of the proposed PSR reserve
guidel ines with exi.st.ing reserve guidelines for the SIR and '1'SR .. as
~edp. based on the current fiscal year. Adopting the propos~d P$R
policy will result in the follovinq:
• Gas Fund: The miniIiru.m, target, and maximum guidelines will
be lowered apprc·xirnately 6 to 10 p~rcen.t.~
!I. RefUse Furld: The minimum g1.l.idelir:.e for the SIR is $2,000,000
~hile applicacian of the RSR minimum guideline would be
approxi'mately $1,950,000 -basically no difference.
• Electric Fund: Based on Fi 1992-93 datal adoption of the
RSR would have resulted in a 10.8 percent increase in the
minimum guideline and a 12.7 percent increase in the ma)(i::nulJl
guideline relc;,tive to e)(isting guidel ines for the combined
srR aI'!d TSR.
• Water Fund: T~e minimu~, target and maximum guidelines ~ill
b~ raised 21-30 percent. This is considered a favorable
result since this fund has traditionally peen underfunded.
• Wastewater Collection Fund: Based on FY 1992-93 data, the
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minimuT!l~ target, and m<3.XilJ1UDl C'uidelines will be raised
approximately 100 percent~ H;wever, because a major
infrastructure capital projec:t is planned f,or 1994, the
re6ul ting reserve guidel ines for this fund .ill act .... ally
decreas~ under the RSR formula. The reason is t.hat the
current SIP. formula is based en th_@-next 'i"ear I s elF 'Which
'Will rise substantially in 1994" For example, the SlR
ndnilllum guideline level for 'F'i 199)-9" • .. :o~ld be $3.4
million (75% of $4.5 million, which is FY 1994-95 eIP;. In
comparison, the RSR minimum guidel ine for F"'i 1993-94 is
$2.4million. Therefore, adoption of the RSR ""ould result in
a 29 percent lower guideline for FY 1993-94 .
• Storm Drain Fund: No impact, change in title only.
In the Wastewater Treatment Fund, it appears tt-.at the larqest
impact v.rould occur by replacing the current SIR .... ith an RSR. For
example, the min:i.rnum guidel ine for the SIR would be approximately
$700,000 while the mini-rr'.u111 guideline for an RSR would be
approximately $1,500,000. Despite the significant increase, this
outcome 15 not considered undesirable due to that fund's exposure
to long delays in payments in dispute from certain partners. On
one occasion, East Palo 1t.lto withheld pay:oent of approximately
$500,000 for six months while disputinq an issue. Sucr~ delays
impact ~orking capital and dra~ dc~n on reseL~es.
"ecOM.enda.tiol!.
Staff recommends that the Council adopt the attached resolution
establishing the proposed Util ities Reserve Policy contained in
this report effective FY 1993-94.
Respectfully submitted,
'-(./4~7~i(<L-/ _
w. RANDY BALD$CHw~
Assl.stant Director of Utilities/ A1?n:;1ices
EDwARD J. KRIZEK
Interi~ Director of utilities
~ City Manager
Attachment: R~solution
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RESOLtrr'rON NO.
RESOLUTION OF THE COUNCIL OF TliE CITY OF PALO ALTO
ESTA.I3LISHING RATE STABILIZAT!ON RBSEr-.VES FOR THE
ELECTRIC, GAS, REFUSE, STO~ DRAIN r WASTEWATER,
N.tD WATER UTILITIES
WHER?AS. pursuant to its Resolution No. 639 C, adopt.ed
May 28, 19S5~ and Ordinance No. 3622. adopted June 24, 1985, the
City of Palo Alto established transfer stabilization reserves fo~
its electric, gas l and water utilities; and
WHEREAS, pursuant to its Resolution No+ £331, ad.:;J:pted May
28, 1985 .. the Cit}, o~ Palo Alto est-ablishe,d a system improvement
reserve for its ..... ater utility; and
W"rlEREAS, pursuant to Ordina:J.::'.e No. 3477, adopted October 3,
19B3, the City of Palo Alto established a system ~mprovf' .. !·l'1.ent
reserve for its gas utility; and
'WHEREAS, at various times, tt-~e Cou:-~cil has adopte,:; or
consented to the establ ishrner..t of s),stem improvement reserves to.:.
its electric, refuse, storm drain, and wastewa~er utiliti~s; and
WHEREAS,. the Council has considered and adopted a Utiliti.es
Reserve Policy " .. hich becomes effective during the fiscal year 19.93 ..
94; a.nd
WHERP.AS, under thE Utilities Reserve Pol icy ~ the exist ing
system irr.provement resentes anj the transfer stabilization resenres
are replaced by rate stabilization res€rves for the electric, gas,
refuse, storm drain, wastewater, and water utilities;
NOW, THEKEFORE, the Council of tr.e Cit.:_y <:If Palo Alto d:J~s
nereby RESOLVE as follows!
SECTION 1. There iE hereby created Rate Stabilization
Reserves fOr the Electric,. Gas, Refu_se} Stonn Drain, Waste .. ,.ater
Collection, Wa.stewater Treatment, and Water Funds ..... hich \liill
replace an.d incorporate the existing system improvement reserve and
transfer stabilizatior~ reserve of each fund, as applicable. Rate
Stabilization Reserves shall be Established in order that the City
rray anticipate both contingent events, where operational and
capital imp~ov€ment costs of the utilities rr~y be irnpacteo l a~d
current circum..':~t3.nces, 'Where operating CQsts exceed operating
revenues. Tbe levels of the R::ite Sta.bili zation Resenres shall
conform to th,= reserve level guidel ines and other criteria set
forth in the Utilities Reserve Policy, as such may be amended fro~.
time to time. and shall b~ accounted for or disposed of by action
of the Council during the fiscal year in wr.:ich revemJes are pla::ed
therein or in the budget of the next succeeding fiscal year.
COUIJcil
actions
SECTION 2. Resolution Nos~ 6390 and 6391 and such other
ordinances and resolutions, or sections thereof, and
..... hich established the transfer stabilization reserves or
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sys'cem impr.ove.'nent r~selVes. or both, as applicable~ fa!' the City
of Palo Alto electric, gas, refuSE~ storm drain, 'Wastewater, a:1d
water utilities are hereby r~scinded and repealed.
SEr""T iON J. The Council finds that t~e adopt ion of thia
I'e901u~ion is exempted u:lder t~~ CEQA Guidelino:!s under Sc:ction
1$273 of Title 14 of the California Code of Regulations.
INTRODUCED p~~ PASSED:
AYES,
NOES!
ABSENT:
AF:l.STBh""TlONS:
APPROVED;
-------City Cle-rk
APPROVED AS TO :FOP,}~:
Se:'lior Asst. --City Attorney nfre-ctor of Fina.nce
Director of Utilities
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