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Home My WebLink AboutINS-2023-247 - Natural Gas Purchase Policy Review - 2023 REPORT TO: Finance and Corporate Services Committee DATE OF MEETING: June 5, 2023 SUBMITTED BY: Greg St. Louis, Director, Gas & Water Utilities, 519-741-2600 ext. 4538 PREPARED BY: Khaled Abu-Eseifan, Manager, Gas Supply and Engineering, 519-741- 2600 ext. 4826 WARD(S) INVOLVED: All Ward(s) DATE OF REPORT: May 22, 2023 REPORT NO.: INS-2023-247 SUBJECT: Natural Gas Purchase Policy Review - 2023 RECOMMENDATION: That the proposed updates to Policy No. FIN-ACQ-560 as proposed by report No. INS- 2023-247 and provided in Appendix A be approved. REPORT HIGHLIGHTS: The purpose of this report is to review the performance of the natural gas purchase portfolio in meeting its strategic objectives and to provide recommendations for improvements. The key finding of this report is that the current purchase horizon of 3 years is sufficient to maintain a balance between rate stability and market responsiveness. The report also recommends changes to supplier financial health criteria to qualify more suppliers for short term deals. There are no immediate financial implications for this report however the proposed modifications to the Gas Purchase Policy are intended to provide gas supply purchases that are market responsive and provide rate stability to Kitchener Utilities customers. This report supports the delivery of core services. BACKGROUND: In January 1998, Council adopted policy I-560 (The Gas Purchase Policy), which outlines the for this separate policy is that the nature, extent, and timing of these transactions did not align and services. Since its inception, this policy has been amended four times, with the most recent amendment being in June 2014 when council established a more management of the gas purchase portfolio. This was accomplished by reducing the proportion of fixed purchases and the purchase horizon from 5 years to 3 years. Fixed proportions determine the minimum and maximum limits of forward fixed price contracts (hedging) out of the total annual requirements. These limits ensure the use of disciplined approach to acquire blended portfolio *** This information is available in accessible formats upon request. *** Please call 519-741-2345 or TTY 1-866-969-9994 for assistance. of natural gas that balance between rate stability and market responsiveness. Tables 1 and 2 below provide the fixed portfolio limits before and after the changes. Table 1: Pre 2014 Fixed Portfolio Limits Past Fixed Limits Year 1 Year 2 Year 3 Year 4 Year 5 Maximum 90% 70% 50% 30% 20% Minimum 40% 30% 20% 10% 10% Table 2: Post 2014 To Date Fixed Portfolio Limits Current Fixed Limits Year 1 Year 2 Year 3 Maximum 60% 40% 20% Minimum 20% 20% 0% As per clause 4 of the gas purchasing policy, Staff is required to review the policy on a no less than three-year basis to ensure that the ongoing performance of the portfolio is meeting its strategic objectives and per clause 4. REPORT: Since the introduction of the market responsive policy in 2014, Staff has found that retail rates charged to Kitchener Utilities customers continue to be more reflective of market costs as will as being reasonably stable. Figure 1 below depicts gas rate charged to its customers compared to market prices and Enbridge Gas rates. relation to the market trend. Section 1 The previous report (INS-17-085) in 2017 described how well the 5-year horizon and Maximum/Minimum fixed percentages performed in extreme volatility (upward and downward) during the 16-year period including 2014. Volatility during that period was attributed to strong natural gas demand with supply unable to keep up, driving high prices. High prices led to significant re-investment in North America in both LNG import terminals as well as unconventional gas retrieval from shale formations. The success of the latter led to the substantial price drop occurring in 2008/09 coincidentally during the financial crisis. egacy fixed prices reaching out 5 years showed poor responsiveness which led to the recommendation and approval to reduce the purchase horizon to 3 years. Section 2 The period of June 2014 to October 2017 was too short a period to evaluate the new parameters, however during that period it appeared to show the rates to be more market responsive as the gas market fell again and KU rates subsequently followed. Section 3 This gas market in the most recent period from November 2017 to April 2023presented mid-range volatility. The changingmarket conditions and aglobal pandemic brought in demand uncertainty and resulted in a recent spike in prices. The policy provided the parameters that enabled. KU to set rates that were relatively stable, more competitive compared to Enbridge rates and able to buffer market prices spikes for longer periods of time. Section 4 This section provides a forecast for future market