20021204Risk Management Policy Manual.pdf

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IDAHO POWER COMPANY
O. BOX 70
BOISE, IDAHO 83707
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BETSY GAL TNEY
Regulatory Affairs Representative
Pricing & Regulatory Services
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MAIL bqaltnevaD.idahopower.com
December 4, 2002
Ms. Jean Jewell
Commission Secretary
Idaho Public Utilities Commission
PO Box 83720
Boise, Idaho 83720-0074
RE:Case No. IPC-01-
Commission Order No. 29102
Dear Ms. Jewell:
In Order No. 29102 issued in Case No. IPC-01-16 on August 28, 2002, the
Commission directed Idaho Power Company to submit the Risk Management and Policy
Manual and the 2003-2004 Risk Guidelines as approved by the Idaho Power Company Board
of Directors Audit Committee to the Commission for final review and approval.
Attached to this Compliance Filing is the Idaho Power Company Energy Risk
Management Policy Manual and the 2003-2004 Risk Guidelines as approved by the audit
committee of the Board.
Three extra copies of this report are enclosed for Randy Lobb, Lisa Nordstrom , and
Terri Carlock.
Very truly yours
' J-~aJh'\QAjX--I~\'~'
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Betsy Galtney
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Enclosuresc: Randy Budge
David Hawk
Pam Eaton
Dan Kincaid
Francis McDonnell
Don Reading
Peter Richardson
Janice Stover
Lynn Tominaga
Ric Gale, IPCO
Bart Kline , IPCO
RECEIVED 0FilED
zuni DEC -4 Pt'112: 12
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UTILIT1ES CG "iSSION
IDAHO POWER COMPANY
ENERGY RISK MANAGEMENT
POLICY MANUAL
November 2002
TABLE OF CONTENTS
I. RISK MANAGEMENT POLICY INTRODUCTION AND SCOPE .................................
II. ESTABLISHMENT OF A COLLABORATIVE APPROACH WITH CUSTOMERS....... 3
III. ENERGY RISK MANAGEMENT POLICY OBJECTIVES ..........................................
IV. ORGANIZATIONAL STRUCTURE.........................
......... ....... .....
............................. 5
A. BOARD OF DIRECTORS ..............................................................................................
B. PRESIDENT , IDAHO POWER COMPANY........................................................................
C. IPC RISK MANAGEMENT COMMITTEE.........................................................................
D. RISK MANAGEMENT EXECUTION (FRONT OFFICE)....................................................... 8
E. RISK EVALUATION (MIDDLE OFFICE) ..........................................................................
F. RESOURCE DISPATCH PLANNING ...............................................................................
G. TREASURY...................................................... ......................................................... 9
H. LEGAL AND REGULATORY AFFAIRS ............................................................................
I. Long Term Resource Planning .................................................................................
V. MARKET RISK........................................................................................................ 10
A. THE INTERIM RISK GUIDELINES - THE THREE TIER ApPROACH ............."................... 1 0
(i). Tier One - Total PCA Exposure..................... .................................. ......... ........ 10
(ii). Tier Two - Monthly Volumetric Limit Deficiencies and Surpluses ..................."
(iii).Tier Three - Floor Limit ........................................................................,............ 12
(iv). Breach of Limits............................................................................................... 13
(v). Day-Ahead Risk Approach ............................................................................... 14
B. THE PROSPECTIVE MARKET RISK ApPROACH ........................................................... 14
(i). Market Risk Definition .......................................................................................
(ii). Market Risk Quantification....................... .,.................... .................. .......... ....... 14
(iv). PCA Risk Tolerance Limit................................................................................
(v). Breach of PCA Risk Tolerance.........................................................................
VI. CREDIT RISK.........................................................................................................
A. CREDIT RISK DEFINED.............................................................................................
B. COUNTERPARTY CREDIT STANDARDS ......................................................................
C. EXTENSION OF CREDIT............................................................................................
D. LIMIT EXCEPTION PROCESS.....................................................................................
E. CREDIT EXPOSURE REPORTING ............................................................................... 19
VII. PERFORMANCE BENCHMARKING........................... ......... ................................. 19
A. MIDDLE OFFICE FUNCTION - IPCo RISK EVALUATION GROUP ...................................
B. FRONT OFFICE FUNCTION -IPCo TRADER............................................................... 19
VIII. SYSTEMS AND ACCOUNTING ...........................................................................
A. SYSTEMS................................................................................................................ 21
B. ACCOUNTING FOR TRANSACTIONS ...........................................................................
IX. DOCUMENTATION , NEW PRODUCT INITIATION................................................ 22
A. LEGAL DOCUMENTATION...................... ........................ ........................................... 22
B. NEW PRODUCT INITIATION PROCESS........................................................................
Business Rationale................................................................................................. 23
Management Responsibilities.................................................................................
X. MANAGEMENT REPORTING............... ............................... ................................... 25
A. DAILY AND WEEKLY POSITION REPORT .................................................................... 26
B. ANNUAL BENCHMARKING REPORT............................................................................
C. COUNTERPARTY CREDIT ANALYSIS.......................................................................... 26
D. EXCEPTION LOG .....................................................................................................
E. MINUTES OF THE RMC MEETINGS ...........................................................................
XI. RESTRICTED ACTIVITIES AND DISCIPLINARY ACTION .................................... 28
APPENDIX A: BOARD RESOLUTION............. ............... ................. 0""""""""""""'" 29
APPENDIX B: IPC RISK MANAGEMENT COMMITTEE MEMBERS........................... 29
APPENDIX C: AUTHORIZED SIGNATORIES ON BEHALF OF THE COMPANY....... 31
APPENDIX D: COUNTERPARTY CREDIT STANDARDS ...........................................
APPENDIX E: APPROVED INSTRUMENTS, MARKETS ............................................ 32
FINANCIAL SWAPS AND OPTIONS..................................................................................
PHYSICAL ARRANGEMENTS.......................................................................................... 32
Appendix F: Risk Guidelines For The 2002-2003 PCA Year ........................................ 33
Risk Management Policy Introduction and Scope
Idaho Power Company ("IPC" or "the Company ) is an investor-owned utility
serving customers in Idaho and Oregon.
