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HomeMy WebLinkAboutResolution No. UB- 06-C0120 RESOLUTION NO. 06-C 12 0 A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF AZUSA, CALIFORNIA, SETTING CERTAIN RESERVE POLICIES FOR THE UTILITIES DEPARTMENT WHEREAS, the Utilities Department operates an electric and water utility on an enterprise basis; and WHEREAS, for the Utilities Department enterprises to be managed in a fiscally responsible way, proper financial reserve policies must be set, monitored and updated from time to time; and WHEREAS, the last year in which the Utilities Department reserve policies were updated was 2001; and WHEREAS, changes have occurred in the operations and capital needs of the Utilities Department since 2001, due to the reliability and maintenance of the San Juan Power Resource, and need to upgrade the Canyon Water Treatment Plant; and WHEREAS, on January 26, 2006, the City Council acting in its capacity as the Utility Board, directed staff to set forth new reserve policies in the form of a resolution to be adopted by the Utility Board at its regular meeting on February 27, 2006; and NOW, THEREFORE, THE CITY COUNCIL OF THE CITY OF AZUSA, DOES HEREBY RESOLVE AS FOLLOWS: SECTION 1. That the Utilities Department shall maintain the following reserves for financial planning and risk management purposes as set forth below: Reserve Policy Type Electric Water —days Operating Reserve 60 days / $6.5 million 60 / $3.7 million Capital Reserve $2.5 million $12.5 million Contingency Reserve $8 million 0 Net Short Procurement $1 million N/A Total $17.5 million $16.2 million SECTION 2. That the background for the above amounts is set forth in Exhibit A, which is attached to this Resolution and made a part hereof. SECTION 3. That these reserve levels shall be reviewed annually during the budget preparation process, and if warranted, changes will be proposed and made through an updated resolution. E SECTION 4. The City Clerk shall certify to the adoption of this Resolution. PASSED, APPROVED AND ADOPTED THIS 27th day of February, 2006. Diane Chagnon, Mayor ATTEST: Vera Mendoza City Clerk STATE OF CALIFORNIA ) COUNTY OF LOS ANGELES ) ss. CITY OF AZUSA ) I HEREBY CERTIFY that the foregoing Resolution was duly adopted by the Utility Board/City Council of the City of Azusa at a regular meeting of the Azusa Light & Water Utility Board on the 27th day of February, 2006. AYES: COUNCILMEMBERS: HARDISON, CARRILLO, ROCHA, HANKS, CHAGNON NOES: COUNCILMEMBERS: NONE NONE EXHIBIT A AZUSA LIGHT AND WATER RESERVE POLICIES Background: The City operates municipal electric and water utilities. hi the course of operating the utilities as business enterprises, the Utilities Department has the need to maintain prudent cash reserves to enable the following: • To provide sufficient financial liquidities to cover near term expenses (Operating Reserves) To provide sufficient cash reserves to fund specific and emergency capital requirements (Capital Reserves) To provide sufficient financial cushion for contingencies to avoid substantial near term rate shocks to retail customers (Contingency Reserves) There is no single "right" way to set the appropriate reserve policies. Rather reserve policies should be set that are consistent with: Utilities' exposure to operational contingencies and the degree of impact such contingencies pose to utilities' financial bottom lines • The retail rate setting philosophy of the Utility Board, with flexibility to adjust rates as required • Alternatives to holding cash reserves Following are two discussions, one focusing on setting reserve policies for the Electric Utility, and the other focusing on reserve policies for the Water Utility. Operating and capital reserve policies are discussed, including the formulas and calculations which show how the Utilities Department arrived at the proposed policies. ELECTRIC UTILITY RESERVE DISCUSSION AND PROPOSED POLICIES: A. Operating Reserves It is recommended that the Electric Utility keep sufficient liquidity in reserves to cover 60 days of operating expenses at all times. At present time, the Electric Utility's annual gross operating expense (not netting wholesale revenues and including GF transfers as "operating" expenses) as budgeted is about $40 million and thus 60 days of operating expenses translate into about $6.5 million. 0 0 B. Capital Reserves It is recommended that Electric Utility keep sufficient reserves to equity fund well defined capital projects that are not intended to be debt funded or only partially debt funded. At present time, the Electric Utility is planning to undertake the Utility Automatic Meter Reading (AMR) project in the next two to five years. The AMR project will require substantial capital investments that most likely will be funded through the Electric Utility's retained earnings, which are currently estimated to be $1 million. Further; the Electric Utility should review its historical internally funded capital project expenditure level and set a Capital Reserve requirement equal to the average of the most recent three year average expenditure level. In addition, Capital Reserve should have a reasonable amount reserved for emergency repairs and replacement of major and critical equipment or apparatus within the system. As a starter, this reserve should at least be sufficient to replace one substation transformer which