standing committee on finance agenda...

City Council Agenda February 11, 2013/Page 1

File No.: 167-S2-2013

STANDING COMMITTEE ON FINANCE

AGENDA REPORT

Subject: UTILITY FISCAL POLICY Recommendation(s): That the Utility Fiscal Policy Draft Report, Attachment 1 to the February 11, 2013 Utility Fiscal Policy agenda report be received as information and that Administration bring forward a draft Utility Fiscal Policy for Committee review at the March 11, 2013 Meeting. Legislative History: On May 11, 2009, Finance and Audit Committee passed the following resolution:

(FAC68-2009) That Administration prepare a draft Utility Fiscal Policy to be reviewed by Finance and Audit Committee prior to being considered by Council, including the potential impact on utility rates and property taxes and based on the principles outlined in the confidential report of April 21, 2009, and that the policy be considered at the Finance and Audit Committee Meeting in January 2010.

Council met in camera on June 21, 2011 for a priorities and planning session. One component of which was further discussion on a proposed Utility Fiscal Policy. The outcome of the discussion was that Administration would prepare the policy for presentation to the Standing Committee on Finance during the second quarter of 2012 and funding for the required analysis was provided in the 2012 Budget. Report: Administration initiated the Utility Fiscal Policy Study to review current financial management practices for the City of St. Albert Utilities with the intent to establish a Utility Fiscal Policy that will provide future best practices in the financial management of the City of St. Albert Utilities. Through a formal RFP Process, the City selected the firm Conroy Ross Partners as the consultant to conduct the study in August 2012. The primary task of the consultant was to provide expert analysis and recommendations to develop a comprehensive and overarching Utility Fiscal Policy. This policy is to be the fundamental policy document for the City to guide the utility fiscal framework for the next 10 to 15 years.

Standing Committee on Finance Agenda February 11, 2013/Page 2

File No.: 167-S2-2013

The project consisted of five key phases;

1. Project Planning & Kick Off 2. Background Review & Internal Interviews 3. External Scan 4. Analyze Findings & Develop Recommendations 5. Deliver Reports to Standing Committee on Finance

Through the development of the report, the consultants conducted an overview analysis of the current situation at the City of St. Albert, including, Governance and by-laws, scope of services, the St. Albert situation in the Capital Region, historic and future capital expenditures, current financial management practices and key challenges. The consultant also conducted an external scan of 13 other municipalities and their utilities operations throughout Alberta and Canada. These municipalities were selected based on various criteria such as similar operating models, similar city size, established fiscal policies, best practice and comparable financial policies. Based on the analysis performed, Conroy Ross Partners has provided key recommendations in four major fiscal policy areas.

1. Self-Sustaining Operations 2. Financing Techniques 3. Reserves Management 4. Utility Rate Modeling and Water Consumption Considerations

Background/Rationale: A municipality’s fiscal policy has a substantial effect on its ability to finance required infrastructure, provide for programs and services, limit increases to taxation and user fees and achieve overall sustainability. The City is currently guided by City Council Policy “Budget and Taxation Guiding Principles” to provide direction regarding the overall fiscal administration of the City. However, there is no current specific policy that addresses the administration and direction of fiscal decisions regarding Utilities. Similar to other Municipalities the City has relied on past practice in this area rather than a prescribed utility fiscal policy. The City currently utilizes a one hundred year utility model, developed in Excel, that calculates rates based on estimates of future capital costs, reserve balances and operating costs. This model is based on a self-funding solution and does not include considerations for debt or debt financing.

Standing Committee on Finance Agenda February 11, 2013/Page 3

File No.: 167-S2-2013

The City entered into the RFP process to develop a formal Utility Fiscal Policy with the following objectives.

i. Provide a framework for fiscal decisions made related to utilities for a period

of at least 10 to 15 years ii. Clarify the City’s utility fiscal philosophy to ratepayers iii. Improve financial transparency iv. Promote conservation v. Support better decision making; and vi. Contribute to improved sustainability

