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HomeMy WebLinkAboutMinutes - November 28, 2006 SSCITY OF LODI INFORMAL INFORMATIONAL MEETING "SHIRTSLEEVE" SESSION CARNEGIE FORUM, 305 WEST PINE STREET TUESDAY, NOVEMBER 28, 2006 An Informal Informational Meeting ("Shirtsleeve" Session) of the Lodi City Council was held Tuesday, November 28, 2006, commencing at 7:02 a.m. A. ROLL CALL Present: Council Members — Hansen, Johnson, and Mayor Hitchcock Absent: Council Members — Beckman and Mounce Also Present: City Manager King, City Attorney Schwabauer, and City Clerk Johl B. TOPIC(S) B-1 "Electric Reserve Fund Study Overview" City Manager King briefly introduced the subject matter. Electric Utility Director Morrow introduced Ron Stassi of Navigant Consulting. Mr. Stassi provided a presentation regarding the Electric Reserve Fund. General topics of discussion included the study purpose, background, benefits of a formal reserve policy, study approach, types of reserves, operating reserves, capital reserves, special reserves, survey results, electric cash balance, recommendations, and current versus recommended reserve levels. Mayor Pro Tempore Johnson inquired about the timing of a proposed plan. Mr. Stassi affirmed rating agencies would like to proceed sooner than later. He also stated it is important to show seriousness with a realistic plan that is supported by actions. Mr. Stassi stated the City does have operating reserves on file with Northern California Power Agency (NCPA). Council Member Hansen inquired about the fluctuation for the 20% rate stabilization fund. Mr. Stassi stated the current amount should be $4.2 million and the guidelines will translate to specific numbers. City Manager King stated the 20% increase is over a six-month period and the goal is to have a shock absorber if power costs go up. Council Member Hansen stated he would like to see both percentages and actual numbers. Council Member Hansen inquired about wild fluctuations. Mr. Stassi stated some utilities faired well during the fluctuations because they had reserves, natural resources, and power contracts in place. Council Member Hansen asked if the 20% protects agencies from immediate rate increases. Mr. Stassi replied in the affirmative. Council Member Hansen inquired about the lack of a recommendation for bond reserves. Mr. Stassi stated many utilities do not have bond reserves. He stated a reasonable and attainable plan is currently presented but bond reserves can be revisited in the future. Discussion ensued between Mayor Hitchcock, City Manager King, Mr. Stassi, and Electric Utility Director Morrow regarding NCPA's desire to require a $5.5 million reserve and additional insurance in the future. Continued November 28, 2006 Mayor Hitchcock inquired about counting the NCPA funds twice. Mr. Morrow stated it is permissible because the funds were never earmarked for a specific purpose; although, some movement may occur in the future. City Manager King stated cash from bond proceeds is also available. Mayor Pro Tempore Johnson inquired about timing and the NCPA reserves. Electric Utility Director Morrow replied it is fine for now because there is $.5 million on the books for contingencies. He stated the funds will need to be built back up no matter who uses the funds or for what purpose. Mr. Morrow provided a presentation regarding possible sources of additional reserves, policy questions, and the next steps in the process. Council Member Hansen inquired about project rights and the elimination of operation and maintenance monies. City Manager King stated a deal may include those costs when a property is sold. Council Member Hansen inquired about bond proceeds. Electric Utility Director Morrow stated those funds will be useful for future projects, including possibly Phase II for the Lodi project and lines to the west. Mayor Pro Tempore Johnson inquired about the timing for power project rights and putting everything into the power line. Electric Utility Director Morrow stated deals in the electric utility business are generally slow. He stated the City would have to look at all possibilities, including marketability and the cost of assets xersus replacement values while it is looking to generate capital over the next six months. Mayor Hitchcock inquired about selling assets to Roseville. Electric Utility Morrow stated negotiations between Roseville and NCPA are taking place and, until those negotiations are completed, the impact of selling an asset to Roseville is unknown. Mayor Hitchcock inquired about the sale of ancillary services. Electric Utility Director Morrow stated controlled area projects can provide various service support, which is called ancillary services. He stated NCPA currently looks at both the values of the City's assets and the ancillary services. Mayor Hitchcock suggested if increases are required they be smaller incremental increases rather than large, lump sum increases. Council Member Hansen inquired about market cost adjustments (MCA). Mr. Morrow stated staff would return to Council with some type of an energy cost adjustment mechanism that could possibly be a way to move costs according to the market. Discussion ensued between Mayor Hitchcock and Council Member Hansen regarding the relationship between