Resolution No. 2012-045RESOLUTION NO. 2012-45
A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF
VERNON APPROVING AND ADOPTING A ENERGY AND CREDIT
RISK MANAGEMENT POLICY FOR THE CITY OF VERNON
WHEREAS, on December 17, 2007, the City Council of the City
of Vernon adopted Resolution No. 9500 approving and adopting an Energy
and Credit Risk Management Policy (the "Policy") for the City of
Vernon; and
WHEREAS, the Light & Power Department has prepared an
updated Policy to fulfill the current California Independent System
Operator ("CAISO") Tariff requirements for participating in the CAISO
markets and to satisfy anticipated requests from potential contractual
counterparties; and
WHEREAS, the Policy provides guidelines;.to govern the Light
& Power Department's energy portfolio and risk control activities and
provide a framework through which management and personnel will
identify, measure, manage, and report financial and other portfolio
risks; and
WHEREAS, the Policy is not intended to deal with the
mitigation of risk of catastrophic events, environmental impacts, or
regulatory exposures; and
WHEREAS, by memorandum dated March 19, 2012, the Director of
Light & Power has recommended the City Council of the City of Vernon
approve the updated Policy; and
WHEREAS, the City Council of the City of Vernon desires to
approve and adopt the Energy and Credit Risk Management Policy.
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 hereby
finds and determines that the recitals contained hereinabove are true
and correct.
SECTION 2: The City Council of the City of Vernon hereby
approves and adopts the Energy and Credit Risk Management Policy, a
copy of which is attached hereto as Exhibit A.
SECTION 3: The City Clerk of the City of Vernon shall
certify to the passage, approval and adoption of this resolution, and
the City Clerk of the City of Vernon shall cause this resolution and
the City Clerk's certification to be entered in the File of
Resolutions of the Council of this City.
APPROVED AND ADOPTED .this 3rd day of April, 2012.
Name: William J. Davis
Title:•-i e-r / Mayor Pro-Tem
2
STATE OF CALIFORNIA )
) ss
COUNTY OF LOS ANGELES )
I, Willard G. Yamaguchi, City Clerk of the City of Vernon, do
hereby certify that the foregoing Resolution, being Resolution
No. 2012-45, was duly passed, approved and adopted by the City Council
of the City of Vernon at a regular meeting of the City Council duly
held on Tuesday, April 3, 2012, and thereafter was duly signed by the
Mayor or Mayor Pro-Tem of the City of Vernon.
Executed this day of April"atvernon, alifoa.
W, ity Clerk
(SEAL)
- 3 -
EXHIBIT A
City of Vernon
Light & Power Department
ENERGY AND CREDIT RISK
MANAGEMENT POLICY
MARCH 15, 2012
TABLE OF CONTENTS
1.
SUMMARY
3
2.
OBJECTIVES
4
OVERVIEW
4
OBJECTIVES
4
RETAIN AND ATTRACT CUSTOMER BASE
4
BE FINANCIALLY SOUND
4
OPTIMIZE RESOURCES
4
3.
ENERGY PORTFOLIO
5
PHYSICAL POSITION
5
PRICE RISK POSITION
6
4.
RISKS
g
OPERATIONAL RISK
9
RESOURCE COST RISK
g
ORGANIZATIONAL RISK
10
TRADING
10
CREDIT RISK
10
COMPETITION
10
5.
RESPONSIBILITIES & AUTHORIZATIONS
11
TRANSACTIONS AUTHORITY
11
RISK MANAGEMENT RESPONSIBILITIES
11
CITY ADMINISTRATOR
1 I
DIRECTOR OF LIGHT & POWER
12
ENERGY & CREDIT RISK MANAGER
12
RESOURCE PLANNING MANAGER & RESOURCE SCHEDULERS
13
6.
RISK MANAGEMENT
14
RISK ANALYSIS
14
RISK MANAGEMENT TOOLS
14
HEDGES
14
STRATEGIES FOR MANAGING PRICE RISK
14
Energy Risk Management Policy 1
3/27/2012
7. AUTHORIZED TRANSACTIONS 16
TYPE 16
PHYSICAL 16
FINANCIAL
16
PURCHASES
16
SALES
16
AUTHORIZED TRADERS
16
TRANSACTION LIMITS
17
CHANGING LIMITS
18
8. REPORTING
19
REPORTING REQUIREMENTS
19
APPENDIX
20
A. CREDIT RISK CONTROL POLICY
20
B. TRANSACTION TERMINOLOGY
24
Energy Risk Management Policy 2 3/27/2012
1. SUMMARY
The Light and Power Department (L&P) is responsible for generation, transmission, and
distribution of electricity for the benefit of the City of Vernon (COV). L&P's primary
objectives are to develop the least cost supply portfolio to meet load requirements, to
hedge customers against volatility in rates associated with commodity and price risks
and to maximize revenues from sales of surplus energy, capacity, and other wholesale
energy services, while complying with this policy. There are risks associated with L&P's
responsibilities and objectives. This risk management Policy discusses and sets
guidelines to help L&P identify and manage those risks. Specifically, the Policy:
• Reflects the goals and risk tolerance of L&P, establishing limits and reporting
requirements, without placing undue restrictions on UP Operations
• Establishes guidelines for L&P to control the risks associated with an energy
portfolio and energy transactions
• Focuses on stabilizing the cost of energy and associated risk while maintaining
reliable energy supplies for retail customers
• Is not intended to deal with the mitigation of risk of catastrophic events,
environmental impacts, or regulatory exposures
This Policy is designed for the specific requirements and constraints of L&P. Resulting
risk management activities shall govern L&P's energy portfolio and risk control activities
and provide a framework through which management and personnel will identify,
measure, manage, and report financial and other portfolio risks. The results of risk
management activities will be continually evaluated relative to L&P's objectives to
ensure correct and beneficial implementation.
