Central Distribution Subcommittee

Recommendation to Senate Fiscal Committee

March 13, 2012

TOPIC:

Utility Reserve

BACKGROUND:

The Utility Reserve was established to protect OSU from large unanticipated increases in the price of electricity or gas. It can be used to absorb short-term spikes in these costs or to buffer the full effect of abrupt increases so that units can adjust their budgets to cover these increases over several fiscal years.

This fund balance currently stands at $29M (see Appendix 1), having grown by an average of over $5M per year FY08-11. FOD (see Appendix 2) has estimated that we require $15M to protect against potential back-to-back increases in gas prices (an unlikely 50% increase costs about $8M) and electricity prices (50% increase costs about $5.5M). The Office of Financial Analysis and Planning (see Appendix 3) has found a range for similar reserve funds from 60 to 180 days of annual expenses, with FOD’s recommendation being at the upper end of this range.

RECOMMENDATION:

Reduce Utility Reserve to one half of our annual expenditures on electricity and gas (currently about $15M) and use remainder to fund other initiatives accomplishing the desired outcome of decreasing our energy usage.

ISSUES:

  • There is no rigorous method to establish the risk of drastic changes in energy prices due to terrorist activity, global instability, or other possibilities that have large impacts on all markets.
  • A strong argument can be made that all or at least part of these funds should be returned to the units that paid them.
  • If these funds are used to finance other initiatives, a strong argument can be made that they should fund initiatives that reduce the POM budget from which they were derived.

Forwarded for review:To Senate Fiscal Committee with the recommendation of Central Distribution Subcommittee.

Appendix 1 Utility Reserve History

Appendix 2 FOD presentation

Appendix 3 Office of Financial Planning and Analysis

“Typical” target levels for utilities operating reserves are usually expressed as a percentage of annual operating expenses, or as a given number of days of operating expenses. This can be anywhere between 30 and 180 days.

  1. City Of Sacramento Department of Utilities

Utility Rate Study, March 2011

FCS Group

Appropriate reserve levels: Generally, utilities should target a defined minimum working capital asa beginning cash balance to provide the liquidity needed to allow regular management of payablesand payment cycles. When setting this reserve level, the utility should consider the policies of itsother reserves. Depending on several factors (including bond requirements, a separate ratestabilization reserve, revenue collection variability, and fiscal prudence), the target level of anoperating reserve can range from as little as 30 to as much as 180 days of its annual operatingexpenses.

Replenishing reserves: The reserve should be reviewed and recalibrated through the normal annualbudget and rate-setting process. Since expenses typically increase over time, the reserve targetshould also increase proportionally with increases in expenditures, meaning that rates wouldincorporate small annual increments of additions to the operating reserve. Recognizing that reservesare intended to stabilize and strengthen utility finances, a policy for replenishing reserves whendrawn below targets should require a strategy for recovering target levels, but should allow flexibilityin such attainment.

Liquidating reserves: If the operating reserve exceeds the target balance, it should be brought backto the target level through a sequential decision process, with progress contingent on a surplusremaining. This would include steps such as:

?Determining whether near-term increases in the operating reserve target would consume all

or part of the surplus.

?Determining whether the rate stabilization fund (discussed below) is at or above its target

level. If not, the surplus could be applied toward the rate stabilization reserve target.

?Determining whether funds would have a designated use for one-time or capital outlays.

?Make the surplus balance available to meet projected capital expenditures.

The Department should set its operating reserve minimum targets at a range of 60 to 120 days of its annual operating expenses (including general fund transfers). The Department could consider setting this minimum reserve target at the lower end of the range for funds with stable revenue collection.Stable revenue funds include wastewater, storm drainage, and solid waste. However, for funds with greater revenue collection volatility, such as the water fund, the City should consider setting theminimum target at the higher end of the range. A higher minimum reserve provides some protectionagainst seasonal fluctuations in revenues and expenditures. As the City continues with the meteringprogram, it will experience greater seasonal swings in water rate revenues. The City should adjust itsreserve target over time, and as necessary, to protect against potential revenues losses and based onfunds held in other reserves, such as a rate stabilization fund. The working capital reserve will workin concert with other reserves, as discussed below.

Recommendation

The Department should set its operating reserve minimum targets at a range of 60 to 120 daysof its annual operating expenses (including general fund transfers). Based on current marketconditions, an aggregate, minimum unrestricted working capital balance of 120 days shouldbe maintained between the various reserves.


  1. Boston Water and Sewer Commission

2011 Rate Document

The Commission is annually required to deposit into the Operating Reserve Fund an amount equal to one-sixth of the Commission’s operating and maintenance expenses and the accrued Massachusetts Water Resource Authority Assessments for that year.

  1. City of Mercer Island, WA

Budget Policies: Utility Funds

It is appropriate to maintain sufficient cash reserves to accommodate routine fluctuations in revenues and expenses. The city therefore establishes operating reserves for the water and sewer utilities. Utility budgets will target ending cash balances sufficient to meet the reserve targets. The following reserves are established:

Sewer: 30 days of operating expenses (8.2% of annual operating budget)

Storm water: 30 days of operating expenses (8.2% of annual operating budget)

Water: 75 days of operating expenses (20.5% of annual operating budget)

  1. FY 2011 Utility Revenue Analysis

City of Cape Coral

Burton & Associates Utility & Governmental Economics

Final Report September 2011

2.2.12 Minimum Operating Reserve

The Revenue Sufficiency Analysis targets a minimum operating reserve equal to 3-months of operating and maintenance expenses. The level of operating reserve is within the typical industry rangein Florida and is consistent with the prudent amount as identified by a recent analysis conducted by the Rates and Charges Sub-committee of the American Water WorkAssociation (AWWA). Based upon our industry experience, water and sewer utilitieswill generally target a minimum working capital reserve, or operating reserve, in therange of 2 – 6 months of operating and maintenance expenses. This range is consistent with the results of the recent analysis performed by the Rates and Charges Subcommitteeof the AWWA, which concluded that adequate working capital reserves forwater and sewer utility systems should be at least equal to 2 months of operating andmaintenance expenses. Moreover, this amount is considered "Good" for utility systemsby one of the major municipal water and sewer utility credit rating agencies.

  1. A utility financing policy: guiding forecasts of long-term capital financing needs

Kalamazoo, MI

The financial policy recommends that , within the operation and maintenance fund, a working capital reserve equivalent to 90- days of operation and maintenance expense be maintained. The purpose of this reserve is to address the fluctuations in short-term cash receipts and disbursements that are common to utilities, which are subject to weather patterns.