LETTER NO. L-34-00 ROBERT J. PELLATT SIXTH FLOOR, 900 HOWE STREET, BOX 250 COMMISSION SECRETARY VANCOUVER, B.C. CANADA V6Z 2N3 Commission.Secretary@bcuc.com TELEPHONE: (604) 660-4700 web site: http://www.bcuc.com BC TOLL FREE: 1-800-663-1385 FACSIMILE: (604) 660-1102 Log No. 3602 VIA FACSIMILE July 17, 2000 Mr. R. Brian Wallace Mr. R.G. Gathercole Bull, Housser & Tupper Executive Director Barristers & Solicitors BC Public Interest Advocacy Centre 3000 Royal Centre, P.O. Box 11130 815-815 West Hastings Street 2500-1055 West Georgia Street Vancouver, B.C. V6C 1B4 Vancouver, B.C. V6E 3R3 Dear Sirs: Re: British Columbia Hydro and Power Authority (“B.C. Hydro”) Report on Export Trade ______________BCUC Staff Information Request_____________ In Commission Letter No. L-15-00, the Commission directed B.C. Hydro to file a report related to its electricity trade activities, in part, since actions taken by B.C. Hydro at this time can have significant consequences to ratepayers after the expiry of the rate freeze. The Commission noted that electricity trade was a contentious issue at B.C. Hydro’s last revenue requirements hearing, and that the Commission’s forecast of electricity trade revenues was made using less than adequate information. Commission Letter No. L-15-00 directed B.C. Hydro to fully describe its export trade activities in the following three areas: The structure of agreements between B.C. Hydro and Powerex; Financial information; and The rate stabilization account. B.C. Hydro responded with the enclosed Report on Export Trade dated June 30, 2000. Since the request for the Report on Export Trade evolved out of a complaint by the Joint Industry Electricity Steering Committee (“JIESC”) and the Consumers’ Association of Canada (B.C.) et al. (“CAC (B.C.) et al.”), the Commission is providing an opportunity for these parties to comment on B.C. Hydro’s report and the degree to which it provides the information requested in Commission Letter No. L-15-00. Specifically, the Commission encourages JIESC and CAC (B.C.) et al. to comment on the following issues: 1. The Structure of Agreements between B.C. Hydro and Powerex In Commission Letter No. L-15-00, the Commission acknowledged that Powerex would not be a public utility if it acts at arms-length from B.C. Hydro. The Commission requests comments from the JIESC and CAC (B.C.) et al. on the relationship between Powerex and B.C. Hydro and any implications for the Commission’s involvement in monitoring the activities of B.C. Hydro and Powerex. …/2
LETTER NO. L-34-00 2 2. Financial Information In Commission Letter No. L-15-00, the Commission requested that B.C. Hydro provide financial information to demonstrate how export trade activities benefit ratepayers fairly for the storage and generation assets of B.C. Hydro, and to help the Commission in forecasting net export revenues under average water conditions for next year’s revenue requirements hearing. The Commission requests the comments of JIESC and CAC (B.C.) et al. on the extent to which the financial data provided in B.C. Hydro’s report is sufficient for these purposes. B.C. Hydro indicated that the net income for fiscal 2001 may be higher than forecast in the report, based on actual results to date in fiscal 2001. JIESC and CAC (B.C.) et al. may also wish to comment on the merits of requiring B.C. Hydro to file up-to-date financial information on export trade activities on a periodic basis. 3. The Rate Stabilization Account The Commission requested that B.C. Hydro explain the nature of transactions between B.C. Hydro and Powerex. B.C. Hydro’s response indicated that the method of apportioning the proceeds of electricity trade activities between B.C. Hydro and Powerex is described in the B.C. Hydro/Powerex Energy Transfer Pricing Agreement, which has not been provided to the Commission. B.C. Hydro further indicated that the Commission’s determination of B.C. Hydro’s return on equity is dependent upon the consolidated financial impact to B.C. Hydro, not the Energy Transfer Pricing Agreement. JIESC and CAC (B.C.) et al. may wish to comment on the potential impact of the current transfer pricing methodology on ratepayers after the rate freeze expires in September 2001, particularly with regard to water levels and possible future structural and regulatory changes in the way consolidated net income may be calculated. In addition to the above, the JIESC and CAC (B.C.) et al. may wish to comment on the processes, if any, the Commission might use to review both the June 30 report and B.C. Hydro’s export trade activities on an ongoing basis. The Commission requests that the comments of JIESC and CAC (B.C.) et al. be forwarded to the Commission by Friday, August 11, 2000. Yours truly, Original signed by: Robert J. Pellatt MAG/mmc Enclosures cc: Mr. Ray Aldeguer, Senior Vice President Legal & Regulatory Affairs & General Counsel British Columbia Hydro and Power Authority BCH/2000RR-Export Trade/CAC(BC), JIESC Info Rqst-L-34
