PURPOSE

Staff recommends the City Council adopt a proposed Resolution that will extend existing authority for the Burbank Water and Power (BWP) General Manager to make short-term sales and purchases for the products and services needed to effectively conduct its retail and wholesale electric operations.  The proposed Resolution extends the authority given in Resolution 26,097, which will expire on December 31, 2006.  The proposed Resolution allows transactions to be made without regard to the City�s formal competitive bidding process and grants the BWP General Manager the authority to negotiate and enter into forward contracts for products and services, provided the commencement date for performance of any forward contract is not more than five years from the date the contract is made and the agreement is for no more than five years in duration.  In no event shall the duration of any agreement extend beyond December 31, 2021.  On August 3, 2006, the BWP Board recommended approval of the proposed Resolution.

BACKGROUND

• It is a standard business practice in the electric utility industry to buy and sell power on an �as needed� or �spot basis.�  These transactions occur within competitive markets and due to the need to act expeditiously, they cannot be facilitated through the City�s normal bidding process. Typically, these transactions are quickly negotiated over the telephone and the time between closing a deal and a transaction starting can be as short as a matter of minutes. Historically, such purchases comprise approximately one-third of BWP�s power supply for native load and nearly 100% of wholesale transactions. 

• Deregulation of the electric industry has created new forums, institutions and organizations with whom Burbank needs to conduct business.  Examples are the California Independent System Operator (�ISO�), power and energy brokers and various marketing organizations.  These parties typically require a �live� negotiation and bidding process for transactions that may occur on an hour-ahead or day-ahead basis.

• For many of the products sold, there are associated transaction fees such as scheduling coordination and access/uplift fees that must be paid.

• Power supply shortages have resulted in highly volatile markets.  Risk management tools and techniques using options, swaps, futures, contracts for physicals and financial hedges are becoming increasing necessary to minimize costs and protect against unwanted price moves.

• Deregulation of the electric industry has resulted in the unbundling of traditional electricity products like capacity and energy.  A whole new class of products or services called ancillary services has been created.  It includes various forms of spinning reserve and regulation.  BWP needs to be able to buy and sell these as well as new products that may come to market.

• Deregulation of the natural gas industry has also resulted in the unbundling of transport from the commodity.  Gas can be bought on a daily basis or terms spanning years.  As well, it is possible to buy space on an interstate pipeline for a single day or terms up to several years from third parties or bulletin boards operated by the various pipelines.  Likewise, natural gas storage has been unbundled into inventory, injection and withdrawal rights.  It is also possible to buy gas for balancing and making trades or purchases at the end the month to resolve imbalances between the volume of gas burned vs. the volume transported.  Historically, it has been prudent to purchase significant portions of natural gas, the primary fuel of BWP�s power plants, for short terms or on a spot basis.  Thus, BWP needs to be able to transact on a short-term basis buying and selling gas and other related products in order to assure the reliable and economic delivery of fuel to local generating facilities.

• BWP is part of the South Coast Air Quality Management District�s Regional Clean Air Incentives Market (SCAQMD RECLAIM) program.  Under this program, certain entities emitting Nitrogen Oxides (NOx) are assigned NOx Reclaim Trading Credits (RTC) by the SCAQMD depending on the size and nature of their business.  There is a market for the credits and BWP would be in a position to sell its� credits if the NOx output of its� generation units is under SCAQMD�s allotment. Conversely, BWP may need to buy additional credits if its� NOx output is above the allotment.

• When possible, a competitive bidding process is used by BWP to acquire fuel, purchased power, transmission capacity and emission credits.  However, in many cases this is impractical because of time limitations.  Thus, BWP uses a negotiation process that pits contending parties against each other competing for our business.

• Estimates of spot purchases of power and fuel are incorporated into BWP�s annual budget.  Costs are recovered through the Energy Cost Adjustment Charge (ECAC). 

• The purchase and sale of electricity, gas and RECLAIM emission credits is not subject to the provisions of the California Environmental Quality Act (CEQA) pursuant to Section 15378 of the State CEQA Guidelines.

EXAMPLES OF TRADING OPPORTUNITIES

Opportunities exist for BWP to profit from the effective and efficient management of idle assets.  Typical situations when this may occur are as follows:

• Anticipating continued load growth, a utility enters into a long-term contract to provide secure long-term benefits for its ratepayers, but may be unable to use the entire purchase initially.                                                          

• A utility has installed sufficient generating capacity, or acquired transmission facilities, to take it through its peak-load period.  Consequently, during the winter when certain resources are not required for its customers needs, the utility has surplus idle capacity that could be sold to others.

