Appendix to the Letter Sent to Seattle Mayor and City Councilmembers on November 20, 2002

Appendix - Compilation of findings leading to conclusion of No Confidence:

1) Risk Management

A principal shortcoming of SCL’s senior management has been its failure to anticipate, plan for and manage the risks inherent in a market environment in which the utility places significant reliance on hydroelectric generation. Although City Light’s ratepayers have been significantly exposed to market forces since 1996, SCL still has not developed a comprehensive risk management program to minimize the impact of market volatility or low stream flows on its ratepayers. "The [current] Risk Management Manual, a critically important document, is out of date, incorrect, inadequate, and poorly controlled. It is not serving the policy and programmatic functions for which it is necessary and intended." Vantage Consulting Audit dated October 31, 2002 (VC), p.34.

In 1996, City Light dramatically increased its market exposure by reducing its purchase contract with the Bonneville Power Administration. Concerned about the absence of a risk management plan, the City Council called for this document in its 2000 work plan. Recognizing the increased market risk as SCL became a net purchaser of electricity in the market, the work plan directed SCL to finalize the Strategic Resource Assessment and to present alternate power portfolios and risk management strategies by the end of the second quarter of 2000. In the face of various announcements of a coming crisis in power supply in 1999 and 2000, the increased risk resulting from the sale of the low-cost Centralia power source, increasing price volatility , and the failure of SCL to comply with the 2000 work plan directive in a timely fashion, the Council found it necessary to reiterate the requirement for a risk management plan in a November, 2000 ordinance granting a rate increase.

An August 2000 Deloitte & Touché audit of the Power Marketing Group had proposed that a risk management plan contain loss limits, but "[SCL] lost a major opportunity to improve its operations and move to a higher performance level when it categorically ignored many elements of the D&T audit." VC 45-47

2) Strategic Planning

City Light has failed to prepare, maintain and utilize strategic plans in making recommendations to the City Council and obtaining approval of significant changes in its power supply. The Vantage report indicates that the last Strategic Plan was completed in 1996 and an update commenced in 1997-98 was never completed. VC p.75.

In 1997, SCL disbanded its Energy Resources Planning and Forecasting Division, a group responsible for load forecasting, evaluation of resource supply options, and risk analyses. The strategic resource planning function was subordinated by assigning it to other managers who had other priorities and strategic planning received less attention with fewer supporting resources. The de-emphasis of strategic planning resulted in failures to utilize analytic processes to identify options and to describe the consequences, risks and benefits of those options to the City Council and stakeholders to enable them to make well-informed decisions. Thus, SCL management did not make any analytic presentation regarding the options, risks or benefits for the ratepayers after SCL sold its interest in the low-cost Centralia steam plant in the spring of 2000, and the League has not been able to obtain such a plan prepared by SCL in connection with the above-market long-term contract to purchase wind power in 2001.

3) Dysfunctional Culture

The culture of the senior management at SCL is seriously flawed---substituting public relations tactics and defensiveness for strategic planning, risk management and self-analysis. The League believes that the continuing defensiveness, lack of self-analysis, and quickness to attack critics compels the conclusion that this problem will not be easily resolved without change in SCL leadership to establish capable, forward-looking management.

"The culture of the utility seems to lack the "we can do better" attitude that is invariably present in high performance groups. The conclusion is evidenced by: (1) SCL’s generally defensive response to issues; (2) a limited or less than enthusiastic response to improvement initiatives; (3) a tendency to dismiss criticism and attack its source, even when such criticism appears to have at least some merit; and (4) a bent towards explaining away past problems as opposed to learning from them." VC p. 89.

After the energy crisis, SCL failed to identify or confront its own failure to update its strategic plans or to present to the Council the twice-requested risk management program. Vantage notes that SCL described its performance as heroic in the 2000 Annual Report, when "one could argue that miscalculations leading to the crisis were indeed made" VC p. 89. The "heroism" was then rewarded with substantial raises, which placed SCL senior managers among the highest paid officials in city government.

The League has concluded that City Light was unprepared to manage the risks of volatility and shortages when they were forewarned of shortages by the Northwest Power Planning Council and by market volatility in other states. These factors would inevitably have an extraordinary impact on SCL’s operating costs in the event of a shortage of water flow for hydro generation, a shortage which statistics suggest will is likely to occur as often as once every four years.

After the crisis, the SCL senior management team failed badly in self-analysis leading to lessons learned. " The [current] draft of the [lessons learned] document, at least so far, is long on rhetoric and short on self-analysis. It represents a history of the crisis focused on blaming others far more than a critical self-assessment with an eye towards ‘lessons learned.’" VC p.90.

SCL has also failed to respond constructively to external directions and suggestions. As noted above, it failed to respond to the City Council’s directives to prepare a risk management plan as required in the 2000 work plan and November 2000 ordinance. They also ignored much of the 2000 Deloitte & Touche audit referred to above which recommended a risk management plan including loss limits, a feature that is still missing from their risk management plan two years later.

"SCL readily dismissed much of the external criticism relating to the crisis as inappropriate. We are unaware of a positive response to any of the external criticisms even though those analyses make some correct observations. The Seattle Times’ series and the Municipal League observations seem to be two legitimate pieces of work that deserved a better response." VC p. 11.

SCL’s principal response to the League’s report and The Seattle Times’ article, and to a series of billing snafus, was to hire a public relations firm to convene a series of public meetings. When the superintendent was asked at a public meeting why Seattle’s rates had gone up so much more than Tacoma Power’s, he responded that TP’s rates increased less because TP had shut down major employers in Tacoma, hence throwing many people out of work. SCL’s public relations consultant then approached Municipal League committee members and demanded that the League retract its report because the comparison with Tacoma Power was unfair for the reason stated. When the League requested City Light to provide the facts about TP protecting its rates by throwing people out of work, SCL responded in writing that "I don’t think we want the inference out there that Tacoma protected itself by closing down plants."

