Burbank Water and Power
Energy risk management
Hedging plan and procedures
BURBANK WATER & POWER
ENERGY RISK MANAGEMENT
HEDGING PLAN AND PROCEDURES
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Hedging plan and procedures
Burbank Water and Power
Energy risk management
Hedging plan and procedures
Foreword
This energy risk management hedging plan and procedures document (“hedging plan”) for capacity and energy risk management is consistent with the energy risk management policy (risk policy”), and the credit risk policy (“credit policy”). The hedging plan provides a roadmap for risk mitigation in the fuel and power portfolio , and includes internal controls and procedures, transaction controls, and defines the roles and responsibilities for the front office, middle office, back office, and Risk Oversight Committee (“ROC”). On a case by case basis, the ROC may approve alternative strategies, limits, or authorizations to those in the hedging plan.
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Burbank Water and Power
Energy Risk Management
Hedging plan and procedures
Table of Contents
1.0 INTRODUCTION
2.0 RISK MITIGATION OBJECTIVES
2.1 Risk Tolerance and Hedging Strategies
2.2 Customer Strategies
3.0 INTERNAL CONTROLS
4. 0 RISK ANALYSIS AND REPORTING
5.0 RISK EXPOSURES AND MITIGATION STRATEGIES
6.0 AUTHORIZED INTRUMENTS
7.0 AUTHORIZED LIMITS
ATTACHMENTS
1 Risk Oversight Committee Charter
2 Types of Transactions
3 Authorized Instruments
4 Authorized Limits
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1.0 Introduction
Burbank Water & Power’s (BWP) load and resources continue to evolve amidst changing market conditions and regulations. The purpose of the e nergy risk management h edging plan and procedures (“hedging plan”) is to define risk mitigation objectives and provide risk management guidelines for managing energy risks.
BWP hedging decisions are based upon the thorough risk analysis and the hedging strategies are executed with authorized instruments and within the authorized targets and limits. The hedging plan also includes procedures that are internal controls for managing risks exposures. These include segregation of duties among the front, middle and back offices, as well as the type of risk analysis that will be conducted.
The hedging plan is approved by the ROC and is intended to guide risk analysis and risk mitigation decisions. The hedging plan strictly prohibits speculative trading and transactions.
The hedging plan is not intended to substitute for exercising sound employee judgment in managing BWP’s fuel and power supply portfolio. An exception from the limit and target levels discussed throughout the hedging plan will be approved by the ROC. At any time, the ROC may approve alternative strategies and instruments from what is in the hedging plan; these will be captured in ROC meeting minutes.
2.0 Risk mitigation objectives
BWP’s risk management objectives are to: i) manage price risk; ii) manage physical delivery risks in the power supply portfolio; iii ) efficiently dispatch resources; iv) integrate intermittent resources; v) manage deficiency or excess capacity; and v i) comply with regulations impacting power and gas supply operations.
Risk mitigation objectives include defining a risk tolerance, establishing hedging objectives, efficiently managing load and resources, mitigating risk exposures, and understanding the impact of retail customer programs on fuel and power costs.
2.1 Risk tolerance and hedging objectives
The ROC will approve energy and capacity hedging decision s annually by June 30 th for the following fiscal year. The risk tolerance at that time will be defined in the context of the estimated power supply costs in the current fiscal year. The risk tolerance is a target to not exceed the fuel and power costs in the current fiscal year by more than 10% from city council approved budget . BWP will develop energy hedging strategies to ensure ATTACHMENT 2
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reliable energy supply and to help manage power and fuel supply costs within the risk tolerance.
The back office will prepare power variance reports comparing the budgeted fuel and power costs to the combined actual and forecasted fuel and power costs for the current fiscal year. If actual and forecasted fuel and power costs in the current exceed the risk tolerance, this will trigger a Stop-loss limit (described in 7.1 Retail transaction limits). The Stop-loss limit is a requirement that the ROC review the cause for the exceedance of the risk tolerance and decide what action, if any, should be taken.
2.2 Customer strategies
BWP will monitor the potential effects of retail customer strategies on the fuel and power portfolio. This will help BWP to understand where these strategies reduce or add risks, which could lead to adapting or changing the customer -facing strategies in the future .
Customer strategies could include, but are not limited to, demand response program, time of day rates, feed -in tariffs, customer battery charging, retail energy storage, electrification, and other mitigation strategies.
