Resolution No. 7728RESOLUTION NO. 7728
A RESOLUTION OF THE CITY COUNCIL OF THE
CITY OF VERNON AMENDING RESOLUTION NO. 7489
WHICH ADOPTED A STRATEGIC DIRECTION REPORT
FOR THE UTILITIES DEPARTMENT
WHEREAS, the City Council has approved a Resource
Procurement Plan and Credit Risk Management Policy (the "Policy") for,
the Utilities Department (the "Department") in order to enable the
Department to plan, execute and control the management of a variety
of risk inherent in power resource procurement in the deregulated
power market;
WHEREAS, the Policy requires the establishment of a multi-
year strategic direction for resource procurement;
WHEREAS, the Department has prepared a Strategic Direction
for Resource Procurement and Portfolio Management (the "Strategic
Direction") to satisfy the requirements of the Policy, to establish
and communicate a plan that will enable the Department to provide low
cost power and optimize its resource portfolio while managing and
mitigating risk; and
WHEREAS, the City Administrator, by letter dated March 14,
2001, has recommended the adoption of the Strategic Direction.
NOW, THEREFORE, BE IT RESOLVED BY THE CITY COUNCIL OF THE
CITY OF VERNON AS FOLLOWS:
SECTION 1: The City Council of the City of Vernon does
hereby find and determine that the recitals contained hereinabove are
true and correct.
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SECTION 2: The City Council of the City of Vernon hereby
approvesandadopts the Strategic Direction For Resource Procurement
and Portfolio Management, (the "Strategic Direction"), for calendar
year 2001, presented to the City Council concurrently with this
Resolution, and the City Council hereby orders said Strategic
Direction to be received and filed by the City Clerk.
SECTION 3: This Resolution replaces City Council
Resolution No. 7489 in its entirety.
SECTION 4: The City Clerk of the City of Vernon shall
certify to the passage of this Resolution and thereupon and
thereafter the same shall be in full force and effect.
APPROVED AND ADOPTED this 21"t day of March, 2001.
(ATTEST:
i --
Z�
BRUCE V. MALKENHORST, City Clerk
EONIS C. MALB G, Ma or
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STATE OF CALIFORNIA )
COUNTY OF LOS ANGELES )
I, BRUCE V. MALKENHORST, City Clerk of the City of Vernon,
do hereby certify that the foregoing Resolution, being Resolution
No. 7728, was duly adopted by the City Council of the City of Vernon
at a regular meeting of the City Council duly held on Wednesday,
March 21St, 2001, and thereafter was duly signed by the Mayor of the
City of Vernon.
BRUCE V. MALKENHORST, City Clerk
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SUPPORTING
DOCUMENTS
OFFICE OF THE CITY ADMINISTRATOR/CITY CLERK
INTER -OFFICE MEMORANDUM
DATE: March 27, 2001
TO: Kenneth DeDario
Director of Utilities
FROM: Gloria Oros o, hief Deputy City Clerk
RE: Resolution Nos. 7728
Transmitted herewith is Resolution No. 7728 approved and
adopted by City Council at their meeting held March 21,
2001.
GJO:ng
C C :
Ert c, ��ti
CITY COUNCIL
LEONIS C. MALBURG
Mayor
THOMAS A. YBARRA
Mayor Pro-Tem
WM. 'BILL" DAVIS
Councilman
H. "LARRY" GONZALES
Councilman
W. MICHAEL MCCORMICK
Councilman
BRUCE V. MALKENHORST
City Administrator / City Clerk
FAX (323) 581-7924
City Council
City of Vernon
Honorable Members:
EDUARDO OLIVO
City Attorney
FAX: (562) 927-8722
VIN WILSON
ireeofmmunity Services & Water
1: (323) 588-2761
�j' ^ lKgEETHDeDARIO
coro cipal Utilities
/) o� F : (323) 583-1983
STEVEN E. PARKER
Fire Chief
FAX: (323) 581-1385
CITY HALL
4305 SANTA FE AVENUE, VERNON, CALIFORNIA 90058
TELEPHONE (323) 583-8811
March 14, 2001
BRUCE W. OLSON
Police Chief
FAX: (323) 583-5236
On February 16, 1999, this legislative body approved the Resource
Procurement Plan & Credit Risk Management Policy (Plan & Policy) which
established guidelines for the Utilities Department to plan, execute,
and control the management of a variety of risks inherent in power
resource procurement. Section 3.4 of the Plan & Policy requires the
establishment of a multi -year strategic direction for resource
procurement and the net position risk tolerance for the department.
This directional plan will enable the department to provide low cost
power and optimize its portfolio while manage and mitigate risk.
The City of Vernon's Strategic Direction has been reviewed by our
Financial Consultant and it is hereby recommended that the Strategic
Direction for Resource Procurement and Portfolio Management be
approved and adopted.
