PURPOSE

Staff requests that the City Council adopt the attached resolution.  Approval of this resolution will authorize staff to substantially lower gas costs by entering into a 30 year prepaid natural gas supply agreement with Southern California Public Power Authority (SCPPA).  The agreement will reduce natural gas cost by $32 to $45 million over the next 30 years.  This will be achieved by taking advantage of BWP�s good credit and low borrowing rate to finance future gas expenses.

BACKGROUND

Burbank�s Gas Requirements

BWP owns and operates natural gas power generators that provide electric power and reliability for the City of Burbank.  Generators located at BWP provide 40 percent of the power required by the City of Burbank.  The remaining power is provided by hydro, wind, natural gas, nuclear, and coal generation sites outside of Burbank.

Fuel for the generators in Burbank is primarily provided by forward natural gas contracts. Forward contracts are agreements between parties specifying the price, location, and amount of gas to be delivered at a future date.  Payment is issued after the delivery of the fuel. Depending on the season, natural gas requirements can range from 6,000-8,000 MMBtu per day during the winter, and as high as 18,000 MMBtu per day during the summer.  The price of natural gas can be extremely volatile; over the past six years the price has varied in range from $3 to over $40 per MMBtu.  Currently, it is trading in the range of $7 to $10 per MMBtu.  The cost of natural gas for BWP in Fiscal Year 2007/08 is budgeted at $29 million.

Over the past several years, BWP has added new generation and retrofitted existing generation units.  Lake 1 was placed in service in 2002, Olive 1 and 2 were retrofitted in 2003, and the Magnolia Power Plant was placed in service in 2005.  The expected economic life of the new plants is at least 30 years.  The City�s electrical demand and the economic and relatively clean source of generation create a long term need for natural gas.

ANALYSIS

What is a Prepaid Transaction?

Prepaid transactions for municipals are not new.  They have been around since the early 1990�s. In 2003 the Internal Revenue Service issued updated tax regulations that specifically authorized these transactions and the parameters for how they are structured.  Since that time, prepay transactions have increased.  After the clarifications, transactions totaling more than $12 billion in debt were completed.  Electric and gas utilities that issue bonds for prepaid gas include: Sacramento Municipal Utility (SMUD), Roseville (CA) Electric Utility, Memphis Light, Gas and Water, Municipal Gas Authority of Georgia, Florida Gas Utility, and Tennessee Energy Acquisitions Corp.  

A gas prepaid transaction occurs when a municipal entity issues bonds and uses the funds to prepay for natural gas at a discounted price.  The bond proceeds are paid in advance to the gas supplier in exchange for natural gas to be delivered to participating municipal utilities over time.  The discount is offered because the municipal�s borrowing cost is lower than the borrowing cost of the gas supplier.  In other words, it is less costly for the gas supplier to borrow from utilities than it is to borrow from the bond market.  The gas supplier shares a portion of savings with the utilities by offering a discount for the natural gas.

It is common for the participating utilities to use a joint action agency (JPA) as the bond issuer.  In this agreement, the municipal utilities involved are Burbank, Los Angeles, Pasadena, Anaheim, Glendale, and Colton.  The JPA is SCPPA and the gas supplier is J. Aron.  The transaction involves these basic steps:

• SCPPA issues the debt.

• SCPPA prepays J. Aron for the natural gas.

• J. Aron delivers the gas to the utilities on a daily basis.

• SCPPA collects monthly revenues from the utilities sufficient to pay the debt service on the bonds, as J. Aron has already been paid for the supply of gas from the proceeds of the bonds.

The Selection of a Gas Supplier

In July 2006, SCPPA solicited bids from banks and gas suppliers.  Fifteen vendors submitted proposals.  A group of five (Goldman Sachs, UBS, JP Morgan, Citigroup, Merrill Lynch) was selected from the fifteen.  The five were then interviewed by SCPPA, Public Financial Management (financial advisor), and the participating municipals: Burbank, Anaheim, Pasadena, Los Angeles, Glendale, and Colton.  J. Aron was selected after evaluating the vendors based on the following criteria:

• Economics (discount).

• Financial strength of the vendor.

• Strength of business terms and reduction of risk to SCPPA and its Participants.

• Vendor presence in the gas market.

• Vendor involvement with similar transactions.

J. Aron has been in the commodities business for over 100 years. It was acquired by Goldman Sachs in 1981.  It specializes in energy, power, metals and petrochemicals.  J. Aron also manages the Goldman Sachs Commodity Index (GSCI) that measures commodity market performance over time. As the parent company, Goldman Sachs fully backs J. Aron�s obligations. Goldman Sachs has a AA- rating from Standard and Poor�s and Fitch, and a Aa3 rating from Moody�s.

