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Questions persist for Lodi Electric Utility

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Posted: Friday, August 26, 2005 10:00 pm

Lodi's Electric Utility has long been a financial machine, pumping out money that helps support other city operations such as the fire and police departments.

The machine has been a reason for Lodi's quality of life -- and the city's ability to attract new, power-thirsty businesses.

But after a series of sharp financial blows, that machine is now faltering, and the consequences for taxpayers and ratepayers alike could be substantial.

Consider:

• Rising power costs and dropping cash reserves could force the utility to post a $2 million deficit by the end of the fiscal year.

• Local residents could be hit with an electric rate increase this winter.

• In the past five years, a cash surplus of more than $20 million, due to various factors, has evaporated.

• The utility's credit rating has dropped to below that of comparable utilities in Northern California.

With a budget of more than $65 million -- that's much larger then the city's General Fund of $44 million -- problems with the electric fund mean problems for the city as a whole.

The Lodi Electric Utility provides service to more than 25,000 customers and brings in more than $50 million a year in revenue, of which roughly $4 million goes to support varied city operations such as emergency services and the city's parks.

One could even argue that the utility built the city.

In 1910, the city bought an electric company and transmission network from local businessmen and brothers Ed and Fred Cary for $35,000.

That turned out to be a sage investment, as in 1927 the city was able to spend $85,000 in cash generated by the electric utility to build its current City Hall.

In the decades that followed, Lodi residents would continue to enjoy consistent service at affordable rates. They still enjoy that type of service today.

The city's electric rates are still cheaper than its largest competitor, Pacific Gas and Electric. PG&E's baseline rate is $0.11 per kilowatt hour, and Lodi Electric Utility's is $0.O9.

Yet it now appears that those low rates could be one reason for a steady draining of reserves; too much money has flowed out, not enough has flowed in.

The solution, discussed in recent months by city staff and the City Council, appears to be a rate increase.

But that's likely to be unwelcome news for Lodi residents, many of whom are now vehemently opposing a proposed water rate increase.

Dropping reserves

Lodi City Councilman Larry Hansen is concerned about the future of the city's electrical provider.

No stranger to the electrical industry -- Hansen serves as Lodi's representative on the Northern California Power Agency commission -- he feels that Lodi needs its utility to remain strong.

He believes that if there is one city department that could bring the rest of the city down, it's the utility.

"I want to make sure decades from now it's still seen as a great benefit to the rate payers and the community at large," he said.

In the past five years, though, the utility's cash reserves have trickled down to a fraction of its past level. At the same time, the utility's liabilities have also increased, a little like someone racking up credit card debt while their checking account is shrinking.

According to city of Lodi financial documents, the utility now owes $78 million and its net equity stands at a little more than $15 million. About five years ago, things were much different. It's equity stood at $36 million and its debt around $43 million.

During the last budget process, the City Council received a shock when it discovered the amount budgeted for the utility's power demands was far short of what is needed.

And if no adjustments are made between now and the end of the current fiscal year June 30, the utility stands to post a $2 million deficit.

Since 2000, the city spent more than $9.6 million, lowering its cash balance from about $16 million to $6.3 million, according to city financial reports and interviews with city staff.

As the state slipped into its energy crisis, the utility faced a huge upswing in power costs and it discovered that it was more than $14 million short to pay for its power needs for that year.

A "market cost adjustment" to the city's power rates that year did bring in an additional $7 million, but not enough to cover the increased cost of power.

That loss caused the utility's bond rating to dip from an A rating to a BBB+, which has put Lodi below its fellow members of the Northern California Power Agency.

That spending, and the drop in the utility's equity, account for the loss of the utility's multi million-dollar surplus.

Finance Director Jim Krueger said energy costs have gone much higher, while Lodi's electrical rates remained largely the same.

The remaining balance in the electric fund will be exhausted by the end of this fiscal year, unless the city takes action to increase the utility's revenue, he said.

"The cash position has deteriorated gradually over the last five years but will deteriorate more rapidly in the current year," Krueger said.

A decade for director for Lodi Electric Utility


Alan Vallow has served as the director of Lodi Electric Utility for more than 10 years, after being hired to the post in April 1995.

During Vallow's time, the utility has continued to offer residential and commercial customers affordable and reliable service, as well as play a strong role within the Northern California Power Agency.

During the state's energy crisis, Vallow received national attention for not turning off Lodi's power in defiance of then-Governor Gray Davis' orders for rolling blackouts.

Prior to joining the city of Lodi, Vallow was the director of Legislative and Regulatory Policy for the Los Angeles Department of Water and Power.

He received a bachelor's of science degree from the Pennsylvania State University in 1982, a master's degree in electrical engineering from the University of Southern California in 1985, and a master's of business administration from Pepperdine University in 1987.

Vallow has served on the board of directors for the California Municipal Utilities Association and the California Power Exchange.

- News-Sentinel staff.

Low rates may also have an effect on the utility's credit. One of the requirements for the millions the utility borrowed against the electric system was a "rate covenant" that the utility charge rates sufficient to "equal at least 110" percent of adjusted annual debt service for a fiscal year. The covenant is included in the official statement, or bond offering documents outlying the city of Lodi's obligations for the financing.