2.3 Electric fund liquidity
The hedging plan should be utilized in conjunction with BWP’s cash reserves policy. The back office will report the electric fund reserve balance along with hedging report to the ROC before the start of a fiscal year . In the event cash reserves are below recommended levels, the back office may recommend higher than minimum capacity and energy hedging level.
3.0 Internal controls
Consistent with the energy risk management policy (“risk policy”), BWP will maintain a set of procedures to maintain appropriate internal controls in the energy risk management program.
Attachment 1 – Risk Oversight Committee (“ROC”) charter includes the organizational structure and roles and responsibilities of the ROC, the front, mid and back office. Attachment 2 – Key trading processes includes a description of the key trading processes to manage energy transactions. These include procedures for both standard and non-standard transactions (Note- non-standard transactions require ROC trade orders).
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The back office will review this hedging plan, and its attachments, and will advise the front, mid office and the ROC of proposed updates as needed . These may be caused by new external regulatory or market drivers, organizational developments, changes in load and resources, and/or changing operating practices.
The back office will notify the ROC of violations of the r isk policy, credit policy, and hedging plan.
4.0 Risk analysis and reporting
Risk analysis is completed to estimate the cost to serve retail load as well as to identify potential risk exposures resulting from net supply deficits and surpluses amidst different market conditions. BWP uses several models and tools to conduct portfolio analysis:
4.1 Deterministic risk analysis – A deterministic risk analysis is a base case analysis, developed with a load forecast, estimated fuel and power costs based upon current forward market prices, and estimated energy supply (power purchase agreements and estimated generation dispatch). On an annual basis, power supply division prepares a forecast of the estimated costs to serve retail load in the coming year as part of the annual budget process. The back office will track monthly financial results.
4.2 Potential risk analysis – A potential risk analysis is an analysis of potential risks that may be caused by changing load, changing resources, changing fuel and power prices , and different supply scenarios. To understand potential risk exposures, the front and back offices will work together to review seasonal, monthly, and hourly risks in BWP’s load and resources. The variability in hourly load, intermittent resources, and th e associated market price impacts can be estimated from historical data. This model is maintained by back office and available to the front office to use as well.
4.3 Sensitivity analysis – The front and back office will review the power and fuel costs based upon incremental movements up and down in power and gas prices by running different market price assumptions for power and gas costs and different resource availability scenarios. This will be done on as needed basis and the results provided to the ROC.
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4.4 Stress testing analysis –The front office and the back office will review the impact of major operational and market events on the portfolio such as the loss of a major resource or transmission path. This will be done on as needed basis and the results provided to the ROC.
BWP will use other risk repor ts that are prepared by the b ack office in the risk management program, such as a mark- to-market report and a credit risk exposure report. The mark-to-market report calculates the financial results of valuing open forward contracts relative to the current forward market. The c redit exposure report calculates counterparty risk exposures and tracks current exposure to credit limits is provided to the front office, consistent with the credit policy.
Other risk reports may be prepared as needed for risk management decisions.
5.0 Risk exposures and mitigation strategies
BWP will monitor power supply risk exposures in order to design mitigation strategies. The risk mitigation strategies will be developed in conjunction with cash reserves management and retail rate design. BWP has identified examples of risk exposures and current mitigation strategies.
5.1 Price risk - In high demand months, BWP needs to purchase gas to dispatch gas generation to meet load and/or purchase firm power to meet load. In low demand months, BWP may have surplus power and capacity to sell. Since forward positions are correlated, where long positions provide some protection against short positions, BWP will look at the integrated portfolio when it executes buy and sell strategies.
Strategy: BWP will use market hedges and customer strategies to mitigate price risk exposure in the fuel and power supply portfolio. The market hedges will be executed with third parties through standard transactions and non - standard transactions. See Attachment 2 for standard and non-standard transaction definitions. Customer strategies may also be used to analyze and mitigate impacts on the overall power supply costs.
5.2 Locational risk – In the past, BWP experienced high delivered gas costs as a result of gas transmission constraints that created an increase in the basis between supply location and delivered to the plant (this is also an operational risk).
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Strategy: BWP will try to find alternatives to hedge natural gas on a delivered basis, or find transportation options, to mitigate the risk of gas transmission constraints until more pipeline capacity and/or storage is added regionally or regional gas demand changes.
5.3 Volumetric and c apacity risk – Intermittent generation risk poses resource adequacy challenges as BWP experiences variation in energy production from its wind and solar purchased power agreements and other owned resources. BWP must plan how to integrate the intermittent energy with backup resources.