Energy Risk Management Policy 3 3/27/2012
2. OBJECTIVES
OVERVIEW
The L&P Department endeavors to provide low cost, reliable energy to its customers
without undue risk taking. In the volatile energy market, this is a significant challenge.
To meet this challenge, L&P participates in different markets (physical and financial)
with different requirements, transactions, and associated risks. Successful participation
requires developing and implementing portfolio and risk management procedures, skulls,
and tools.
OBJECTIVES
The L&P's objectives, that risk management activities are designed to help achieve, are:
RETAIN AND ATTRACT CUSTOMER BASE
Provide reliable, quality service and satisfy customers, while maintaining low and
competitive electric rates.
BE FINANCIALLY SOUND
Plan and conduct operations such that total expenses of L&P, including depreciation,
are less than revenues.
OPTIMIZE RESOURCES
Utilize the skills and assets of existing staff to optimize energy resources, including
allowing for hedging to protect against adverse changes in energy market prices and rate
increases to customers. However, unlike a private -sector entity, Vernon's primary
purpose in the power supply business is to serve its customers. The L&P Department's
goal is to be a cost hedger for its customer loads. The L&P Department is prohibited
under this policy from engaging in speculative activities typical to many organizations
orientated toward profit maximization. Taking risks in order to arbitrage market
opportunities, or risks unrelated to the L&P Department's normal power supply business
activities is prohibited.
Energy Risk Management Policy 4 3/27/2012
3.
4. ENERGY PORTFOLIO
Following is an overview of L&P's energy portfolio positions. The portfolio is
comprised of the physical position (load/resource balance) and the price risk position.
PHYSICAL POSITION
The physical position or load/resource balance shows the energy demand (load) vs. the
energy available (resources) to meet demand. L&P's total resources (generation plus
purchases) meet most or all of its on -peak and off-peak energy requirements for the
foreseeable future.
There are different ways to,present a load/resource balance. Table 3.1 shows L&P's
peak load -resource capacity balance on a fiscal year basis for on -peak and off-peak
requirements. Load growth is forecast to increase 1.5% annually for the next five years,
and resources are shown on a capacity basis.
Table 3.1— Peak Load vs. Resource Capacity Balance (MV* )
FY-12
FY13'
FY14
FY15
EY16
On -Peak
Peak Load
197
200
203
206
209
Hoover
22
22
22
22
22
Palo Verde
11
11
11
11
11
MGS
134
134
134
134
134
Renewable Energy
Purchases
60
25
60
70
80
s0
Net Long/(Short)
Position
55
27
34
41
38
FY72
, FPY13,,
Off -Peak
Peak Load
154
157
159
161
164
Palo Verde
11
11
11
ll
11
MGS
134
134
134
134
134
Renewable Energy
Purchases
60
60
70
80
80
Nei Long/(Short)
Position
51
48
56
64
61
' COV- owned gas turbine and diesel units not shown
Energy Risk Management Policy 5 3/27/2012
PRICE RISK POSITION
A utility's price risk position measures the utility's sales rates (retail and wholesale),
against its costs of generation. Typically, the sales rates are fixed while some of the costs
of generation are not fixed. This imbalance creates a "short" energy price risk, as
floating energy costs will increase with the market while fixed sales rates will not.
A short price position has the risk of the cost of resources nearing or exceeding sales 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 sales
rates, the result is a negative cash flow that, over time, will be detrimental to continued
operations.
For a balanced position, load must be met with resources that are purchased and priced 2.
(Depending on the resources, this may or may not be an economical decision. The issue
here is risk.) Some of L&P's resources are priced, except for the natural gas for MGS
and renewable energy resources. The resulting price risk position is shown in Table 3.23.
Table 3.2 —Price Risk Position (MV0
FY12
FY.13.
FY14
'.�FY15
Y16
On -Peak
Peak Load
197
200
203
206
209
Hoover
22
22
22
22
22
Palo Verde
I
11
11
11
11
1VMGS
75
75
75
75
75
Renewable Energy
Purchases
60
-
60
70
80
-
80
-
Nef Long/(Short)
Position
29
32
25
18
21
Off -Peak
Peak Load
154
157
159
161
164
Palo Verde
I1
11 -
11
11
11
MGS
75
75
75
75
75
Renewable Energy
Purchases
60
0
60
0
70
0
80
0
80
0
Net Long/(Short)
Position
8
11
3
5
2
2 Resources can be either physical or financial. Financial positions may be "converted" to
physical resources when the financial positions expire.
3 Volumes are consistent with Table 3.1
Energy Risk Management Policy 6 3/27/2012
The fact that MGS is the primary resource means most of L&P's energy price risk is in
natural gas rather than power
L&P will ensure L&P's price risk position stays within acceptable limits established in
this Policy.
