Economics | Strategy | Stakeholders | Sustainability
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Phone: (720) 633-9514
July 27, 2023
via email
Richard Corbi
Planning and Analysis Manager
City of Vernon | Vernon Public Utilities
4305 Santa Fe Avenue
Vernon, CA 90058
Subject: Electric Utility Cost of Service Study and Financial Forecast Recommendations Dear Mr. Corbi:
NewGen Strategies and Solutions, LLC (NewGen) was retained by Vernon Public Utilities (VPU) to perform an Electric Utility Cost of Service (COS) and provide a financial forecast of operating results over a seven‐ year period. The critical part of this study was identifying necessary rate changes to ensure the financial sustainability of the utility over the forecast period. The primary goal of the COS was to identify system average and the energy cost adjustment (ECA) rate changes required to maintain the key financial metrics which support the financial sustainability of the utility.
Summary of Electric Utility System
VPU is a municipal electric, water, fiber, and natural gas utility. This study focused on the electric utility, which provides electric service to roughly 1,900 customers in the City of Vernon, California. The majority of VPU's customers are commercial and/or industrial electric customers. VPU sold roughly 1.1 million MWh of electricity in fiscal year 2022 and had a peak demand of just over 190 MWs. VPU provides power through a combination of VPU‐owned generation, purchase power contracts, and market purchases.
VPU, like many other California utilities, are facing increasing demandsfor renewable energy as mandated by the State in addition to volatile electric and gas market prices.
VPU recently issued a significant amount of debt over an eight‐year period to re‐purchase the Malburg Generating Station (MGS), eliminating the existing purchase power agreement and bringing operations and expenses directly in‐house. VPU’s debt associated with MGS will end in 2029 which provides the utility significant flexibility in funding, identifying additional power supply options, and setting retail rates.
Cost of Service and Rate Design Overview
The COS and rate making process typically includes five steps as follows:
1. Financial Forecast and Determination of the Revenue Requirement – The first step examines the utility’s financial needs and determines the amount of revenue that must be generated from rates.
For municipal utilities, the revenue requirement is determined on a “cash basis.” A “cash basis” analysis examines the cash obligations of the utility such as operations and maintenance (O&M) expenses, debt service, cash funded capital projects, and city transfers. The key component to this step for VPU was to develop a financial forecast to project revenues and expenses under a series of scenarios and options. In our analysis of the electric rates and the development of the revenue requirement, NewGen relied upon VPU's Fiscal Year (FY) 2024 Budget and forecasts revenues and DocuSign Envelope ID: 203621CC-FF0C-45FA-ABCF-F26D7117C1D5 Richard Corbi
July 27, 2023
VPU Financial Forecast Letter Report 072723
expenses through 2030. The focus of the rate recommendations and revenue requirements was the forecast period of FY 2024 through FY 2026.
2. Functionalization of Costs – The revenue requirement is then assigned to the particular function or sub‐function of the utility. Electric utilities like VPU typically have power supply, transmission, distribution, and customer service functions.
3. Classification of Costs – Once costs are functionalized, costs are then classified based on the underlying nature of the costs. Of particular importance is the determination of fixed versus variable costs. Fixed costs remain a financial obligation of the utility regardless of the amount of energy produced whereas variable costs fluctuate based on system energy requirements. Further, fixed and variable costs are associated with utility requirements to meet customer demand, energy, and customer service needs.
4. Allocation of Costs – Once costs are classified, costs are then allocated to the various customer classes. Allocation factors align with cost classification. Demand‐related costs are allocated on measures of class demand such as class contribution to the system coincident peak (CP). Energy allocation factors are based on energy consumed by customers. Customer allocation factors are based on the number of customers.
5. Rate Design – The fifth, and final, step is rate design, which translates COS results into rates for each customer class. In this case, the final recommendationsfor VPU were system level base rate increases which then determined the required ECA rates. The effort to date did not set rates for each individual class as no rate increases were recommended other than small adjustments to the ECA as explained later in this letter.