The report provided by Conroy Ross is a significant step towards achieving these objectives. Overall there are 14 policy recommendations in regards to the way we structure the future financial operations of the Utilities. Some of these will have future rate impacts and are a shift away from previous direction. Some of these also have operational impacts that will need to be phased in over time. The implementation of these recommendations will require planning and thought. Administration proposes to incorporate any feedback from the Committee and bring forward a plan to report the recommendation to the March 11 Standing Committee on Finance Meeting. Financial Implications: The immediate project cost is $52,800. However, there will be significant future financial implications as the City adopts the recommendations in the consultant report. Each of the recommendations provided by the consultant provides an indicator to the impact on utility rates to the residents. Legal Implications: At this juncture, there are no legal implications. Attachments: 1. Utility Fiscal Policy Review Draft Report, Conroy Ross Partners 2. Utility Fiscal Policy Presentation of Final Report, Conroy Ross Partners Report Date January 31, 2013 Originating Department Financial Services Prepared by: Ed Kaemingh Approved by Anita Ho City Manager Review Patrick Draper

Utility Fiscal Policy ReviewFinal Report

City of St. AlbertJanuary 31, 2013

3800 Bow Valley Square 2 | 205 – 5 Avenue SW | Calgary, Alberta T2P 2V7

T 403.261.8080 | F 403.261.8085 | www.conroyross.com

cvalliereTypewritten TextAttachment 1

PRIVATE AND CONFIDENTIAL

Utility Fiscal Policy Final Report | City of St. Albert 1 | P a g e

Table of Contents

1.0 Executive Summary ...................................................................................................... 2

2.0 Purpose and Work Plan ................................................................................................ 6

2.1 Purpose of Review .................................................................................................... 6

2.2 Work Plan .................................................................................................................. 6

3.0 Current Situation ......................................................................................................... 10

3.1 Overview of the Utility .............................................................................................. 10

3.1.1 Governance and By-laws .................................................................................. 10

3.1.2 Scope of Services ............................................................................................. 10

3.1.3 Situation in Capital Region ............................................................................... 11

3.1.4 Historic and Future Capital Expenditures ......................................................... 12

3.2 Current Financial Management Practices and Key Challenges .............................. 13

3.2.1 Current Financial Management Practices ........................................................ 13

3.2.2 Financial Projections: Baseline Scenario ......................................................... 15

3.3 Key Utility Fiscal Objectives .................................................................................... 16

4.0 Analysis of Fiscal Policies ........................................................................................... 17

4.1 Self-Sustaining Operation ....................................................................................... 17

4.1.1 Grant Funding ................................................................................................... 17

4.1.2 Cross Utility Service Line Subsidizations ......................................................... 18

4.1.3 Reserves Management..................................................................................... 20

4.1.4 Administration Fees .......................................................................................... 22

4.2 Financing Techniques ............................................................................................. 24

4.2.1 Debt vs. Cash Financing ................................................................................... 24

4.2.2 Debt and Debt Servicing Limits ........................................................................ 28

4.2.3 Debt Term ......................................................................................................... 31

4.2.4 Utility Dividend / Return .................................................................................... 32

4.2.5 Utility Franchise Fees ....................................................................................... 33

4.3 Utility Rate Modeling and Water Consumption Considerations ................................ 34

4.3.1 Rate Requirement Drivers ................................................................................ 35

4.3.2 External Scan ................................................................................................... 39

4.3.3 Utility Rate Making Best Practices .................................................................... 41

4.4 Financing Growth .................................................................................................... 43

5.0 Summary of Recommendations .................................................................................. 47

Appendix A: Financial Forecasting Model Assumptions ................................................... 50



1.0 Executive Summary In September 2012, The City of St. Albert engaged the business advisory firm Conroy Ross Partners to perform a fiscal policy review of their four Utilities (herein described as the “Utility”). The Utility support four different service lines: Water, Wastewater, Storm, and Solid Waste. The purpose of this review was to provide analysis on key fiscal policy topics and provide recommendations which could be taken by the Utility to develop a formal fiscal policy. To facilitate this review, a structured approach was followed. Following a kick-off with the St. Albert Steering Committee, the Conroy Ross consulting team performed a current state review of background financial documents and interviewed key internal subject matter experts. A key focus of these interviews was on desired fiscal policy objectives, which were subsequently vetted in a workshop with the Steering Committee. These main objectives are:

1. The primary focus of the Utility is on servicing residents and clients within its municipal boundaries;

2. Each of the four Utilities (i.e. Water, Wastewater, Storm, and Solid Waste) are intended to be self-funding and financially sustainable;

