RECOMMENDATION:

Staff requests that the City Council adopt the proposed Resolution which will enable the General Manager of Burbank Water and Power to execute an agreement with Southern California Public Power Authority (�SCPPA�), to participate in the initial phase of a SCPPA project intended to lead to the acquisition of 1,000 Dth/day of natural gas reserves for BWP�s natural gas fuel portfolio.

DISCUSSION:

In the last few years natural gas prices have become very volatile with prices ranging from $3/Dth to as high as $58/Dth.  Natural gas price volatility is expected to continue. With the amount of volatility of prices in the short-term gas market combined with the large amount of gas BWP requires, typically 3000 to 20,000 Dth/day, BWP along with several members within SCPPA believe that long-term gas supplies would be a practical strategy to lock-in the certainty of gas availability as well as provide stable pricing for budgeting for fuel cost for the next 5-20 years of operation.

One way to achieve this is to acquire existing proven in-ground gas reserves in fields that can deliver gas to Southern California.  This approach is conceptually similar to coal reserves Burbank owns (through Intermountain Power Agency) for its entitlement in the Intermountain Power Project.  In FY 2002/03 Sacramento Metropolitan Utility District (SMUD) acquired over $135 million in gas reserves.

On September 8, 2003 SCPPA engaged Petrie Parkman & Company pursuant to SCPPA Resolution No. 2003-34 to assist the Cities Anaheim, Burbank, Colton, Glendale, Los Angeles, and Pasadena in the acquisition of natural gas rights and related facilities to be used as fuel for power generation and as a means of stabilizing power generation fuel costs.

Natural gas reserve ownership has other risks associated with the amount of gas actually in the ground and its extraction. These risks are mitigated by securing wells within proven, developed, and producing fields and using a comprehensive due diligence program prior to the acquisitions. The due diligence program includes an analysis by a nationally recognized reservoir engineering firm to estimate the amount of gas associated with the reserve field and the cost of production over the life of the reserve, legal review including clear title with necessary mineral rights and regulatory review, and environmental consultants to review environmental impacts associated with the reserves.

Parties who have agreed to be involved in the agreement include the following SCPPA members: Los Angeles Department of Water and Power and the Cities of Anaheim, Glendale, Burbank, Pasadena and Colton; and the following non-SCPPA utilities: Redding, Turlock Irrigation District and Southern Nevada Water Authority.  The total expenses associated with the project are estimated to be as shown in the following table. 

Burbank�s share of the total project costs are estimated to be as shown in the following table.  Burbank intends to obtain reimbursement of most or all of these costs at a later phase in the project after bond financing.

Petrie Parkman has recommended that as many as 8 separate gas reserve sites should be identified and procured in the next 18 months to develop a diversified portfolio that will meet participant needs. The cost of actually acquiring each reserve would be determined in a separate agreement between the owner of the reserves and SCPPA that, for Burbank, would be funded through SCPPA-issued bonds.  In addition to the actual gas in the ground, other costs involved with owning gas reserves would include operational expenses to retrieve the gas and transportation costs to get the gas to Burbank.  These costs will also be arranged through SCPPA in separate agreements.

Putting all these expenses together, it is estimated that the actual cost of gas to Burbank from these reserves should be in a range of $4.75 - $5.25/Dth over the life of the reserves.  Based on current conditions, these prices are competitive with expected future prices.   

Attached to this staff report is a FUEL PROCUREMENT STRATEGY for BWP.  It outlines a fuel procurement strategy designed to minimize price volatility and achieve a stable low priced natural gas portfolio for local generation.  At this point, BWP has determined that it would be prudent to acquire a small the portion of its fuel portfolio, reserved for long term purchases, through this approach by procuring 1,000 Dth/day of natural gas reserves.  The remaining long term portion of portfolio could come from contracts with marketers or liquefied natural gas, when available.  The remaining fuel portfolio will be a mix of long-term/short-term gas supply contracts and short-term strip purchases such as those currently purchased for use in our local generating facilities. 