Very truly yours,
Bruce V. Malkenhorst
City Administrator/City Clerk
BVM/ng
March 12, 2001
TO: Bruce V. Malkenhorst, City Administrator
FROM: Kenneth J. DeDario, Director of Utilities Y
SUBJECT: Strategic Direction For Resource Procurement And Portfolio Management
I recommend approval of the attached Strategic Direction For Resource Procurement
and Portfolio Management (Strategic Direction).
On February 16, 1999 Council approved the Resource Procurement Plan &Credit Risk
Management Policy (Plan & Policy) which established guidelines for the Utilities
Department to plan, execute and control the management of a variety of risks inherent
in power resource procurement. Section 3.4 of the Plan & Policy requires the
establishment of a multi -year strategic direction for resource procurement and the net
position risk tolerance for the Utilities Department. The attached Strategic Direction
document satisfies those requirements, establishing and communicating a plan that will
better enable the Utilities Department to provide low cost power and optimize its
portfolio while managing and mitigating risk. This has been reviewed by the City's
Financial Legal Consultant, Eric T. Fresch.
If you have any questions or comments, please contact me. Thank you for you
consideration.
KJD:ah
Attachment
119
CITY OF VERNON
UTILITIES DEPARTMENT
STRATEGIC DIRECTION
RESOURCE PROCUREMENT
AND PORTFOLIO MANAGEMENT
March 21, 2001
STRATEGIC DIRECTION
I. SUMMARY .................................................... 3
H.
PURPOSE.............................................................................................................. 4
III.
UTILITIES DEPARTMENT OBJECTIVES....................................................
5
A) Retain and Attract Customer Base.................................................................
5
B) Be Financially Sound.....................................................................................
5
C) Optimize Resources.......................................................................................
5
IV.
LOAD/RESOURCE BALANCE.........................................................................
6
V.
PRICE POSITION................................................................................................ 8
VL
TRANSACTION TOOLS.................................................................................... 9
V11
STRATEGIC OPTIONS.........................:..........................................................
10
VIII.
RECOMMENDED STRATEGY.......................................................................
12
IX.
RISK PROFILE..................................................................................................
13
X.
RISK TOLERANCE.........................................................---...............................
14
2
L SUMMARY
The City of Vernon's overall electricity position is mostly balanced through June.
2005. A series of long-term purchases and hedges, starting in early 2000, have
put Vernon in the position of meeting almost all of its load requirements for the
next four years. The decision to balance the portfolio was a result of recognizing
the unacceptably high financial risk to Vernon and its customers with respect to a
short position in the highly volatile California energy market.
One of Vernon's key goals is to provide low cost power while maintaining the
reliability of the electric distribution system. Up until early 2000, this had been
accomplished through the purchase of energy and related products and services in
the short-term wholesale electricity market. The Utilities Department (the
"Department") maintained low electric rates, satisfying existing customers and
attracting new customers and business. In 2000, the risk and cost of this short-
term strategy became unacceptable; i.e. market risk exceeded Vernon's risk
tolerance. For that reason, the Department purchased long-term energy to satisfy
most or all of its energy requirements while maintaining relatively low rates for
its customers.
The deregulated power market continues to present challenges for the Department
to provide low cost power to its customers on a long-term basis. The challenges
include competition from various sources for buying and selling low cost power,
developing and implementing the skills and conditions necessary to participate in
different markets for physical supply and financial hedges, and managing
portfolio risks, including credit risk. Since early 2000, the Department has
expanded its transaction tools 1 (see Section VI) and transaction horizon to meet
the objective of low cost energy at low -to -moderate risk. Other operational
changes and strategies are being considered. These strategies are discussed
herein, leading to a proposed strategic direction to govern for the next 12 months.
' In accordance with the fifth bullet item of Section 3.4.1 of the Resource Procurement Plan & Credit Risk
Management Policy
3
H. PURPOSE
Section 3.4 of the Resource Procurement Plan & Credit Risk Management Policy
requires the Director of the Utilities Department to work with the City Council to
establish a multi -year strategic direction for resource procurement, consistent with
Vernon's risk tolerance. The purpose of this document is to satisfy that
requirement, and establish a plan for the Department to take the necessary steps to
continue to provide low cost power and optimize its portfolio while managing and
mitigating risk.
The document should be reviewed and revised, as appropriate, on an annual basis
and as market conditions warrant.
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The Department's operational objectives are:
A) Retain and Attract Customer Base
Provide reliable, quality service and satisfy customers, while maintaining
low and competitive electric rates 2.
B) Be Financially Sound
Plan and conduct operations such that the total expenses of the
Department, including depreciation, are less than revenues.