3. Managing Utility revenues against required expenditures and “revenue requirements” needs to be clean and transparent;

4. All Utility services rates need to be stable, equitable, and affordable; and

5. Utility services need to support municipal plans for growth and economic development.

Based on the analysis performed, which included an external scan of 13 other municipal utilities within Alberta and across Canada, the following significant findings and recommendations were made. These are summarized in the following table, which includes both the high-level rationale for each and its likely impact on the Utility’s overall rate revenue requirements (defined as the total operating and capital costs which are to be recovered through the Utility rates):

Fiscal Policy Area

Recommendation and Rationale High-level impact on Rate Revenue Requirements

Self-Sustaining Operation

Grant Funding

(Section 4.1.1)

1. The Utility plans to fund future capital programs through sources other than the municipal tax base or grants which could be deployed for municipal tax-supported programs.

Rationale: This will help achieve sustainable self-financing of the Utility and better enables municipal tax-supported programs to use this capital funding instead.

• Grant funding for capital reinvestment projects will need to be replaced by rate revenues.

Cross Utility Service Line Subsidizations

(Section 4.1.2)

2. Cross utility line subsidization not be utilized going forward, and planning is performed to correct the present negative reserve balance in Solid Waste over time. The execution of this plan should take place over a duration that will not put excessive upward pressure on Utility rates and should balance individual utility rate stabilization objectives.

Rationale: This will achieve an improved state of self-sustainability as each Utility is treated as a separate entity.

Since the net balance of all four reserves combined is positive, the impact over the long term will be negligible.



Combined vs. Individual Reserves

(Section 4.1.3)

3. The Utility adopt practices to manage each utility reserve (i.e. Water vs. Wastewater vs. Storm vs. Solid Waste) independently with the objective to ensure that each utility service line is financially self-sustaining.

Rationale: This will achieve an improved state of self-sustainability as each Utility is treated as a separate entity.

Given the current total reserve balance, this practice will not have a long-term impact on rates.

Reserve Purposes

(Section 4.1.3)

4. Each Utility Reserve address both “Rate Stabilization” and “Capital” component requirements sufficiently in order to further reinforce the objective that each Utility be financially self-sustaining. A minimum balance would need to be established to recognize rate stabilization requirements based on an evaluation of operating budget variability. Rationale: This will further reinforce the objective that the Utility be financially self-sustaining. This would also protect required contributions to the capital reserves should it continue to budget based on the “cash-needs basis”.

Given the current total reserve balance, this practice will not have a long-term impact on rates.

Reserve Cash Balances

(Section 4.1.3)

5. The end-of-year balances are targeted not less than the following year’s projected cash-financed capital expenditures.

Rationale: This will promote transparency on target end-of-year balances, ensure sufficient cash on hand, and minimize the total reserve contributions.

Present rate requirement methods are based on building up large reserve balances to pay for future capital requirements. This recommendation will eliminate the need to build up large reserves.

Administration Fees

(Section 4.1.4)

6. The administration fee calculation method be updated, confirmed, and communicated based on appropriate cost drivers and value for money. Further, it is recommended that this method be used at appropriate time intervals as determined by St. Albert to determine appropriate administration fee costs to allocate to the Utility based on actual cost driver values.

Rationale: By more accurately and transparently capturing the allocated costs associated with the Utility it will support the objective for the Utility to be fully self-sustaining.

Since an administrative fee is already being paid from the Utility to the municipality, the impact will be minor (pending updates to the administrative fee cost allocation model).

Financing Techniques

Debt vs. Cash Financing

(Section 4.2.1)

7. The Utility debt finance capital projects that are substantial in cost and where the investment’s benefits will extend over a relatively long period. Correspondingly, it is recommended that the Utility cash finance capital project which are either (i); less expensive assets whose benefits are relatively short-lived, or (ii); part of ongoing capital maintenance and reinvestment programs for existing infrastructure.

Rationale: This will allow for required capital projects to progress without financing delays, support inter-generational equity (i.e. enable “pay-as-you-benefit”, not “pay-as-you-go”), help achieve rate stability, and avoid short and mid-term rate spikes.

Rate requirements in the short and mid- term will decrease based on the forecasted capital plan and its funding requirements.