Energy Risk Management Policy 7 3/27/2012
5. RISKS
L&P is a fairly active participant in the power and natural gas markets. Due to the
volatility and other variables in those markets, L&P is moderately exposed to cost
uncertainty in its energy portfolio, potentially resulting in net revenue shortfalls. L&P is
well positioned, however, in managing its energy cost and other uncertainties (risks)
through its experienced staff and implementation of the directives & authorizations in this
Policy.
The following table identifies the types of risk relevant to L&P through its energy market
activities. It summarizes how those risks are addressed.
Table 4.1- Tvaes of Risk
uperational
lnsutticient or excess
Higher costs than
Requires coordination
(Load-
resources to serve load
expected on surplus
on operational and
Resource
due to a range of
or deficit as
financial risk issues.
imbalances)
potential conditions
position is balanced
Builds on existing
(resource or
transaction
transmission outages;
authorizations & limits,
higher or lower
as well as monitoring
demand conditions
procedures.
than expected; poor
planning)
Resource Cost
Adverse fluctuations in
Energy costs higher
Allows for the use of
the wholesale prices of
than budget
risk management tools
power and natural gas
resulting in net
to stabilize prices and
purchased for resale or
revenue shortfalls
capture costs lower than
generation purposes
budget
Failure to capitalize on
Value not delivered
market opportunities to
to customers or
reduce costs.
L&P.
Organizational
Unclear lines of
Sub -optimum
Specifies transaction
authority or inadequate
pricing and
authorizations and
staffing, lack of deal
operational
limits, appropriate
"ownership"
decisions;
transactions flows, and
confusion within
reporting procedures.
and outside the
organization
Energy Risk Management Policy 8 3/27/2012
POTENTIAL
ENERGY&,CREDIT
RISK- '
DRION
-
NEGATIVE IMPACT
KMM .RISIAGEMENT, ;
;POLICY: , -
Trading
Trading activity
Financial losses
Permits limited asset -
separate from, but
related and portfolio -
complementary to,
consistent transactions
asset -based (covered)
under the authority of
activity
the Energy & Credit
Risk Manager
Credit
Inability or
Resale of energy at
Centralizes and
unwillingness of a
a lower price
consolidates the
counter -party to
resulting in reduced
responsibility for credit
perform in a bilateral
revenue or
activities under the
transaction
repurchase of
authority of the Energy
energy at a higher
& Credit Risk Manager
price resulting in
increased cost
Competition
More competitive
Reduced revenue
Authorizes L&P to
electric rates offered by
due to loss of
respond with different
competitors in
customers
energy pricing structures
surrounding regions;
for existing customers to
loss of customers
retain market share
OPERATIONAL RISK
All utilities have operational risks that are managed by standard and accepted industry
practices, such as the following:
• Maintaining adequate planning resource margins and operating reserves;
• Owning or contracting for fuel storage and/or fuel supply to assure continued
operations under potential shortage conditions;
• Emergency action and customer curtailment plans to respond to emergency
conditions.
Operational risk of extreme load conditions and resource or transmission outages are not
specifically addressed in this Policy because L&P is well experienced in preparing for
and managing these risks. The importance of an accurate load/resource balance forecast
and the ability to react to contingencies are well understood by L&P.
RESOURCE COST RISK
L&P's firm resources are cost competitive, particularly the hydroelectric and nuclear
energy resources. MGS is only at risk of being uneconomic relative to L&P's retail or
wholesale rates if natural gas prices are very high. L&P has higher price risk exposure to
power prices when and if L&P must purchase energy to meet peak load requirements. If
costs are exceedingly high, it may be necessary for L&P to increase its rates to recover
high costs.
Energy Risk Management Policy 9 3/27/2012
To protect margins and avoid the need for rate increases, this Policy authorizes L&P to
participate in the wholesale power and natural gas markets to manage its energy portfolio
proactively, seizing opportunities to limit risk and produce additional revenues, consistent
with this risk management policy. The power and natural gas markets contain
opportunities to stabilize prices through forward transactions, including hedges. L&P
will continue to capitalize on those opportunities to support existing rates.
ORGANIZATIONAL RISK
Responsibilities and authorizations by L&P are clearly delineated in Section 5.
TRADING
Trading, also referred to revenue generation activities, is permitted on a limited basis to
capitalize on occasional market opportunities in power and natural gas. A "trade" is a
transaction in the wholesale power or natural gas markets for the sole purpose of
generating a profit. The opening sale (or purchase) of power or natural gas will be closed
with the purchase (or sale) of a commodity, creating a financial gain or loss on the
transaction due to a difference in the opening and closing prices. A power trade sale
creates a short position at the outset. It is a sale in excess of available resources. A
power trade purchase is one that is not required to serve load and does not replace a
higher cost resource.
Trading contains price risk, potentially leading to financial losses. L&P's tolerance for
potentially significant financial losses is low. Therefore, only limited and controlled
transactions in highly liquid energy markets are permitted. Further, they are transactions
that are supported by and within the experience of the Energy & Credit Risk Manager.
Trading controls (responsibilities, limits, authorizations, and reports) are detailed in
Sections 5, 6, and 7.
CREDIT RISK
Credit exposure is the risk that a counterparty in a transaction will be unable or unwilling
to fulfill its present and future financial obligations; i.e. perform on a sale or purchase
agreement. Substantial unrealized gains or losses may accrue in physical contracts before
any delivery obligation. The value of outstanding contracts can escalate substantially
over time without the counter -party having to post or deposit any security in the form of
collateral. These credit exposures are a concern for over-the-counter (OTC) transactions,
not for exchange -based transactions.