Strategy: BWP will review volumetric uncertainty from its intermittent resources in the power portfolio. As the percentage of renewable energy grows in future years, it is ant icipated there will be increasing ramp rates up and down to meet load requirements and adapt for intermittent energy availability. BWP will consider diversification in new renewable projects to include geographical and fuel diversification to mitigate the intermittency.
Additionally, the definition of ‘on- peak’ and ‘off -peak’ hourly blocks may change; and to provide more insight to the hourly needs, BWP will explore alternative ways to expand its capabilities to analyze forward period hourly risks.
LADWP currently provides ancillaries to BWP through the annual BAAS A agreement. Th is contract renews annually, so there is some uncertainty relating to continued contractual renewal and the cost of ancillaries in future years. Therefore, BWP will develop an ‘ancillaries’ volumetric position for future periods.
BWP will continue to monitor the participation rate and the financial results of the customer electric vehicle charging and the Time of Day rates. One or both of these customer offerings could potentially be used to partially mitigate the hourly capacity risk. BWP will also look into energy storage to address this intermittency.
5.4 Operational risk - BWP focuses on efficient resource dispatch, but unexpected plant outages and transmission constraints can occur. Depending upon the scale and duration of the outage, these are operational risks than can significantly affect BWP’s resource availability. This risk is greatest during high demand and high priced periods, such as peak load summer months.
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Strategy: Reasonably- priced call options, higher retail rates during summer and energy exchanges, and more opportunities from wholesale transactions to potentially mitigate this risk.
5.5 Credit risk – Counterparty credit risk is associated with entering into third party transactions.
Strategy: BWP will continue to monitor individual counterparties and the number of counterparties in use , to assess counterparty exposure and to review concentration risk.
5.6 Regulatory risk –BWP will need to comply with existing and new regulation.
Strategy: front and middle offices will be involved in resource analysis, so that the potential impacts of new regulation to retail ratepayers and the power supply operations can be studied and mitigated.
6.0 Authorized Instruments
The approved commodity types and authorized instruments which the front office may transact are included in Attachment 3 – Authorized Instruments. These are subject to the Authorized targets and limits in Attachment 4 - Authorized t argets. T he ROC ma y approve new Authorized Instruments and/or place limitations on listed Authorized instruments. Changes will be captured in the ROC meeting minutes and reflected in the next updated hedging plan.
7.0 Authorized limits
BWP uses limits to manage risks in its fuel and power portfolio, and for incremental transactions.
Below are descriptions of retail transaction l imits, minimum capacity targets, and wholesale transactions limits that fall under the average energy limits in the risk policy. The limits levels are included in Attachment 4 – Authorized limits.
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7.1 Retail transaction limits
BWP will look at its forward gas and power portfolio to: i) ensure there is adequate supply to meet load; ii) manage portfolio to reduce risk exposure associated with large deficit energy positions and surplus energy positions; and iii) protect against large fuel and power cost increases.
BWP will establish an annual hedging, for which the strategies below will be used.
The strategies vary depending upon market conditions and how actual and projected fuel and power costs compare to the city council approved budget. Risk limit levels associated with each strategy are included in Attachment 4 – Authorized limits.
7.1.1 Time-driven execution – If no other strategy has already been executed, the default strategy will be a time-driven execution strategy, where a percentage of hedged annual volume will be set before the start of a new and following fiscal year . This strategy ensures a mi nimum target level of hedging is executed before the start of a new fiscal year.
7.1.2 Opportunistic – The opportunistic strategy is to hedge more volume, or to hedge at an accelerated pace , when market opportunities arise. When this strategy can be executed, it may result in a higher percentage hedged than with the time-driven execution strategy. The opportunistic strategy will be pursued when BWP believes a forward hedge is attractive relative to the budget or favorable forward prices compare to historical prices, or that there is reason to believe forward market prices are more likely to rise than decline. Decisional criteria may be based on quantitative as well as qualitative analysis, including but not limited to , historical price analysis , forward natural gas and power prices, fundamental market analysis, new regulations, economic indicators, and new technologies.
7.1.3 Stop-loss – The stop-loss limit is triggered by an exceedance of the risk tolerance described in 2.0 Risk mitigation objectives. When the risk tolerance is exceeded in current fiscal year , the ROC will receive a stop-l oss limit notification. This will require the ROC to review the cause o f the negative deviation in budget and determine what, if any, action may be appropriate to take. Decisional criteria will be the most recent budget forecast prepared by the back office and any other relevant data.