LETTER NO. L-15-00 ROBERT J. PELLATT SIXTH FLOOR, 900 HOWE STREET, BOX 250 COMMISSION SECRETARY VANCOUVER, B.C. CANADA V6Z 2N3 Commission.Secretary@bcuc.com TELEPHONE: (604) 660-4700 web site: http://www.bcuc.com BC TOLL FREE: 1-800-663-1385 FACSIMILE: (604) 660-1102 Log No. 2973 VIA FACSIMILE April 6, 2000 Mr. Ray Aldeguer Senior Vice President Legal, Regulatory Affairs and General Counsel British Columbia Hydro and Power Authority 17 th Floor, 333 Dunsmuir Street Vancouver, B.C. V6B 5R3 Dear Mr. Aldeguer: Re: British Columbia Hydro and Power Authority Commission Letter No. L-7-00 __________Report on Export Trade___________ The Commission has considered your submissions of February 29, 2000 and March 29, 2000 in response to Commission Letter No. L-7-00. The Commission has also considered the submissions of the Joint Industry Electricity Steering Committee and the Consumers’ Association of Canada (B.C.) et al. on this issue. The Commission agrees with B.C. Hydro that the pending legislation to extend the rate freeze until September 30, 2001 will postpone any revenue requirements review of the Utility during this fiscal year. Therefore, the requirement to obtain export trade information could be delayed if this information was needed solely for rate setting purposes. The Commission also accepts that Powerex is not a public utility if it acts at arms-length from B.C. Hydro, and as such the focus of further reporting by B.C. Hydro should be on the nature of the transactions entered into by B.C. Hydro with its non-regulated subsidiary. However, as recently affirmed by Order in Council No. 493 (dated March 30, 2000) amending Special Direction No. 8, the Commission is directed to calculate B.C. Hydro’s return on equity using projections of consolidated net income that include an amount of electricity trade income consistent with the Commission’s forecast of annual net export revenue under average water conditions. The Commission also agrees with the submissions of the customer groups that the actions of B.C. Hydro with respect to electricity trade are very important to the welfare of ratepayers. In its most recent correspondence, B.C. Hydro indicates that a modified Rate Stabilization Account is to be established by the government through an Order in Council to change Special Directive No. 2 to B.C. Hydro. Order in Council No. 494, dated March 30, 2000, establishing Special Directive No. 4 to B.C. Hydro, sets out the operation of the Rate Stabilization Account for the dual purpose of helping B.C. Hydro achieve its targeted return on equity and keeping rates stable despite stream flow fluctuations. Therefore, actions taken by B.C. Hydro at this time, can have significant consequences to ratepayers after the expiry of the rate freeze. The ways in which B.C. Hydro manages its reservoirs in relation to the water flows into those reservoirs have the greatest single operational impact on the rates paid by domestic customers. The Commission has an ongoing responsibility pursuant to Sections 23, 24, and 43 of the Utilities Commission Act to keep itself informed about B.C. Hydro’s actions with respect to electricity trade. Electricity trade activities of B.C. Hydro have not been reviewed since 1994 and the nature of electricity
LETTER NO. L-15-00 2 markets has changed dramatically since that time. In its February 2000 Interim Report for the Nine Months ended December 31, 1999, B.C. Hydro stressed how the evolution of electricity markets had created a substantial opportunity for the Utility to purchase electricity from external sources when prices are low and store water behind its reservoirs to later utilize for export trade activity when market prices are high. The Commission therefore directs B.C. Hydro to submit a report to the Commission by June 30, 2000 fully describing its export trade activities in the following three areas: 1. The Structure of Agreements between B.C. Hydro and Powerex B.C. Hydro is to clearly explain the nature of the transactions with respect to electricity trade between B.C. Hydro and its subsidiary Powerex. B.C. Hydro should also clearly explain how the content of each agreement entered into between them affects the structure of the electricity trade arrangements between the two parties. This section of the report should demonstrate the extent to which B.C. Hydro is safeguarding its domestic customers’ interest in its arrangements with Powerex. For instance, the report should explain whether or not B.C. Hydro and Powerex are acting at arms-length. The Utility should also detail how it is safeguarding the interests of its domestic ratepayers through the consolidation of Powerex’s revenues for revenue requirement purposes, or by transfers from Powerex to B.C. Hydro prior to export sales. The information provided should explain the nature of the agreements without disclosing any commercially sensitive information with respect to export trade. 2. Financial Information B.C. Hydro is to demonstrate, through the provision of historic and current financial information, how the export trade activities between B.C. Hydro and Powerex benefit domestic ratepayers fairly for the storage and generation assets of B.C. Hydro. The Commission recognizes B.C. Hydro’s concern with respect to disclosing commercially sensitive information, but the Commission requires B.C. Hydro to provide adequate data to fully inform the Commission on the conduct of its public utility business with respect to electricity trade. B.C. Hydro should respond to those matters addressed in Commission Letter No. L-7-00 and provide financial details to the Commission without disclosing any commercially sensitive information. 