is estimated at $1.5 million. C. Contingency Reserves Due to the continuing volatility of the energy market and the dependence on San Juan's reliability performance it is recommended that Electric Utility keep sufficient reserves for well defined contingencies in order to maintain retail rate stability. At present time, it is recommended that the following three contingency events be considered: C.1 San Juan Power Resource Outage Contingency C.2 Electric Utility "Met Short" Power Procurement Contingency C.3 Electric Utility Legal and Regulatory Risk Contingency Each one of these contingencies is discussed in detail below. CA San Juan Outage Contingency The electric utility is heavily dependent on the output of San Juan unit #3 for power supply. Whenever the San Juan resource is forced out, the electric utility will incur unanticipated replacement power costs. Although a rate adjustment mechanism has been adopted called Fuel Cost Adjustment or FCA in case of a San Juan resource outage, the FCA does not completely immunize the electric utility against financial distress as the FCA is capped at 10% of the retail rate. Thus it is recommended that the following methodology be used to establish a CONTINGENCY RESERVE amount for the San Juan resource as follows: Step 1: Calculate a minimum CONTINGENCY RESERVE for San Juan as follows: Deem a credible, San Juan forced outage scenario (45 -day in the summer season which has happened before in summer 2001). Compute the San Juan replacement power cost for this scenario valued at the immediately succeeding summer power prices. Subtract from replacement power cost so determined the amount that can be recovered through the FCA. The application of the above in today's environment will yield: Total replacement power in MWhs = 45 days X 24 hours/day x 30 MW/hour = 32,400 MWhs Summer 2006 power prices = $90/MWh Total replacement power cost = 32,400 x 90 = $2,916,000 Total recoverable from FCA = $710,000/2 = $355,000 ($710,000 is the quarterly FCA cap, 45 - day FCA cap is half) Minimum Contingency Reserve = $2,916,000 -$355,000 = $2,561,000 Step 2: Calculate a maximum CONTINGENCY RESERVE for San Juan as follows: Deem a severe but credible San Juan forced outage scenario (180 -day in the summer season which can happen with 20% probability in the next twenty years based on PNM survey of underground coal mines. The severe scenario can happen if the underground mine catches fire). Compute the San Juan replacement power cost for this scenario valued at the immediately succeeding summer power prices. Subtract from replacement power cost so determined the amount that can be recovered through the FCA. The application of the above in today's environment will yield: Total replacement power in MWhs = 180 days X 24 hours/day x 30 MW/hour = 129,600 MWhs Summer 2006 power prices = $90/MWh Total replacement power cost = 129,600 x 90 = $11,664,000 Total recoverable from FCA = $710,000 x 2 = $1,420,000 ($710,000 is the quarterly FCA cap, 180 -day FCA cap is twice) Maximum Contingency Reserve = $11,664,000 - $1,420,000 = $10,244,000 Step 3: Determine the Appropriate Level of San Juan Contingency Reserve Determine the appropriate level of San Juan Contingency Reserve between the minimum and the maximum level based on other available alternatives to hedge the replacement power cost, e.g., if multi-year forced outage insurance products are available and the market is relatively stable then a level toward the minimum level may be appropriate. If however, multi-year forced outage insurance products are not available and the market is extremely volatile and high, then a much higher level of contingency reserve should be held. RECOMMENDATION FOR SAN JUAN CONTINGENCY RESERVE: It is recommended that a minimum and a maximum San Juan Contingency Reserve be established as discussed above and be funded initially at $8 million as the target level. The target cash reserve level should be reviewed and reevaluated annually and adjusted accordingly pursuant to methodology above. The Electric Utility will prepare a report as part of the annual review process to enable the Utility Board to make informed decision to adjust the target level of San Juan Contingency Reserve the Electric Utility should retain. C.2 Electric Utility "Net Short" Power Procurement Contingency The electric utility may have energy needs which are beyond the current level of energy supply. This is a situation referred to as a "Net Short" power resource condition. In this case, the Electric Utility needs to procure power at near term prices, which may not be supported by the current retail rates. Thus it is recommended that the following methodology be used to establish a CONTINGENCY RESERVE amount for "Net Short" Power Procurement as follows: Step 1: Calculate the Annual Net Short Requirements for the Immediately Three Years: In our case, we are almost fully covered for 2006 and 2007 from the energy requirement perspective; we are not covered from the energy requirement for summer 2008, thus: Net short 2006 = Zero Net short 2007 = Zero Net short 2008 = 24,000 MWhs (15 MW on -peak power for June through September) Choose the highest Net Short of the three years, i.e., 24,000 MWhs Step 2: Calculate the Power Cost That Can Support Net Short Procurement within Existing Revenue Structure This step can simply be accomplished by computing the average wholesale