The Company s customers and shareholders are exposed to a variety of market-
driven and operational risks. For customers, these risks can lead to a higher
cost of power. For shareholders , these risks can lead to a diminution in cash
flow and net income. By resolution of the Idaho Power Company Board of
Directors, (see Appendix A) the Company is mandated to engage in a program
on behalf of both customers and shareholders that systematically identifies
measures , evaluates and actively manages and reports on the market-driven
risks associated with its commercial operations.
The policies being established herein (collectively considered the "Manual") shall
address the means by which the Company will manage these risks in a manner
consistent with the Idaho Power Company Board of Directors' authorization to
engage in such activity. The President may from time to time modify the Manual.
However, all changes to this Manual must ultimately be ratified by the Audit
Committee of the Board of Directors and filed with the IPUC.
Every employee involved in the risk management process must sign a personal
acknowledgement form stating that they have read this Manual, understand this
Manual and will comply with this Manual.
The Company shall create a risk management program that will overlay a control
framework on existing commercial practices. Such a program will consist of the
establishment of predefined risk parameters, a delineation of management
responsibilities, and a set of organizational relationships within the Company.
The program will further consist of the development and implementation of
transaction accounting systems and procedures for systematically identifying,
measuring, evaluating and responding to the variety of risks inherent in the
Company s commercial operations. The program s control framework will consist
also of a disclosure and reporting mechanism designed to keep the Senior
Management team responsible for supervising risk and all levels of management
fully informed of the operation s day-to-day status with respect to its performance
parameters. The implementation of these control measures, which are detailed
in the sections and appendices to this document , which follow, collectively will
define, and constitute the Company s Energy Risk Management Program.
In addition to the policies set forth in this manual , the President, officers and all
employees involved in the energy exposure management activities of the
Company shall receive a copy of the Idaho Power Company Energy Risk
Page 1
Management Procedures Manual as that document becomes available. The
Procedures Manual exists to define the operational implementation of the
policies set out herein , and to ensure compliance by employees of the Company
with the approved practices governing the Company s exposure management
activities.
Page 2
II.Establishment of a Collaborative Approach with Customers
Most of the risk management activity undertaken by IPC will be on behalf of
customers. As a result, it is essential that IPC undertake to create and maintain
a collaborative approach with customers surrounding the framework of the risk
management program and specific implementation procedures. The risk
management program will be characterized by the following features:
IPC staff will undertake to conduct an annual collaborative review and
additional workshops as needed with IPUC Staff and customer
representatives to enhance the understanding of the risk profile faced by
IPC's customers;
IPC will seek input from IPUC Staff with respect to desired risk tolerances
and solicit upfront support for proposed implementation procedures;
IPC will provide IPUC Staff with regular updates on the status of the IPC risk
position and its impact on the Power Cost Adjustment ('PCA") balance.
Page 3
III.Energy Risk Management Policy Objectives
The objective of the IPC risk management program is to protect against adverse
movements in the IPC PCA bafance and to ensure that the PCA balance does
not move beyond a tolerance level acceptable to customers and shareholders.
The least cost energy supply will be identified and documented. However, the
overall objective (to manage the cost of energy supply with respect for the risk
tolerance of the stakeholders) should complement the Company efforts to
achieve the lowest cost of energy supply within the identified acceptable limits of
risk.
In order to accomplish this objective , the risk management program will provide
senior management , directors and customer representatives with a process to
quantify the Company s PCA balance sensitivity to movements in energy
markets and to manage the market-based risks.
The Company risk management program will not contain an element
whereby corporate risk management decisions are based on IPC'
uncertain expectations of future market price movements. Risk
management positions will not be established that create incremental aggregate
market exposure to the Company. Risk management positions can only be
established that reduce the Company s aggregate underlying exposure to market
price movements. The decision to enter or not enter into any proposed hedging
transaction will not be dictated by IPC's market price view.
The efficacy of the risk management program will be benchmarked against the
contribution made by the risk management activity to the containment of PCA
balances within agreed-upon risk tolerances called "Risk Guidelines . Gains or
losses incurred on hedge positions in isolation will not be included in the
benchmarking process.
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IV.Organizational Structure
Board of Directors
The Board of Directors has ultimate responsibility from a corporate governance
perspective for the identification of the principal risks of the corporation
business and ensuring the implementation of appropriate systems to manage
these risks. In this role , the Board of Directors will have the duty to have a
workable understanding of the nature of the Company s risks and the basic
strategies that can be used to map the Company s desired profile.
The Audit Committee of the Board of Directors will have direct responsibility for
approving this Energy Risk Management Policy Manual ("Manual"). The IPC
Risk Management Committee will have direct responsibility for approving the
specific Risk Guidelines as per Appendix F , of this Manual. On an interim basis,
certain discretion will be granted to the President with respect to modifications to
the Manual. However, on a quarterly basis , any interim alterations authorized by
the President must receive Board approval. The President will not be granted
any interim discretion to alter the Company s System Risk Limit.
President, Idaho Power Company
The Manual defines the risk parameters that the President must observe and the
risk management techniques that he/she must require the officers and
employees to use in managing the Company s desired risk profile in conjunction
with the desired risk profile of customers. At his/her discretion , the President
may assign to officers or employees of operating groups or wholly owned
subsidiaries of the Company certain responsibilities associated with this risk
management function. Documentation of the assignment of responsibilities and
the risk management decisions will be maintained to facilitate audit of the risk
management function.
The President will establish the overall direction , structure , conduct, and control
of the Company s energy risk management program , both in the physical market
and the financial derivatives market. The President will have the interim
authority between Board meetings to alter policies in this document, except that
the Risk Guidelines cannot be altered without prior Board approval. Any interim
alterations to the Manual authorized by the President must receive approval from
the Board at the next quarterly Board meeting before these alterations become
permanent. All alterations must be documented for IPUC and customer group
review.
