This graph is based on extremely preliminary estimates and is likely to change substantially. It is intended to be conceptual to illustrate the

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1 Agenda Number 7. 1

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4 This graph is based on extremely preliminary estimates and is likely to change substantially. It is intended to be conceptual to illustrate the discussion in this presentation, not to describe any particular price levels or trends. 4

5 See pg for more about the energy market. NGS "Pre Contract" and "pre BART Regulatory costs include: Rights of way accidentally omitted from current lease Coal royalties and other adders Revised NGS operating plan costs NGS water lease MATS regulatory costs (mercury and air toxics standards) Ash rule regulatory costs NEPA compliance costs related to NGS Lease and Coal Supply Agreement extensions 5

6 See pg for more about the energy market. NGS "Pre Contract" and "pre BART Regulatory costs include: Rights of way accidentally omitted from current lease Coal royalties and other adders Revised NGS operating plan costs NGS water lease MATS regulatory costs (mercury and air toxics standards) Ash rule regulatory costs NEPA compliance costs related to NGS Lease and Coal Supply Agreement extensions 6

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8 Too much uncertainty/ overlap among NGS contracts, NEPA related to those contracts and BART may result in more difficult or expensive finance and ultimately in plant closure. 8

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11 March 2013 March 2013 March 2013 April 2013 May 2013 May 2013 June 2013 June 2013 FAP Meeting Reconcile 2012 Water Rates Publish Preliminary 2014 Rates FAP Meeting Preliminary 2014 Rates Board Work/Study Rates & Taxes Board Adopt Preliminary 2014 Rates FAP Meeting Property Taxes Board Adopt Final 2014 Rates & Taxes 11

12 September 2013 October 2013 October 2013 November 2013 March 2014 April 2014 April 2014 May 2014 June 2014 June 2014 Publish Budget Submission Customer Budget Workshop FAP Meeting Budget Board Adopt Budget Publish Preliminary Rates Customer Rate Workshop FAP Meeting Preliminary Rates Board Adopt Preliminary Rates FAP Meeting Property Taxes Board Adopt Final Rates & Taxes 12

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14 Some alternatives work better than others for certain problems Some alternatives are not available for certain problems While some alternatives can be applied to more than one problem, there may not be sufficient resources for multiple applications There is no single alternative that will solve all problems 14

15 Resources shown are in addition to adjusting forward (2014+) water rates and capital charges. List does not include financing/bonding, which would be unique to specific circumstances, or extension of 4 cent tax (post 2016). 15

16 Major revenue sources are identified on the left. Primary uses of revenue are the buckets on the right. The arrows identify how various sources of revenue may be used, as determined by statute, contract or policy. The arrows also indicate how changes in a specific expense or use of revenue will or will not impact revenue requirements: For example, since water delivery rates are based on cost of service, lowering an operating expense will only lower water delivery charges. Lower OM&R has a minor effect on property taxes as it is only a small percentage of OM&R that is covered by property tax. Reserves are only impacted by property taxes, not water delivery charges. Capital charges (Big R) are part of the water delivery charges but are smoothed out from significant fluctuations by reserves. 16

17 * The Bureau of Reclamation pays both rate components (Fixed OM&R and CAP Energy) for the Ak Chin Indian Community. 17

18 All costs will grow over time, but Pumping Power will consume a larger piece of the pie, resulting in lower proportions for other costs. Pumping Power, Transmission and Repayment are not subject to much discretion or control by CAP, if any. Capital includes capital projects and capital equipment, both replacement and new initiatives ( Big R ). People Costs includes salaries and related costs such as benefits and payroll taxes. Other Operating Costs includes outside services, materials and supplies, travel, training, etc. This relatively small category contains most of the costs that CAP can most easily control on a short term basis, but also includes essential/ non discretionary costs such as MSCP, Board elections, utilities, maintenance contracts, software licenses, security and janitorial services, etc. 18

19 This chart shows the consistency of CAP Fixed O&M costs. Actual costs have historically been very close to both assumptions included in pre set rates and budget. 19

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21 The use of Restricted Reserves is limited to those specified by contract or law The use of Designated Reserves is defined by the Board Unrestricted Reserves are available for any purpose, but are in place primarily to absorb the seasonality of revenue and expenses within each year 21

22 Contractual reserves are established in the Master Repayment contract and, if used, must be replaced. Strategic reserves will not cover any conceivable catastrophic event, but can be pooled to cover significant items when needed. They also give the opportunity to take advantage of unplanned opportunities that may come up, such as Brock Reservoir (previously Drop 2). Although reserves can be established that are targeted for special purposes, strategic reserves that are available in the event of an unusual, unplanned or catastrophic event as well as daily operating needs. It does not include specific purpose reserves that are created through board specified financing mechanisms for funds focused on areas like rate stabilization, Navajo Generating Station decommissioning, future investments or other special purposes. 22

23 Strategic reserves fluctuate throughout the year. The discretionary reserve targets are measured as of December 31 (highest point of the year) Reserve levels dip during the early part of the year due to federal repayment, and seasonal expenses Reserve levels are replenished during mid year and towards the end of the year due to receipt of property tax revenues 23