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If the ROC determines additional hedging is required, t he stop-loss hedges will be executed to the best of BWP’s ability (subject to market liquidity and available instruments). Because the stop-Loss limit would likely be triggered in an extreme market, the ROC may use its discretion regarding whether how far forward hedged should be executed. The ROC may also suspend this limit for extenuating circumstances.
7.2 Minimum capacity levels
A minimum capacity l evel of 90% is desirable to meet projected annual peak demand. Before the start of new fiscal year, the front office will, at a minimum, present the ROC with the status of existing capacity to meet system peak demand which typically occurs from July to Oct ober. The ROC will determine whether additional capacity is needed to meet projected peak demand. The minimum capacity levels are intended to help BWP develop strategies, such as acquiring additional capacity for deficit p ositions, and/or implementing new customer strategies to help shape load to mitigate the surplus and deficit hourly positions.
These are target levels as opposed to limits, since there may not be liquid market instruments available or they may be too costly in th e forward market .
Additionally, customer strategies take time to develop and implement, and may only partly mitigate the hourly risk exposures.
7.3 Wholesale transaction limits
BWP’s front office may see opportunities to arbitrage” (not related to managing resources and supply in BWP’s retail fuel and power portfolio) with wholesale transactions. While there are no volumetric wholesale transaction limits, there are limits relating to when these transactions may be executed. Because there can be scheduling and counterparty risks associated with wholesale transactions, there may be constraints on the number of transactions and MWh that can be conducted.
These activities are permissible under the following conditions.
7.3.1 Incremental to fuel and power portfolio – wholesale transactions are incremental, and lower priority to managing the fuel and power p ortfolio to serve retail customer load. They will not be executed if they could compromise ATTACHMENT 2
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reliable delivery of energy to retail customers or add extra costs to customer rates. Additionally, wholesale transactions should not use up available counterparty credit needed to execute transactions for retail needs.
7.3.2 Firm and unit contingent sales – Firm and/or financially firm energy may only be sold to the extent that matching firm and or financially firm energy has been purchased. Unit contingent or transmission contingent energy may only be sold to the extent that unit contingent energy has been purchased.
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ATTACHMENTS
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ATTACHMENT 1 –ROC CHARTER
The composition of the ROC is provided in Figure 1 below. The table includes titles, attendance required, and voting status.
Figure 1 –ROC composition
Composition Title Attendance Voting
Chairperson Chief Financial Officer Yes Yes
Members General Manager Yes Yes
Assistant General Manager-Power Supply Yes Yes
Energy Control Center (ECC) Manager Yes Yes
Power Production Manager Yes Yes
Power Resource Manager Yes Yes
Financial Planning and Risk Manager Yes Yes
Energy Traders Yes No
Power Supply Financial Analyst Yes No
Advisory Role City Attorney’s Office Yes No
The ROC should meet monthly to discuss operational issues such as power plant or mechanical issues; system operations; transmission issues; evaluate open positions and energy hedging; review forward energy prices; propose new trade orders and monitor open trade orders; review credit limit violations and exceptions; discuss other issues such as Greenhouse gas (GHG), North American Electric Reliability (NERC) Standard s; and discuss other legal, regulatory or market issues impacting the fuel and power portfolio.
The ROC chairperson has the overall responsibility for organizing and conducting ROC meetings.
A quorum of at least 50 percent of committee voting members must be present. The back office monitors and reports on ROC-approved strategies such as open trade orders. Meeting minutes of ROC decisions and approvals will be maintained by the back office.
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ATTACHMENT 2 – TYPES OF TRANSACTIONS
There are different transaction procedures, depending upon whether a transaction is a standard transaction or a non-standard transaction. Below are definitions for both.
• Standard transaction p rocedures – This is standard process for recurring transacti ons within the current fiscal year or within twelve months of time horizon . Standard transactions have contractual, credit, market, and delivery terms and conditions that BWP has agreed to in the past.
• Non-standard transaction procedures – This process is for transactions that are longer than twelve months forward in time or are transactions that have non -standard terms or conditions. A non-standard transaction may include but is not limited to the following: a new product as result of new regulation or market development, a complex structure such as an option contract, a transaction at a new market location or involving a new transmission path that BWP has not previously used, and/or a one-time transaction. Non- Standard transactions require a ROC trade order that details the purpose and describes the terms of the proposed transaction. An ROC trade order will include the signatures of ROC members with voting rights that have reviewed the non-standard transaction. The trade order is routed for ROC approval and then forwarded to front office for execution.