Rate spikes will also be avoided, and debt will smooth out funding requirements over time.

Debt & Debt Servicing Limits

(Section 4.2.2)

8. To support the recommended debt financing policy (as described in Recommendation #7), it is recommended that the Utility be enabled to secure long-term debt with upper debt limits guided by: overall municipal debt and debt servicing constraints, potential debt financing requirements of other municipal departments, utility rate affordability targets, and debt-to-equity ratio upper limit targets of 60:40 per Utility Service. As a general rule

It is expected that effective debt financing will enhance rate stabilization performance, thereby providing more stable and manageable rate increases to the utility rate payers.



and at a minimum, the Utility should be enabled to secure up to its proportionate share of the municipality’s debt limit. Given the capital-intensive nature of the Utility relative to other municipal departments, there may also be occasions where it should be enabled to exceed this proportionate share pending approval by the municipality.

Rationale: This will enable the Utility to adopt industry-recognize generally accepted financial management practices given the Utility’s relatively high level of capital intensity.

Debt Term Limit

(Section 4.2.3)

9. Debt terms be selected to closely match up to (and never beyond) the infrastructure’s expected life span and within the Alberta MGA constraints.

Rationale: Matching a debt term with the asset’s useful life expectancy is a best practice to realize “pay-as-you-benefit” intergenerational equity objectives.

Spreading out principal and interest charges spreads rate requirements from current rate payers to future rate payers.

Utility Dividend / Return

(Section 4.2.4)

10. Introducing a dividend payment is not recommended for the short to mid-term horizon.

Rationale:

i. The Utility is not yet financially self-supporting;

ii. There is not yet a significant level of utility services offered to “outside” or regional customers; and,

iii. This would be counter to the key utility fiscal policy objective of achieving rate stability.

Since the Utility currently does not provide a return there will be no impact.

Utility Franchise Fees

(Section 4.2.5)

11. A franchise fee be considered and planned for implementation in the mid to long-term for the Water, Wastewater, and Storm Utilities. The franchise fee would be charged and collected by the Utility and “flow through” to the municipality.

Rationale: A franchise fee would promote competitive equity vs. private-sector utility providers and provide the municipality with another legitimate, predictable and sustainable revenue source that would help alleviate further pressure to increase taxes.

A franchise fee would likely add ~ 7-10% to rate revenues (pending final determination of this fee).

Utility Rate Modeling and Water Consumption Considerations

Rate Structure Review

(Section 4.3)

12. It is recommended that the Utility perform a rate review and rate structure design based on priority objectives (to be approved by Council) and develop a new rate structure to not only support these objectives but also promote enhanced rate equity.

Rationale: A new rate structure would more accurately charge customers for the services they receive and enhance the Utility’s financial sustainability.

The rates and the respective increases / decreases would be determined by the output of the review.

Rate Model

(Section 4.3)

13. It is recommended that the Utility design and construct a new rate model with features that support the rate making requirements and objectives.

Rationale: The existing model does not support the financial modeling of various scenarios and forward looking scenarios (e.g. utilizing debt.)

Developing a new model will not have an impact on the rates.

Financing Growth

Financing Growth

(Section 4.4)

14. Debt financing be used to front-end growth-related capital so as not to “hold-up” development. Further, it would be expected that all offsite levy receipts be used to pay for financing for this growth-related capital.

Rationale: This will support municipal growth and better achieve rate stability.

Funding would otherwise need to come from existing rate payers if debt funding for these projects is not adopted.



During this engagement a financial model was created to help develop and determine the effects of the above recommendations. Key output estimates of the model include the “total rate revenue requirement” and “average monthly rate per household” of the Utility over the next 10 years (i.e. 2013-2022). These outputs help demonstrate the potential impact of various policy decisions on the estimated rate requirements of the Utility. A “Base Case” scenario was created using the financial policies and practices in existence today in order to establish a base from which to compare the effect of changing policy. Scenarios were then created and compared to the “Base Case” in order to model the effect of various potential policy changes. The key scenarios developed, and their underlying assumptions and results are displayed in the table below.

Scenario

Total estimated 2013-2022 rate

revenue requirement ($ Millions)

Average estimated monthly rate

(per household)

Variance from Base Case on average

monthly rate

Actual 2012 Average Rates n/a $ 111.41 n/a

1. Base Case

(Existing financing practices)

Demonstrates the effect of maintaining existing financial policies and practices going forward.