MCA, building reserves, and small incremental increases. City Manager King stated the two issues to be considered are having an operating budget in the black and building reserves for a ready cash flow. Mr. King stated the MCA generally goes to the operating budget. Mr. Morrow suggested a three-piece mechanism including MCA, special reserve fund, and special surcharge to address the two separate issues. Discussion ensued between Council Member Hansen and Electric Utility Director Morrow regarding the utilities' historically low commercial and industrial rates and the goal of maintaining the same. Mayor Hitchcock inquired about the subsidy of development costs. City Manager King elaborated on the policy for development to pay its own electric costs and meetings with the community to gather concerns regarding the same. He stated the City would get rate of return over time, but needs a large cash amount to begin. Mr. King stated staff would be bringing the matter before Council for consideration in the near future. Mayor Hitchcock suggested a matrix illustrating how to raise money for the same. W Continued November 28, 2006 Discussion ensued between Council Member Hansen, Mayor Pro Tempore Johnson, Mr. Stassi, Electric Utility Director Morrow, and City Manager King regarding reserve amounts sufficient for 20, 30, and 45 day periods. City Manager King stated staffs approach to returning with options will be dictated by Council's direction as the subject matter was generally presented for Council consideration. C. COMMENTS BY THE PUBLIC ON NON -AGENDA ITEMS ►= D. ADJOURNMENT No action was taken by the City Council. The meeting was adjourned at 8:25 a.m. ATTEST: Randi Johl City Clerk AGENDA ITEM B-01 CITY OF LODI COUNCIL COMMUNICATION TM AGENDA TITLE: Electric Reserve Fund Study Overview (EUD) MEETING DATE: November 28,2006 PREPARED BY: Electric Utility Director RECOMMENDED ACTION: Receive report by Navigant Consulting Inc. regarding the appropriate level of cash reserves to be maintained by the Electric Utility Department. BACKGROUNDIN FORMATION: Navigant Consulting Inc. was retained by the City to make a recommendation regarding the appropriate level cf cash reserves for the Electric Utility Department. Mr. Ron Stassi of Navigant will be available to summarize the report to the City Council at its November 28,2006, Shirtsleeve session. FISCAL IMPACT: None at this time. FUNDING: Not applicable. Attachment F. Morrow Utility Director Blair King, City Manager NAVIGAN CON sU[IF r , November 21, 2006 George F. Morrow Electric Utility Director City of Lodi 1331 S. Ham Lane Lodi, CA 95242-3995 Re: Lodi Fund Reserve Final Report Dear George: Che California Raza 300 South Owd Avenue 291' Floor Los Angeles, CA 90071 213.6703200 phone 213.6703250fax Attached is a copy of the Lodi Fund Reserve Final Report. It was a pleasure to work with you and your staff on this assignment. I look forward to meeting with the City of Lodi City Council on November 281h. If you need anything in the meantime, please give me a call. Sincerely, Ra'1 Sag Ronald V. Stassi Attachment DETERMINATION OF PRUDENT AND APPROPRIATE CASH RESERV E L EV ELS FO R LODI ELECTRIC UTILITY N OV EM BER 2006 PURPOSE To determine prudent and appropriate levels of cash reserves that should be maintained by Lodi Electric Utility. BACKGROUND In Lodi, the cost of operating and maintaining its electrical system is supported primarily by retail rates. Historically, these costs have had some degree of predictability, however, in recent times price volati I ity as result of power scarcity, natural gas price increases and environmental compliance issues have created periods of price instability. Such effects have been most notable in energy markets over the past few years as city councils and utility boards have struggled with rate setting decisions that relate to maintaining the financial health of their utilities. Unlike those utilities that have strong cash positions, Lodi Electric Utility finds itself in a cash poor position as a result of some past decisions relating to fuel markets, purchased power and rates. Lodi Electric Utility recognizes that maintaining adequatecash reserves is an operational need aswell as a primary determinateof its bond ratings. Since Lodi Electric Utility isa member of the Northern California Power Agency (N CPA), it isfaced with the additional consideration that itsfinancial situation also hasan effect upon NCPA's future financings, bond ratingsand costs. Sncethe establishment of reserves isoften viewed asa policy issue, the determination of appropriate reserve levels is best decided by the City Council. For that reason, Lodi Electric Utility has undertaken this study to develop a criteria and recommendations to advise the City Council on the level of reserves needed to maintain thefiscal health of its el ectri c system. STUDY APPROACH The process used to develop the recommendations found in this report included: oo Consideration of the contingencies and probabilities of Lodi Electric Utility encountering those contingencies oo A review of reserves levels in the electric utility industry oo A limited survey of the practices employed by comparably sized California municipal utilities oo Discussions with Lodi Electric staff. The focus