C) Optimize Resources
Utilize the skills and assets of the Department to optimize power
resources.
The proposed strategic direction in this document is designed to meet or
exceed these objectives. The objectives are the driving force in the
activities of the Department.
2 It is expected Vernon's current average 6.2¢lkwh rate will satisfy this objective through June 2005.
5
IV. LOAD/RESOURCE BALANCE
A load/resource balance shows the energy demand (load) vs. the energy available
(resources) to satisfy the demand. Vernon's total resources (purchases plus
generation) meet most of on -peak load through June 2005, and most of the off-
peak load through 2003. Vernon's position becomes increasingly short in
subsequent years (after June 2005 for on -peak and after 2003 for off-peak).
While intentional, this future short position is temporary while the Department
studies participation in generation projects and other options.
To be completely covered, load must be satisfied with resources that are
purchased and priced 3. Vernon's long-term purchases are priced, while
generation resources are not priced until fuel costs are fixed.
Figure 1 shows Vernon's average monthly on -peak and off-peak loads in fiscal
year 2002. Vernon's load growth is forecast to be flat for the next five years, so
the monthly loads are representative for the next few years.
Figure 2 shows Vernon's capacity (peak) for both on -peak and off-peak loads in
fiscal year 2002.
3 Resources can be either physical or financial. Financial positions are eventually converted to physical
resources.
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Vernon's generation resources are the Palo Verde nuclear plant, Hoover Dam, and
Vernon -based gas turbines and diesels. The generation capacity available to
Vernon from these resources is 58 MW. Due to operational and economic
limitations, these resources are expected to produce less than 16 MW of base
load. Therefore, most of Vernon's energy needs are met with open -market
purchases from various counter -parties.
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V. PRICE POSITION
Since Vernon has a mostly balanced portfolio through June 2005, the wholesale
price of electricity is less of a significant factor in examining Vernon's price
position. The volume and average price of Vernon's long-term purchases should
support the City's competitive rate of 6.2 ¢lkwh.
Figure 3 shows Vernon's price position from FY 2002 to FY 2005.
Figure 3: Price Risk Position
FY2002 to FY2005 i
0/kwh
7.5
i
6.5
i
i
5.5
4.5 I
3.5
i
2.5
i
FY02 FY03 FY04 FY05
Avg Total Rate --On-Peak Purchases —Off-Peak Purchases
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VI. TRANSACTION TOOLS
The Department has capitalized on its authorization to use various transaction
tools to meet its objective of low cost energy at low -to -moderate risk. The
Department will continue to monitor the market for opportunities to protect and
optimize Vernon's energy portfolio.
One or more of the following transactions have been used by the Department to
manage Vernon's energy portfolio:
• Futures: financial positions (contracts) on the New York Mercantile Exchange
(NYMEX) in electricity or natural gas that can be converted to physical
positions for delivery with a counter -party at expiration of the contract 4
• Forwards: same as futures, except the position is a bilateral contract with a
specific counter -party is the over-the-counter market (generally through
WSPP agreement)
• Swap: a contract to exchange fixed for floating payments on a given quantity
of electricity
• Contracts for differences: same as a swap, except the fixed for floating
payments are on differences in price between two locations for electricity
• Option: a contract that, for a premium, gives the buyer the right to buy or sell
electricity at a given price (the strike price) on or before a specific date
• Market position management: exchanging one physical position in electricity
for another of the same quantity, but at a different location or for a different
delivery period-
4 Only financial positions in electricity would be converted to physical positions for delivery.
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VIE. STRATEGIC OPTIONS
With its mostly balanced portfolio through June 2005, the Department has ample
time to develop and implement long term solutions to its energy requirements_
The following solutions (strategic options) have been implemented or are under
consideration by the Department:
A. Purchase short-term supplies to satisfy balance of requirements
B. Purchase long-term supplies to satisfy balance of requirements
C. Purchase or develop generation assets
A. Since the Department converted Vernon's short energy position to a
mostly balanced position through June 2005, a "short-term purchase
strategy" has been in effect. This approach, coupled with risk limiting
transactions, is a fair and reasonable approach to managing Vernon's
energy portfolio until after June 2005 when Vernon's open position
increases. Short-term purchases were the Department's default strategy
before deregulation. A short-term strategy is not considered an
appropriate long-term solution to Vernon's energy requirements and its
commitment to low rates because of the high prices and volatility in the
energy market. Other strategies are warranted-
B. The "long-term purchase strategy" has been in effect since early 2000 and
has been beneficial to Vernon. The City is expecting to maintain its low
rates through June 2005 while satisfying its energy requirements.
Typically, long-term purchases are more reasonably priced than short-term
purchases, and establish working relationships with asset -based energy
suppliers. The strategy creates long-term commitments (supply
dependency), however, and exposes the City to increased credit risk.