3. The Rate Stabilization Account To better understand the impacts on ratepayers, B.C. Hydro is to detail the operation of the Rate Stabilization Account for Fiscal Year 1999/00, and its expected operation for Fiscal Years 2000/01 and 2001/02. The report should provide details on the state of B.C. Hydro’s reservoirs and the expected water inflows based upon up-to-date snowpack information and forecasts of low, average and high precipitation for the remainder of calendar year 2000 and 2001 up to September 2001. Depending on the nature of the transactions between B.C. Hydro and Powerex, storage rights and water inventories held by Powerex at different times over the period should be identified. B.C. Hydro should then provide its load resource analysis to indicate domestic demand and export trade activities throughout the period to demonstrate how domestic customers will be protected during the rate freeze period and how B.C. Hydro will be well positioned to protect customers after the end of the rate freeze. B.C. Hydro should indicate if there are any conditions under which the Rate Stabilization Account balance will be used for any purpose other than domestic customer rate protection and protection of payments to the provincial government pursuant to Sections 5, 6, and 7 of Special Directive No. 4.
LETTER NO. L-15-00 3 Electricity trade was a contentious issue at B.C. Hydro’s last revenue requirements hearing, and the Commission’s forecast of electricity trade revenues was made using less than adequate information. Since 1994, B.C. Hydro’s net income from electricity trade has more than tripled, its revenues from electricity trade are approaching one-third of its total revenues, Powerex has become a sophisticated trader, and markets for electricity trade have become more accessible, diverse, and complex. The Commission has an ongoing obligation to ratepayers, to B.C. Hydro, and to the Lieutenant Governor in Council to gain a better understanding of B.C. Hydro’s electricity trade activities and accounting practices. Yours truly, Original signed by: Robert J. Pellatt WJG/mmc cc: Mr. Richard Gathercole Executive Director B.C. Public Interest Advocacy Centre Mr. R. Brian Wallace Bull, Housser & Tupper Barristers & Solicitors BCH/Highload(NIS)/2000RR/ExptTrade, L-15-00
BChydro E Ray Aldeguer Senior Vice-President Legal, Regulatory Affairs and General Counsel Phone: (604) 623-4513 Fax: (604) 623-4407 Mr. Robert J. Pellatt Commission Secretary British Columbia Utilities Commission P.O. Box 250 600-900 Howe Street Vancouver, B.C. V6Z 2N3 Dear Mr. Pellatt: RE: British Columbia Hydro and British Columbia Utilities Commission Letter No. L-15-00 - Report Please find enclosed BC Hydro’s letter requesting information about the export subsidiary Powerex. While the report is self-explanatory, understood in their proper context. The first provide reliable, low cost electricity to its domestic BC Hydro and Powerex have always been will not allow its trade activities to undermine The recent amendments to Special Directive No. 4 create a new form of Rate Stabilization Commission to offset any projected revenue RSA. However, those legislative changes have not caused to change either its domestic service activities It should also be noted that the report 3 February 2000, announcement regarding 30 September 2001, the Minister responsible address a number of structural and regulatory requirement hearing. Therefore, while some may change ahead of BC Hydro’s revenue speculation about any such changes and Commission in the context of existing policy. British Columbia Hydro and Power Authority, www.bchydro.com THE POWER IS YOURS 30 June 2000 Power Authority (“BC Hydro”) (“Commission”) on Export Trade response to the Commission’s 6 April 2000 trade activities of BC Hydra and its the activities described therein must be and foremost function of BC Hydro is to customers. The trade activities of a means to that end. BC Hydro has not and that goal. Direction No.8 and the issuance of Special Account (“RSA”) and direct the deficiency by any positive balance in the and will not cause BC Hydra or its trade activities in any way. reflects current government policy. In the the extension of the BC Hydro rate freeze to indicated the government’s intention to issues in advance of a revenue of the assumptions underlying the report requirement filing, BC Hydro has avoided has appropriately responded to the 333 Dunsmuir Street, Vancouver BC V6B 5R3
-2- With the foregoing comments in mind, provides the information the Commission requires. Enclosure BC Hydro trusts that the enclosed report Senior Vice-President Legal, Regulatory Affairs and General Counsel
BChydro E REPORT ON EXPORT 30June2000 THE POWER IS YOURS TRADE
1. The Structure of Agreements between (0 Consolidation of Powerex’s revenues Under Special Direction No. 8 as amended 30, 2000, the Commission is required allow BC Hydro to achieve an annual allowed, on a pre-income tax basis, utility regulated under the Utilities Special Direction No. 8 requires equity must be calculated using this purpose, projections of consolidated electricity trade income consistent export revenue under average Commission’s report to the Lieutenant as amended on BC Hydro’s Energy projected consolidated net income, transfers, is less than the amount rate of return, projections are also transfer from the Rate Stabilization Stabilization Account are subject BC Hydro uses Generally Accepted its subsidiaries, including Powerex. with their parent company on a line by line basis and any inter-company eliminated on consolidation. The solely from transactions with external between BC Hydra and Powerex BC Hydro’s rates at this time. Since consolidated net income is used for rate setting of electricity trade income benefits of the revenue requirement that Moreover, where water conditions overearning relative to the allowed through the Rate Stabilization Account (ii) Nature of Transactions with respect and