Key assumptions:

• Zero inflation; • Utilize grants as forecasted

(~$29.8M); • Utilize off-site levies as forecasted

(~$47.6M); • Capital expenditures include

funded and unfunded projects; • Do not permit use of debt; • Combined Utility reserve opening

2013 balance of $7.15M allocated across each individual Utility as follows: – Water: $3.66M; – Wastewater: $3.07M; – Storm Water: $9.64M; and – Solid Waste: (-$9.21M).

• Individual reserves closing balance >= 0.

$399.2 M $154.07 n/a

2. Eliminate Reliance on Grants As per recommendation #1, demonstrates the effect of the Utiltiy becoming more self-sustaining by no longer relying on grants.

Key assumptions:

• Grants no longer utilized (~$29.8M);

• All else same as Base Case.

$429.0 M $165. 72 $11.65 (7.6%)

3. Recommended Case

(Debt financing utilized, Grants not utilized)

Building on all other analysis and as per recommendations #7-9 and #14, demonstrates the further effect of utilizing debt for appropriate capital projects.

Key assumptions:

• Grants no longer utilized (~$29.8M);

• Debt utilized to fund appropriate capital projects > $10M;

• All else same as Base Case.

$388.9 M $150.14 - $3.93 (-2.6%)



2.0 Purpose and Work Plan

2.1 Purpose of Review The purpose of this fiscal policy review was to provide analysis and recommendations for the following topics, as per the St. Albert Request for Proposal

1:

i. Recommendations, best practices and methods to monitor and control

consumption – this should include water conservation and an analysis on available meter reading technology to achieve conservation goals

ii. Recommendations on a utility fiscal philosophy and financing guidelines

iii. If applicable, the recommendations should also include:

a. Recommended debt financing guidelines

b. Recommended maximum debt to equity ratio, including the influence of the City’s municipal debt requirements

iv. Recommendations regarding practices the City could employ to maintain the self-financed nature of the Utility Fund and recognize the financial and administrative contributions from the General Fund. This may include, but not be limited to, techniques such as subsidization guidelines, dividend/return on investment guidelines, etc.

v. Recommendations regarding the City’s current utility rate model, including the:

a. Appropriate inputs from operating and capital requirements

b. Appropriate tools for calculating rates ,including a recommendations for a minimum of two available software models (other than MS Excel)

vi. Recommendations on optimal utility reserve and cash balances to ensure the ongoing sustainability of the fund and its services

vii. Sample policy wording that could be used to incorporate recommendations and best practices into the City’s own proposed Utility Fiscal Policy

2.2 Work Plan The high-level work plan and timeline followed are displayed in the following diagram:

1 The City of St. Albert, “Request for Proposal RFP12-0006 Utility Fiscal Policy Consultant”, June 28, 2012



The activities performed to execute this project included: 1. Project Planning and Kick-off

This activity involved the development, documentation, and confirmation of the project plan, incorporating learning’s from a review of all initially-provided background materials, and a kick-off meeting with the Steering Committee on September 26, 2012. From this meeting the desired outcomes for the engagement were confirmed and the project plan, including key deliverables and timelines, were finalized.

2. Background Review and Internal Interviews Background Review During this activity a comprehensive financial review and analysis of the City’s utility system was conducted through a review of all relevant internal documents and financial reports.

Internal Interviews (5 Participants) During this activity interviews were conducted with key internal stakeholders in order to confirm and clarify findings from the Background Review, learn of additional key considerations, and determine areas requiring further exploration. A key focus was key financial management objectives and desired financial performance targets for the Utility. These key objectives and performance targets formed part of the basis for final recommendations.

