Board Members present: Patrick Lanning, Ron Farmer, and Dorothy Anderson. Commissioner Sandra Bishop, arrived at 6:30 p.m.

Others present: Randy Berggren, Jim Origliosso, Dick Varner, Jim Wiley, Roseanna McArthur, Dick Helgeson, Tom Buckhouse, Debra Wright, and Krista Hince of the EWEB staff.

President Lanning called the meeting to order at 5:30 p.m.

PRE-BUDGET FINANCIAL PLANNING FOR 2004 THROUGH 2008

• Context for the Work Session

General Manager Randy Berggren said the night's meeting was a discussion over the five year financial forecast for the utility. Starting with the year 2000, Mr. Berggren outlined the history of the utilities' finances and rate actions until the current date.

Mr. Berggren said 2003 showed a continuation of drought conditions and noted that Bonneville Power Administration had raised its rates which the Board had decided not to pass on to rate payers. He said, in 2004, in addition to the 5.7 percent surcharge, there needed to be a rate increase of an additional 5.8 percent to address capital requirements. He said the capital plan would go up to approximately $15 million from $7 million to keep enough funding to adequately address facilities investment. He noted that there would be rate increases in 2004-06 and commented that this would not be tolerated in the community. He said staff had determined to come up with a alternative cost reduction strategy based on a multi-year plan.

Mr. Berggren said staff had established targets for the rate actions for the next three years and said the night's meeting was for getting feedback from the Board on those strategies.

Mr. Berggren said the needed rate action for 2004 had been reduced from 12 percent to six percent or less. He said no rate action was projected for 2005 and said 2006 would see an increase of 4-5 percent. He said, after 2006, there would be rate actions every two years to reflect the rate of inflation.

Mr. Berggren said staff had assumed in its forecast that any BPA rate increases would be passed through to rate payers. He said this might add as much as two percent to current rate targets. He added that the proposed five year plan would provide for full funding of capital requirements.

Mr. Berggren said the plan would only allow for a minimum level of reserves and said it was yet to be determined how reserves could be fully funded and what the definition of "fully funded" would be. He said the utility did not have a capital reserve or an Operations and maintenance reserve but noted that the post retirement reserve would begin to be funded under the proposed financial plan.

Mr. Berggren said staff was also assuming that any excess contributions generated through cost management strategies would not be refunded to the rate payers but would be used to strengthen the financial position of the utility and build reserves. He said there needed to be discussion over these staff assumptions. He said there also needed to be discussion over standard staff assumptions and whether a more conservative track needed to be taken.

• Financial Planning Assumptions

Fiscal Services Supervisor Dick Varner said the objective for the Work Session was to have the Board understand the financial situation of the utility and provide feedback on proposed strategies.

Mr. Varner said the previous plan was to allow a general cost escalation of three percent a year. He noted that staff had decided to allow for two percent per year, in 2005-06, while increasing by one-half of one percent per year until the three percent figure was reached. He outlined projections for pay and benefits, capital improvements, debt issues and debt service, and non-rate revenues. He noted that the cost for health care for employees would nearly double in the next five years.

In response to a question from President Lanning regarding the use of a forecast average, Mr. Varner said staff was making its best guess as to what cost escalations would be. He said staff was assuming that the trend of low inflation would not last and would increase to a higher percentage in the next two years.

In response to a question from President Lanning regarding the impact of labor votes, Mr. Berggren said there were no assumptions in the projections about the impact of the Union on the projections.

In response to a question from President Lanning regarding projections of significantly increased in health care costs, Corporate Services Director Roseanna McArthur said the utility had chosen a provider which had bid lower than others but noted that they would not negotiate for a long period because of the state of healthcare costs generally. She said when the contract was up was when the company would add its significant costs. She said retiree utilization was up which had a large impact on costs.

Mr. Berggren added that the utility could go out for other bids on health care coverage but noted that any company would look at utilization numbers and cover themselves on that risk.

Mr. Varner said it was also too late for a bidding process for 2004.

In response to a question from Vice President Farmer regarding the reason for not using a rebidding process every year, Ms. McArthur said it was an intensive effort to go out every year. She added that staff had not anticipated the amount of retiree utilization.

Vice President Farmer suggested that it might be prudent to consider a more frequent rebidding process given the significant rises in costs that were anticipated.

Mr. Berggren said that, normally, when a health care contract ended, negotiations could be made to keep costs down but noted that utilization factors of retirees were working against the utility.