Powerex BC Hydro’s primary objective is to provide domestic customers. Within this support optimal economic utilization non-committed generation capability 30 June 2000 BC Hydro and Powerex for revenue requirements purposes by an Order in Council dated March to ensure electricity rates are sufficient to rate of return on equity equal to the return by the most comparable investor-owned Commission Act. that for rate setting purposes, the return on consolidated net income from all sources. For net income must include “an amount of with the Commission’s forecast of annual net water conditions, as contained in the Governor in Council dated June 30, 1992, Removal Certificate application”. Where before any Rate Stabilization Account needed by BC Hydro to achieve its allowed to include an allowance for an appropriate Account. Transfers from the Rate to a positive balance existing in the account. Accounting Principles (GAAP) to consolidate Under GAAP, subsidiaries are consolidated profit is result shows consolidated net income resulting third parties. The transfer pricing applied thus has no relevance in determining purposes, the optimization domestic ratepayers by reducing the portion must be collected through domestic rates. and electricity trade activities lead to an return on equity, ratepayers benefit from this as described in more detail below. to electricity trade between BC Hydro low-cost, reliable electricity supply to context, Powerex’s activities are designed to of BC Hydro’s electricity assets by using to earn income. Page 1
Powerex deals with BC Hydro optimizing utilization of system wholesale transmission service, unit (“Power Supply”) within BC Hydro, operations personnel as it would provisions, grid operations has adopted to ensure that Powerex and Power business units are treated as third parties. On the other hand, when it comes Powerex’s relationship with Power Supply conscious effort is made by Powerex co-operate closely to ensure maximum operation of its system. Because provincial regulatory and income can be managed for the benefit framework has allowed Powerex mastering the rules and characteristics While energy transfers between transactions between separate coordination processes ensure wide perspective. Similarly, BC Hydra’s and processes are integrated to ensure ensure both adequate supply to domestic capability. Energy transactions between purchases of energy. Powerex energy transactions result from generation when its value is high value is low. This means ensuring BC Hydro domestic load and optimizing to physical and environmental constraints energy in the reservoirs. In order to maximize value and purchases along three dimensions There are three significant markets Pacific Northwest and California. selling energy in each region prices and demand for energy transmission to reach each market, 30 June 2000 REPORT ON EXPORT TRADE as both a transmission user and to assist in capability. With respect to arrangements for both for itself and for the Power Supply business Powerex deals with BC Hydro’s grid a third party. Pursuant to the WTS tariff strict codes of conduct and procedures Supply and BC Hydra’s customer services to the optimization of the generation assets, is intended to be very close. Indeed a and Power Supply to share information and efficiency and profitability in BC Hydra’s Powerex is a separate legal entity, the extra- tax implications of Powerex’s external activities of BC Hydro as a whole. In addition, this to develop a trading group that can focus on of markets external to B.C. BC Hydro and Powerex are accounted for as legal entities, various communication and that transactions are beneficial from a corporate- commodity risk management policies that the generation assets are used to customers and optimum use of system BC Hydra and Powerex are solely sales and has no storage rights or water inventory. These BC Hydra’s desire to maximize energy and to minimize energy generation when its there is sufficient energy and capacity to meet BC Hydro generation for trade, subject and considering the long-term value of manage risks, Powerex allocates sales and - geographic, time and market channels. in which Powerex transacts: Alberta, the U.S. The decisions with respect to buying and are based on the actual and expected market in each market, cost and availability of and the risk of transmission curtailments. Page 2
Time allocation means allocating market, the next-day market, and the forward are based on the actual and expected and risk-adjusted forecasts of transmission that will be available market prices can be quite volatile system, Powerex can take advantage purchases. A key factor affecting limited liquidity, no one market can absorb Allocating among different market transact in for a particular geographic day-ahead market at the California-Oregon in both the bilateral market with Power Exchange’s (Cal PX) day-ahead can transact in the bilateral market, California Independent System Another alternative is the market value-added customer benefits straight commodity sales. Such re-marketing rights in the event Powerex makes these decisions energy in the different markets management policy described below. Powerex and Power Supply work and iterative. Power Supply determines system to deliver and/or receive to several years forward. Power value of generation (which is electricity and gas market prices water use). Powerex seeks to maximize the net revenue from Powerex on forecast market price, capabilities is important to Power marginal value. Detailed forecast value of generation are commercially Information about BC Hydro’s generating trading strategy. Information BC Hydro’s plant operating decisions Supply and Powerex share optimizing trading on a Real including the next day and month, years. Information is shared for longer-term arise. 