3. External Scan (13 Municipalities)

This activity focused on confirming the 13 total external scan candidates, determining the required information to be collected, and collecting, summarizing and consolidating the external scan information. The 13 municipalities and the rationale for their inclusion in the external scan are listed below:

Utility Rationale for Selection

1. Edmonton

(Drainage Services)

• Established utility fiscal policies which guide financial management decisions

• Similar operating model as St. Albert (i.e. no treatment plants)

• Capital Region member municipality

2. Strathcona County Utilities Department


• Similar constituent size as St. Albert

• Capital Region member municipality

3. Grande Prairie

(Aquatera)


• Significant Alberta-based municipally-owned utility

4. Red Deer • Recently developed a utility policy document which guide financial management decisions

• Significant Alberta-based municipal utility

5. Airdrie • Similar operating model as St. Albert (i.e. no treatment plants)





6. Calgary

(Water Resources & Water Services)

• Recently developed / updated utility fiscal policies which guide financial management decisions


7. Lethbridge • Similar constituent size as St. Albert


8. Medicine Hat • Similar constituent size as St. Albert


9. North Vancouver • Similar operating model as St. Albert (i.e. purchase water commodity and wastewater treatment services)

• Similar constituent size / municipal context as St. Albert (i.e. close proximity to a large Canadian city)

10. Ottawa • Recently established and published a 5-year financial plan, including fiscal policies and financial benchmarks

11. Region of Peel • Recently established a 5-year financial plan, including fiscal policies and financial benchmarks

• Policy that “growth pays for 100% of growth”

12. Markham • Recently developed a utility 5-year financial plan


• Policy of “no debt”

• Similar / scalable constituent size vs. St. Albert

13. Halifax Water • Recently performed a Cost of Service and Rate Review

• Recently developed a 5-year business plan, including fiscal policies and financial benchmarks

4. Analyzed findings and developed recommendations

This activity involved the analysis of the information gathered from all previous steps and the development of applicable recommendations. In addition, a workshop was conducted with internal subject matter experts to clarify and confirm desired Utility financial management objectives and desired performance targets against which to base specific recommendations. In addition, a high-level financial forecasting model was developed in order to project the potential impact that various financial scenarios would have on the funding requirements of the Utility. The purpose of this model was to provide directional, indicative implications on rate revenue requirements and average user rates from adjusting specific fiscal policies or financial management practices. Specifically, the model provided key output estimates used to assess the impact from varying financial management practices. For the purposes of this evaluation, these are described below:

i. Total Rate Revenue Requirements: defined as the total operating and capital costs incurred by the Utility across 2013-2022 which require to be met from user rate revenues. This factored in estimated Utility 2012 reserve closing balances and included operating and maintenance, commodity, and capital specific costs. Forecasted revenues from off-site levies used to pay for growth-related infrastructure and miscellaneous non-rate revenues are subtracted, which leaves just the amount of revenue requirements to be recovered through Utility rates.



ii. Average Monthly Rate per Household: defined as the average annual Utility rate per household customer across 2013-2022. This is calculated by first determining the forecasted average Utility rate for each forecasted year based on the annual total rate revenue requirement (as described above) and the number of customers (per Utility). Then, a simple average of these estimates is calculated. It should also be noted that this average rate is not specific to any service levels provided (e.g. solid waste container size), as it is simply an overall average of the total estimated rate revenue requirements divided by the total number of customers.

Note that this financial model should not be viewed as a fully developed rates model. It was developed from necessity to develop high-level projections and financial impacts of alternative financial management practices. Further detail (including the assumptions and calculations used in the model) can be found in Appendix A: Financial Forecasting Model Assumptions.

5. Deliver final report and presentation

This activity involves the preparation and presentation of a draft report to the City (Steering Committee), and completing revisions as required as a result. A final report will then completed and delivered to the City both electronically (one copy) and in hardcopy (10 copies,) as outlined in the RFP. Following the finalization of the report a presentation will be made to Senior Management and/or City Council (Standing Committee on Finance).



3.0 Current Situation The purpose of this section is to provide a high-level overview of the Utility within St. Albert and provide context of the current situation that must be considered when evaluating forward looking financial policies. Relevant background information, historical data, and key challenges facing the Utility are included to provide the context of the current situation.