The following flow-chart in Figure 2 illustrates the transaction procedures for standard and non- standard transactions.
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Figure 2 – Standard and non-standard transactions flow chart
Eno ug h
Resources to
Meet Retail Load ?
Start
Matching Retail Load
and Resources
EndR et ai l &
Arbitrage Sales
Interested
Parties?
YES
NO
R et ai l M arket
Purchase
NO
YES
Terms: 12 months
or longer ? R OC App ro val
YES
Terms: 12 months
or longer ?
YES
NO
Stand ar d
Transactions ?
YES
Traders execute and
enter transactions in the
system
Settlement
Discrepancies
YES
NO
Process Invoice
NO
Stand ar d
Transactions ?
YES
NO
R OC App ro val
R OC App ro val
NO
R OC App ro val
Fron t Office work with
counterparty to reach
agreement
Traders execute and
enter transactions in the
system
Settlement
Discrepancies
NO
YES Fron t Office work with
counterparty to reach
agreement
Process Invoice
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ATTACHMENT 3 – AUTHORIZED INSTRUMENTS
Figure 3 – Commodity type and authorized instruments
Commodity type Authorized instruments
Power fixed price Physical
Futures
Financial swaps
Power options (Physical and
Financial)
Power puts
Power calls
Heat rate options
Structured options (a combination of two or more options such as a “fence” or “straddle”)
Capacity Purchases
Sales
Ancillaries Purchases
Sales
Power locational price risk Congestion Revenue Rights (CRR) Financial exchanges
Physical exchanges
Power transmission
Natural gas fixed price Physical, futures, or financial swaps Natural gas options (Physical
and Financial)
Natural gas puts
Natural gas calls
Structured options (a combination of two or more options such as a “fence” or “straddle”)
Natural gas locational price risk Financial basis swaps Financial exchanges
Physical exchanges
Pipeline transportation
Natural gas storage Physical contracted storage facility rights or buy/sell arrangements with third parties to simulate storage.
Renewable energy credits Purchases and sales of renewable energy credits to balance BWP’s Renewable Energy Credits (RECs) portfolio.
Carbon allowances Purchases of carbon allowances to meet emissions. Sales of carbon allowances when BWP has a surplus position.
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Greenhouse gas (GHG) Participate in the quarterly auctions Bilateral purchases and sales
Low Carbon Fuel Standard
(LCFS)
Sell LCFS credits annually
Notes:
• Option strategies that would potentially increase BWP’s risk exposure must be approved by the ROC.
• Sales of city-gate basis or ‘delivered’ basis are not allowed unless there is a corresponding long city-gate position in BWP’s fuel and power portfolio.
• Electric energy storage: BWP will explore electric energy storage opportunities as part of its resource planning, but to date, this is not a conventional instrument commonly available in the market. For this reason, it is not currently listed as an authorized instrument.
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ATTACHMENT 4 – AUTHORIZED LIMITS
Energy Limits
The energy limits are defined as a percentage of Net Energy to Load (“NEL”). The definition of “hedged” refers to the percentage of the NEL that is met with resources and contracts that have no or very limited price exposures.
Figure 4 –Time driven and Opportunistic limits – By June 30th or prior to a new fiscal year, BWP expects to be at 90% hedge and 60% hedge for the following year.
% of NEL FY1 Forecast FY2
Time-driven limit (Minimum
hedged by June 30th)
90% 60%
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Figure 5 – Opportunistic limits
Price
decile
Example: Socal
Citygate(1) as of
January 2022
Hedge
level
FY0 (2) FY1 FY2 FY3 FY4
50th
Decile
$ 5.52 Up to 100% 95% 80% 75% 70% 40th
Decile
$ 4.79 Up to 100% 95% 80% 75% 70% 30th
Decile
$ 4.38 Up to 100% 95% 90% 85% 80% 20th
Decile
$ 3.77 Up to 100% 95% 90% 85% 80%
Definitions:
(1) Average Socal Citygate natural gas forward monthly prices as published by S&P Capital IQ or other verified third-party sources plus 10% adjustment. (2) FY0 is current fiscal year, FY1 is planning year 1, FY2 is planning year 2, etc.
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