L&P's Credit Risk Control Policy (Appendix A) governs and specifies the means to
manage counterparty credit risk.
COMPETITION
Among L&P's goals are to maintain and expand (if possible) market share and customer
base, so L&P must be empowered to respond to and provide competitive rates. The
authorizations and directives in this Policy empower L&P to do that, allowing for rate
changes to meet or beat competition while managing portfolio risks that may result from
rate changes.
Energy Risk Management Policy 10 3/27/2012
6. RESPONSIBILITIES & AUTHORIZATIONS
In general, the areas of responsibility of an organization engaged in physical and financial
power and natural gas transactions may be categorized as front, middle, and back -office
functions. These are listed in Table 5.1.
Table 5.1- Front. Middle, and Back -Office Functions
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Responsibility of L&P
Responsibility of the
Joint responsibility of
Department
Energy & Credit Risk
L&P and COV's Finance
Manager (or equivalents)
Department
• Marketing &
• Risk measurement,
• Confirmations
counterparty contact
monitoring, and
. Reconciliations
• Pricing
reporting
• Account booking
• Transaction booking
• Risk control Counter-
a Settlements
• Positioning
party credit
Invoicing
authorization &
• Scheduling
monitoring
• Trading/hedging
TRANSACTIONS AUTHORITY
Energy transactions range from hourly to multi -year deals. The longer the term and the
greater the volume, the higher the level of authority required to approve the transaction.
Real-time deals (hourly and balance -of -day) have the lowest level of authority, whereas
multi -year deals must be approved at the highest level. Specific authorizations by level
are shown in Table 7.1.
The risks accompanying these transactions are managed in different ways across all
authority levels.
RISK MANAGEMENT RESPONSIBILITIES
The individuals or groups responsible for implementing this Policy range from the City
Administrator to Resource Schedulers. Risk management responsibilities by authority
level are as follows:
City Administrator
The City Administrator is responsible to promote receptivity within COV to risk
management activities. He should also:
• Ensure L&P employees engage only in those activities that correlate with the
business needs of the organization
• Require management involvement to ensure adherence to this Policy at all levels
Energy Risk Management Policy 11 3/27/2012
• Support the implementation, tracking, and reporting of hedging and revenue
generation activities that include the use of financial instruments such as futures,
forwards, swaps, and options
Director of Light & Power
The Director of L&P is responsible for the overall direction, structure, conduct, and
reporting of risk management activities. He should report to the City Administrator
periodically on the results of risk management activities. He should also:
• Periodically assess the adequacy and functioning of risk management activities
relative to L&P's multi -year strategic direction
• Ensure the risk in the energy portfolio is within L&P's risk tolerance
• Assure that adequate staffing and resources are devoted to implementation of this
Policy
• Authorize traders and approve transaction counter parties
• Establish the tone of the organization with respect to the importance of the
resource procurement and control activities
• Set targets for energy purchases and sales to meet or beat budget projections
• Assure adequate reserves are maintained for credit operations and liquidity
Energy & Credit Risk Manager
The Energy & Credit Risk Manager is primarily responsible for implementation of this
Policy. He shall:
• Monitor compliance with this Policy
• Measure and report the risk taking and risk management activities of L&P with a
market position report
• Serve as the in-house expert on financial products and pricing and structuring of
physical contracts with embedded financial features
• Provide financial and physical market pricing expertise when evaluating the
feasibility of structured products and services to customers
• Take specific courses of action if a portfolio position exceeds or approaches the
limits established by this Policy
• Ensure that risks for all transactions have been identified and can be valued
• Monitor for breakdowns in execution of duties especially during changes in
personnel or organizational structure
• Be able to estimate the financial exposure in L&P's energy portfolio by applying
standard risk measurement and valuation tools
• Work with the Resource Planning Manager and Resource Schedulers to generate
additional revenues through opportunistic market transactions
Energy Risk Management Policy 12 3/27/2012
Resource Planning Manager & Resource Schedulers
The L&P Resource Planning Manager and Resource Schedulers are responsible for
execution and management of physical and financial energy portfolio activities.
Regarding risk management, they are responsible to:
• Develop physical and financial transaction expertise in power and natural gas
markets
• Abide by transaction limits specified herein
• Provide a first line of defense against credit risk by helping to identify and by not
transacting with counter parties that are known or believed to be not creditworthy
or which lack integrity
• Maintain communications with the Director of L&P and Energy & Credit Risk
Manager on the status of all risk taking and resource procurement activities
• Utilize and provide input for the market position report
• Monitor market conditions and maintain operational procedures to manage
positions proactively
• Monitor the effectiveness of internal communications, e.g. distribution of market
information among relevant parties.
• Recommend and implement agreed upon portfolio hedges
Energy Risk Management Policy 13 3/27/2012
7. RISK MANAGEMENT
Risk management is the process of identifying, assessing, and controlling risks associated
with physical and financial market transactions. Risk management activities may vary
considerably among entities. Some entities may focus on reducing, limiting, and
avoiding risk, while others focus on accepting, selecting, altering, and even taking risk.
L&P risk management focuses on ensuring risks remain within acceptable limits.
