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2023-047 Change in ERCOT Credit Policies July 14, 2023 Report No. 2023-047 INFORMAL STAFF REPORT TO MAYOR AND CITY COUNCIL SUBJECT: Change in ERCOT Credit Policies EXECUTIVE SUMMARY As a direct result of the short pay and defaults of ERCOT market participants during winter storm Uri, ERCOT staff recommended to the ERCOT Board of Directors that the practice of granting unsecured credit to market participants with excellent credit, like Denton Municipal Electric (DME), be terminated. The default of Brazos Electric Cooperative for $1.2 billion and Rayburn Electric Cooperative for$800 million,both of whom had been extended a level of unsecured credit, was cited as the reason for this policy change. It is important to note that the elimination of unsecured credit to investment grade entities is counter to best practices in the commodity and energy trading business. Under the approved credit protocol changes adopted by the ERCOT Board, market participants can use cash or letters of credit to securitize their credit and collateral obligations. The City's Finance Department has explored the cost of obtaining and using a bank letter of credit as the mechanism to meet this requirement as opposed to posting the daily cash margin requirements, which would require the City to keep funds liquid and not invested. Given current interest rates for instruments authorized for investment by the City, staff determined it will be more cost effective to utilize a bank letter of credit. The letter of credit will not exceed DME's ability to provide payment to the bank or ERCOT if so required. The use of the letter of credit is only to meet the day-to-day collateral requirements that will become effective on October 1, 2023. Currently DME has a$40 million unsecured line of credit with ERCOT based upon the A+(S&P) and A (Fitch) ratings of DME's revenue bonds and the City's credit rating of AA+. On average DME's use of this credit lien is approximately $15 million but during high priced periods in the summer and winter, the use of the credit line approaches $30 million. While not anticipated to happen because of market changes and conservative operations by ERCOT since winter storm Uri, maximum credit requirements could rise as high as $60 million. These conditions would only persist for a limited number of days since DME is both a payer to ERCOT for the energy purchased to serve load(creating the need to post credit to meet payment obligations) and a receiver of funds from ERCOT associated with the sale of energy by DME from renewable PPA positions and the Denton Energy Center. However, under ERCOT protocols, accounts payable to ERCOT are due at least one day prior to amounts receivable from ERCOT. Consequently, these positions do not offset one another to reduce ERCOT's credit exposure to DME or DME's collateral posting requirements to ERCOT. The City issued a request for proposal on July 9, 2023, for ERCOT-qualified banking institutions for up to $60 million. Finance sought and obtained opinions from its Financial Advisors and Bond Counsel indicating that such a letter of credit can be legally obtained for the purpose of providing collateral to meet DME's obligations. July 14, 2023 Report No. 2023-047 CONCLUSION: The request for proposal for up to$60 million in qualified letters of credit from ERCOT-accredited banks will be concluded in late August and brought to City Council for consideration to enter into the required agreements with the winning bank. STAFF CONTACT: Randee Klingele, Treasury Manager