The substitution of public relations tactics for acceptance of criticism is continuing even after the VC Audit.

"SCL recently posted on the City’s internal and external web sites a letter …stating that …[the Vantage] audit and the Mayor’s City Light Review Committee represent ‘a strong affirmation of our quality as an organization and a sharp reminder that we can do better.’ The auditor disagreed with SCL’s description of its report. " While we [Vantage] appreciate the stance stated in these letters indicating a readiness by SCL to do a better job, it is inaccurate to suggest that our audit is a strong affirmation of quality." (Underlining added) VC p. 90.

SCL also attacked the Vantage report In the November 11, 2002 issue of "Clearing Up" an energy news journal in which the following statement is credited to the SCL superintendent:

"Zarker said that the auditors did not fully appreciate City Light’s position during and after the energy crisis and that they mistook calculated, non-disclosure for defensiveness. In particular, Zarker said, the auditors mischaracterized City Light managers’ guarded responses to a series of Seattle Times articles published last spring that were critical of the utility’s policies and handling of the energy crisis. Auditors accused City Light managers of blaming others rather than themselves.

Zarker countered that the auditors were confused by the utility’s aggressive legal stance, in which the agency maintained that energy traders had manipulated West Coast power markets and power sellers had taken advantage of the situation to overcharge City Light, …After City Light filed its refund complaint with the Federal Energy Regulatory Commission in 2001, utility managers did not want to admit any wrongdoing in public, a move that could have aided the utility’s legal opponents in the case. Zarker said. ‘We said that fraud is what was going on and FERC had a statutory responsibility that they failed to exercise,’ Zarker said. The auditors didn’t get it, he said. ‘Geographically, [the auditors] are far away; they’re from Key West,’" he added. "(emphasis added)

There are two responses to this statement.

a) If the SCL attorneys had instructed the SCL senior managers to withhold information from the auditors, it would have been simple enough to tell the auditors that they were instructed not to respond because of pending litigation. It would have been easy enough to clarify this when both the Superintendent and the Vantage team appeared before the Council or communicated with one another at other points in the audit process.

b) An attack on the Vantage consultants because of a Key West headquarters was completely inappropriate. The auditors have a national practice, having more that 100 years of consulting experience working in a wide range of utility environments from San Diego Gas & Electric, Southern California Edison, Pacific Gas & Electric, the California Public Utility Commission and major utilities in Illinois, Pennsylvania, New Jersey and Kentucky. The focus of the audit was to determine how well the City was managing and governing SCL in the face of a volatile market even if it was subject to manipulation by predators. The location of the lead consultant’s headquarters had nothing to do with the auditors' ability to evaluate management and governance.

4) Relationship Between SCL and the City Council

"The current working relationships between SCL and the City Council seriously impede and perhaps preclude Council’s ability to faithfully discharge its risk management responsibilities." VC, p.67 The audit found that "the current financial crisis is largely the result of SCL’s management practices, including not providing sufficient information to decision makers to make fully informed decisions." VC p.90.

5) Management of Debt

City Light senior management and the City Council have failed to manage debt in the best interests of the bill payers and the utility, resulting in multiple downgrades in City Light’s debt rating which produce higher borrowing cost for the ratepayers Although SCL senior management has repeatedly stated that the debt ratings are under control, the most recent downgrade from Standard & Poor’s earlier this month was "because of the continuing financial pressure on the utility, its sizeable capital needs, and the current expectation that short-term borrowing will not be repaid until April 2004"

"SCL’s current financial practices are not adequate for managing a large-scale utility, particularly in an era of price volatility and deregulation. There are problems concerning SCL’s strategic (overriding goals and objectives) and tactical (tools used) policies which, if addressed, should help ensure the long-term financial health of SCL. … We have also concluded that SCL’s assumptions are probably too optimistic to maintain acceptable levels of financial risk." (emphasis added) VC p. 11.

The Vantage report noted that though the need to limit and control the increasing debt burden had been recognized as early as 1994 and 1997, the indebtedness has continued to spiral through a variety of practices where decisions were made to capitalize expenses, such as deferred interest, short-lived assets, or some Administrative and General expenses that might very well have been expensed rather than being capitalized. The consultant noted that the practices adopted "cumulatively resulted in a continuous upward trend in debt that ultimately reached over $1.7 billion." VC p.13.

6) Controlling Costs

City Light Senior Management has failed to cut costs in an aggressive manner in response to the overwhelming financial problems flowing from the energy crisis of 2000-2001. In the Vantage presentation to the City Council, it was stated that the cost cutting at SCL was "underwhelming." They noted that during the past ten years, other utilities have experienced very large increases in productivity, resulting in significant reductions in personnel. VC p. 80. They indicated that the proposed 8% reduction from the proposed 2002 budget does not appear to be a significant cut since there have been no substantial reductions over the last few years. VC p.81. Among 18 comparable utilities, they found that SCL had the third highest staffing per 1,000 customers. Pps. 86-87.

7) Management Credentials

The SCL senior management team, assembled by the current superintendent, has limited breadth of electric utility experience. VC p. 88. The current management team has not fully implemented the planning and monitoring tools typically utilized by successful utility managers elsewhere. VC p. 88. The need for greater breadth in utility experience was also noted by the Mayor’s City Light Review Committee. The League recognizes, however, that the senior managers are capable individuals with long, successful careers in various branches of city government.