30 June 2000 REPORT ON EXPORT TRADE sales and purchases among the Real Time market. These allocation decisions market prices and demand for energy, the BC Hydro generating capability and in each time period. Because the forward and because of the nature of BC Hydra’s of this volatility in its forward sales and the time allocation decisions is that, because of all the power available to sell. channels means selecting the best markets to area and time period. For example, in the border (COB), Powerex can transact other utilities or marketers, or in the California market. In the hourly market, Powerex the Cal PX hour-ahead market, or the Operator (Cal ISO) imbalance energy market. for structured or complex deals, which include that yield higher margins for Powerex than benefits include delivery to a customer’s site, or that a customer’s load unexpectedly drops. based on the expected price and demand for within limits established in BC Hydra’s risk together in a process that is both cooperative the net capability of the BC Hydro power at the B.C. border ranging from real-time Supply also establishes the system marginal influenced primarily by the forecast forward as well as probability of spill and efficiency of buy below and sell above this value so as to electricity trade. Information provided by market depth, and expected transmission Supply in the determination of this system reservoir energy storage data and the marginal sensitive information. capability and value drives Powerex’s about market opportunities is considered in and the scheduling of maintenance. Power information continuously for the purpose of Time or hour-to-hour basis, over the period and for the period from one month to two opportunities as these opportunities Page 3
(4 Real Time Hour-to-hour coordination shift engineer and the proximity to one another identifies market opportunities operations shift engineer that is available for trade obligations have been met, and this information, the Powerex next hour. 04 Short Term The Power Supply next-day Powerex traders on expectations imports and exports and then purchases from the BC Hydra priority is always given uses this information BC Hydro operations planners maintenance outages. If, for example, high, BC Hydro could accelerate, maintenance outage. (4 Medium Term For the next day to three-year generation and operations expectations of market planners provide Powerex system and the amount month for trade. These hydroelectric and thermal generation outage schedule. (4 Long Term All energy transactions of a duration specific approval of the BC Hydro and Powerex advise on and review any long-term Contracts with terms over government and National trading authorizations issued 30 June 2000 REPORT ON EXPORT TRADE takes place between the BC Hydro operations Powerex Real Time trader, who work in close on the Powerex trade floor. The Powerex trader to buy or sell power. The BC Hydra determines the amount of generating capability after BC Hydro’s power and non-power the value of this generation. Based on trader will make buy or sell decisions for the operations planners seek input from the of market prices and quantities for provides a system capability for sales and system. In determining system capability, to serving domestic load. The Powerex trader to engage in purchases and sales and the use the information to plan short-term market prices are expected to be re-schedule or cancel a generation period, Powerex provides BC Hydro planners with forward market prices and demand. BC Hydro generation and operations with the value of energy in the BC Hydro of generation capability that is available each are based on forecasts of the availability of energy in the system, BC Hydra’s load, and the in excess of three years require the Risk Management Committee and/or the Boards. Powerex relies on Power Supply to contracts contemplated by Powerex. five years also require separate provincial Energy Board approval under the terms of to BC Hydro and Powerex. Page 4
Power Supply relies on Powerex contracts contemplated by Power Powerex work together to execute long-term Power Supply The preceding paragraphs refer to system an important adjunct to, the BC Hydra activity, Powerex engages in a very locational arbitrage. Forward physical blocks of energy, or options from changes in prices. Locational buying transmission to another activities are independent of the BC Hydro knowledge and price discovery information. (iii) Policies, agreements and protocols The activities between BC Hydro framework of governing principles, The primary components of the framework l BC Hydro Commodity Risk Management l BC Hydro I Powerex Energy (4 BC Hydro Commodity Risk In early 1997, BC Hydro as part of a two-year project The objective of the project was to meet or exceed for risk management. contributions from BC Hydro creation of the BC Hvdro respect to Powerex (“the was approved by the BC Hydro the fall of 1999. The Policy Directors and by the BC Hydra The Policy has now been implemented The Policy has also been reviewed 2000, BC Hydro and Powerex that have been approved section 79.3 of the Financial 30 June 2000 REPORT ON EXPORT TRADE to advise on and review any long-term Supply. In