3.1 Overview of the Utility

3.1.1 Governance and By-laws The Utility at the City of St. Albert is operated as a public utility and is governed under the enabling legislature of the Municipal Government Act (Part 3, Division 3: Public Utilities)

2

and the Public Utilities Act3. These statutes enable the municipality of St. Albert to

develop and administer municipal policies to govern and operate its own public utility for the purposes of servicing its constituents. The Utility sets the rates, fees, and charges with the approval of Council. Four by-laws (consolidated by by-law 45/2011) form the basis of its operations:

• By-law 5/2001: “The St. Albert Water By-law” (Water Utility) • By-law 33/2001: “The St. Albert Sanitary Sewer By-law” (Wastewater Utility) • By-law 6/2003: “The St. Albert Storm Sewer By-law” (Storm Utility) • By-law 24/2011: “Residential Solid Waste Management By-law” (Solid Waste

Utility) Furthermore, the Utility holds agreements with external providers of utility services in order to fully provide services to customers of the Utility:

• Agreement with EPCOR: o EPCOR sells potable water to St. Albert for the purposes of distribution

to the customers of St. Albert as specified within its Water By-law o Note: St. Albert would need to negotiate with EPCOR and gain its

permission should it wish to “resell” this potable water to “Outside” or regional customers outside its municipal boundaries.

• Agreement with Alberta Capital Region Wastewater Commission (ACRWC): o The ACRWC provides wastewater treatment services to St. Albert

It is further noted that should St. Albert elect to become a “regional” potable water service provider, those specific operations would be subject to the Alberta Utilities Commission (AUC).

3.1.2 Scope of Services A description of the four Utilities (Water, Wastewater, Storm, and Solid Waste) is provided in the table below:

2 Province of Alberta, “Municipal Government Act: Revised Statutes of Alberta 2000 Chapter M-26”, Alberta Queen’s Printer,

November 24, 2010 3 Province of Alberta, “Public Utilities Act: Revised Statutes of Alberta 2000 Chapter P-45”, Alberta Queen’s Printer, November

1, 2010



Utility 2012 Budget

($ millions)

Services 2012 Rate Structure

Water Operating: $9.71 M • Purchase water from EPCOR

• Provide water transmission & distribution

Flat: $8.50

Capital: $5.64M Variable: $1.42/m3

Wastewater Operating: $9.52M • Purchase wastewater treatment from the Alberta Capital Region Wastewater Commission

• Provide wastewater collection & transmission

Flat: $8.50

Capital: $3.30M

Variable (80%): $1.73/m3

Variable (100%): $1.38/m3

Storm Operating: $3.30 M

• Provide storm water collection & transmission

Residential Fixed (SF/side-by-side):

$11.44

Capital: $3.46M

Residential Fixed (stacked/condo):

$8.91

Non-Residential: $31.18

Solid Waste

Operating: $5.65M

• Provide curbside solid waste collection and disposal based on “pay-as-you-throw” approach

• Provide curbside recycling • Provide curbside organics

Solid Waste Flat: • 60 Litre: • 120 Litre: • 240 Litre: • Refuse Stickers:

$6.67 $1.10 $4.40 $9.00 $2.15

Capital: $9.00M Recycling: $5.50

Organics: $5.77

Total Operating: $28.2M Totals based on water use of 20 m3 per

month and 240 Litre option for solid waste $111.41

Capital: $21.4M Data source: The City of St. Albert, “Approved Business Plan and Budget 2012-2014”, January 7, 2011

3.1.3 Situation in Capital Region To help understand the context in which St. Albert finds itself, a comparison of key factors was performed against select Capital Region municipal neighbors. From this analysis, three conclusions were drawn: 1. Based on reviewing census data on population, St. Albert’s population growth has

significantly slowed over past five years (6.5% increase from 2006-2011) compared to other Capital Region municipalities (range of 11.2-34.2% during this same timeframe). This is in contrast to their growth performance relative to their Capital Region municipal counterparts in the early 2000’s, as during this period it ranked among the highest. This shows that St. Albert’s rate of growth has slowed significantly and is nearing a “little-to-no growth” situation.

Comparative Population Growth in the Capital Region

St. Albert Edmonton Spruce Grove Stony Plain Sherwood Park (Strathcona)

Fort Saskatchewan

Total Growth (%)*

Total Growth (%)*

Total Growth (%)*

Total Growth (%)*

Total Growth (%)*

Total Growth (%)*

2001 53081 13.2 666104 8.1 15983 12 9589 15.9 47645 13.5 13121 5.7

2006 57719 8.7 730372 9.6 19496 22 12363 28.9 56845 19.3 14958 14

2011 61466 6.5 812201 11.2 26171 34.2 15051 21.7 65475 15.2 19051 27.4

Data source: Statistics Canada Federal Census *Growth (%) = population growth as a percent over the previous period

2. St. Albert’s average 2012 household monthly utility rates (based on 20 m

3 water use

per month and its largest (240 L) solid waste container) are currently on the lower end relative to select Capital Region utilities. This is despite recent annual utility rate increases of 9.5%.