power cost of Azusa's existing resource portfolio, which is about $55/MWh. 0 0 Step 3: Calculate the Cost above that can be supported by Azusa's retail rate for the Net Short Procurement This can be accomplished by computing: Total Net Short procurement Cost at the Summer Prices = 24,000 MWhs x $100/MWh = $2,400,000 Cost that can supported by retail rates for Net Short = 24,000 MWhs x $55/MWh = $1,320,000 Cost not supported by existing retail rate for Net Short Procurement = 2,400,000 —1,320,000 = $1,080,000 RECOMMENDATION FOR NET SHORT PROCUREMNT RESERVE: It is recommended that a NET SHORT PROCUREMENT RESERVE is established as discussed above and be funded initially at $1 million, as the target level. The target cash reserve level should be reviewed and re-evaluated annually and adjusted accordingly pursuant to methodology above. The Electric Utility will prepare a report as part of the annual review process to enable the Utility Board to make informed decision to adjust the target level of Net Short Procurement Reserve the Electric Utility should retain. C.3 Electric Utility Legal and Regulatory Risk Contingency There is no specific recommendation at this time for this risk as the risk to refund "overcharges" during the energy crisis has subsided significantly. SUMMARY: Staff recommends the initial Reserve targets as follows: Operating Reserve Account = $ 6,000,000 Capital Reserve Account = $ 2,500,000 San Juan Contingency Reserve= $ 8,000,000 Net Short Procurement Reserve = $ 1,000,000 Legal and Regulatory Contingency= $ 0 Total $17,500,000 Existing Cash Reserves = $19,500,000 Unencumbered Reserves= $ 2.000.000 The target Reserve levels shall be reviewed and updated every fiscal year during the approval processes for the following fiscal year's budget. Any adjustment, including operating cost reduction and/or retail rate increase, should be considered in order to maintain the reserve level for each component as prescribed above. 0 WATER UTILITY RESERVE DISCUSSION AND PROPOSED POLICIES: Similar to the Electric Utility, Water Utility should consider the establishment of three reserve accounts: • Operating Reserves • Capital Reserves • Contingency Reserves A. Operating Reserves It is recommended that the Water Utility keep sufficient liquidity in reserves to cover 60 days of operating expenses plus annual debt service payment at all times. At present time, the Water Utility's annual gross operating expense (including GF transfers as "operating" expenses) as budgeted is about $13.5 million and thus 60 days of operating expenses translate into about $2.2 million. Adding the annual debt service payment of about $1.5 million will yield $3.7 million. 13. Capital Reserves It is recommended that Water Utility keep sufficient reserves to equity fund well defined capital projects that are not intended to be debt funded or only partially debt funded. Further, it is recommended that Water Utility keep sufficient reserves to make a strong showing to the financial community for the anticipated water treatment plant financing The Citywill receive advice on this from a Financial Advisor as it begins the process of financing this new facilities, however, high reserves are generally looked at positively by the financing community. At present time, the Water Utility internally funds between $1.5 to $2.5 million per year in capital projects out of its operating revenues and is expected to continue to do so in the foreseeable future. Further for water treatment plant financing, it is expected that the Water Utility may be under pressure to affirm its bond ratings of "AA-" due to the size of the bonds, and thus keeping sufficient reserves is likely to alleviate the pressures in the rating of the bonds. RECOMMENDATION• It is recommended that CAPITAL RESERVE ACCOUNT be created and be funded with $12.5 million initially as the target reserve level ($2.5 million for internally funded capital projects and $10 million for water treatment plant financing purposes). The target cash reserve level should be reviewed and reevaluated annually and adjusted accordingly. The Water Utility will prepare a list of capital projects with sufficient details as part of the annual review process to enable the Utility Board to make informed decision to adjust the target level of capital reserves the Water Utility i • should retain. The Water Utility will also prepare a report detailing the level of funding that might be required as part of the support services it receives from other divisions or departments of the City. C. Contingency Reserves At this time there are no specific contingencies that warrant a special reserve be established, although replacement for such things as an old water reservoir in the event of an earthquake could trigger unforeseen need for capital. SUMMARY: Staff recommends the initial Reserve targets for the Water Utility as follows: Operating Reserve Account = $ 3,700,000 Capital Reserve Account = $12,500,000 Contingency Reserves= $ 0 Total $16,200,000 Existing Cash Reserves = $16,500,000 Unencumbered Reserves= $ 300.000 The target Reserve levels shall be reviewed and updated every fiscal year during the approval processes for the following fiscal year's budget. Any adjustment, including operating cost reduction and/or retail rate increase, should be considered in order to maintain the reserve level for each component described above.