addition, Power Supply and such contracts. An example of such a contract is the Non-Treaty Storage Agreement. trading; this trading is enabled by or is generation system. In addition to this limited amount of forward hub trading and hub trading means buying or selling forward on blocks of energy, with a view to profit arbitrage means buying energy at one point, point, and selling energy for a profit. These system but provide valuable market between BC Hydro and Powerex and Powerex are subject to a management policies, agreements, and working protocols. are: Policy - with respect to Powerex Transfer Pricing Management Framework engaged the consulting firm Deloitte & Touche to enhance its risk management capability. industry best practices The work of the consultants, with significant and Powerex staff, culminated in the Commodity Risk Manaqement Policv - with Policy”) and related infrastructure. The Policy Risk Management Committee (RMC) in was approved by the Powerex Board of Board of Directors in December 1999. within BC Hydro and Powerex. and endorsed by government. In June were designated as government bodies to trade in commodity derivatives pursuant to Administration Act. Page 5
The Policy describes the processes related to electricity market and credit exposure counterparties, locations, methodologies, transaction processes used by Powerex. The risk management framework practices. The framework Touche in setting-up risk framework is consistent frameworks such as developed by Coopers & Lybrand G30 (Group of 30). The commodity risk management Policy and risk management l Price Risk: The risk of financial or volatility. l Credit Risk: The risk that a counterparty defaults on delivery and/or l Procedural Risk: The risk of financial willful breaches in policy. transact has been given. l Volume Risk: The volumes and transmission Powerex identifies and Policy. Powerex establishes consistent with the Policy limits and controls specified and Powerex actively monitor reflect industry best practices. RMC and the Boards personnel adhere to the contained in this Policy. The Policy describes the established and maintained, Powerex is permitted to contains five elements: segregation of duties, recording and transaction limits. The covered below: 30 June 2000 REPORT ON EXPORT TRADE risk management policies, controls, and trade transactions. These include the limits which apply to transactions, products, or portfolios. It also describes the valuation controls, and reporting and approval adopted is consistent with industry best is derived from the consulting firm Deloitte & management infrastructure worldwide. This with other industry-standard risk management GARP (Generally-Accepted Risk Principles (now Price Waterhouse Coopers)) and infrastructure, the risk management procedures control the following risks: loss due to changes in market prices in a commodity transaction settlement. loss due to procedural errors, or Procedural risk is assumed once authority to risk of financial loss due to lower production constraints. manages these risks in accordance with the risk management procedures that are and conducts its activities within the specific by the Policy and the procedures. BC Hydro the Policy and change it as necessary to Any changes must be approved by the of both BC Hydro and Powerex. All Powerex risk parameters, authorizations, and limits risk management infrastructure that must be and specifies the business activities that engage in, and limits on these activities. It independent oversight of trading activities, of transactions, reporting on activities elements of the Policy and procedures are Page 6
l Independent Oversiqht independent oversight conducted within the Manager, Commodity Powerex VP Finance; Director, Debt Management Corporate Relations; respect to independent BC Hydro Corporate BC Hydro President and CEO. It is made up of: l Senior VP, Corporate l Senior VP, Marketing, 0 Senior VP, Power Supply l VP, Strategic l Senior VP, Legal, (Vice-Chair) l President & CEO, Powerex The RMC meets monthly ensuring it is implemented procedures and systems, the limits and controls changes to the Policy through the President risk management issues necessary. Finally, the boards of directors responsible for understanding ensuring they are approved the Policy and must approve l Seqreaation of Duties: procedural risk. It means executing transactions, and settling and invoicing organized into a front (transaction oversight, (accounting). l Recordinq of Transactions: management and scheduling outcome of the risk Zai*Net system continues and power scheduling 30 June 2000 of Tradinq Activities: The objective of is to ensure that trading activities are being limits of the Policy. The RMC; the BC Hydro Risk; the BC Hydro Credit Risk Manager; the the Powerex Risk Manager; the Executive Branch, Ministry of Finance and and auditors all have responsibilities with oversight. The RMC is a subset of the Management Committee and reports to the and Financial Affairs and CFO (Chair) Communications and Public Affairs Issues and Planning Regulatory Affairs and General Counsel and is responsible for approving the Policy, through the development of appropriate and ensuring that risks are managed within specified in the Policy and procedures. Any must be approved by the RMC. The RMC, and CEO, will report any significant commodity to the BC Hydro Board of Directors, as of both BC Hydro and Powerex are the risks taken by the corporations and appropriately managed. Both Boards have any changes. Segregation of duties is critical to avoiding that no one employee may be involved in confirming transactions with counterparties, transactions. As a result, Powerex is office (transaction staff), middle office risk and credit management) and back office Powerex implemented the Zai*Net risk system in mid-1999. This was a key management project described above. The to be a leading integrated risk management system. The Policy requires that all energy and Page 7