Credit risk is controlled by ensuring energy suppliers have generation
assets, a long-term market presence, and substantial financial strength.
Vernon's current and future suppliers satisfy these requirements, but this
strategy still leaves Vernon dependent on favorable power market prices in
the future. Future power prices may not support Vernon's low rates after
June 2005.
C. The "owned generation strategy" is a long-term solution to the risk of high
power prices on Vernon's entire portfolio after June 2005, as well as the
risk of high power prices on the balance of requirements up until June
2005. There are many types of generation assets (e.g. gas -fired turbines,
fuel cells, solar thermal units, micro -turbines, and photovoltaics) requiring
significant capital commitments. Given high power prices, the payoff
period for these assets is much shorter than historical. Gas -fired turbines
shift price risk from electricity to natural gas, which is generally less.
volatile and much more easily hedged than power. Additionally,
generation within the ISO -controlled area will provide Vernon the
opportunity to self -provide ancillary services.
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Owned generation is not without risk -- there are operational issues
(performance, reliability, etc.). However, economic generation assets will
give Vernon a more robust portfolio and more effective price control.
They also provide an opportunity to increase revenues that, in turn, will
help Vernon to maintain low rates.
The Department is actively engaged in evaluating the benefits of
developing and owning different generation assets.
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A combination of strategies A, B, and C is recommended, with increasing
emphasis on C (owned -generation) as 2005 approaches. The combined strategies
build on the Department's success in balancing its portfolio and capitalize on the
Department's experience and transactions authorizations. The Department NNIIII
strive to implement the combined strategies over the course of the next 12
months.
Given this approach, Figure 4 indicates how Vernon's energy requirement may
be satisfied in the next few years. Short-term (S-T) purchases are less than one
year and long-term transactions are greater than I year. Long-term (L-T)
transactions include purchases associated with the Palo Verde nuclear plant and
Hoover Dam.
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Figure 4: Energy Coverage
100
W
E
80
-
Cr
60
W
40
0
20.1
-----------
0
FY01
FY02 FY03 FY04 FY05 FY06
- ----------- - - - -------
0 S-T Purchs 0 L-T Purchs ■ Owned Generation 11
-------- -- -----
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IX. RISK PROFILE
A risk profile provides an assessment of the economic risk in an organization's
portfolio. The profile shows the marked -to -market position of the organization
(volume long or short at an average price) vs. the market price. From the risk
profile, the risk position of the organization can be established on a qualitative
(low to high) and quantitative basis (measured in $ at risk).
An open energy position (fixed-rate sales vs. floating costs) has the risk of the
cost of power exceeding rates at any time --- particularly in high load periods (e.g.
summer and winter) and during abnormal operating conditions (e.g. resource
outages). If the cost of power exceeds rates, the result is a negative cash flow
that, over time, could be substantial. Since early 2000, Vernon's open position
has been modified to a mostly balanced position. As such, the economic risk in
the portfolio has been significantly reduced --- at least through June 2005. Thus,
the City has a low -to -moderate risk profile.
However, there is moderate risk in the sense that not all load requirements have
been met and market prices remain high and volatile. Additionally, there is a
small, but not insignificant, risk of a collapse in load due to an economic
recession and, to a lesser extent, energy conservation efforts. The Department is
monitoring this "reduced load" risk and will take the necessary steps to manage
the risk, including selling power from long-term purchases as necessary.
The portfolio risk may be further reduced by developing economic owned
generation and opening risk -limiting transactions (e.g. purchasing call options)
throughout the year, especially in the third quarter. The Department is examining
opportunities to develop and own economic assets. It is already authorized and `
positioned to take advantage of risk -limiting transactions as they become
available and are economically attractive.
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X. RISK TOLERANCE
For a utility with a short position, risk tolerance is defined by the extent
and time the utility is willing to leave its load uncommitted (i.e. leave its
position open). For example, in a high cash flow risk period such as the
third quarter, covering the open position with real time transactions only
reflects a high degree of risk tolerance. Conversely, in a low risk period
such as the second quarter, covering the open position at the earliest
opportunity reflects a low degree of risk tolerance. (Note that low risk
tolerance does not necessarily lead to optimal purchase decisions.)
Given the volatility and magnitude of power market prices, the
Department has adopted a low -to -moderate degree of risk tolerance. This
is reflected in its long-term purchase decisions and the increased emphasis
on owned -generation. Based on recent experience and market
expectations, a low -to -moderate degree of risk tolerance is warranted. The
Department has successfully implemented risk -limiting transactions and
tools in the past year.
The risk tolerance and resulting portfolio position will be updated and
revised as appropriate, based on the latest market information, to enable
the Department to meet or exceed its objective of providing low cost,
reliable power to its customers.
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