Financial Forecast
NewGen developed a financial forecast to support the eventual development of the annual and Test Year Revenue Requirements. Thisfinancial forecast wasthe focus of the overall Study, as FY 2024 system‐wide rate increases were adopted during this Study. Thus, the financial forecast focused on identifying additional base rate or subsequent ECA changes required to maintain key financial metrics in FY 2025 and FY 2026. The financial forecast was based on VPU’s FY 2024 budget, load projections, a power supply cost projection from Ascend Analytics (Ascend), a five‐year capital plan, and related assumptions and cost escalation factors. The following were the key inputs and assumptions in the forecast:
Ascend Power Supply Forecast: Ascend provided forecasts costs based on providing power and capacity to serve the retail loads. The power supply forecast included natural gas costs, purchased power costs,salesrevenuesto the CAISO market, purchasesin CAISO market to serve load, Renewable Energy Credit (REC) expenses, and carbon emission costs. Debt Service: Debt service projections were provided by VPU based on existing outstanding debt.
There are no additional or future debt issuances included in the forecast. Capital Plan: VPU includes a cash‐funded capital plan of approximately $16 million per year during the Study period.
Inflation and Escalation Factors: Several different escalation factors were used to project VPU’s individual chart of accounts and expenses through 2029. These included basic inflation factors linked to the U.S. general inflation indicators, labor expenses inflation, construction cost inflation, and transmission access charge forecasts.
Load Forecast: The VPU load forecast includes current base load projections, new customer cited distributed energy, energy efficiency, growth in electric vehicle load, and specific customer growth in certain market segments. The overall load forecast shows growth in load across the Study period.
DocuSign Envelope ID: 203621CC-FF0C-45FA-ABCF-F26D7117C1D5 Richard Corbi
July 27, 2023
VPU Financial Forecast Letter Report 072723
In addition to the key inputs and assumptions used to project revenues and expenses, NewGen calculated key financial metrics commonly used to maintain and measure financial sustainability. There were two key metrics that were monitored and maintained:
Debt Service Coverage Ratio (DSCR): Net revenues available after subtracting operating expenses that are available to pay debt service. VPU has a bond covenant requirement to maintain a 1.1 DSCR and set a target of 1.2 DSCR for setting rates in the forecast period. Cash Balances / Days Cash on Hand: Number of days of operating expenses available in unrestricted cash reserves. VPU set a minimum level of cash reserves at approximately 180 days and a target of 300 days cash on hand to maintain with rates.
NewGen used these metrics as the primary driver in developing the forecast and evaluating alternative rate recommendations. The summary level financial forecastresults are shown in Table 1 with the existing base rate increases. Based on the projected power supply cost recovered in the base rate revenues, the resulting ECA rates must be $0.02 per kWh for FY 2024 FY 2025 and $0.01 per kWh for FY 2026.