Vice President Farmer suggested, to general consensus, that a review of bids for health care be undertaken.

President Lanning said the health care structure needed to be reviewed in contract negotiations and needed to be acknowledged in any future projections.

Vice President Farmer commented that O&M costs had increased more than revenue. He said reserves could not be rebuilt when costs were greater than revenue. He stressed the importance of balancing expenses with revenue.

Mr. Varner noted that health care increases were what was driving increases in cost without a balancing increase in revenue.

In response to a question from Vice President Farmer regarding annual depreciation costs, Mr. Varner said the utility tended to have depreciation lives on the low end of what the useful life of the equipment would be so it would help make up for cost escalation over time. He note that the utility had a lot of new generation plants that the utility was depreciating. He said depreciation, in the near term, tended to provide additional funding for the capital program if the utility matched its rates to the capital expense.

In response to a question from President Lanning regarding whether the five-year plan took into account undergrounding efforts, Mr. Berggren said there would be an attempt to coordinate undergrounding efforts with pole replacement. He said the utility would not replace poles if it knew there would be undergrounding going on in the area in the next couple of years. He said the problem was how to coordinate those undergrounding efforts with other public agencies.

President Lanning raised concern over the fact that there was nothing in the plan about diversifying the utility's portfolio.

In response to a question from Commissioner Anderson regarding undergrounding costs, Mr. Berggren said the standard amount was figured into the five-year plan, but anything out of the ordinary had not been planned for.

In response to a question from President Lanning regarding when there would be a green credit discussion, Mr. Varner said there would be a Consent Calendar item at the next meeting. Mr. Berggren added that there could be a discussion if the item were pulled from the Consent Calendar but, otherwise, there was no discussion scheduled.

President Lanning asked for a personal meeting with staff to discuss green credits.

• Uncertainties in Electric Forecast

Mr. Varner outlined uncertainties in the electric forecast. He listed the major uncertainties as; generation, retail load, wholesale prices, and BPA rates.

In response to a question from Vice President Farmer regarding the reason why there was a $20 million difference between 2003 and 2008 purchase power costs, Mr. Varner said the biggest reason was that 2003 was a low water year and 2008 was projected to be a standard water year. He said the utility had sold power forward and had to buy calls to protect itself. He said the cost of buying power under those calls caused costs to go up. He said purchase power and revenue had to be looked at together to get the full picture. He reiterated that the difference in cost was between a normal water year and a low water year of power generation.

In response to a question from Vice President Farmer regarding reductions in power costs by 2008 being taken up by operations and maintenance costs, Mr. Berggren noted that the bulk of that cost increase was for medical benefits. Vice President Farmer reiterated the importance of balancing costs with revenue.

Mr. Varner said the biggest risk to the utility was generation volume. He said this was driven by precipitation. He said, beyond precipitation, the shape of the precipitation also made a big difference, meaning whether the precipitation was snow pack or rain. He said the resource was dominated by hydroelectric power. He noted a bad generation year could mean a $30 million impact to the utility. He said fuel risk was a big issue for any utility and said that for electric generation the fuel was the availability of water.

Mr. Varner said the second biggest risk was wholesale prices. He said there was more room for wholesale prices to drop rather than increase. He said natural gas dominated wholesale prices. He said a $1 change in wholesale prices, given an average year of precipitation, meant $1 million difference in the amount of bottom line.

Mr. Varner said the utility tried to set price floors with hedges. He said 12 months was relatively easy, 18-24 months was acceptable, and anything over 24 months and the utility would have trouble getting other utilities to take the risk on prices. He said the utility was not sensitive to wholesale prices during the first two years of the five-year plan but the last three years would be very sensitive. He said if the market drifted down during those years then the projection would be much worse than what was currently being shown.

Mr. Varner said staff were expecting no change in Bonneville prices in the projected years because staff had received no good information about future BPA plans. He said staff had received indications that rates would stay flat for that time because Bonneville had to deal with an augmentation issue until 2006. He added that Bonneville had also pushed its costs into the next five years.

• Financial Policy Issues

Jim Origliosso, Treasurer, outlined financial policy issues faced by the utility. He cited assumptions versus reserve levels, passing through BPA costs to rate payers, passing through contribution margin performance to rate payers, and budgeting for post-retirement costs and reserves. He said the utility did not budget for building reserves typically but tended to make assumptions about costs that reflected working with no reserves. He said current assumptions of policies and reserve levels were not consistent and stressed that no reserves meant no flexibility.