Page 5
The President will have the authority to permit the deferral of risk mitigation
activity should a Risk Guideline be breached.
The President is required to approve any energy risk management transaction
with a duration longer than two years.
The President will request input from the IPC Risk Management Committee in
any decision-making process surrounding energy risk management issues.
The President shall report at least annually to the IPC Board of Directors to
obtain approval for the Company s policies, strategic direction , and program
parameters surrounding its risk management program activities. Further, the
President shall provide reports to the IPC Board of Directors at least quarterly on
the nature and profile of the Company s market exposure and on the results of
the risk management program activities. Copies of these reports will be
maintained with the risk management documentation.
,PC Risk Management Committee
A senior management team established by the President is responsible for
providing advice and recommendations to the President on energy risk
management-related issues and providing senior level oversight of the risk
management program. This group called the IPC Risk Management Committee
or "RMC", shall consist of those positions appearing in Appendix B. A quorum of
the RMC will consist of at least 50% of the RMC membership.
The RMC may also request other parties to attend the meetings for expert
advice/consultation , however those individuals will not be members of the RMC
or be entitled to decide any matters on behalf of the RMC.
The RMC shall report at a minimum quarterly to the President to provide an
update on the energy risk management program activities.
The RMC has been charged by the President with oversight responsibility for the
following aspects of the risk management program:
a) Development of energy risk management policies and procedures;
b) Communication with external customer groups with respect to risk
management issues and the solicitation of upfront support for any risk
management initiative from these external groups;
c) Authorization of strategic hedging program guidelines under which hedges are
to be established;
d) Authorization of specific commodities and derivative instruments to be traded;
Page 6
e) Resolution of any disputes concerning the appropriate application of the
Manual that may arise;
f) Development and authorization of appropriate systems for recording,
monitoring and reporting the commodity exposure inherent in the Company
operations and the risk management activity undertaken to alter the
underlying risk profile;
g) Recommendation to the Board of the appropriate Risk Guidelines based on
the collaborative process with customer representatives.
h) Approval of the IPC Energy Risk Management Procedures Manual.
With the assistance of the Middle Office function responsible for the
quantification of risk (as outlined in Section IV-E), the RMC will also
responsible for the monitoring of compliance with the Manual. To the extent that
the RMC believes that compliance is not being maintained or risk tolerance
parameters have been breached , they are required to give written direction to
the appropriate officers or employees of the Company to take such action on the
Company s behalf to bring it into compliance with the Manual. Such action shall
be taken based on an affirmative majority vote of a quorum of the RMC.
The RMC's mandate also includes the ongoing general assessment of the
appropriateness of the Company strategies for energy risk management
activities, taking into account current and expected future economic conditions
and their effect on the general business environment, both internally and
externally. The policies described in this document cannot be altered
except by approval of the President.
The RMC or any officer of the Company may request that the President make a
change in this Manual or its appendices. Such requests shall include an
explanation of the application and benefit of the proposed change to the
Company. For new risk management products , the explanation should also be
in accordance with the New Product Initiation Process described in Section IX of
this Manual. For any change in a policy or procedure described in this Manual to
become effective, it must be approved by an affirmative vote of the President.
The Risk Guidelines can only be modified with direct approval from the
President. All modifications to this Manual must ultimately be ratified by the
Audit Committee of the Board of Directors.
The RMC shall meet at least once a month , or more frequently as requested by
the Chairman of the RMC. The purpose of the meetings will be to review the
profile , performance , appropriateness, and current risk management activities of
the Company. Minutes of the RMC meeting will be kept as an accurate record of
the actions of the RMC.
The RMC will also have responsibility for the preparation of the Annual
Page 7
Benchmarking Report covering the qualitative aspects of the energy risk
management program activities.
D. Risk Management Execution (Front Office)
The execution of day-ahead and real-time transactions will be conducted by
Idaho Power Company or its designee. The execution of term transactions for
periods beyond the day-ahead timeframe will be performed by a designated IPC
Trader. The Policy Manual and accompanying Procedures Manual will identify a
largely automated approach to the implementation of hedge transactions , with
very limited Trader discretion. The Procedures Manual outlines the competitive
bidding process that must be undertaken by the Trader for all IPC term
transactions.
Risk Evaluation (Middle Office)
The monitoring and reporting of IPC's risk positions will be conducted by the IPC
Risk Evaluation Group or its designee. This IPC Risk Evaluation Group shall
serve as an independent compliance group for the Company s energy risk
management program , providing periodic revised forecasts of the PCA balance
based on current forward market conditions and the potential variance in the
PCA forecast based on different pricing and resource availability scenarios. The
designee is responsible for measuring, evaluating, and reporting to the
Company s management and the RMC the amount of exposure faced by the
Company and its customers through its portfolio of ongoing operating exposures
and outstanding risk management transactions.
The IPC Risk Evaluation oversight responsibilities will include the following:
involvement in corporate decisions that impact the Company s exposure to
market and operational risks;
development and maintenance of the process and systems to identify,
quantify and report the market risks embedded in the operations of the
Company;
quantification of market exposures from a corporate perspective;
ensuring that limits prescribed in this Manual are not exceeded;
monitoring approved counterparty credit exposures for risk management
transactions undertaken by IPC;
notification to the RMC as soon as market risk or credit risk limits are
exceeded;
review of transactions involving new commodities , new delivery points and/or
new risk management structures. This review will consider potential liquidity
constraints and the ability to monitor the position through time , following the
guidelines established for the New Product Initiation Process described in
Section IX; and
Page 8
preparation of reports with respect to current positions, including the forecast
PCA balance and the potential variability in the PCA balance.
F. Resource Dispatch Planning
IPC staff is responsible for the development of resource availability forecasts and
load forecasts. This data will be used to optimize the resource dispatch plan.
G. Treasury
The Treasury function within IPC will have the following responsibilities:
to make and receive payments under all term transactions;
to control the flow of confirmations for term transactions;
to maintain the appropriate accounting of hedge transactions;
determination of credit ratings to counterparties.