RISK ANALYSIS
Analysis and reporting of L&P's energy portfolio risk are the responsibility of the Energy
& Credit Risk Manager, primarily through a market position report. The position report,
or mark -to -market report, is a valuable tool for measuring and monitoring risk. It
contains a summary of all forward open energy positions. All open positions, such as
required energy purchases, are marked to market to provide information on the current
value and cash flows associated with the open positions.
For many organizations, the position report enables value -at -risk (VAR) calculations to
be made on a transactional and portfolio basis. VAR is not critical for a municipal utility
like L&P as long as its energy costs may be passed through to its customers. When and if
L&P's rate structure changes such that L&P has more significant financial risk, VAR
may be an appropriate risk measure for L&P's portfolio.
RISK MANAGEMENT TOOLS
One or more of the following transaction tools have been and will be used by L&P to
manage energy price risk:
• Futures: financial positions (contracts) on the New York Mercantile Exchange
(NYMEX) in power or natural gas
• Forwards: same as futures, except the position is a bilateral contract with a
specific counter -party in the over-the-counter market
• Swaps: a contract exchanging fixed for floating payments on a given quantity of
power or gas
• Options: a contract that, for a fixed premium, gives the buyer the right to buy or
sell power at a given price (the strike price) on or before a specific date
HEDGES
Hedges are transactions that reduce price risk relative to a current or future physical
position. They can help protect L&P against high fuel costs and/or increasing costs of
required energy purchases. Typically, hedges are financial in nature and on a next -month
forward basis. Hedges may include transactions in the power and natural gas futures
markets.
STRATEGIES FOR MANAGING PRICE RISK
Table 6.1 lists different strategies for managing (or hedging) exposure to higher forward
energy prices.
Energy Risk Management Policy 14 3/27/2012
Table 6.1— Hedging Strategies for Enerav Purchase Requirements
Strategy
Description
Upside
I Downside
A) Buy fixed
Fix the price of
Eliminates upside
Market price may be
forward "
energy in a future
price risk and locks in
lower at time of
month
purchase price at an
delivery
approved level
B) Buy index
forward
Float the price of
Purchase price will be
"at the market"
Market price maybe
energy until
higher at time of
delivery month
delivery
Q Buy fixed
Fix price in future
Eliminates upside
Market price may be
forward plus
month, protect
price risk, locks in
lower at delivery,
buy put option 5
against downside
purchase price at
down to strike price
price risk
approved level, and
of put option with
price won't be "out of
loss in put option
the market" by more
premium
than the difference in
the purchase price less
the strike price of the
put option
D) Buy index
Float price until
Purchase price will be
"at
Market price may be
forward plus
delivery month,
the market" but
wont exceed strike
higher at delivery, up
buy call option 6
protect against
price of call option
to strike price of call
upside price risk
option with loss in
call option premium
E) Buy index
Float price until
Purchase price will be
"at the market", at
Market price may be
forward plus
delivery month,
strike price of call
higher up to strike
buy call option
protect against
option, or at strike
price of call option or
and sell put
upside price risk at
price of put option
market may be lower
option
reduced (or zero)
than strike price of
premium
put option
Ideally, the fixed price is at or below the "buy" level for the month.
5 Or buy put option spread to reduce the net premium paid.
G Or buy call option spread to reduce the net premium paid.
Energy Risk Management Policy 15 3/27/2012
8. AUTHORIZED TRANSACTIONS
TYPE
Physical
Physical transactions are executed by Resource Schedulers. The transactions are within
WECC (Western Electricity Coordinating Council), and may be fixed -price, exchanges
(buy/sells), options, capacity, transmission, and ancillary services.
Transaction counter -parties are members of the WSPP (Western System Power Pool), the
California ISO, and other credit -approved parties
Financial
Financial energy transactions are executed by the L&P Resource Planning Manager and
Resource Schedulers.
The financial power and natural gas transactions are:
• Futures and futures options
• CAISO Inter -Scheduling Coordinator Trade (IST) enabled products.
Purchases
Physical or financial energy purchases are for the purpose of meeting or hedging excess
load requirements, providing reliability, replacing higher cost resources, or capturing
market opportunities, consistent with this policy.
Sales
Physical or financial energy sales are for the purpose of producing or hedging revenues
from excess generation, balancing excess purchases, or capturing market opportunities,
consistent with this policy. Power sales shall not create a short physical portfolio
position in any period..
AUTHORIZED TRADERS
In order of authority: Director of
L&P
Resource Planning
Manager
Resource Schedulers
Energy Risk Management Policy 16 3/27/2012
TRANSACTION LIMITS
Specifying and adhering to transaction limits is vital to controlling operational, financial,
and credit risk. Limits ensure risk is controlled at various levels of position aggregation
(e.g. by counter -party, delivery location, delivery period, instrument type, etc.).
The primary purpose of L&P's energy transactions is to meet load requirements in a
prudent, economical fashion. Limits do not apply to these transactions.
L&P engages in other "second tier" energy transactions to hedge risk or generate
additional revenues. Hedging transactions are for the purpose of helping L&P achieve
the Objectives listed on p.4. Revenue generation transactions are for the purpose of
creating additional revenues by taking advantage of perceived market opportunities.
These second tier transactions (hedges and revenue generation) are limited in type, time,
and volume to ensure any associated risks are controlled and within acceptable bounds.
Authorizations and limits for hedges are specified in Table 7.1
Table 7.1—.Hed2inu Authorizations & Limits
Resource Planning Manager /
Resource Schedulers
r: Drrector of
I &pr
Cl
Administrator.
