City Council Agenda Report
Meeting Date: August 20, 2024
From: Todd Dusenberry, General Manager of Public Utilities Department: Public Utilities
Submitted by: Adriana Ramos, Administrative Analyst
Subject
Vernon Public Utilities Financial Reserves Policy
Recommendation
Approve and adopt the Vernon Public Utilities Financial Reserves Policy.
Background
The 2019 Electric Cost of Service Analysis and Rate Design Study (Study) for Vernon Public Utilities (VPU) included a multi-year financial plan. On April 2, 2019, the City Council adopted Resolution No. 2019-07, approving and adopting a four-step rate adjustment for Fiscal Years (FYs) 2020 through 2023 as follows: (i) a 0.8% electric rate increase effective July 1, 2019, (ii) a
1.9% electric rate increase effective July 1, 2020, (iii) a 4% electric rate increase effective July 1, 2021, and (iv) a 4% rate increase effective July 1, 2022. However, the 2019 Study did not include a comprehensive Financial Reserves Policy (FRP) for the VPU Electric Fund.
On April 4, 2023, the City Council approved an agreement with NewGen Strategies & Solutions, LLC (NewGen) to conduct a new Study and to provide rate adjustment and rate design recommendations, which included a plan to establish and implement a long-term FRP for VPU.
As part of the FY 2023-24 budget, VPU included a five percent (5%) electric rate increase to address factors beyond the Department’s control, including rising energy and natural gas costs, supply chain issues, and regulatory and legislative mandates, as well as the departure of key business customers. On June 6, 2023, the City Council adopted Resolution No. 2023-13, amending the electric rates for FY 2023-24 with a five percent (5%) rate adjustment effective July 1, 2023.
Additionally, on August 15, 2023, the City Council adopted Resolution No. 2013-19 to update and implement an Energy Cost Adjustment Billing Factor procedure and computation method which establishes an Energy Cost Adjustment to be billed under all electrical rate schedules for energy transmitted, distributed, and supplied to the City of Vernon electric customers. At the time, the plan to present the FRP was deferred so that staff could focus on the results and implementation of the Study.
The FRP is one of the most important financial policies that VPU can utilize for its overall financial strategy and managing its financial risk. As financial and operational risks impact VPU on an ongoing basis, the FRP will guide VPU management in mitigating that risk. It will also ensure that VPU has sufficient funding available to meet its operating, capital, energy resources, and emergency requirements. The FRP supports VPU’s strategy to strive to meet the goal of having the lowest electric rates in California by 2030.
The Electric Fund has faced many challenges over the last several years, including the COVID19 pandemic, the impact of uncertain political and security situations in the world, including the invasion of Ukraine on natural gas prices, high inflation, and supply chain issues, including higher costs for materials and supplies, chemicals, and construction costs, which have resulted in a recent rate adjustment to VPU’s customers. Moreover, energy prices and natural gas costs are significantly higher when compared to historical average prices. VPU is also experiencing electric load reductions when compared to the 2019 Study. As noted during the FY 2023-24 budget process and the August 15, 2023 Study presentation, VPU is in a transition period for the next several years to develop and implement a clean commerce business strategy to attract more customers as well as a more diverse customer base.
Historically, VPU has not had an established FRP to respond to the need to adjust rates, loss of customers, unforeseen emergency repairs to its distribution and generation systems, mitigate higher energy and natural gas costs, respond to higher-than-expected operating costs, or fund capital investment when issuing debt is not financially prudent.
The FRP is designed to define overall cash reserve levels that are reasonable, prudent, and necessary to provide adequate liquidity for the Electric Fund. The FRP will enhance VPU’s longterm financial stability and help to maintain level rates that are competitive and as stable as reasonably possible. Levelized rates will help VPU maintain its competitive position in the statewide utility industry in order to attract and retain a robust, diversified customer base. At the same time, funding reserves will promote financial stability by mitigating operating, capital, and volatile energy market risks.
Publicly Owned Utilities, such as VPU, are cash-driven utilities and ensure short and long-term financial stability by maintaining enough cash after operating expenses to meet debt service, support infrastructure investment, provide working capital, and fund other cash needs. In addition, utilities such as VPU are subject to a broad array of risks, which vary from small temporary business disruptions to substantial events, which could result in significant adverse financial consequences for VPU and its customers. Financial reserves help VPU mitigate these risks and reduce volatility in financial performance and customer impacts. Industry practice shows that the proper FRP can address both the operating cash needs and risk mitigation opportunities facing utilities.
Cash reserve balances are also a critical element in reviewing a municipal utility’s financial health by rating agencies such as Standard and Poor’s and Moody’s. These reviews lead to the rating agency determining a rating on the creditworthiness of the utility, which, in turn, affects the cost of borrowing for the utility.
VPU is subject to many types of risk that can be mitigated by having sufficient cash reserves to ensure adequate and reasonable liquidity. The major areas of risk are the loss of a major customer(s), the risk that budgeted revenue is not realized, the risk of sudden increases in commodity costs (i.e., natural gas and energy), the risk of a major equipment or utility asset failure, an unforeseen natural disaster, and the risk of unexpected increases in operating costs.
The FRP also establishes funds to reduce the amount of debt that the utility would otherwise be required to issue to maintain or expand its capital infrastructure. The funds will also be used for additions and replacement of major electric utility assets.
The funds defined in the FRP, and the targeted balances of these funds are based upon rating agency guidelines, staff assessment of the probability of certain risks associated with the Electric Fund, and historical volatility in revenues and expenses. The FRP was developed by VPU staff and was reviewed by NewGen. The recommended FRP is based on Days Cash on Hand, which is a financial metric used by rating agencies when reviewing and updating each utility’s credit profile.
The specific Reserve Funds to be established in this Policy include the following:
1. Rate Stabilization Fund
Funded at an amount to help protect VPU’s overall liquidity and includes Revenue Risks, Commodity Risks, and Counterparty Credit Risks. It is used to temporarily absorb permanent increases until decisions are made to adjust rates, if necessary. This type of fund avoids “rate shock” to customers.
2. Operating Reserves Fund (Working Capital)
Funded in an amount to ensure adequate liquidity to meet VPU’s ongoing operations.
3. Capital Reserve Fund
Provides for future capital expenditure needs for planned capital improvement projects and provides a contingency for unexpected capital funding needs.
The recommended minimum and target levels for the FRP are summarized below.
Recommended Funding Levels by
2030
In Million ($)
Reserve Type Minimum Target
Rate Stabilization Fund $ 70.2 $ 135.5
Operating Reserves Fund $ 26.9 $ 53.9
Capital Reserve Fund $ 21.7 $ 65.1
Total Financial Reserves $ 118.8 $ 254.5
The FRP also defines the specific events and uses of each type of reserve. It also defines a process and timeframe for replenishing each reserve type if it falls below the minimum levels.
The FRP defines recommended minimum and targeted levels of liquidity for each type of reserve.
The FRP should be reviewed annually as part of VPU’s financial planning and budgeting process and, more often, as material changes or other event(s) deemed critical by VPU management impact VPU’s financial and operational risk profile.
VPU staff recommends that the City Council approve and adopt VPU’s FRP.
The FRP has been reviewed and approved as to form by the City Attorney’s Office.
Fiscal Impact
There is no fiscal impact associated with this report.
Attachments
1. Vernon Public Utilities Financial Reserves Policy