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ATTACHMENT #1 LF&A Committee Meeting of 11/10/2008 Legislative, Finance and Administration Committee Power Supply Hedges – Letter of Credit LF&A Committee Meeting of 11/10/2008 ATTACHMENT #1 November 10, 2008

Forward Contracts: A Future Obligation Timeline Six Months Today In the Future Product Delivered Price Paid $80 / Barrel Two parties execute a legally binding The parties satisfy their obligations contract by • The selling party will sell an agreed upon • The selling party delivers the product on an agreed upon date and at agreed upon product. an agreed upon price. • The buying party pays the • The buying party pays at the future date previously agreed to price and and takes delivery of the product. takes delivery. -2- Proprietary & Confidential The Power of Integration

Why Use Forward Contracts 1. Provides price certainty Price Difference between agreed to price and actual market iprice at time of delivery. Time Contracted Receive Product Agreed to & Pay at Contract Price Price 2. Allows the City to buy its power supply at a set price for future delivery to minimize volatility in customer rates. -3- Proprietary & Confidential The Power of Integration

How to Value Forward Obligations • When a party enters into a forward contract to buy a product the value of that obligation changes over time based on the market value of the product. Contract +3 +6 Executed Months Months Current Date 12/1/2008 3/1/2009 6/1/2009 Delivery Date 9/1/2009 9/1/2009 9/1/2009 Product 1 Barrel 1 Barrel 1 Barrel Contracted Agreed to Price $80 $80 $80 Current Forward Market Price $80 $70 $90 Value of Forward Contract $0 -$10 +$10 -4- Proprietary & Confidential The Power of Integration

When Prices Change Forward Contracts Result in a Loan Being Granted • Buyer agrees to buy 1 Barrel of Oil on 6/1/2009 for $80. • On 3/1/2009 the iprice of 1 Barrel of oil for d li elivery on 6/1/2009 is $50. • Seller is happy to be selling at a price in excess of current market, but… • …if buyer fails to buy, seller will realize a $30 loss. • Therefore, the seller may require buyer to pay the $30 to ensure there can be no loss. • But if seller believes buyer will fulfill the future obligation then he will not require an upfront payment. -5- Proprietary & Confidential The Power of Integration

Buyers and Sellers in Forward Transactions Set Thresholds for Credit • Assume Buyers and Sellers each agree to provide the other a $100 credit threshold. As long as the value of the forward contract(s) is less than $100 both parties are comfortable with their exposure • If the value of the forward contract exceeds $100 then the parties have agreed that collateral must be provided to ensure the party fulfills their obligation -6- Proprietary & Confidential The Power of Integration

Example of How Credit Thresholds Manage Exposure: $100 Credit Threshold Contract +2 +4 +6 +9 Executed Months Months Months Months Current Date 12/1/2008 2/1/2009 4/1/2009 6/1/2009 9/1/2009 Delivery Date 9/1/2009 9/1/2009 9/1/2009 9/1/2009 9/1/2009 Product 10 Barrels 10 Barrels 10 Barrels 10 Barrels 10 Barrels Forward Agreed to Price $80 $80 $80 $80 $80 Market Price $80 $78 $74 $68 N/A Delivery Price N/A N/A N/A N/A $80 Value of Forward Contract $0 ($20) ($60) ($120) $0 Credit Threshold $100 $100 $100 $100 $100 Required Collateral $0 $0 $0 $20 $0 -7- Proprietary & Confidential The Power of Integration

Example of How Credit Thresholds Manage Exposure: $100 Credit Threshold, An Alternative View $ per Barrel 12/2008 02/2009 04/2009 06/2009 $80 Date $70 Post collateral when Price < $70 Barrel e.g., 10 Barrels X ($70 – $80) = $100 threshold -8- Proprietary & Confidential The Power of Integration

Example of How Credit Thresholds Manage Exposure: $100 Credit Threshold, An Alternative View Counter-Party Price Credit Threshold 12/2008 02/2009 04/2009 06/2009 Executed Price Date Dover Credit Threshold -9- Proprietary & Confidential The Power of Integration

Counterparty Thresholds • Six Counterparties as of 9/30/08 • Credit Thresholds vary depending on credit ti rating and finances of the City and the Counterparty; • Current thresholds ¾ Two Counterparties at $10 million; ¾ Three Counterparties at $15 million; ¾ One Counterparty at $30 million; - 10 - Proprietary & Confidential The Power of Integration

Forward Contracts - Recap • Forward Contracts are executed to lock in the price of future months’ power supply currently in increments of 5, 10, 15 & 25 megawatts • Creates a tiered effect in which one months supply will be made up of several incremental purchases • Current incremental purchases go out to June 30, 2013 • The requirement to post collateral will go away when the incremental purchases are settled (delivery) - 11 - Proprietary & Confidential The Power of Integration