Physical power and natural gas
Type
Both
Both
Financial power and natural gas
Time ahead
Up to one year
Up to two years
Up to five
years
Duration
Up to six months
Up to one year
Up to five
years
Total hedge
Up to 100% of estimated volume
volume per
required to completely offset market risk
o
Up to 100 /o
0
Up to 100 /o
month
Counter -party
From approved
Same
Same
Same
credit list
L
Authorizations and limits for revenue generation are specified in Table 7.2.
Energy Risk Management Policy 17 3/27/2012
Table 7.2 - Tradine (Revenue Generation) Authorizations & Limits
Physical power and Financial Power
Type natural gas and natural gas Both Both
Time ahead Up to one year Same Same Same
Duration
Up to one quarter
Up to six months
Up to one year
Up to two years
Volume:
Per transaction
25 MW
10 contracts 7
Same
Same
Total open
50 MW long
50 contracts
Up to
Up to additional
position per
25 MW short
additional 50%
100%
month
-- cred---T
it lis-- •--- Same Same I Same
t
CHANGING LIMITS
Limits depend on evolving business needs and/or risk tolerance. Limits may be adjusted,
upward or downward, by the City Administrator and Director of L&P. The Energy &
Credit Risk Manager is responsible for monitoring and maintaining transaction limits.
He shall assess the effectiveness of limits for achieving net revenue targets and propose
changes in limits as market conditions, operating circumstances, and opportunities
warrant.
1 contract = 10,000 MMBtu
Energy Risk Management Policy 18 3/27/2012
9. REPORTING
Risk management and risk -related reports communicate the market and credit risks of an
organization, and provide information to evaluate the portfolio performance and the
effectiveness of the risk management program. The reports are used as a basis for risk
management discussions and future energy transactions and strategy.
Reporting Requirements
The following table identifies the risk management and related reports that must be
produced, their normal frequency, distribution, and the originator of the report:
Table 8.1- Enerav & Credit Risk Management Reports
Report
F4 gquency, r
Originator
Load/Resource
Monthly
Resource Planning
Balance
Manager
Position Report
Monthly
Energy & Credit Risk
Manager
Credit approved
updated
City Administrator and
counter -parties
717s
Director of L&P
Energy Risk Management Policy 19 3/27/2012
APPENDIX
A. CREDIT RISK CONTROL POLICY
The Light and Power Department (L&P) recognizes the need to manage credit risk as an
essential component of the management of its business. In addition to the existing retail
credit policy governing the financial interactions of L&P and its customers, this Credit
Risk Control Policy shall govern the financial interactions between L&P and its
wholesale counterparties in power, natural gas, transmission, or ancillary services
transactions. Such transactions contain the risk of non-performance in payment for
products, and the risk of non-performance in delivery or receipt of such products. To
control those risks, the following rules for wholesale credit will be adhered to in the
course of business at UP:
1. L&P will only transact with approved counterparties (CP's). The City Council grants
authority to the City Administrator and the Director of L&P to approve or disapprove
of counterparties proposed by L&P.
2. For each counterparty (CP), the City Council authorizes the City Administrator and
the Director of L&P to establish individual levels of unsecured credit exposure
commensurate with the CP's ability to perform in and remit payment for the
wholesale transactions it undertakes with L&P. These unsecured credit limits will be
derived from documented and replicable credit analyses. From time to time, but at
least once every 12 months, such credit limits will be reviewed and updated. CP's
falling in the lowest credit risk category will be given a de minimus unsecured credit
limit.
3. The credit exposure to each CP will be calculated to include payables and receivables
in each month, and the mark -to -market of any open forward contracts. These will be
kept evergreen and reported by the Energy & Credit Risk Manager to the Director of
L&P.
4. The maximum uncollateralized credit exposure to any CP will be capped according to
counterparty "Class". Counterparty Class and the corresponding maximum unsecured
credit extended to CP's in each class are listed in the following section on Credit
Procedures. The amount of unsecured credit will be extended beyond the specified
unsecured maximum only to organizations having the highest credit ratings and
assessments, and recognized as trading partners of strategic value to L&P, and with
whom L&P has traded in large enough volumes over a sufficient time to warrant
confidence in the CP's performance. The City Administrator and the Director of L&P
shall judge the satisfaction of these terms.
5. Credit agreements will be negotiated with all existing CP's to provide mechanisms
for collateralization should a CP exceed its credit limit, to establish protections
required by L&P in the event of CP bankruptcy, and to formalize and document
credit activities between the parties. These agreements will be reviewed by the
Director of L&P and signed by the City Administrator. Prior to conclusion of such
agreements, all CP's will be held to 25% of their recommended credit limit.
Energy Risk Management Policy 20 3/27/2012
6. The management of Credit Procedures, counterparty limits, and credit agreements are
the responsibility of the Energy & Credit Risk Manager.
7. L&P will not engage in credit intermediation ("sleeving") transactions without
approval by the Director of L&P.
8. The only exception to these rules and associated procedures is the event of the need to
transact with a CP in real time to balance L&P's energy position.
CREDIT PROCEDURES
A. Counterparty Approval
1. L&P will consider all existing CP's (those with currently open forward contracts
and/or those with whom the City has historically done business) as "conditionally
approved" until such time as the CP's can be evaluated for credit worthiness by
the Energy & Credit Risk Manager and the Director of L&P, and assigned a credit
limit.