Legal and Regulatory Affairs
The IPC Legal Department will assist in the counterparty documentation process
outlined in Section IX of this Manual. Regulatory Affairs will have the
responsibility to co-ordinate the collaborative approach with customer
representatives and to ensure the receipt of appropriate risk management
information by IPUC Staff.
Long Term Resource Planning
Longer term resource acquisition policies will continue to be governed by the
Integrated Resource Planning (IRP) process. The planning coordination
between the IRP and the risk management policies will be reviewed and
discussed with customer representatives and Commission Staff in conjunction
with the annual establishment of risk management guidelines described below.
The Risk Guidelines as adopted each year will reflect a collaborative effort
between Idaho Power, customer representatives , and the Idaho Public Utilities
Commission Staff. The Company will consider supply-side options for resource
acquisition consistent with the IRP in the annual Risk Guideline development
process. The IRP process will operate under the direction of the RMC.
Page 9
Market Risk
The quantification of market risk for electric generation and distribution
companies is a complex process. The Manual calls for the development of a risk
quantification framework over time while recognizing the need in the interim to
define a risk management implementation strategy prior to the establishment of
the requisite risk quantification system. The Market Risk section of the Manual
begins by outlining the interim market risk management approach and is then
followed by a description of the nature of the risk management approach and
guidelines that IPC will strive to implement over the medium term as the
technology to monitor the IPC risk position in a more advanced fashion is
employed.
The Interim Risk Guidelines Risk Guidelines The Three Tier
Approach
In the interim , IPC will define market risk as the exposure to adverse movements
in regional power prices , in conjunction with adverse hydro conditions. The risk
management horizon covered by this Manual will be centered around PCA year
periods. Risk will be tracked for the current PCA year and will be tracked for the
subsequent PCA year beginning on October 1st
The proposed implementation strategy would have three risk limit structures or
tiers. The first level of exposure limit would be tied to estimates of the impact of
worst-case prices and worst-case hydro resources on the year-end PCA
balance. The second exposure limit would be a monthly volumetric exposure
limit. The third tier takes advantage of low-price market conditions when the
benefit to customers of participating in a further price decline falls below the
benefit of avoiding the impact of any subsequent price rise.
(i)Tier One - System Risk Limit
IPC through the collaborative process with the IPUC Staff and customers will set
an upper tolerance limit for the negative variance between the Baseline
Expected Cost Forecast ("BECF") and the low water/high price scenario called
the System Risk Limit (see Appendix F). This maximum negative variance is
established annually by the RMC. The parameters for the estimation of the
BECF areas follows:
The BECF is established on October 1 prior to the commencement of the
upcoming PCA year;
Page 10
The BECF is based on expected water conditions based on system
conditions on October 1
The BECF is based on current forward market prices to estimate purchase
power costs and the revenue from any forecast surplus.
The parameters for estimation of the low water/high price scenario are as
follows:
Low water is based on current snowpack and 50% of normal precipitation
through the remainder of the current runoff season;
The high price is calculated on the basis of a 95% confidence interval move
based on a lognormal distribution and implied volatility levels sourced from
the marketplace. Only one time in 20 would one expect to witness a rise in
price greater than the high price estimation;
. The high price is applied only to those months where a deficit is forecast
under a low-water year scenario. The current forward market price will be
applied to all other forward months.
On at least a monthly basis or more frequently if mandated by the RMC, updates
will be run on the low water/high price scenario and the expected cost forecast.
The revised expected forecast will be used for the second tier limit structure but
does not form a component of the first tier limit analysis.
If the variance between the updated low water/high price cost scenario and the
BECF is greater than the System Risk Limit established by the RMC, forward
purchases will be executed to reduce the risk below the variance limit. The
parameters governing the execution of hedge transactions are as follows:
IPC will establish hedges first on the nearest-month deficit positions and will
continue to move out along the forward curve until sufficient hedges have
been established so that the variance between the low water/high price
scenario and the BECF has fallen below the limit. The rationale for this
approach is to take advantage of more attractive liquidity characteristics in
near-term forward months;
Hedges will be established in minimum tranches;
If revisions to the low water/high price scenario create a situation where
hedges can be removed without the variance rising above the limit, then IPC
will remove hedges in minimum tranches beginning with near months and
extending the hedge liquidation out along the forward curve until the point
where any further liquidation would result in a variance greater than the limit.
The risk management transactions dictated by the Tier One limit structure will
take precedence over the Tier Two limit structure and Tier Three opportunities
Page 11
The RMC may modify its hedging activities associated with Tier One constraints
to recognize more efficient market transactions (Le. buy for a quarter instead of
individual months).
(ii).Tier Two -Volumetric Limit (Deficiencies and Surpluses)
IPC will limit its HL and LL volumetric exposure for any month during the PCA
year in question to a maximum number of MW as indicated in Appendix F. The
parameters around this limit structure are as follows:
Deficiencies are managed to the expected water scenario;
Surpluses are managed to the low water scenario;
Hedges would be established in minimum MW tranches to bring IPC back
below the Volumetric Limit;
. New forecasts could result in a reduction in underlying positions that would
allow for the liquidation of hedge positions that are no longer needed to keep
positions under the Volumetric Limit. Positions would be liquidated in
minimum MW tranches , as outlines in Appendix F , if this can be done without
causing a position limit breach;
Positions will be determined on a flat basis for both HL and LL without regard
for hourly shaping at this time;
Positions will be determined based on "in-the-money" resources. Peaking
units which are deemed to be uneconomic based on current forward prices
would not be included in the determination of total resources;
. The initial establishment of position limit hedges will commence on October
and must be executed by December 31 of the year prior to the upcoming
PCA year. Positions will be established in a ratable fashion. The rationale
for execution flexibility is not to take advantage of price views but to ensure
the orderly execution of these forward positions in the marketplace.