Mr. Origliosso said his goal was to give the Board a sense of priority about what reserves needed to be funded. He said in order for reserves to be developed, the staff assumptions on financial policy needed to be conservative over the next five year period. He reiterated that limited reserves limited the financial flexibility of the utility.

Mr. Origliosso said the BPA pass through to rate payers policy had not been followed consistently and had brought down reserves significantly. He noted that there had not been a rate increase to customers from 1982 to 1989.

Mr. Varner said passing through BPA rate increases needed to be passed through 18 months before reserves were tapped out.

Mr. Origliosso said the utility was in danger of not recovering full power costs from rates and stressed the importance of recovering those costs.

Mr. Varner commented that BPA had potential to change rates twice a year while the Board, working from a political standpoint, was reluctant to have a rate increase more than once a year. He said the Board needed to ready to go with the rate changes from BPA and pass them through to customers for full cost recovery.

In response to a question from Vice President Farmer regarding whether the Board had actually said it would not raise rates more than once per year, Mr. Varner said that was more of a perception of past Board action.

Commissioner Anderson, while acknowledging that there had been no unanimous action, noted that the majority of the Board had been concerned over raising rates before winter weather increased electric use. She added that customers preferred more rate stability over time.

Mr. Origliosso said that a certain reserve level needed to be targeted.

Mr. Berggren said staff were suggesting no refunds to rate payers until reserves were rebuilt.

President Lanning suggested creating a policy that stated that once reserve levels were back to acceptable levels then rate reductions would be possible.

Mr. Berggren said the utility was still 18 months away from having acceptable reserves.

Regarding post retirement costs, Mr. Origliosso said any PERS action could not take place until the legislature had taken decisive action. He said there was no certain rate news from PERS and there was no way to determine what the final outcome would be so he was recommending planning to retain a reserve of $20 million for actuarial liability until PERS litigation was completed.

Mr. Origliosso said one of the reserves that needed to be addressed first was the Capital Improvement Reserve. He said staff were recommending a reserve of one year's depreciation of electric and water utility capital, ($15 million and $3 million respectively).

Mr. Origliosso said the utility had been going into debt for things that the long term debt policy did not allow for. He stressed the importance of following the policy and financing more long term capital projects. He reiterated that the capital reserve had a zero balance.

In response to a question from Vice President Farmer regarding Mr. Origlosso's priority for what reserve funds were most important, Mr. Origliosso cited working capital, power operating reserve, capital improvement reserve, and post retirement reserves.

Mr. Varner said assumptions around hydro were neutral to slightly optimistic. He said there was some question over whether the utility would be able to generate enough to fund the power operating reserve. He said staff had done probability analysis and recommended a reserve of enough to cover at least one bad year of precipitation, $20 million - $30 million, backed up by up to $60 million in short term borrowing authority.

In response to a question from Commissioner Anderson regarding the amount of water that could be counted on from underground streams, Mr. Varner said the best predictor of water levels in the McKenzie River was the precipitation one year previously compared to precipitation of the previous month. He said the quantity of water that fell this winter had more to do with water levels in the river in the next year.

In response to a question from Commissioner Bishop regarding how the assumptions of staff were reached, Mr. Varner said staff had taken the history of precipitation from the last 60 years, volatility of wholesale prices and retail loads, and trying to create a scenario.

President Lanning said climate change needed to be considered in any long range planning. He said there was no real scientific debate over the subject and stressed the importance of planning for that now.

Mr. Berggren said the question was when to start making assumptions about revenue due to climate change. He noted that data changed yearly and remarked that choices needed to be made about long and short term assumptions.

President Lanning said raising rates and cutting costs were short term ways to deal with the issue while longer range planning would include alternative ideas for generation. He raised concern that there was no mention of that in the five year projection.

Mr. Varner said the Board needed to ask itself whether it would pass through BPA costs to rate payers, either up or down, regardless of the change.

Commissioner Bishop said if the Board agreed to pass those rate changes through to the customer it needed to be consistent in doing so.

Mr. Berggren said there had to be some practical acknowledgment of current circumstances in any rate action passed on to rate payers.

Vice President Farmer said any policy on rate action needed to reflect a firm policy on where reserve levels needed to be.