of th is study is not on those reserve balances associated with the issuance of bonds, but rather on those more commonly set-aside by businesses for general, particular or contingency purposes. It is also important to note that this study is not designed to determine the adequacy of revenues generated from utility billings to support reserve funds. It is presented on a revenue -neutral basis and does not address utility rates or revenues. ANALYSIS Cash reserves are highly liquid assets that are set aside by business organizations to provide funds to address operational contingencies. Factors that guide the types and sizes of reserves vary from organization to organization and business to business. Both businessand governmental organizations that arewell managed generally maintain cash reserves in amounts appropriate for the risks associated with their line of work. The size of the reserve is generally based upon an assessment of specific contingencies that might require the use of fund reserves and the probability of such events occurring. Reserves are often classified in thefollowing manner: Operating Reserves Most utilities maintain Operating Reserves in oneform or another. The amount or level of reserves is generally based upon providing" coveragd' of expenses over a number of days. Typically, Operating Reserves are sized to cover 30-60 days' expenses. Operating Reserves represent the most common form of cash reserves in place in the utility industry. Capital Reserves A second type of reserve that is often encountered among capital intensive businesses is Capital Reserves. Irrespectiveof whether they aregovernmental or investor-owned, utilities by their very nature are highly capital intensive. That is, a lot of high cost infrastructure is necessary for a utility to function properly. Asa result, utilities often issue bonds to finance a" plant" that will last for many years. Aswell, Capital Reserve Funds are often setup to fund the emergency replacement of expensive capital equipment. For example, an electric utility may establish a capital reservefund at an amount sufficient to fund the replacement of a failure of a turbine -generator, its largest system contingency. Capital Reserves that are called upon to fund capital projects are generally replenished from subsequent bond issues or rate revenue. General Reserves General Reserves are often established asa"catch all" toaddresseither awiderangeof typically unspecified/ undefined contingencies. Because they are not created with specific intent, they are often subject to criticism particularly when funded with ratepayer dollars. It is not recommended that Lodi Electric Utility consider establishing General Resery es at t h i s t i m e. Sped al/Sped f i c Reserves Reserves are often created and designated for specific purposes. For example, in the last decade many California municipal electric utilities established temporary reserves to help ensure their competitiveness in the volatile restructured electric utility environment. These reserves were often labeled "Stranded Investment Funds," "Competitiveness Funds," "RateStabilization Reserves," or other similar titles which are somewhat descriptive of their purpose. Debt Service or Bond Reserves Issuers of debt sometimes maintain a debt reserve fund equal to some multiple of the average periodicdebt service payment. This requirement could even beformalized in theform of a bond resolution associated with the borrowing. Utility debt service payments generally become due twice a year. The existence of a debt service reserve policy and associated funding could also send a favorable signal to investors and rating agencies. If Operating Reserves take debt service obligations into account, the establishment of a debt service reserve is generally not warranted. D I SCU SSI O N Operating Reserves, sometimes referred to as working capital are well suited for addressing normal variationsfrom planned or budgeted cash flows, aswell as addressing contingencies that may arisefrom utility operations. They aregenerally established by formal policy. Restricted cash reservesset equal to 30to60days operating costsaretypical in the electric utility industry. Many California municipal utilities have historically conducted businesswith only operating reservesand such additional cash reserves as might be required under bond covenants. Capital Reserves are often appropriate for utilities that own large power facilities. Also, some utilities set aside capital reserves associated with their participation in shared generation or transmission projects, such as those sponsored by NCPA. Beyond the requirement to fund its share of capital reserves for joint power facilities, no need has been noted for Lodi Electric Utility to establish capital reservesfor additional power supply. There are, however, capital need contingencies associated with its on-site infrastructure. The establishment ofaSpecial Reserveto ensurethat Lodi Electric Utility " remains competitive" during this period followingthe unsuccessful restructuring of the electric utility industry in California warrants somediscussion. During early 2001 power price volatility exceeded what anyone could have predicted. Even though California power marketshavenow somewhat