For those months where forward market liquidity exists for multiple-month
blocks (e.g. quarterly) rather than single month blocks , IPC will initially
manage the exposure on a quarterly basis. For example , if one was deemed
to be in deficit one month 300 MW and in surplus 150 MW in each of the two
other months in the quarter , the quarterly position would be deemed to be flat
and no hedging would be required. If the net quarterly position was in excess
or the volumetric limit, a, quarterly hedge would be established on this net
position. As liquidity improves to the point where the monthly block trades on
a discrete basis, the hedge management will be shifted to an examination of
monthly positions on a stand-alone basis with the appropriate monthly hedge
positions established.
(iii).Tier Three - Floor Limit
Page 12
This tier facilitates the establishment of hedge positions when it is deemed that
the benefit of maintaining participation in a further price decline is less than the
benefit of reducing the exposure to a potential upside price movement. These
positions are not established based on a price view - IPC fully recognizes that
after these positions are established , there is a material probability that prices
will fall. However, to reiterate , the ability to avoid any negative exposure to a
potential price rise is deemed to be more valuable than the retention of further
downside price participation.
The tier involves the establishment of HL and LL price targets for forecast
deficiency positions under both the expected scenario and the low water
scenario. The limits are established by the RMC after consultation with the IPUC
and customer groups. The limits are described in Appendix
The Tier Three limit structure will take precedence over Tier One and Tier Two
limit structures. First, Tier Three hedges will always serve to reduce the risk of a
variance between the BECF and the low water/high price and as a result there is
no concern that Tier Three positions will lead to an unwanted violation of the Tier
One Limit. Tier Three hedges may result in violations of the Tier Two limit
structure - low-water deficiencies may be covered by long positions that result in
monthly surplus positions in the case of expected water that exceed the Tier Two
limit. In this scenario, the Tier Three hedges would be maintained because of
the relative risk trade-off that drives the Tier Three limit structure.
Hedges will be established and removed in minimum tranches as described in
Appendix F.
(iv).Breach of Limits
The worst-case price , worst-case load , worst-case hydro scenario may result in a
breach of the System Risk Limit for two reasons:
adverse power market movements , changes in load forecasts or reductions in
hydro availability could serve to increase the forecasted year-end PCA
balance;
increasing power price volatility.
The Volumetric Limits could be breached by altered forecasts of hydro
availability.
If the risk analysis reveals that hedging action is required under any of the three
tiers, the IPC Trader must enter into cost-effective risk management transactions
Page 13
that reduce positions below the risk limits. If market conditions prevent efficient
execution of the requisite risk-reducing transactions, or if forecast results for
outlying months rely too heavily on estimated weather and hydro conditions, the
IPC Trader will approach the RMC for a deferral of the execution of these
transactions. Prior to granting approval to this deferral , the President, must be
notified and provided with an explanation for the decision to defer the risk-
reducing activity, so that the President, can approve the decision to defer the
risk-reducing activity.
All members of the RMC and the President will receive daily notification and
ongoing reports detailing any limit breach , until this breach is rectified.
(v).Day-Ahead Risk Approach
It is the policy of IPC that it will enter each day in a forecast flat position
whenever possible. Day-ahead transactions will be established to reduce or
eliminate whenever possible any hourly surplus or deficit positions. The
objective of this policy is to mitigate customer and shareholder exposure to the
extreme volatility that can occur on a real-time basis.
The Prospective Market Risk Approach
(i).Market Risk Definition
In the future , market risk will encompass a broader definition than the definition
used for the interim approach. Market risk for the Company will be defined as
the uncertainty with respect to PCA balances caused by changes in anticipated
market pricing for natural gas , power, generation unit outages , hydro availability,
transmission constraints and customer load. Market risk will be defined in
quantitative form as PCA-at-risk ("PCAR"). The PCAR measures the extent to
which the PCA balance may deviate from forecast expectations within a
statistically defined confidence interval based on movements in market prices,
generation resources and customer load.
(ii).Market Risk Quantification
Determining the Company s PCAR involves complex arithmetic modeling. It will
be the responsibility of the IPC Risk Evaluation function to develop and refine the
optimal quantitative model that generates a PCAR estimation that is credible
reproducible and can be determined in a timely fashion.
There are several parameters associated with the PCAR calculation that will be
governed by the Manual:
Page 14
holding period. The PCAR will be based on a holding period through the
conclusion of the relevant exposure period. The current-year risk calculation
will be through the conclusion of the current PCA year. The subsequent year
risk calculation will be through the conclusion of the subsequent PCA year.
confidence interval. The PCAR will be based on a confidence interval
defined in an appendix.
The selection of other modeling parameters will be at the discretion of the IPC
Risk Evaluation group. This discretion will apply to a number of parameters
including:
the anticipated volatility in model inputs like power prices , natural gas prices
fuel oil prices , transmission constraints , load and generation statistics , foreign
exchange and interest rates;
the distributional characteristics of these variables;
the correlation between the input variables.
fundamental component of the Company s ongoing risk analysis is the
updated forecast of the year-end PCA balance based on current expectations of
future power and natural gas prices , load and generation resources over the
remainder of the exposure period. The updated end-of-year PCA balance
information is required to manage the Company s risk profile because it provides
senior management with ongoing snapshots of performance versus budgeted
expectations.
(iv).System Risk Limit
IPC will calculate on an as needed basis the current forecast year-end PCA
balances and also the PCAR. These two amounts will be summed and
compared against the System Risk Limit established in the collaborative
approach between IPC and customer representatives.
(v).Breach of System Risk Limit
The sum of the forecast year-end PCA balance and the PCAR can increase
above the approved System Risk Limit for several reasons:
adverse market movements , alterations in load or reductions in generation
availability could serve to increase the forecasted year-end PCA balance;
increasing volatility in the parameters impacting the PCA balance can lead to
an increase in the PCAR.
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Should the sum of the forecast year-end PCA balance and the PCAR reveal that
the System Risk Limit has been breached , the IPC Trader must enter into cost-
effective risk management transactions that reduce the year end forecast PCA
plus the PCAR below the System Risk Limit. If market conditions prevent
efficient execution of the requisite risk-reducing transactions; the IPC Trader will
approach the RMC for a deferral of the execution of these transactions. Prior to
granting approval to this deferral, the President must be notified and provided
with an explanation for the decision to defer the risk-reducing activity, so that the
President can approve the decision to defer the risk-reducing activity in
conjunction with the RMC.