prices based on Kitchener Utilities consultant advice. They consider future supply and demand factors, projects and market trends and provide periodical market updates and forecasts. The latest forecast shows an upward trending market prices with mid-range volatility for the coming 3 -5 years. The current purchase policy parameters are expected to perform well in these conditions. bD ağƩƉĻƷ tƩźĭĻ ǝƭ Y Dğƭ wğƷĻ ǝƭ 9ƓĬƩźķŭĻ Dğƭ wğƷĻ ЎЉ͵Љ ağƩƉĻƷ CƚƩǞğƩķ ƩĻƭƦƚƓƭźǝĻ ƒğƩƉĻƷ ƦƩźĭĻ ƦƚƌźĭǤ ЍЎ͵Љ Ќ ЊЍ Ћ ЍЉ͵Љ ЌЎ͵Љ ЌЉ͵Љ Ќ ƒ ЋЎ͵Љ Ʃ Ļ Ʀ ƭ Ʒ ЋЉ͵Љ Ɠ Ļ ĭ Ɠ ЊЎ͵Љ ķ / ЊЉ͵Љ Ў͵Љ Љ͵Љ БВЉЊЋЌЍЎЏАБВЉЊЋЌЍЎЏАБВЉЊЋЌЍЎЏА ВВЉЉЉЉЉЉЉЉЉЉЊЊЊЊЊЊЊЊЊЊЋЋЋЋЋЋЋЋ ΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏ ƌƌƌƌƌƌƌƌƌƌƌƌƌƌƌƌƌƌƌƌƌƌƌƌƌƌƌƌ ƌƌ ǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒǒ WWWWWWWWWWWWWWWWWWWWWWWWWWWWWW ΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏΏ ЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊЊ Y Dğƭ wğƷĻ Ώ ĭĻƓƷƭ ƦĻƩ ƒЌ9ƓĬƩźķŭĻ Dğƭ ƩğƷĻ Ώ ĭĻƓƷƭ ƦĻƩ ƒЌağƩƉĻƷ Figure 1: Natural Gas Market Price vs. KU Gas Rate vs. Enbridge Gas Rate Table 3: Market trends vs. KU Rate Impact Summary Section Market Trend KU Rate Impact Good performance during rising market prices; poor 1 High Volatility responsiveness in dramatic fall-off of prices. 2 Low Volatility New 3-year rate impact seems more responsive and stable. Multi-year stable pricing was enabled by the policy. The Mid-range 3 increased volatility has a mild impact on rate Volatility responsiveness. Forward market forecasts are projected to be upward Mid-range 4 trending with mid-range volatility. Purchase policy is Volatility expected to soften the impact of these conditions. The current gas purchase policy with the 3-year purchase horizon provides a balanced approach between rate stability and market responsiveness. It allows Kitchener Utilities to soften price hikes in volatile market conditions, maintain price stability in upward/increasing market conditions and respond to market prices in downward/decreasing markets. Staff recommends that the purchase policy horizon of 3 years and the fixed portfolio limits in table 2 remain unchanged until the next natural gas purchase policy review in 2026. It is important to note that hedging is not about beating the market and winning but its primary goal is to reduce volatility in prices and keep rates stable for customers. Also, supply rates are charged at cost and the utility makes no money from these programs. During some periods, lower. This is the trade-off required for stable rates, which are favored by most Kitchener Utilities customers. Modification of financial health minimum required by natural gas suppliers Market volatility often is the result of tightly matched supply and demand and more specifically is riskier when the market sentiment is that demand is outpacing supply growth. This is the current and foreseeable market situation globally and to a lesser extent in North America. A control exists in the policy to protect the portfolio from suppliers that are not strong financially to deliver contracted supply throughout the full term of the transaction regardless of current market pricing at any point in time. For example, in February 2021, winter storm Uri resulted in widespread sustained extreme low temperatures in Oklahoma and Texas triggering high demand for gas and simultaneously choked off supply due to wellhead freeze-offs. This also triggered extreme volatility in day pricing in excess of $100/MMBtu for several consecutive days due to firm contracted supply failures which lead to high cost of supply replacement and/or penalties levied by utilities and pipelines. Suppliers that cannot sustain this kind of extreme cost risk typically are not financially strong. This financial strength leads to inherent cost premiums to support the security. Also, multiple suppliers help to make a deeper, liquid market and better price discovery. Both principles exist in the current purchasing policy. What is found typically in a pool of suppliers is that those with high credit rating (financial strength) often carry price offers that are on the high side of the data pool. Conversely, those with less financial strength have less overhead cost to recover so have the opportunity to make lower offers (with all other price drivers being equal). This is an example of the classic risk-reward trade off. The fixed price risk of a longer term is higher with a less credit-worthy counterparty. An adjustment to the policy is recommended as a result of these findings to enable suppliers op-year timeframe. Currently suppliers up to and including line 10 in Table 4 are qualified to participate in natural gas purchases and the change will allow the ones in line 11 to bid on year 1 deals. This will qualify more suppliers to bid on short term deals which will provide better prices for the City while maintaining the risk mitigation measures for long term deals. The proposed