President Lanning said there was an economic view that it would make sense to reflect directly what BPA was doing with its rates. He said his preference was to let customers know when BPA was changing its rates and when EWEB was making adjustments according to those rate changes.

Commissioner Bishop suggested a certain percentage level of rate change from BPA that would trigger a likely rate action by the Board to adjust for those new costs. She stressed the need for a clear policy to work with and raised concern that cutting costs was not a sustainable way of making up for changing power costs.

Vice President Farmer stressed the need for the Board to have the flexibility to make a judgement at any given time.

• Electric Forecast Review

Mr. Varner noted that there would likely be a 2 percent increase from BPA the next spring. He opined that the utility did not need to take any pass through rate action in October.

Regarding retail rate actions, Mr. Varner said the pro forma plan was to get rid of the surcharge and work on a long term replacement for it that would fund the last part of the power reserve and would then go to capital funding. He said this would mean a permanent rate increase instead of the surcharge but noted that it would mean a zero net impact in billing.

Vice President Farmer said he would argue for more reserve.

In response to a question from Vice President Farmer regarding whether it would be breaking faith with customers to make the surcharge a permanent increase, Mr. Berggren said the surcharge would be removed when reserves were back to an appropriate level. He said the situation would have to be treated carefully but noted that there would be no real increase in rates but no decrease either.

Commissioner Anderson said there would need to be a Board discussion about the issue.

Mr. Varner said another choice was letting the surcharge expire and then raise rates a few months later.

President Lanning said the capital situation was something that needed to be addressed. He confirmed that the surcharge was scheduled to be removed in 2004.

Mr. Berggren reiterated that rates would depend heavily on the rainfall in the next year.

President Lanning raised concern over multiple rate changes during the year but said he would not have a problem with a rate increase followed by elimination of the surcharge.

Mr. Varner said issue was whether the Board was comfortable with the recommended level of rate action over the next five years.

In response to a question from President Lanning regarding what percent rate increase would build reserves to desired levels, Mr. Varner said 2 percent increase in 2004 would achieve the result.

• Water Forecast

Mr. Varner said projected rate action for water was higher than the electric projection because labor was a much bigger portion for water than for electric. He noted that water was cheaper than power and said an eight percent increase would result in an average of an extra dollar per customer per month.

Mr. Varner said water was in much better working shape than the electric utility. He noted that water reserves were well funded and there was good coverage of debt ratios.

Mr. Berggren noted that there were no real capital projects for the next five years excepting the groundwater project.

• Steam Forecast

Mr. Varner said the biggest issue for steam was fuel costs. He noted that there would be a 28 percent increase in fuel rates which would result in a 14 percent increase in rates to customers that fall and biennial rate increases of 3 to 4 percent. He noted that customers would see the same increase if they switched to natural gas since that was the fuel used to generate steam.

Mr. Helgeson said there had been no significant increases in steam rates. He noted that opportunities in cutting costs for the steam utility were limited because the operation was relatively small.

In response to a question from Commissioner Anderson regarding whether staff were assuming the same number of customers, Mr. Helgeson customer numbers were fairly consistent over the last ten years. He raised concern over the expected increase in natural gas prices.

In response to a question from Vice President Farmer regarding the need for capital reserve projects in the steam utility, Mr. Varner said the equipment was all in good shape and the boilers had been replaced recently.

• Wrap Up

Mr. Varner recapped what he had heard from the Board that evening;

1. There was concern over the level of reserves in the electric utility.

2. There was willingness, on the part of the Board, to look at rates as a potential funding strategy along with cost management to build financial reserves.

3. The projected rate increases were within the right range but were not so high that the Board would refuse them.

4. There was consensus among the Board members to pass through BPA rate increases to rate payers although it wanted to review each situation before taking action.

Mr. Varner expressed his desire to hear from the Board at the next meeting over whether it wanted more conservative projections. He said staff would come to the Board every six months with information on BPA rates.

Vice President Farmer reiterated his concern over the rate of expenses versus the growth of revenue.

Vice President Farmer said there should be a process of reviewing strategic goals when budgeting for the future.

Mr. Berggren said there would be a high alignment between goals and financial strategies.

Mr. Varner said staff would present a detailed capital plan in September so it could be reviewed before budget planning in October.

President Lanning called for data on rising health care costs and how alternative contracts could be obtained.

The meeting adjourned at 9:30 p.m.

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Assistant Secretary President