All members of the RMC will receive daily notification and ongoing reports
detailing any risk limit breach, until this breach is rectified.
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VI.Credit Risk
Credit Risk Defined
Credit exposure is defined as the risk that a counterparty to a transaction will be
unable to fulfill its present and future financial obligations to the Company. This
credit exposure would extend to counterparties with whom the Company trades
physical commodities, as often payment for the delivery of the product does not
occur until after delivery has been made in full. In addition, substantial
unrealized gains or losses may accrue in physical contracts prior to any delivery
obligation. Credit exposure also exists for Over-the-Counter (OTC) traded
derivative transactions , as the value of outstanding contracts can escalate
substantially over time without the ' counterparty having to post or deposit any
security in the form of the payment of collateral.
Managing credit exposure becomes an important component in the overall risk
management program, The creditworthiness of trading partners , both in the
physical and financial marketplace, becomes a function of both qualitative and
quantitative factors , centered on the credit rating assigned a counterparty by the
major credit rating services or an internal evaluation of the counterparty s ability
to pay. Information relating to the credit standing of any given trading partner
can be determined by factors such as its credit rating published by one of the
commonly recognized rating agencies , market intelligence , electronic news
releases and other public information sources.
Counterparty Credit Standards
Credit exposure to any given counterparty consists of three components. The
first is the traditional measure of credit risk - accounts receivable. The second is
the cost of replacing the instrument in the marketplace today, defined as a
trading position s current or "mark-to-market" value. The third is an estimate of
the future replacement cost of a transaction , known as the Credit Value-at-Risk
CV AR") which uses a probability analysis over the remaining term.
The current replacement cost of a transaction evaluates the actual risk to the
Company that a counterparty will fail to perform on its financial commitments.
This is the current value of the transaction to the Company based on the
movement in the price of the underlying market relative to the contract price, and
can be either a positive or a negative amount. If the market value of the
transaction is negative (i.e., the Company owes money to the counterparty
based on a mark-to-market valuation) then there will be no current replacement
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cost exposure. Quantification of current exposure to a counterparty is a function
of a mark-to-market calculation.
Potential credit exposure (CV AR) to any counterparty is a more complex issue
and involves a probability component which takes into account the underlying
market volatility anticipated during the period in which the transaction will remain
open. The IPC Risk Evaluation group will use a methodology involving the
observed volatility of the underlying commodity applied to the underlying volume
and term of the transaction to determine the CV AR amount.
It is important in an analysis of credit risk to determine whether netting applies to
the counterparty with whom the Company has a number of open positions.
Gross exposure measurement weighs equally the absolute value of both positive
and negative exposures , while netting allows a consolidated measurement of the
net exposure. Exposures will be netted whenever the contracts with the
counterparty provide for this practice.
Monitoring credit information of counterparties and assigning counterparty credit
limits shall be performed by the IPC Treasury group or its designee. Credit and
term limits for each category of counterparty are defined in the Appendix D.
Calculation and distribution of the counterparty credit analyses are to
performed independent of the execution function , ensuring appropriate
segregation of duties within the Company.
Treasury will prepare and distribute the status of a Corporate Counterparty
Credit Analysis to the IPC Risk Evaluation group and the RMC members. Once
counterparty credit limits are established the IPC Risk Evaluation group will track
and report the aggregate amounts of outstanding credit categorized by individual
counterparty. Distribution of credit reports is described in the Management
Reporting section of this Manual.
Extension of Credit
The Company will enter into transactions with a counterparty only when the
CV AR , when added or netted with the current credit exposure with the same
counterparty for such transaction , will not exceed the maximum limit and term
based on the assigned credit rating assigned to that counterparty. It is the
responsibility of the IPC Risk Evaluation group to communicate the amounts of
credit available for each counterparty to the IPC Trader at intervals specified in
the Management Reporting section of this Manual.
Limit Exception Process
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The IPC Trader will immediately suspend initiation of additional business with
individual counterparties where that specific counterparty s credit limit has been
reached or exceeded. This situation might occur due to an increase in volatility
and/or market price movements adversely impacting the counterparty s position
with the Company. A report will be generated daily by the IPC Risk Evaluation
group while the counterparty maintains a credit exposure to the Company
beyond its assigned limit, and be distributed as described in the Management
Reporting section of this Manual. Any member of senior management may call a
special meeting of the RMC to review alternatives relating to the credit standing
of the counterparty in violation of credit standards. These alternatives could
include unwinding all or part of the open positions creating the credit exposure
as permitted by contract, continued monitoring of the situation , or calling for
some form of collateral to be posted by the counterparty.
Under no circumstances is the IPC Trader permitted to knowingly increase the
credit exposure to a counterparty that has exceeded its approved level of credit
with the Company until Treasury reviews the credit limit and grants written
authorization.
Credit Exposure Reporting
Reporting of credit exposures should provide management with relevant,
accurate and timely information about counterparty credit exposures and
approved lines of credit. Reporting of credit exposure against pre-defined limits
shall be done weekly in the Weekly Position report generated by the IPC Risk
Evaluation group. Exceptions and changes to a published credit rating or
outlook would be documented in the Counterparty Credit Analysis report
generated monthly by Treasury.
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VII. Performance Benchmarking
The performance benchmarking of the Risk Management Program will be based
quantitatively on the degree to which the PCA balance is restricted within the
System Risk Limit. The program will also be judged on the effectiveness of the
collaborative approach established between IPC and customer representatives
in an effort to mitigate negative regulatory hindsight reviews of the risk
management activity. The middle office and front office functions will also be
benchmarked against the qualitative criteria outlined below.
Middle Office Function IPC Risk Evaluation Group
The middle office function will be evaluated on the following points:
effective communication of the Company s risk position to the RMC;
development of appropriate monitoring and reporting systems that meet
best industry practices and external audit standards;
timely production of meaningful risk position reports;
development of the advanced quantitative model to assess the
Company s risk position;
co-operative relationships with other business units within the Company;
firm wide and external education with respect to market concepts and risk
management practices; and
contribution to a favorable external characterization of the Company
energy risk management process.