• It may be necessary for a utility to bring base load generation on-line to meet its daily on-peak requirement.  Then, at night, during off-peak hours when demand from domestic customers drops, this generation may be sold to others as it is not practical to start and stop base load generation on a daily basis.

Similarly, significant margins can be realized in the wholesale market by continuously moving in and out of trading positions.

• BWP can take advantage of its relationships with others to acquire power or other products at favorable prices and then reselling to third parties at a profit.               

The aforementioned situations apply to BWP�s surplus transmission and generation assets.

HOW THE INDUSTRY CONDUCTS BUSINESS

Sales and purchases are typically made through Master Agreements, such as the Western Systems Power Pool (WSPP) Agreement[v1] .  These agreements are usually written to last for years, but generally have short-term cancellation rights like 30 days should a party wish to terminate the agreement.  Actual trades are discretionary, allowing a party to enter into deals only when they determine it is in their best business interest.  The frequency of the transactions and the short time period in which a decision must be made makes it impractical to seek City Council approval.

Burbank needs to be able to continue to purchase electric power, fuel for generation, emission credits and other related products and services by means other than through formal bidding.  Approximately one-third of BWP�s total requirements of electric energy for native load and nearly 100% of wholesale transactions (purchases and sales) are made through negotiations and informal bidding.  Typically, the transactions are negotiated via telephone and because of market volatility they need to be finalized immediately before prices change. Increasingly, transactions are also being done electronically via bulletin board or web sites where bids are immediately accepted, or rejected.  In any event, a trader needs to make almost instant decisions and have the authority to commit to the trade once the terms of the transaction are negotiated.  In order to facilitate the deals, the Department must accept the offers without delay or the opportunity is lost.

THE NEED TO DO TERM TRANSACTIONS

As indicated earlier in this report, BWP is requesting the approval of a Resolution for the continuation of current practices. 

There are several reasons why it is necessary and advantageous for BWP to have the authority to enter into deals for terms of up to five years.  Currently, the markets for most energy products and services are backward dated.  This means that prices in the near-term, from several months to two years out, are higher than similar products three or more years out.  BWP can benefit from such market conditions in two ways.  First, being able to buy over a longer time period will enable BWP to average down the price, thereby reducing its� power supply costs in the early years.  Second, energy markets from time�to-time present attractive opportunities to purchase power or gas for periods that may not begin up until five years after the date the contract is signed. Authority to enter into deals of this type will allow BWP to contract at lower costs by entering into favorable futures contracts when opportunity allows.  Future energy and gas prices a few years beyond the current term are priced-based on market fundamentals and are devoid of short-term factors such as hurricanes and threats of terrorism which tend to raise prices.

FISCAL IMPACT

Any purchases made under the authority of the Resolution requested in this memo would be included as part of an approved BWP budget.

CONSEQUENCE OF NOT HAVING THE AUTHORITY SOUGHT BY THIS RESOLUTION

BWP faces the prospect of not being able to run its electrical system and/or incurring a substantial increase in costs if the proposed Resolution is not approved.

Significant benefits will continue to accrue to BWP�s ratepayers from the continued ability of the BWP General Manager to buy and sell to others without delay, electric power, transmission services, fuel, emission credits and related products and services for up to five years in duration.  The ability to engage in such short-term transactions is imperative in order for BWP to remain a viable and competitive business enterprise.

Should the proposed Resolution not be approved, BWP will be unable to operate efficiently and would most likely be unable to conduct business.  BWP would have to change its contracting so that all fuel and power purchases would be done using long-term contracts.  Doing so would preclude BWP from using short-term purchases to enhance the economics of its operations, thus, raising the cost of service to customers.

CONCLUSION

Extend the current authority of the BWP General Manager to enter into short-term transactions for up to terms of five years for the products and services related to its energy services.

RECOMMENDATION

If the Council concurs, the appropriate action would be a motion to adopt the Resolution entitled,

�A RESOLUTION OF THE COUNCIL OF THE CITY OF BURBANK, AUTHORIZING THE GENERAL MANAGER OF BURBANK WATER AND POWER TO UNDERTAKE SHORT-TERM SALES AND PURCHASES OF UP TO FIVE YEARS IN DURATION FOR PRODUCTS AND SERVICES NECESSARY FOR OPERATION OF THE CITY�S ELECTRIC UTILITY.�

RED:FCF:HP

/HP/Council Memo (5 Year Sale Purchase), rev. 08-31-06

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