The Discount and Term

BWP will enter into a 30 year agreement with SCPPA for the delivery of 4,000 MMBtu per day.  This is about 33% of BWP�s natural gas requirement.  Burbank�s portion of the bond issue will be sized at approximately $175,000,000.  The prepayment will result in a fixed discount of $0.75 to $1.05 to the prevailing index price for every MMBtu delivered.  However, the fixed discount achieved will depend on the interest rates and gas prices at the time of SCPPA�s bond sale. 

It is important to reiterate that BWP will receive gas at the monthly index price.  There is no commitment to lock up natural gas at a fixed price for the next 30 years.  The index price allows BWP the flexibility of firming the price at a later date.  The monthly index price is published in Inside FERCs Gas Market Report (published by Platts, a division of the McGraw-Hill Companies).  Platts is the largest publisher of energy related data. 

THE BENEFITS OF THE PREPAID TRANSACTION

The prepaid agreement results in significant savings over the life of the agreement.  The cost of natural gas is reduced by $0.75 to $1.05 for every MMBtu delivered through the contract. For example, if the index price of gas is $8.00 and the discount is $1.00, BWP would pay $8.00 minus the $1.00 discount, for a net payment of $7.00 and achieve savings of 12.5%.  BWP�s annual volume of 1,460,000 MMBtu per year would yield an annual saving of $1,460,000.  Over the term of 30 years, and depending on the discount, this agreement is expected to generate a   gross savings of $32 to $45 million.

An important aspect in the gas prepay transaction is the ability to shift virtually all risk of gas delivery to the gas supplier, J. Aron.  While a prepayment is made to J. Aron through the issuance of bonds, SCPPA�s (and in turn, Burbank�s) obligation is to pay only for the actual natural gas delivered.  If J. Aron fails to perform, Burbank will have no financial obligation to pay for the gas or bonds, and the bondholders can only look to J. Aron for repayment.  Further, should J. Aron cause an Event of Default, they will pay SCPPA a default fee.

Another positive aspect is that the issuance bond has no impact on the utility�s financial debt ratios.  To the rating agencies (Standard & Poor�s, Moody�s, Fitch), the debt obligation is viewed as an operation expense.

In the event a SCPPA participant defaults, Burbank will not be required to step-up and take over the payments of the defaulting party.  Burbank does not assume any credit risk from the other SCPPA participants� failure to pay for the gas or use the natural gas in a qualified manner. 

THE RISKS OF THE PREPAID TRANSACTION

Gas Supplier Fails to Deliver Fuel

In the event that J. Aron cannot deliver gas as scheduled, BWP will purchase replacement gas from another vendor, and J. Aron will be obligated to pay the replacement price as well as an additional 5 cent/MMBtu administrative fee.  If J. Aron persistently fails to deliver the natural gas, Burbank can terminate the transaction and J. Aron will be obligated to pay Burbank�s share of the prepayment bonds as well as pay a default fee of 5 to 20 cents per MMBtu for the outstanding gas.

Burbank Cannot Take Delivery of the Fuel

BWP is obligated to burn 90% of the fuel delivered over the life of the contract or sell the natural gas to a municipal utility that will use it in its service territory. The amount of gas purchased will be sized to meet this requirement. In the event fuel is not burned, it can be addressed by the following options:

• Fuel can be sold to another municipality.

• Fuel can be sold to a gas supplier and the funds received can be used to purchase power.

• Fuel can be delivered to a balancing agent for temporary storage.

• Fuel can be sold by our balancing agent to another municipal.

• Fuel can be assigned to J. Aron for remarketing to other municipals.

However, it is important to note that Burbank�s unexpected inability to comply with the qualified use requirements is a risk borne by J. Aron, not Burbank.  Ultimately, J. Aron is required to assist Burbank with finding qualified use of the gas if Burbank can not burn it, and J. Aron�s failure to do that may cause an early termination of the transaction, but allows Burbank to walk away from the transaction without any further financial obligation to J. Aron or the bondholders.

Prior to this prepaid transaction, BWP had purchased the majority of its gas requirements for the next 4 years.  It will not be able to burn the fuel from the prepaid transaction during this four year period.  To meet the burn requirements of this transaction, the fuel will be sold to other municipals through Coral Energy Resources, L.P., acting as the broker.  As part of the agreement, BWP will sell the gas at a discount of approximately 25 cent/MMBtu.  Even with the sale of the gas at a discount, a net positive cash stream of $700,000 to $1,150,000 per year is expected.     

CONCLUSION

Natural gas is an integral element of the City�s long term electric generating resource portfolio.  Entering a natural gas prepaid agreement will provide savings of $32 to $45 million to the City�s residents and businesses.  It will also provide long term gas from a financially strong gas supplier.

RECOMMENDATION

Adoption of the attached Resolution of the Council of the City of Burbank approving the Gas Supply Agreement between the City of Burbank and the Southern California Public Power Authority, authorizing specified City officials to execute and deliver the Gas Supply Agreement, and approving the participation of the City of Burbank in the activities and program reflected therein pursuant to the terms and conditions of the Gas Supply Agreement.

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