Front Office Function IPC Trader
The front office function will be benchmarked from the perspective of adherence
to this Manual and to the Procedures Manual with respect to the timely execution
of requisite risk management transactions.
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VIII. Systems and Accounting
Systems
Initially, an information system (the "System ) shall be maintained by IE to
identify, track , quantify and report all outstanding elements of the Company
portfolio that are subject to variances in power prices , and hydro availability. The
System will track both market risk and credit risk over the time horizon delineated
in this Manual. It is the responsibility of the IPC Risk Evaluation Group to
implement and monitor the System to ensure that the integrity, timeliness, and
accuracy of the information provided are consistent with the Company
requirements for control over the risk portfolio.
Accounting for Transactions
For external reporting, audit, and control purposes , the process of accounting for
transactions is a key element that must be adhered to at all times, and is
described in greater detail in the Company Energy Risk Management
Procedures Manual.
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IX.Documentation , New Product Initiation
Legal Documentation
To ensure an appropriate level of control, the following policies shall govern
documentation of external transactions that involve the establishment of pricing
mechanisms for power:
Physically-settled transactions shall be governed by the Company s standard
agreements or such other agreements that reflect generally accepted
commercial practices for the underlying marketplace and the Company
criteria for physically-settled transactions. These agreements will typically be
the WSPP agreement for electricity transactions.
The Treasury group with assistance from the Legal Department, is responsible
for negotiating original documentation with all counterparties and having it signed
by the appropriate officer of the Company as soon as possible following initiation
of transactions , and in any event within ninety days of the initial transaction
activity with a counterparty. If the appropriate Document is not signed within 90
days, the RMC will be notified through the Counterparty Credit Analysis report
with an explanation as to why the Document has not been signed and an
estimate as to when a Document may be signed. If the transaction is pending
execution of a Document, and has a contract term beyond the current PCA year
the RMC will be notified immediately following the transaction in the form of the
Counterparty Credit Analysis report if a document has not been signed.
All confirmations for transactions with a counterparty that has not signed a
Document must provide that the Company may terminate the physically-settled
or financially-settled transaction if a Document cannot be negotiated and signed
within a defined time frame of 90 days.
Confirmations of transactions payment advice and all other correspondence
sent by counterparties with regard to risk management transaction activity and
the transfer of money, either by wire transfer or by mail , shall be directed to the
attention of the Treasury Department. This is done with the intent of maintaining
a level of segregation of responsibility from the risk management function within
the Company.
Only those signatures that appear in Appendix C - Authorized Signatories can
bind the Company to confirmations and/or master contracts with external
counterparties.
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New Product Initiation Process
A new product is a pricing mechanism , commodity or commodity delivery point
that is sufficiently different from the slate of instruments and markets previously
approved under this Manual that it has a notably differing risk profile or it requires
different systems , operational procedures or accounting treatment.
A new product would also include those instruments that may be transacted on a
one-off' basis, which would be implementation of a derivative instrument or
entry into a commodity market that, despite the anticipation of being transacted
just once , would still fit the definition of a new product.
The purpose of defining a process for the introduction of a new product or
instrument is to ensure that the exposures associated with it are thoroughly
reviewed and understood by the RMC. On an interim basis , the President must
approve the use of all new products or the entry into different commodity markets
prior to execution of any such transaction by the Company, with formal
ratification by the Board of Directors on a quarterly basis. Products approved for
trading are listed in Appendix E , and any new products that receive approval
would be added to the list as an amendment to that Appendix.
The IPC Trader has the responsibility to define the rationale for each of the new
products introduced to the Company in a formal presentation to the RMC
demonstrating that the new product meets certain criteria. In the presentation to
the RMC , a business case should be put forth that includes the following:
Business Rationale
1. A written description of the product, which includes the purpose , function
expected profitability and benefit to the Company;
2. An analysis of the appropriateness of the new product in relation to the
Company s overall strategy;
3. An analysis of the availability of liquidity in the marketplace for the new
product;
4. A comparison or differentiation from existing approved product;
Page 23
5. Internal evaluation of the exposure profile of the product, including detailed
stress testing of the product over a broad range of market scenarios and the
associated exposure implications;
6. Demonstration of the in-house expertise to manage and support the new
product, and
7. Assurance that an assessment of the potential risks has been completed by
the appropriate departments within the Company.
Management Responsibilities
1. A brief description of the responsibilities of the various departments within the
Company who will have any manner of contact with the new product;
2. Proposed credit and market exposure implications and proposed limits;
3. Proposed reporting requirements including any changes to existing
procedures and systems requirements growing from the addition of this new
product; and
4. Legal , taxation and internal audit review, as necessary, for associated
implications to those departments.
No product or geographic region other than those listed in Appendix E are
authorized until the President has approved them.
The IPC Risk Evaluation Group in conjunction with IPC trading must immediately
report any transactions that involve any commodities or markets that are not pre-
approved to the RMC via an immediate publishing on the Exception Report.
Page 24
Management Reporting
This Manual describes various reports to be generated by different groups within
Company. The following table describes those reports , their normal frequency,
distribution, and the originator of the report:
Report Content 1)istribution Normal Originator
frequency
Daily Position (a)RMC Members Daily I PC Risk
Report President Evaluation Group
IPC Trader
IPC Risk
Evaluation Group
Treasury
Weekly Position (a)RMC Members Weekly IPC Risk
Report President Evaluation Group
IPC Trader
IPC Risk
Evaluation Group
Treasury
IPUC Staff
Annual (b)RMC Members Annual RMC
Benchmarking President
Report Board of Directors
I PC Risk
Evaluation Group
IPC Trader
Counterparty (c)RMC Members Monthly I PC Risk
Credit Analysis IPC Trader Evaluation Group
Report IPC Risk
Evaluation Group
Exception (d)RMC Members As required IPC Risk
Report President Evaluation Group
Treasury
Minutes of RMC (e)RMC Members Soon after RMC RMC Secretary
Treasury meeting
IPC Risk
Evaluation Group
Page 25
Daily and Weekly Position Report
The content of the Daily and Weekly Position Report is intended to summarize
the open positions and exposures of the Company. It will include:
i. Current and forecast end-of-year PCA balance;
ii. Forecast end-of-year PCA balance based on worst-case price, worst-case
hydro scenario and a comparison to the System Risk Limit;
iii. Monthly average MW volume for on-peak and off-peak and a comparison
to monthly average MW position limits;
iv. current exposure and credit availability to each counterparty; and
v. summary of executed term transactions since the publication of the
previous report.