Even if the utility manages to dig itself out of the project $2 million deficit and break even, it still would have millions to go to cover the requirements of that covenant.

A victim of the market?

The electric utility's director, however, maintains that its financial health is good.

Alan Vallow, who has led the utility for more than 10 years, has an open, charismatic personality and makes a point to stress that he works for the city of Lodi's ratepayers.

Lodi has some of the cheapest commercial electricity rates in the state. Vallow has said that helps convince businesses to come to Lodi and stay in Lodi, and that attractive business climate has kept many of the town's residents employed.

He says the troubles facing the utility are symptomatic of the increases in the rising cost of fuel, rather than missteps taken by himself or his staff.

The string of unprecedented hot weather in July should bring some welcome financial relief, he said, as local residents used more power and ran up higher bills.

In fact, that heat wave could change the grim picture presented to the City Council during the city's budget process several months ago, he said.

"Where things looked bleak in March, they're looking a damn sight better now," he said.

To explain how the utility spent so much of its reserves, Vallow goes back five years to the start of the state's energy crisis.

In November 2000, he said he saw the price of power become wildly erratic resulting in a serious blow to the utility's finances.

The city had just ditched a plan to build a generation plant with Calpine and Roseville Electric to produce power at a cost of $65 a megawatt because the market was selling at $52.

A month later, the market was demanding $175 per megawatt, more than three times what power had previously been selling at. Vallow said Lodi was only able to find a deal with Enron for a one-year contract at that high price.

It's as if Lodi had been driving on a full tank of gas waiting for gas prices to drop. By the time Lodi got to "E", however, prices had not only shot up, but the city was stuck filling up the tank with gas that was three times more expensive than earlier.

The $175 per megawatt deal with Enron would come to haunt the utility and its ratepayers. As the energy crisis descended on the state, the federal government stepped in and capped the price of power at $85.

Vallow said that left Lodi with millions of dollars worth of power it bought at a premium price and could not sell at anything higher than the $85.

He added that just shows that contracts and the certainty they bring don't always deliver savings. "I went long I get criticized, I go short I get criticized."

Vallow said he's worked to keep Lodi's rates reasonable in the face of intense price fluctuations in the market while also trying to keep the utility's revenue sufficient.

"All costs are stable except the price of fuel," he said. "We can have a stable price to buy a car, but we don't have a stable price to run it."

City Manager Blair King said the utility is "under review," and he and other city staff are collecting information to determine how to correct the situation. Part of that may involve a "risk management strategy" to ensure Lodi has a plan to always find the resources for its power needs.

"I've worked with lots of utilities and most have a risk strategy," he said.

King has already asked the city's utility administrators to provide quarterly reports to himself and to the City Council. He is talking with other utilities to see how they handle purchasing power and minimizing their risk.

Councilwoman Susan Hitchcock said one couldn't lay the blame for the troubles with Lodi Electric Utility on any one person or decision. She said the power market is just too unpredictable.

"I think the business is inherently risky because the price of power is very volatile," she said. "And so you can always be the Monday morning quarterback."

Rewards of risk management

Even if one argues hindsight is always 20/20, others maintain the Lodi Electric Utility needs a long-range purchasing plan so that it won't be susceptible to dramatic shifts in the market.

That was the route taken by an electric utility north of Lodi.

Tom Habashi, director for the NCPA-member Roseville Electric, said he developed a "risk management plan" in 1997 to prepare for the changes in the state's power market that would follow deregulation.

And in 2000, when the first symptoms of the state's power crisis began to appear, Habashi said Roseville's crisis plan was in place and let the utility ride out the coming storm.

Habashi said before the start of a fiscal year, the utility locks in 95 percent of its power with price contracts. No matter what happens to the market, Roseville will then always be only 5 percent over or under its power budget, he said.

"Whatever the variations are in the market, I don't care because I already fixed my prices for 95 percent of what I need," he said. "I'm not going into a fiscal year being short."

Habashi said other goals of the policy include reviewing the utility's finances on a monthly basis and always maintaining a fiscal balance that's within 10 percent of the cost of the utility's power supply.

"Everything was directed to minimize risk," he said. "Most of the time we've been in the money, sometimes we've been out of the money, but if you look at the total we've done really well, I can't complain."

One of the city's long-term deals that turned out especially successful, Habashi said, was an agreement with Enron in 2000 for $48 a megawatt that got the city through the state's energy crisis.

Roseville struck the deal early enough so that it was able to avoid the steep climb in prices that hurt Lodi.

Vallow said one can't compare Roseville with Lodi, as that city's utility operates through a network of larger producers and doesn't face the same issues as Lodi Electric.

And, he said, Lodi "defers to NCPA policies" when buying its power, so it has always been buying less than one year in advance.

But he does concede the utility would benefit from a contingency plan, in which it is specific responses are in place to changes in the market.

"Any strategic plan has got to be dynamic," he said.

Councilman Hansen said Lodi needs such a plan to ensure that it has the resources to buy the power the city needs.

"We need to look out into the future," he said. "Mr. Vallow and his staff have a lot of work to do, and they need to demonstrate to the council that there are plans to turn this around."

Contact reporter Andrew Adams at andrewa@lodinews.com.

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