2. Credit limits will be based on a CP's assessment score. Some latitude may be
allowed for the strategic significance of the CP to L&P's business, but the
counterparty's limits will be consistent with the limits and assessments of other
CP's in the same Class. Any additional credit "latitude" assigned the CP must be
requested by the CP, recommended by the Energy & Credit Risk Manager, and
approved by the Director of L&P.
3. For each new proposed CP, prior to transacting with that CP, the Energy & Credit
Risk Manager and the Director of L&P must assess the credit worthiness of the
proposed CP and establish a credit limit consistent with CP's in the same Class.
4. Transacting with the CP may proceed after credit approval by the Director of
L&P and the City Administrator.
5. The credit extended will be limited to 25% of the proposed credit limit until such
time as credit agreements are completed between L&P and the CP.
B. Credit Assessment
1. Credit assessment will be performed by the Energy & Credit Risk Manager using
the workbook tool currently employed.
2. The workbook tool provide for the introduction of both quantitative and
qualitative measures related to the CP's credit worthiness. The Energy & Credit
Risk Manager will maintain documentation of the reason for the scores given each
CP.
3. From time to time, the Energy & Credit Risk Manager may decide to alter the tool
or change its weighting functions. L&P will reassess all CP's with the modified
tool. Any changes will be documented and reported to the Directorof L&P, along
with any changes in credit limits suggested by the new assessment.
C. Establishment and Maintenance of Credit Limits
1. CP's will be divided into three qualitative categories. All entities with a credit
assessment greater than 3.00 will be deemed Class I or "high quality" credits.
Energy Risk Management Policy 21 3/27/2012
CP's with ratings between 2.00 and 3.00 will be deemed Class II or "good"
credits. CP's scoring below 2.00 will be deemed Class III or "questionable"
credits.
2. Class I and II credits will be assigned individual credit limits consistent with their
assessment ratings. The maximum single exposure for Class I counterparties is
$15 million, while the maximum single exposure for Class II counterparties is $5
million. Should the order of the credit limits differ from the order of assessment
scores, the Energy & Credit Risk Manager will document reasons for the
discrepancy and report them to the Director of L&P. Class III credits will be
extended no unsecured credit beyond a de minimus amount of $100,000 for
purposes of convenience. Class III credits will be limited to real-time and pre -
schedule trading. Forward contracts will not be entered into with Class III credits.
3. Credit limits will be reassessed every 6 months for Class I credits, every 3 months
for Class II credits, and as often as L&P deems useful and practical for Class III
credits.
4. L&P is responsible to remain current on significant financial changes among
approved CP's. In particular, CP's must be reassessed upon any downgrade or
upgrade by a major credit rating organization or any material change in the CP's
business status.
5. Additional credit, beyond the unsecured credit limits defined above, may be
negotiated with an approved CP. Acceptable forms of credit enhancement include
letters of credit where the issuing institution is rated "A" or better, prepayment,
parental guarantees, or other forms of acceptable collateral as determined by the
Energy & Credit Risk Manager.
D. Exposure Calculation and Reporting
I. Credit exposure for each CP will be defined as the [discounted] sum of payables,
receivables, and the mark -to -market for all forward power and natural gas
contracts.
2. Exposure amounts will be calculated at the close of each month and as often as
UP deems useful and practical.
3. Exposure amounts will be netted and offset to the extent that UP has credit
contracts in place with the CP enabling such treatment.
4. The Energy & Credit Risk Manager will immediately notify the Director of L&P
of any failure of a CP to make payments due. Any CP that fails to make a
scheduled payment beyond the cure period agreed to in the resolution of disputes
will be considered to have exceeded its credit limit. Any additional transactions
with the CP will be suspended until the arrears are paid in full.
E. Credit Agreements
1. L&P will negotiate mutual netting, set-off, and collateral agreements with all
existing and proposed CP's.
Energy Risk Management Policy 22 3/27/2012
2. Those agreements maybe chosen from one of several agreements available and in
common use such as NAESB, WSPP and/or EEI for physical trades, and ISDA
for financial derivatives.
Prior to the completion of such agreements, the CP will be held to 25% of its full credit
line.
F. Credit Watch and Credit Limit
1. When a CP reaches 80% of its credit limit, it will be designated on the Credit
Report as being on credit watch. Authority for additional transactions with the CP
will then be shifted one level of authority higher than currently applicable.
2. When the CP goes on credit watch, L&P must decide what course of action to
take regarding the CP in the event it passes its credit limit. These actions will be
limited to:
a. Increasing the credit limit;
b. Demanding collateralization per L&P's agreements with the CP;
c . Ending trading with the CP and/or requesting that offsetting trades be
entered into with that same CP.
3. When a CP reaches 90% of its credit limit, transactions will be limited to 25 MW
(total volume) or 100, 000 MMBtu and less than one forward month in duration.
4. If a CP reaches its credit limit, L&Ps response determined at the beginning of the
credit watch will be implemented.
Energy Risk Management Policy 23 3/27/2012
B. TRANSACTION TERMINOLOGY
Broker is a derivative agent, who introduces counter -parties to a transaction, arranges the
transaction, and charges a fee for this service. A broker never takes a principal position
in the market.
Call is an option contract that gives the holder the right to buy a specified commodity or
security from the writer of the option for a specified volume at a specified price (strike
price) on or before a specific date.