The authority requested under this Resolution is for the initial phase of the project.  This work is to be completed in September 2004.  At the conclusion of this initial phase, Burbank will then make its election on whether to continue with the project. The authority requested under this Resolution is limited to the initial phase.  Staff expects to return to Council in the fall to seek authority to proceed with the second phase.  Should Burbank decide not to participate in the project at all, it only loses its share of the initial agreement development costs, which are not expected to exceed $50,000.

The second phase of the project requires BWP to participate in each natural gas project in the program until BWP�s allotment of 1,000 Dth/Day has been filled.  In the event 10% of the project participants determine that the gas from a particular property cannot be delivered to the California border at an attractive price, Burbank will have the ability to opt out of that particular property.

As indicated above, this request relates only to the initial development costs.  It is expected that after the initial phase is completed late this summer BWP will return to council for approval of a Natural Gas Purchase Agreement between Burbank and SCPPA contingent on if the decision is made to fully participate in the SCPPA Program.  That Natural Gas Purchase Agreement will be for 1,000 Dth/day.

DEVELOPMENT AGREEMENT

This development agreement includes the following terms and conditions:

1. Participants: Anaheim, Burbank, Colton, Glendale, Los Angeles, Pasadena, Redding, Turlock Irrigation District, and Southern Nevada Water Authority.

2. Production Capacity and Development Work Shares: The maximum daily gas production capacity desired by each Participant.

3. Financing Work Costs: Participants utilizing SCPPA financing will share the associated financing costs.

4. Gas Sales Agreement: Participants not obtaining fee title to the gas reserves and contracting with SCPPA for a delivered gas product will share in the cost of drafting gas sales agreements.

5. Project: The Natural Gas Development Project (�Project�) includes all work necessary to acquire the number of gas properties (�Acquisitions�) necessary to achieve the total production capacity of all Participants. Separate participation agreements will be executed for each Acquisition.

6. Term: The Project will continue through the last acquisition or until the budget is exhausted which is expected to occur prior to December 31, 2007.

7. Budget: The Project Development Work Budget is $3.99 million and the Project Financing Cost Budget is $675,000 for a total of $4,665,000. However, Participants are only obligated for initial Development and Financing budgets until they make an election to continue to participate in the Project after the initial phase.

8. Election to Participate in Project: After the Initial Development and Financing work is complete, the Participants will be asked to elect a participation level as a maximum daily production capacity in Dth/day. After this election, which is expected to occur sometime in the fall of 2004, Participants will be obligated for their pro-rata share of the Project budget and required to participate in all Acquisitions approved by the Coordinating Committee on a pro-rata basis.

9. Coordinating Committee Approval: A super majority vote of the Project Coordinating Committee, based on participation shares, is required for all actions of the Coordinating Committee, including Acquisitions. The approval percentage required for Coordinating Committee approval is equal to 99 percent less the participation shares of the three Participants having the smallest participation shares. For example, if the three smallest participation shares were 1.5%, 3%, and 4.5%, then the Coordinating Committee vote greater than 90% would be required for Coordinating Committee action.

10. Project Manager: Los Angeles Department of Water and Power shall be the Project Manager for the Project.

11. Petrie Parkman Contract: The Participants agree in the Development Agreement to engage Petrie Parkman directly, or through SCPPA, including a transaction fee not to exceed 2% of the purchase price for any completed Acquisition for which Petrie was the procuring cause. All contracts signed with Petrie will have the same terms and conditions, and any quantity discount will apply to the aggregate volumes of all Participant contracts.

As stated earlier, this authorization is for the initial development work related to identifying potential reserves, drafting the SCPPA Gas Sales Agreements, and arranging for financing, if needed.  Consequently staff expects return to Council at a later date to request permission to execute the Sales Agreement with SCPPA and financing documents. We are recommending only this modest amount of gas, 1,000 Dth/day be developed under this agreement.

IMPACT ON RATES:

This effort is expected to result is the acquisition of secure supply and competitively priced natural for use in our generating facilities.  It is expected to lower the cost of electricity and will result in lower cost power for our customers. 

RECOMMENDATION:

It is recommended that the City Council approve the subject Resolution authorizing the General Manager of BWP to enter into the NATURAL GAS PROJECT DEVELOPMENT AGREEMENT with SCPPA, to facilitate the acquisition of 1,000 Dth/day of natural gas reserves for BWP�s natural gas fuel portfolio.