stabilized, albeit at higher levelsthan those of ten tears ago, consideration should still be given to maintaining a special reserveto ensure Lodi Electric rate competitiveness at least forthe next several years. However, just liketen years ago when electrical restructuring was in its infancy, it is not wisefor anyoneto 3 pretend to have knowledge of what future power costs might be. Still, the basisfor setting the level of special reserves remains the same—risk management. Establishment of a Debt Service Reserve couId have value as an indication to rating agencies that Lodi Electric Uti I ity is taking its recent downgrading by Fitch Ratings seriously and that among the steps it is taking to strengthen its cash position, it is formulating one to specifically address lender concerns. COMPARISON WITH LOCAL PRACTICES The attached limited survey, Appendix A, illustrates how each of five similar sized and larger California municipal itiesaddress fund reserves. It is noteworthy that few have formal council policies that address the requirement for and level of cash reserves, but that all maintain operating reserves to some degree. For those utilities that have council directed policieswith respect to operating reserves, the levels range from 30 to 45.6 days. (The45.6-day period results from a policy requiring that operating reserves beset at 1/ 8th of annual expenses.) Operating reserves for electric aswel I as water utilities are typically found to be in the 30 to 45 day range, although 15 -day and 60 -day levels are sometimes encountered. RECOMMENDATIONS It is recommended that Lodi Electric Utility establish an Operating Cash Reserve Fund set at an amount equal to45days of its budgeted operating costs in FY07. Establishing operating reserves at this level is consistent with both local and nationwide electric utility practices. (Normally, the most recent fiscal year would serve as the base year, however, because last year was highly untypical the current budget year is proposed to be used as the base year.) It is also recommended that aCapital Reserve Fund in the amount of $500,000 be established. This is roughly the cost to replace and install a 66/ 12 -kV substation transformer, which represents the largest single contingency on the Lodi Electric Utility system. It is further recommended that the Rate Stabilization Fund be set in the amount that is reflective of a 20% purchased power increase over asix month period. For FY07, this amount would be $4,200,000. FISCAL I M PACT Referring to Table 1 below, at the end of FY 2006, Lodi Electric Utility had approxi matel y $14 M i I I i on i n vari ous u n restri cted accou nts or f u nds. A pproxi matel y $10.6 Million of that amount, however, wasfrom bond proceeds which have restri cti ons placed on their use. The remaining approxi mate $0.5 M i I I i on (Lodi El ectri c U ti I ity operating reserves) represents less than three days of working capital on projected FY 2007 expenses of approximately $66.5 Million. However, the nearly $3.2 million that 4 Lodi Electric Utility has" on account" with NCPA can viewed as contributor to the recommended operating reserve total, since the NCPA Operating Reserve can be used by Lodi Electric to offset NCPA power supply costs and maybe returned to the utility upon request. For this reason it is appropriate to consider the NCPA General Operating Reserve toward meeting the recommended 45 -day operating reserve requirement as developed in Table2. Table 1: Total Cash Available—End of FY2006 Fund Designation Current Balances* Operating Reserve $ 520,000 Capital Reserve -0- Rate Stabilization Reserve -0- Debt Service Reserve -0- Bond Proceeds Balance** $ 6,532,000 NCPA Operating Reserve* $ 3,165,600 Total Cash Available $10,217,600 * As provided by Lodi Electric Utility ** Restricted Use Funds. Total on hand at end of FY2006 was $10,380,000 -- approximately $6.532 available after prior capital project commitments. As shown in Table below, establishment of the three reservefunds at the recommended levelswould requirethat an additional $9,215,000 ($12,900,000- $3,685,000) beset aside. It is not likely that funding at the recommended levels can be accomplished quickly. Lodi Electric Utility will need to consider rate increases or surchargesto convince itscustomersand rating agenciesthat it istaking appropriate stepsto operate its utility on a stronger financial platform. Table 2 Fund Reserve Comparison of Current and Recommended Levels Exclusive of Restricted Funds Fund Designation Current Balances* Recommended Minimum Balances Shortfalls 45 -Day Operating Reserve** NCPA General Operating $ 520,000 $3,165,000 $3,685,000 $ 8,200,000 $ 4,515,000 Capital Reserve -0- $ 500,000 $ 500,000 Rate Stabilization Reserve -0- $ 4,200,000 $ 4,200,000 Total Cash on hand $3,685,000 $12,900,000 $9,215,000 * As of 6/30/06 F:1:1c3 APPENDIX A CASH FUND RESERVE PRACTICES OF SELECTED CALIFORNIA MUNICIPAL UTILITIES MUNI #1 MUNI #2 MUNI #3 MUNI #4 MUNI #5 Utility Department Electric+ H 20 Electric+ H 20 Electric+ H 20 Electric Electric+ H 20 Formal Reserve Policy set by City Council Yes N o N o N o Yes Co -mingled Funds? No No No No No Operating Reserve? Yes, 30 days Yes, undefined Yes, 45 days Yes, undefined Yes, 45.6 days Capital Reserve? Yes N o Yes N o N o