Clearinghouse is an organization that registers, monitors, matches and guarantees trades
on a future market and performs financial settlement of future transactions.
Clearing Member is an exchange's member broker who is responsible for the fulfillment
of a future (options) contract. Brokers that are not clearing members must clear their
trades through clearing members.
Closed Position is a transaction whose value is locked -in and is not susceptible to
changes in market prices or credit factors.
Collar is an option strategy designed to minimize or eliminate the up -front cost of a cap
(floor) through the sale of a floor (cap).
Collateral is an obligation, security, cash, or asset provided in conjunction with a
derivative contract obligation to secure its performance.
Credit Risk is the risk that, in a financial or physical transaction, the counter -party will
not perform in accordance with its contractual commitments.
Derivatives are financial instruments whose value is based on a commodity or other
security, e.g., futures, options, swaps, and forwards.
Futures Commission Merchant (Futures Broker) is a broker who is a member of an
organized futures exchange and who charges a commission for his/her services.
Hedge is a transaction that reduces price risk relative to a position that the organization
has or intends to take in the physical market.
Liquid Market refers to a market for financial instruments in which buying and selling
can be performed with ease, due to the presence of a large number of buyers and sellers
prepared to trade substantial quantities at small price differences. (Opposite is an illiquid
marketplace.)
Margin is the amount of money deposited as a guarantee of fulfillment of contract
obligations. Initial margin is posted when a fixtures contract is initiated. Variation
margin is paid (collected) in order to maintain a minimum margin level based on daily
fluctuations in contract market value.
Market Maker, also known as an intermediary, dealer, or issuer, is the division that
makes a market in an OTC instrument by offering to both buy and sell the instrument.
Mark -to -Market is the daily adjustment of the value of open positions to reflect gains
and losses resulting from price movements occurring during the last trading session. This
periodic review values all positions in a hedge portfolio at current market prices.
Energy Risk Management Policy 24 3/27/2012
Master Swap Agreement is a contract between two derivative counter -parties that
specifies all definitions, terms, conditions and laws governing any swap transaction. It
enables the parties to execute one agreement and transact multiple swaps through
appendices to that agreement, if necessary, rather than executing multiple agreements for
multiple transactions.
Open Position is a transaction whose value changes with the market and/or contains a
degree of credit risk.
Option is a contractual agreement between two counter -parties, where the writer (seller)
grants a right to the buyer, for a fee (premium) to buy or sell a commodity, security, or
asset at a given price (strike price) on a specific date ("European" option) or on or before
a specific date ("American" option).
Over -the -Counter (OTC) is the purchase and sale of financial instruments when not
conducted on an organized exchange. OTC is also referred to as the bilateral market.
Physical Market means the cash market in which the actual commodity is bought and
sold.
Power Marketer is a business entity engaged in buying and selling power, but does not
own generating or transmission facilities. Power marketers take ownership of power and
are involved in interstate trade. These entities file with FERC for status as power
marketers.
Premium is the price paid for an option or instrument with an option -like feature.
Put is an option contract that gives the holder the right to sell a specified commodity,
security, or asset to the writer of the option for a specified volume at a specified price
(strike price) on or before a specific date.
Realized gain/loss is the amount of capital that has actually been received or paid out to
counter -parties as a result of transactional activities.
Strike Price is the pre -determined price level at which option exercise takes place.
Swap is a contractual agreement between two counter -parties to exchange fixed for
floating payments on a given quantity of a commodity or security.
Volatility is the degree to which the price of a commodity or security fluctuates around
some mean value. It is usually measured as the variance or standard deviation of the
price.
Energy Risk Management Policy 25 3/27/2012
CITY CLERK'S OFFICE
INTEROFFICE MEMORANDUM
DATE: April 5, 2012
TO: Carlos Fandino, Jr., Director of Light & Power
FROM: Willard Yamaguchi, City Clerk
RE: Resolution No. 2012-45 - A Resolut' n of the City Council of
the City of Vernon Approving and Adopting a Energy and
Credit Risk Management Policy for the City of Vernon
Transmitted herewith is a copy of Resolution No. 2012-45 referenced
above, which was approved by City Council on April 3, 2012.
Thank you.
WY: dj
c: Javier Valdez
Resolution No. 2012-45
3QECEIVE®
MAR 2 6 2012 40
CITY CLERK'S OFFICE STAFF REPORT
LIGHT & POWER
DATE: March 19, 2012
TO: Honorable Mayor and City Council
FROM: Carlos Fandino Jr., Director of Light & Power
RECEIVE®
MAR 2 0 2012
CITY ADMINISTRATION
RE: Energy and Credit Risk Management Policy Approved by Resolution No.
9500
On December 17, 2007, City Council approved and adopted an Energy and Credit Risk
Management Policy by passing Resolution No. 9500. This policy is needed to fulfill
current CAISO Tariff requirement for participating in the CAISO markets and to satisfy
anticipated requests from potential contractual counterparties. While the CAISO
markets and CFTC rules are continuing to evolve, the City's practice is to periodically
review its policy. Based on staffs review of the existing policy, staff recommends that
City Council approve the Attached updated policy.
Recommendation:
It is recommended that the City Council approve the attached Energy and Credit Risk
Management Policy at the April 3, 2012 City Council meeting.
Fiscal Impact:
No fiscal impact.
CF: jv
Attachment