2000 AGN AUG 01 I09_Professional Services Agreement_

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City Council Meeting I , euuu SUBJECT: REQUEST FOR APPROVAL OF PROFESSIONAL SERVICES AGREEMENT FOR DESIGN OF A POWER GENERATION FACILITY WITH STEWART & STEVENSON, INC., OF SANTA ANA, CALIFORNIA, IN THE AMOUNT OF $150,000 FA FAw1k-1ki Classical risk management calls for the City to purchase hedges to deal with volatility and to procure shares of the most efficient resources available to it. Hedges can be in the form of financial products or physical generation assets. The Electric Utility uses and advocates the continued use of both types, as their different characteristics create a total hedge against a wide range of risk. In short, our investments should create a well -mixed portfolio. Although burdensome in the past, it is fortunate that the City owns a substantial amount (30MW) of coal-fired generation. The coal contract under which the City obtains most of its energy has most of its blocks fixed in price for 10 to 15 years. These prices were above market until this year. It is the City's investment in San Juan Unit 3 in 1993, which has largely mitigated the need to adjust retail rates. The great disadvantage of San Juan is the fact that all the capacity eggs are in one basket. If the unit fails, the City can be exposed to the market for up to 30MW. At the current cap of $500/MWH, the City would pay $15,000 per hour of outage unless it had alternative sources of power. The Electric Utility currently mitigates this risk by purchasing financial hedges during peak months. The success of these financial hedges depends upon the weather. The cooler the weather in a peak month, the greater the net cost of the financial hedge. This is because these products are designed as "must take"; they cannot be turned off when prices in a particular hour are low. Enter the physical hedge. Its disadvantage is ongoing debt service, but it is far more flexible than the financial hedge. If the weather cools, it can be turned off and fuel costs saved. In the case of the reciprocating engine (similar to a truck engine), the unit can be turned on and off several times a day. Thus it is capable of tracking volatility, protecting the City when prices are high by generating and also obtaining very low cost energy by rapidly turning off. If prices jump again in the same day (as they do), the unit can be quickly brought back on line. Computations using actual market prices (attached) show the reciprocating engine hedge to have a lower net cost than the financial hedge by about 10%. The large combined cycle generation plants now under construction as the resources of the future do not have this capability. They must run most of the time to be economical. They model somewhat after the financial hedge. Like the diversity between physical and financial hedges then, there is diversity within physical hedges. The Electric Utility is contemplating two fundamental types: 1. A large scale, high -efficiency, medium flexibility, Colton minority interest, long development time, medium -low contingency risk, complex maintenance, combined cycle plant to provide substantial amounts of competitively priced intermediate energy, with operations under the control of larger partners. Colton's interest would be about 20% (40 MW) of a total estimated plant cost of $193 million. The City has a similar financial stake in San Juan 3. 2. A small scale, medium efficiency, high flexibility, Colton majority interest, short development time, very low contingency risk, simple maintenance, reciprocating Page 2 of 3