transmission transactions necessary to ensure Independent oversight l Reportinq on Transactions: and monthly obligations RMC. Mandatory reports market ‘, profit and generates the reports. including exceptions reported to the BC Hydro and Powerex l Transaction Limits: The products, transaction the optimization of the BC Hydro physical capability reliability. For the off-system of open positions and majority of transactions and the use of volume conservative measures risk end of the energy The risk management Policy contains commercially-sensitive dollar trading limits embedded organization that could be used anticipate its energy trading contains information methodologies, which could be used by other energy Powerex energy pricing, l External Review of Risk Manaoement In February 2000 Standard evaluation. S&P are very practices of energy marketing management capabilities. strategy, the overall risk management the risk management program. ’ Powerex’s position is the sum of its commodity sales and purchases open. A long position exists when a party owns a contract or asset, short position exists when a party has an obligation to deliver a commodity rising market prices. An open position exists when short and long positions ’ To mark to market is to calculate the value of a contract at current replacement or liquidation value of the contract. 30 June 2000 REPORT ON EXPORT TRADE must be recorded in the system. This is appropriate position ’ and risk management. from the middle office ensures that this occurs. The Policy sets forth certain daily, weekly for reporting to staff, managers and to the include position summaries, mark to loss, and risk measures. The middle office Any significant risk management issues, to Policy limits, must be approved by RMC and Boards. Policy lists approved geographical regions, limits and risk metrics. For activities related to system, the limits are based on the to deliver without compromise to domestic transactions, limits are based on volume commitment duration. Requiring that the be backed by physical capability to deliver and duration limits for off-system trading are that ensure that Powerex remains at the low- trading spectrum. document itself has not been provided as it information. The volumetric, location, and in the Policy contain information about the by competitors of PowerexfBC Hydro to and marketing operations. The Policy also on BC Hydro energy price forecasting marketers to predict and therefore trading activity. Framework & Poor’s (S&P) provided a private ratings experienced at reviewing risk management entities to detect the strength of risk S&P reviewed the BC Hydro/Powerex business approach, and the sophistication of contracts or assets and can be expressed as long, short or and is therefore exposed to the risk of falling market prices. A at a fixed price, and is therefore exposed to the risk of are not off-setting. market prices; the mark to market value represents the Page 8
S&P’s review summary included low-risk energy trading business It was noted that: “Powerex flow by selling real time BC Hydro’s marginal cost of generation. BC Hydro’s hydroelectric power. Therefore, Powerex markets. The firm has very few contracts mitigate exposure to market volatility.” S&P also commented on the overall sophistication of the risk management included: . Risk awareness . Risk assessment . Trade . Trade . Performance . Counterparty . Organization . Limits and controls . Market . Stress testing . Risk reporting . Management . Risk measurement . Risk systems . Data capture S&P rated Powerex as average also noted: “Powerex currently would be considered average marketing industry. The market, credit, legal and that: “A high level of concern reflected in Powerex’s Furthermore, management and modifying policies oversight is conducted committee structure.” 3 S&P’s review is a preliminary evaluation based on information information has not been audited. New or changed information could or suweil the results of the evaluation”. 30 June 2000 REPORT ON EXPORT TRADE the following comment: “Powerex has a strategy.” 3 can increase the consolidated BC Hydro cash or day ahead power when prices are above This is facilitated by the fact that generation can quickly ramp up and generate is successful in the real-time and day ahead over one month, which help to risk management approach and the program. The criteria considered and action confirmation settlement evaluation approval process and people risk measurement and scenario analysis frequency reporting methodologies or strong on all criteria reviewed. S&P has an approach to risk awareness that to strong within the energy trading and company has a formal process for identifying regulatory risks.” The review further indicated about control systems and risk limits is policies, practices and organization structure. takes an active role in monitoring this activity as experience dictates the need. Parental through both the board of directors and the provided by SC Hydro and Powerex as of April 2000. The change the evaluation. S&P “is not required to review, modify Page 9