Table 1
Financial Forecast Results
Item 2024 2025 2026 2027 2028 2029
Load (MWh) 1,120,945 1,269,826 1,473,633 1,638,096 1,703,063 1,820,282 Base Rate Increases 5.0% 0.0% 0.0% 0.0% 0.0% 0.0%
ECA ($/kWh) $0.0200 $0.0200 $0.0100 $0.0000 $0.0000 $0.0000
Operating Revenues $210,048,404 $236,225,700 $257,203,864 $267,686,939 $277,873,635 $295,950,566 Operating Expenses
Power Supply $110,730,043 $119,064,978 $134,374,258 $144,129,192 $151,117,129 $158,434,705 Transmission $17,552,410 $18,037,380 $18,537,189 $19,064,248 $19,607,671 $20,168,011 Customer $966,565 $999,024 $1,032,651 $1,067,831 $1,104,283 $1,142,055 A&G $15,208,484 $15,668,479 $16,148,060 $16,658,880 $17,192,270 $17,749,668 Total Operating Expenses $144,457,502 $153,769,860 $170,092,158 $180,920,150 $189,021,353 $197,494,439
Contributions From
Reserves $18,000,000 $0 $0 $0 $0 $0
Available for Debt Service $83,590,902 $82,455,840 $87,111,706 $86,766,789 $88,852,282 $98,456,127 Debt Service $69,710,206 $69,706,538 $69,703,002 $64,704,689 $64,703,340 $9,215,355 DSCR 1.20 1.18 1.25 1.34 1.37 10.68
Other Expenses
(Revenues) $(24,654,814) $(8,280,635) $(8,110,235) $(8,337,916) $(8,773,589) $(10,051,479) Capital Expenses $20,038,000 $15,750,000 $15,900,000 $14,700,000 $14,800,000 $16,237,600 Over (Under Recovery) $18,497,511 $5,279,937 $9,618,939 $15,700,016 $18,122,532 $83,054,651
Cash Balance $91,329,532 $96,609,469 $106,228,408 $121,928,425 $140,050,956 $223,105,607 Days Cash on Hand 231 229 228 246 270 412
DocuSign Envelope ID: 203621CC-FF0C-45FA-ABCF-F26D7117C1D5 Richard Corbi
July 27, 2023
VPU Financial Forecast Letter Report 072723
Based on the previously approved 5% rate increase in 2024 and the use of the ECA at $0.02 per kWh in 2024 and 2025, and $0.01 per kWh in 2026, VPU meets its target DSCR each year and moves towards the targeted level of cash reserves over time. During 2024, there is the need to contribute $18 million from cash reserves to meet the target DSCR; however, no future contributions from reserves are necessary to maintain the target DSCR.
Overall, power supply expenses increase each year; however, this is also influenced by the increasing load VPU must serve each year. Thus, as the load increases, VPU must purchase more power to serve that load. Other operating expenses are stable year to year in the forecast period. The increased debt service associated with MGS endsin 2029, and asseen in Table 1, it leadsto a substantial increase in contributions to the cash reserves from $18.1 million in 2028 to $83.0 million in 2029. This elimination of the MGS debt service in 2029 places VPU in a very flexible rate position and healthy financial position to prepare for future power supply contracts or reinvestments in owned generation / MGS.
Please note, the ECA rates included in Table 1 are based on the projected power supply costs provided by Ascend. These actual costs incurred by VPU each year will change from the projections included in the table. Thus, as load, power supply costs, market prices, and other variables affecting power supply costs change, the ECA will also need to change to ensure proper cost recovery. To the extent power supply prices and costs decline from those projected in the table, the ECA would also go down.
Recommendations
Based on the financial forecast and results shown in Table 1, NewGen recommends VPU continue its utilization of the ECA to ensure proper recovery of power supply costs and maintain an expected $0.02 per kWh charge in 2024 and 2025, declining to $0.01 per kWh in 2026. At the ECA rates, projected power supply costs, and other projected operating costs, VPU will not require any additional base rate increases in 2025 and 2026. During 2026, VPU should consider an update of the COS and eventual update of rates across the customer classes, if the COS results identify any potential shifting in the cost recover from classes it could be implemented at the start of FY 2027.
As no additional rate increases are recommended in the 2024 to 2026 period other than those already approved, the remaining portions of the COS study such asfinal allocation of coststo the customer classes remains in draft format awaiting a COS update in subsequent years. Our recommendation results in no material changes to each customer class’ rates other than the application of the ECA rates. The recommendations maintain VPU’sfinancial performance and supportstability in customer’srates and bills during a very volatile time in California’s energy markets.
The resulting ratesforthe larger commercial and industrial classesfor VPU,such asthe TOU‐V and TOU‐Vt, after the 2024 base rate increase and ECA recommendations maintains VPU’s competitive position in the Southern California electric market with Los Angeles Department of Water and Power (LADWP) and Southern California Edison (SCE).
Sincerely,
NewGen Strategies and Solutions, LLC
Tony Georgis
Managing Partner – Energy Practice
DocuSign Envelope ID: 203621CC-FF0C-45FA-ABCF-F26D7117C1D5