24 The current Strategic Reserve targets were set by the CAP Board in

25 Prior to 2000, facing the threat of the Repayment Litigation and potential back interest and penalties, the CAP reserve strategy was primarily to keep reserves as high as possible. Ad Valorem property taxes were at the maximum 10 cents per $100 of valuation. After the preliminary repayment settlement, the CAP Board began to look at longer term reserve strategies. 25

26 As future financial uncertainty was diminished by the Repayment Settlement, the Board established a Strategic Reserve target of $ million in This target was reviewed many times subsequently, but was not updated until

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35 The change in balance between December 2012 and January 2013 illustrates the seasonality in reserve levels. The decline of $45 million was more severe than usual due to unrealized Navajo Surplus proceeds (resulting from the poor electricity market) and higher NGS costs of generation. 35

36 Prior to 2000, facing the threat of the Repayment Litigation, the reserve strategy was primarily to keep reserves as high as possible. After the preliminary settlement, the CAP Board began to look at longer term reserve strategies. In 2003, the Strategic Reserve Target was set at $ million. Discussions about increasing the Strategic Reserve Target began in The Strategic Reserve Target was increased to $ million in This update also resulted in the incorporation of ARC (Additional Rate Component) proceeds from the CAP Bond Funds within Strategic Reserves as part of the Capital Reserve. 36

37 By the end of 2013, Strategic Reserves are now projected to be $50 million below the 2012 year end level and $50 million below target. This is more than twice as much as was anticipated in the rate case. The forecast shown above assumes, regardless of how the Board chooses to address reserve levels in 2013, maintenance of reserve levels beyond 2013 will depend on adjusting rates and/or taxes or other means or they will continue to drop below the levels shown. 37

38 Water Rate Reconciliation Deviations for Fixed O&M reflect normal fluctuations. The 2012 and 2013 CAP Energy Rates included $5.9 million and $2.8 million per year, respectively in anticipated Shaping and Displacement Revenue. There were no proceeds in 2012 and none forecasted for The 2012 CAP Energy Rate ($49/acre foot) assumed a cost of generation for NGS of $26.48/MWH. Actual cost was $30.89/MWH. The difference applied to 2.5 million MWH is $11 million. Other mechanisms were employed during the rate development to help offset this increase. The 2013 CAP Energy Rate ($53/acre foot) assumed a cost of generation for NGS of $29.32/MWH. This rate was based on the 2011 NGS 10 Year Plan, which has since been revised and includes higher costs. The revised rate for 2013 (which is still subject to a yearend reconciliation by SRP) is $31.48/MWH. This increase will cost $5.5 million. The 2013 CAP Energy Rate also assumed application of $2.4 million in SO2 credit proceeds. Federal Repayment "Other" deviations result primarily from timing and are mostly normal. Sale of Navajo Surplus for 2012 was anticipated to include $25 million in premium from SRP plus about $8 million from additional sales by WAPA. There was actually a loss on additional sales, resulting in a reduction of revenues by about $12 million. Sale of Navajo Surplus for 2013 is expected to be $9 million less than anticipated. 38

39 Illustration of the chain reaction caused by volatility in the electricity market and NGS cost of generation. 39

40 Natural gas prices are an indicator for the overall energy market, including electricity prices. During gas prices were in the $6 8/ million BTU range. In , due to oversupply and the recession, the price dropped to the $4 range. In 2012, gas prices dropped precipitously, falling below $2. Prices have come up somewhat since then, but are still below $4. Historical Henry Hub Futures prices 40

41 The left portion of the graph shows the historical prices from the previous page. Several forecasts of forward gas prices show the same general trend: The undulation in the curves is annual seasonality. Gas prices are expected to recover slowly in 2013 and 2014 from a low of $2 in 2012 The recovery will be relatively slow Gas prices will remain at $4 5 (the same level as ) for roughly 7 10 years due to a supply glut Gas prices will not return to the $6 8 range (the same level as ) for roughly years Note: EMP refers to Black & Veatch Energy Market Perspective. EIA AEO 2012 refers to the U.S. Department of Energy, Energy Information Administration, Annual Energy Outlook report. 41

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43 This slide is the same as slide 14 (except for the shading) 43

44 This slide is a duplicate of slide 15 44

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46 This is a simplified example of the po forma 2012 OM&R Reconciliation. It shows that the reconciled Fixed OM&R rate is about $1/acre foot less than the set rate. This is due to favorable fluctuations in both cost (partially offset by increased transmission costs) and water volumes and is within the normal range. The variance in the CAP Energy Rate is about $7/acre foot. This is extraordinary and is a result of the lack of any shaping and displacement revenue (accounting for about $6 million of the spending variance and about half of the rate variance) and higher NGS cost of generation. Of the reconciled amounts, about $6.5 million is recoverable under contracts from the M&I Subcontractors and the Federal customers. About $3.5 million is associated with the Ag Pool and other Excess Water deliveries and is not recoverable. 46