RED:FCF:cj

Fuel Procurement strategy

May 7, 2004

BWP Power Supply division

By Bruno Jeider

This report is intended to serve as a foundation for the development of natural gas fuel procurement strategy and resulting natural gas fuel portfolio for BWP.

Risk Management:

The heart of BWP�s fuel procurement strategy is centered on eliminating the risk of a volatile and uncertain fuel supply to achieve stable and low prices. 

BWP�s risk management policy calls for increasingly higher levels of hedging the closer in time to the current operating year.  The following table which summarizes Table 2, Page 25, of BWP�s Energy Risk Management Policy and Procedures dated July 10, 2003 shows BWP�s planning driven hedging targets as a function of time.

It is designed so that BWP will make larger purchases of longer duration when prices are attractive compared to historical values.

Anticipated Requirements:

BWP recently completed an exhaustive analysis aimed at gaining a clearer understanding of BWP�s future natural gas requirements.  Several noteworthy assumptions regarding the study are:

BWP�s Jan 10, 2003 load forecast still appears valid. It has load increasing about 1.5% per year.                                                                                                                                             

The BPA contract remained in the Exchange Mode.

The following table shows how BWP�s energy requirements would be met for fiscal years

2004-05 through 2008-09.

Once MPP goes into service, BWP will have most of its energy requirement met by IPP and MPP.  About 70% of MPP�s annual energy output will be used to meet native load requirements. 

The following table has been prepared to show the anticipated average daily fuel needed each month during the study period for BWP�s on-site generating facilities. 

The table shows that once MPP goes into service BWP�s full native load fuel requirements remain fairly constant at about 14,000 DTh/Day. 

Determining Hedging Targets:

BWP staff expects that IPP�s Coordinating Committee will continue its practice of hedging the coal supply for the plant as it has in the past.  Consequently, from BWP�s perspective IPP energy is hedged.  Similarly, energy from Palo Verde, and Hoover are assumed to be hedged.  The result is a portfolio that is already about 52% hedged.

Approximately, 46% of the unhedged 48% portion corresponds to fuel requirements for local generation facilities.

The following table has been prepared to show how much of BWP�s portfolio is currently unhedged.  The values in boldface type correspond to resources that are unhedged.

BWP staff believes that it is desirable to have at least 85% of its portfolio hedged at the start of the calendar year prior to a new fiscal year.  Hedging 71% of the unhedged portion of the portfolio related to fuel for local generation facilities would bring the portfolio to the desired hedged level of 85%.  Thus, hedging 10,000 of the 14,000 Dth/Day anticipated future natural gas requirement would produce the desired result. 

The following figure shows hedged positions in green and the unhedged requirements in blue and purple with the 85% target as a black line.

Designing an Appropriate Natural Gas Portfolio:

As discussed in the preceding section, staff recommends that BWP have sufficient gas under contract at the start of the calendar prior to a new fiscal year so that 85% of the energy requirements for the ensuing fiscal year have been hedged.  This portion of our energy requirements will be referred to as BWP�s core gas requirements.

The goal is to develop a core gas requirements portfolio that is competitively priced and immune from market volatility.  This can be achieved by designing a stratified portfolio that results in the acquisition of gas when it is attractively priced and also provides for continual replenishment to keep it reflective of market.

Below is a chart showing the core gas requirements.  As shown in the chart, staff recommends that approximately 30% of core gas requirements portfolio should be comprised of 10-year, or longer, term strips �like those shown in green� purchased when prices are attractive.  Further, 50% of the portfolio should be comprised of staggered medium term (2 to 5 years) strips that are replenished on a regular basis as they expire.  The final 20% of the portfolio should be comprised of short term (1 year or less) strips that are rolled over annually. 

The end result is a stratified core gas requirements portfolio comprised of strips of different terms.  The following figure gives a visual representation of the proposed buying strategy.  (For purposes of illustration simplicity, the chart shows strip 1,000 Dth but in actuality our strategy would likely be to break these down into 500 Dth blocks.)

Recommendations for specific purchases to build the portfolio will be presented in separate memos.

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