changes to clause 6 of the gas purchase policy are provided in Attachment A. Also, upon closer review of the Gas Purchase Policy a small change is recommended to clarify the intent. Specifically, it is proposed that clause 8 first sentence be updated: Current: The financial exposure of the City will be minimized by seeking financial assurances in the event of supplier default. Proposed: The financial exposure of the City will be minimized by seeking financial assurances in circumstances of a high risk of supplier default Table 4: International Credit Rating Agencies Scores Update and administrative changes of the Gas Purchase policy It is recommended that the administrative updates of the policy purpose, definitions, scope, and content clause 9 of the Gas Purchase policy be revised as provided in Attachment A. STRATEGIC PLAN ALIGNMENT: This report supports the delivery of core services. FINANCIAL IMPLICATIONS: Capital Budget The recommendation has no impact on the Capital Budget. Operating Budget The recommendation has no impact on the Operating Budget. PREVIOUS REPORTS/AUTHORITIES: INS-17-085 3-Year review of Natural Gas Purchasing Policy INS-14-014 Natural Gas Purchase Policy Review FIN-ACQ-560 Gas Purchase Policy APPROVED BY: Denise McGoldrick, General Manager, Infrastructure Services ATTACHMENTS: Attachment A Modified Natural Gas Purchase Policy Attachment B Current Natural Gas Purchase Policy POLICY Policy No: FIN-ACQ-560 Approval Date: January 19, 1998 Policy Title: GAS PURCHASE Policy Type: COUNCIL Reviewed Date: June 2023 Next Review Date: June 2026 Category: Finance Reviewed Date: Click here to enter text. Sub-Category: Acquisitions & Dispositions Last Amended: June 16, 2014 Author: Author Unknown Replaces: I-560- Gas Purchase Dept/Div: Infrastructure Services/Gas and Water Utilities Repealed: Click here to enter a date. Replaced by: Click here to enter text. Related Policies, Procedures and/or Guidelines: N/A 1. POLICY PURPOSE: The purpose of this policy is to allow the transaction of gas commodity and transportation contracts in an effective and efficient manner. Gas commodity pricing is dynamic and fluctuates with the market. The nature of these transaction do not align with the standard purchasing processes and policies. 2. DEFINITIONS: None. 3. SCOPE: POLICY APPLIES TO THE FOLLOWING: All Employees All Full-Time Employees All Union Management C.U.P.E. 68 Civic Non Union C.U.P.E. 68 Mechanics Temporary C.U.P.E. 791 Student I.B.E.W. 636 Part-Time Employees K.P.F.F.A. Specified Positions only: Other: Council Local Boards & Advisory Committees 1 of 3 Policy No: FIN-ACQ-560 Policy Title: GAS PURCHASE This policy applies to the purchase of fuel commodity and transportation contracts to be delivered to Kitchener Utilities customers. 4. POLICY CONTENT: That the following Market Responsive Portfolio be adopted as the Gas Purchase Policy for the City of Kitchener, namely: 1) periodic tendering for consulting services, shall monitor market and economic forces to develop a prudent purchase strategy. 2) The purchase strategy shall reflect a three-year timeframe and use a disciplined approach to acquire a blended portfolio of natural gas contracts which varies the pricing and terms of the contracts to provide rate stability while remaining responsive to market pricing. 3) Given the long-term nature of getting natural gas to the City, acquiring transportation or storage contracts should include a longer-term view with contract terms of up to twenty (20) years. 4) The ongoing performance of the purchase portfolio in meeting its strategic objectives shall be periodically reviewed, not less than every three years and not more than annually and revised as needed and approved by Council. 5) To ensure market competition is used and balanced with contracting costs, the City's expected natural gas supply needs will be placed with no less than four (4) primary suppliers. At no time should more than 50% of the City's annual supply be placed with one supplier. 6) The natural gas supply contracts will only be placed with large, financially secure suppliers with a proven industry track record. Before supply contracts are placed, the City must ensure that the supplier has a strong financial rating as evaluated by an independent evaluator. The minimum rating with Standard & be BBB or equivalent Moody's rating Baa for transactions that fall into Year 2 or later. For transactions falling in less than year 2, the minimum rating will be Standard & BB+ or equivalent Moody's rating Ba1. 7) The natural gas supply contracts will provide the City with the flexibility to swap between indexed and fixed prices at market-based transaction fees. 8) The financial exposure of the City will be minimized by seeking financial assurances in circumstances of high risk of supplier default. These assurances will be maintained commensurate with exposure of the contracts to an individual supplier. 