The S&P ratings evaluation deficiencies in the PowerexlBC The S&P report made a comment on off-system trading contracts, day ahead and next hour trades. its risk analysis and reporting recommendation. Powerex all risk criteria. The S&P review document commercially sensitive information. (W BC HydrolPowerex Energy Powerex, as a separate statements as required energy transfer pricing agreement electricity trade activities Powerex for purposes of preparing done in the form of a market Columbia delivery point as a reference The financial results reported financial impact of BC Hydro’s financial impact of electricity revenues and related costs associated the consolidated financial relevant in determining BC Hydro’s 2. Financial Information The following table provides a summary income to BC Hydro’s earnings for fiscal 2001. This income helps to offset rate cover BC Hydro’s revenue requirements. The income has been segregated between assets and off-system trading which is not dependent 30June2000 REPORT ON EXPORT TRADE process did not identify any significant Hydro risk management infrastructure. that the value at risk (VAR) measure should be expanded to include all forward Powerex is working to expand by 2001 to comply with this S&P is also striving to achieve a strong rating on has not been provided as it contains Transfer Pricing Agreement company, prepares audited year-end financial by the Company Act. The BC HydrolPowerex describes how the overall results of are apportioned between BC Hydro and these financial statements. This is based transfer price that uses the Mid- market. by Powerex are different than the overall electricity trade activities. The consolidated trade activities can be described as the with activities outside of B.C. It is impact, and not the transfer pricing, that is rates. of the contribution of electricity trade net 1999 and 2000 as well as the Plan for fiscal increases that would otherwise be required to system trading which utilizes BC Hydro’s on the BC Hydro system. Page 10
Consolidated Electricity Trade income Income from System and Off-System Trading Activities Year ended Mar 31 $millions Plan 2001 System I Off-System GWh 23.882 Sales 1,188 Cost of Sales Energy Costs a82 Transmission 8 112 other 994 Gross margin 194 Operating Costs Income NOTES: System Trading: Powerex purchases and sells electricity throughout backed trading and through trading that is either enabled by, or is an important Off-System Trading Powerex engages in forward hub trading and locational forward physical blocks of energy, or options on blocks of energy, means buying energy at one point, buying transmission to another dependent upon the SC Hydro system. The fiscal 2001 Plan was prepared using current snowpack conditions at the time. BC Hydro’s system was very close to average 3. The Rate Stablization Account The Rate Stabilization Account (RSA), established on March 30, 2000. Transfers offset the potential of rate increases in lower income Special Direction No. 8 requires that consolidated net income, before any RSA transfers, BC Hydro to achieve its allowed rate allowance for an appropriate transfer from the RSA. Transfers to a positive balance existing in the account. to increase rates to allow BC Hydro to earn when an RSA balance exists. Pursuant to Sections 5, 6 and 7 of Special which the RSA can be used for any protection and protection of the payments return on equity. 30 June 2000 REPORT ON EXPORT TRADE 1999 System [ Off-System I Total 18.715 18.715 739 739 494 494 50 50 544 544 195 195 16 179 the WSCC region and adjacent areas through system- adjunct to, system trading. arbitrage. Forward hub trading means buying or selling with a view to profit from changes in prices. Locational arbitrage point, and selling the energy for a profit. These activities are not a March 1, 2000 inflow forecast based on As it happened that the inflow forecast for (99%) no adjustments have been made. created under Special Directive No. 4, was are made to the RSA in high income years to years. for rate setting purposes, where projected is less than the amount needed by of return, projections are also to include an from the RSA are subject This is the mechanism by which the need the allowed return on equity is mitigated Directive No. 4, there are no conditions under purpose other than domestic customer rate to the government based on the allowed Page 11
The following table indicates forecast net income fiscal 2000 - 2002 based on BC Hydro’s Summarv Financial Net Income before RSA transfer Transfer (to) from RSA Net Income Return on equity Allowed Return on equity Balance of RSA at end of the year BC Hydro transferred $129 million into the RSA in fiscal of $55 million and $70 million for fiscal needed in order for BC Hydro to meet RSA transfers will allow BC Hydro to achieve increases. Based on actual results to date in fiscal higher than Plan due to unexpectedly remain in the RSA upon the expiry of the rate freeze. 30 June 2000 and transfers to and from the RSA for three year plan prepared in March 2000. Information Actual Plan 2000 2001 2002 $545 $367 $357 (129) 55 70 $416 $422 $427 16.69% 16.59% 16.59% 16.69% 16.59% 16.59% $129 $74 $4 2000. Transfers from the RSA 2001 and 2002 respectively are projected to be its allowed return on equity in these years. The its allowed rate of return without any rate 2001, indications are that net income may be high market prices. If so, a higher balance will Page 12
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.