Annual Benchmarking Report
The Annual Benchmarking Report assesses the extent to which the program is
achieving its risk management objectives from a quantitative and qualitative
perspective based on the criteria established in Section VII of this report.
Counterparty Credit Analysis
The counterparty credit analysis contains:
i. a review of approved limits for each counterparty and credit rating
classification
ii. an analysis of open credit exposure
a. classified by counterparty
b. by groupings of credit classification
iii. an editorial review of counterparty credit environment
iv. notes of "pending" status during the period between the transaction and
execution of documentation
Exception Log
The Exception Log records all exceptions to normal execution and clearing of
transactions , including amendments to existing transactions. The detail included
in the report shall include:
i. date exception took place
ii. type of exception
iii. individual responsible for exception counterparty involved (where
applicable)
Page 26
iv. steps taken to rectify the noted exception
v. date and documentation of corrective action taken
Minutes of the RMC Meetings
Documented minutes of the RMC meeting, including discussion and
recommendations, soon after every RMC meeting.
Page 27
XI.Restricted Activities and Disciplinary Action
To ensure that all employees adhere to guidelines and limitations specified in
this Manual , disciplinary action will be taken in the event of a breach of Manual.
Depending on the nature and extent of the Manual breach , such disciplinary
action may lead to termination of employment and criminal prosecution.
The use and disclosure of the financial results , material facts, or information
produced through the Risk Management Program is considered to be sensitive
confidential business information. The disclosure of any confidential information
associated with the Risk Management Program , beyond the disclosure
authorized in this Manual and the accompanying Procedures Manual , is
prohibited.
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Appendix A:Board Resolution
Resolution ofthe Board of Directors
Mandating an Energy Risk Management Program
for Idaho Power Company
In the normal course of conduct of its business activities, Idaho Power Company ("I PC"
the Company ) and its customers are exposed to a number of business and market-driven
variables that can impact the cost of power. The IPC Board of Directors therefore deems it
prudent for the Company to engage in energy risk management activities designed to
systematically identify, measure, evaluate and manage both the physical and financial
exposures to business and market-driven uncertainties within a defined and controlled
framework, in collaboration with customer representatives. It is the Board's desire to
mandate a program that conforms to its intent to create a risk management control
framework. Accordingly, the Board of Directors hereby enacts the following resolutions:
In order to authorize IPC to act in accordance with the Board's desire to develop and
maintain risk management control framework, the Board enacts the following resolution:
Resolution 1:Committee of Senior Management, called the Risk Management
Committee ("RMC") is hereby commissioned. The Board appoints the Vice
President of Power Supply to serve as Chairperson of this Committee who
will appoint its membership from time to time. The RMC shall be comprised
of a balanced composition of Senior Management members ensuring that
both the short-term and the long-term business interests of IPC will be
considered.
In order to establish broad guidelines that will govern the risk management activities and
define management responsibilities in accordance with Board objectives for defined and
controlled framework, the Board enacts the following resolution:
Resolution 2:The RMC shall be responsible to the Board of Directors and is charged with
the overall direction , conduct, control and performance of an ongoing Energy
Risk Management Program (the "Program ) designed to systematically
identify, quantify and manage the exposure of IPC and its customers to the
uncertainties related to the energy markets in which the Company is an
active participant. In the performance of this mandate, the RMC shall be
responsible for developing, documenting and communicating a cohesive
Energy Risk Management Policy Manual governing risk management
activities.
In order to keep the Board apprised of the risk management activities and Program
parameters with defined regularity, the Board enacts the following resolution:
Resolution 3: The RMC shall report annually to the Board on the nature of IPC's exposure
profile and on the results of the energy risk management activities and
annually to obtain approval of IPC's Energy Risk Management Program.
Page 29
Appendix B:IPC Risk Management Committee Members
Darrel Anderson
Ric Gale
LaMont Keen
Bart Kline
Jim Miller
John Prescott
Page 30
Appendix C:Authorized Signatories on Behalf of the Company
LaMont Keen
James Miller
John Prescott
Page 31
Appendix D: Counterparty Credit Standards
Counterparty Scoring Table and Limits
Internal Cr~dit Rating 'l-imit 'Maximum Term
Investment Grade $2 million per counterparty 2 years
Page 32
Appendix E: Approved Instruments, Markets
Financial Swaps and Options
None
Physical Arrangements
Underlying Markets:
Permitted Instruments:
Term:
Mid-Columbia and Palo Verde power markets
Fixed Price
Indexed to the published indices (Le. Dow Jones)
18 months
Page 33
APPENDIX F:RISK GUIDELINES FOR THE 2002-2003 AND 2003-
2004 PCA YEARS
TIER ONE-
System Risk Limit
Hedges Established
Hedges Removed
$100 million
25 MW tranches
50 MW tranches
TIER TWO-
Volumetric Limit
Hedges Established
Hedges Removed
+/-
100 MW
25 MW tranches
50 MW tranches
TIER THREE-
. . .
Expected Forecast
Low-Water Forecast
Hedges Established
Hedges Removed
$30 $15$20 $10
25 MW tranches
50 MW tranches
The RMC may modify its hedging activities associated with each Tier constraint
in order to recognize more efficient market transactions (Le. buy for a quarter
instead of individual months).
The above limits will be reviewed and adjusted by the RMC in conjunction with
customer representative , IPUC Staff, and IPC President input prior to October 1st
of each year.
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