2 of 3 Policy No: FIN-ACQ-560 Policy Title: GAS PURCHASE When dealing with a marketing entity for supply, assurances will be sought from the corporate parent. 9) All natural gas purchase transactions will be authorized by the CFO & City Treasurer, Financial Services Department or in his/her absence one of the Cit signing officers and the Director, Gas and Water Utilities or in his/her absence, Manager, Gas Supply and Engineering. 10) Separate accounting for the supply, transportation and delivery programs should be maintained, audited and reported to Council on a regular basis with other City financial statements. 5. HISTORY OF POLICY CHANGES Administrative Updates 2016-06 - Policy I-560 template re-formatted to new numbering system and given number FIN-ACQ-560 Formal Amendments 2001-08-27 As per Council directive 2002-05-27 As per Council directive 2006-10-06 As per Council directive 2014-06-16 As per Council directive 3 of 3 POLICY Policy No:FIN-ACQ-560 Approval Date:January 19, 1998 Policy Title:GAS PURCHASE Policy Type:COUNCILReviewed Date:July 2016 Next Review Date:July 2021 Category:Finance Reviewed Date: Sub-Category:Acquisitions & Dispositions Last Amended:June 16, 2014 Author:AuthorUnknown Replaces:I-560-GasPurchase Dept/Div:Finance & Corporate Services\\Legal Repealed: Replacedby: Related Policies, Procedures and/or Guidelines: To be included at next review. 1.POLICY PURPOSE: To be included at next review. 2.DEFINITIONS: To be included at next review. 3.SCOPE: POLICY APPLIES TO THE FOLLOWING: All Employees All Full-Time EmployeesAllUnion ManagementC.U.P.E. 68 Civic Non UnionC.U.P.E. 68 Mechanics TemporaryC.U.P.E. 791 StudentI.B.E.W. 636 Part-Time EmployeesK.P.F.F.A. Specified Positions only: Other: CouncilLocal Boards & Advisory Committees To be included at next review. 1of 3 Policy No:FIN-ACQ-560 Policy Title:GAS PURCHASE 4.POLICY CONTENT: That the following Market Responsive Portfolio be adopted as the Gas Purchase Policy for the City of Kitchener, namely: 1)Utilities’ Staff, with assistance from external parties, as appropriate and subject to periodic tendering for consulting services, shall monitor market and economic forces to develop a prudent purchase strategy. 2)The purchase strategy shall reflect a three year timeframe and use a disciplined approach to acquire a blended portfolio of natural gas contracts which varies the pricing and terms of the contracts to provide some rate stability while remaining more responsive to market pricing. 3)Given the long-term nature of getting natural gas to the City, acquiring transportation or storage contracts should include a longer term view with contract terms of up to twenty (20) years. 4)The ongoing performance of the purchase portfolio in meeting itsstrategic objectives and customers’ rate expectations shall be periodically reviewed, not less than every three years and not more than annually, and revised as needed and approved by Council. 5)To ensure market competition is used and balanced with contracting costs, the City's expected natural gas supply needs will be placed with no less than four (4) primary suppliers. At no time should more than 50% of the City's annual supply be placed with one supplier. 6)The gas supply contracts will only be placedwith large, financially secure suppliers with a proven industry track record. Before supply contracts are placed, the City must ensure that the supplier has a strong financial rating as evaluated by an independent evaluator. The minimum rating with be Standard & Poors BBB or equivalent Moody’s rating Baa (Investment Grade). 7)The natural gas supply contracts will provide the City with the flexibility to swap between indexed and fixed prices at market based transaction fees. 8)The financial exposure of the City will be minimized by seeking financial assurances in the event of supplier default. These assurances will be maintained commensurate with exposure of the contracts to an individual supplier. When dealing with a marketing entity for supply, assurances will be sought from the corporate parent. 2of 3 Policy No:FIN-ACQ-560 Policy Title:GAS PURCHASE 9)All natural gas purchase transactions will be authorized by the Deputy CAO & City Treasurer, Finance and Corporate Services Department or in his/her absence one of the City’s signing officers and the Directorof Utilities or in his/her absence, Utilities’ Manager, Regulatory Affairs and Supply. 10) Separate accounting for the supply, transportation and delivery programs should be maintained, audited and reported to Council on a regular basis with other Cityfinancial statements. 5.HISTORY OF POLICY CHANGES Administrative Updates 2016-06-Policy I-560template re-formatted to new numbering system and given numberFIN-ACQ-560. Formal Amendments 2001-08-27-As per Council directive 2002-05-27-As per Council directive 2006-10-06-As per Council directive 2014-06-16-As per Council directive 3of 3