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50 CAP ad valorem tax revenues declined nearly $20 million per year after the Board reduced the rate to 6cents in Valuations (as of the 2012 forecast) were expected to approach previous high levels by Proposition 117 imposes a 5% cap on annual increases in property valuation for property tax purposes beginning in CAP may need to consider increasing the tax rate just to collect the same amount of revenue in a given period of time (e.g., , referring to the green line vs. the solid blue line) or to reach a specific revenue level in a given year (e.g. 2020, referring to the purple line vs. the solid blue line). CAP staff is in the process of updating the valuation analysis for

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56 Graph shows projected 4 cent tax reserve balances through 2023, when Maricopa County M&I firming targets are projected to be met, assuming that 4 cent tax proceeds are restricted to the counties in which they are collected. This graph assumes that the tax is repealed at the end of

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Example illustrating a withdrawal of $70 million in 2013, leaving $107 million in 2023 after Maricopa County M&I firming goals are met, which is projected to be sufficient to meet Pima and Pinal

58 Example illustrating a withdrawal of $70 million in 2013, leaving $107 million in 2023 after Maricopa County M&I firming goals are met, which is projected to be sufficient to meet Pima and Pinal County M&I firming goals as well. Note that by June 2013, $56.3 million will have been collected under the Board resolutions reserving 4 cent tax collections for those years for unrestricted OM&R and/or Repayment. This graph assumes that the tax is repealed at the end of

59 Example illustrating 4 cent tax reserves if all future revenues (July 2013 onward) are diverted to a purpose other than M&I firming. This graph assumes that the tax is repealed at the end of

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62 This slide is the same as slide 14 (except for the shading) 62

This chart shows the 2013 2018 adopted rates

63 This chart shows the adopted rates versus the previous ( ) advisory rates. 63

Significant increases in the CAP Energy Rate during the rate period due to increases in NGS cost of generation, introduction of Energy Big R for capital costs (previously included in the NGS rate and

64 Significant increases in the CAP Energy Rate during the rate period due to increases in NGS cost of generation, introduction of Energy Big R for capital costs (previously included in the NGS rate and taken out in 2012, which caused the CAP Energy Rate to decline by $4 from 2011 to 2012) and phase in of the Hoover Capacity Charge (originally included at 100% in 2013 when offset by shaping and displacement but later reduced and phased in). 64

65 NGS cost of generation has continued to increase since CAP rates were developed. Many of these higher costs were identified in the NGS year Plan that was developed after CAP set rates. Other costs have come about during renegotiation of the NGS Lease and Coal Contract not new contract costs (except for water, which renews in 2014) but forgotten costs in the current contracts. Finally, several regulatory rules have been put in place that will require additional costs. 65

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Comparing future rates to 2013 magnifies the apparent increase, since 2013 set rates, like 2012, included mechanisms to keep rates as low as possible.

67 Comparing future rates to 2013 magnifies the apparent increase, since 2013 set rates, like 2012, included mechanisms to keep rates as low as possible. During the rate case, these mechanisms were discussed in the context of eventually (beginning in 2014) having to phase them in/out and reflect true cost in the water delivery rates. 67

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Approximately $50 million of back capital charges and interest revenue will be generated from the 2013 allocation of Non Indian Agricultural (NIA) priority water by the Arizona Department of Water

69 Approximately $50 million of back capital charges and interest revenue will be generated from the 2013 allocation of Non Indian Agricultural (NIA) priority water by the Arizona Department of Water Resources. Based on a 5 year payment plan, this revenue will be collected by CAP between 2014 and The infusion of funds from back capital charges and interest will be considered a partial reimbursement of the $150 million contributed by property taxes towards CAP Repayment to date, and will be available as part of Strategic Reserves for permissible ad valorem tax purposes. 69

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71 This chart compares the cost of the various Ag programs to the only available current revenue source CAP ad valorem property taxes. Any deficiencies in available property tax revenues must come out of Strategic Reserves. The solid red line indicates the actual and projected property tax revenues at the current rate of 6 cents per $100 of assessed valuation. The blue bars represents the cost of the Ag Consideration, which is Fixed OM&R on Ag Pool deliveries that was given in consideration for the relinquishment of Ag subcontracts as part of the Repayment Settlement. These amounts are not negotiable. These amounts are already included in the updated Strategic Reserve forecast (pg. 37). The solid yellow bars represent the cost of the Ag Incentive program, which is a voluntary program implemented by the CAP Board of Directors in 2009, and designed to keep the total annual increase in the cost of Ag Pool water (CAP Energy Rate less Ag Incentive) no more than $2/acre foot per year ($3 in ). These amounts are already included in the updated Strategic Reserve Forecast (pg. 37). The pink bars represent the increases in the Ag Incentive cost that would occur if the anticipated increases in CAP Energy Rates are absorbed by CAP. The dashed red line represents the anticipated impact of Prop 117 on tax revenues. 71

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FAP Agenda Number 5 & 6.

FAP Agenda Number 5 & 6. CONTACT: Doug Dunlap Gary Given 623-869-2360 623-869-2158 ddunlap@cap-az.com ggiven@cap-az.com MEETING DATE: April 21, 2016 AGENDA ITEM: Discussion Regarding Water Rates, Taxes