This demonstrates that although St. Albert may have a reputation as having relatively higher municipal property taxes within the Capital Region (as noted during internal interviews), it is very competitive in regard to its utility rates.

Comparative Utility Rates in the Capital Region (2012)

St. Albert ($) Edmonton ($) Spruce Grove ($)

Stony Plain ($)

Sherwood Park (Strathcona) ($)

Fort Saskatchewan ($)

Water 36.90 40.94 78.10

38.39 45.26 40.29

Wastewater 36.10 37.45 40.98 40.27 27.23

Storm Water 11.44 8.01 Tax* Tax* 8.87 Tax*

Solid Waste 26.94 33.20 26.00 22.10 22.95 14.07

Total 111.38 119.60 108.01 132.44 139.31 89.26

Data source: Websites of respective utilities - 2012 *Tax = utility services that are funded from the municipal tax base and hence their respective costs are not publicly available

3. In comparing the total 2012 utility rates to the average median household income in

St. Albert (noted at $88,543), they now represent approximately 1.5% of the median household income. This is well below the industry benchmark for rate affordability of approximately 4%

4.

3.1.4 Historic and Future Capital Expenditures St. Albert’s capital expenditure has historically been relatively stable at an average of $7.57 million annually from the period 2004 to 2012, as outlined in the graphic below. The total capital expenditure during this 9-year time period is $68.09 million.

*2012 YTD: data is actual expenditures as of January, 2013 *Data for 2004-2011 is actual capital expenditure

Future capital expenditure forecasts outlined in the next graphic below demonstrate that large increases in capital spending will be required in order to meet the Utility infrastructure needs that are predicted. From 2013 – 2022 the average annual expenditure rises to $21.9 million (compared to $7.57 million for the previous 9 years). In addition, the total expenditure rises to $219.3 million across the next 10 years (compared to $68.09 million for the previous 9 years). A large portion of this increase in

4 Gregory Baird, “Water Affordability: Who’s Going to Pick Up the Check?”, American Water Works Association Journal,

December 2010

$2.22

$11.95

$9.13

$6.52$5.80 $5.58

$9.13$10.03

$7.73

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

$14.00

2004 2005 2006 2007 2008 2009 2010 2011 2012

YTD*

Historic Capital Expenditures ($M)

Total Average = $7.57M



capital expenditure can be attributed to a significant amount of growth-related capital, which is forecasted to represent approximately 34% of the total capital spending.

Data source: Approved 10-year Capital Expenditures, including Funded and Unfunded projects. It was assumed that 25% of all projects denoted as “Growth” are required for “Reinvestment” purposes. *Data spike in 2020 can be largely attributed to two major projects: Sturgeon Heights Pump House Rebuild ($20.2 M, Re-investment, Unfunded,) South Water Reservoir and Pump House ($36.5M, Growth, Unfunded.)

This significant rise in forecasted capital expenditure threatens to pressure both existing rate payers and forecasted development unless sustainable funding sources can be determined. It is also noted that the current capital forecast has opportunities for smoothing to better reflect availability of internal resources and funding to maximize their probability for successful completion.

3.2 Current Financial Management Practices and Key Challenges

3.2.1 Current Financial Management Practices The Utility currently follows a number of key financial management policies and practices. These have been provided to further develop the context around the current situation. Some of the key challenges arising from these practices are explored in the “Key Utility Fiscal Objectives” section below. The current financial management practices include: • No debt financing for Utilities. Although it is permissible in City policy for the

municipality to take out debt, it recently has been common practice not to do so for Utilities. This is a reflection of the municipality’s desire to avoid Utility debt financing costs and obligations.

• “Growth pays for growth”. It has been established that developers are responsible to pay for 100% of their appropriate share of capital costs associated with development (i.e. “growth pays for growth”,) and that these funds are provided through off-site levies. In speaking with internal subject matter experts and review of the current offsite levy bylaw, for the purposes of this report it was assumed that

$19.69 $18.83

$10.26

$32.90

$15.52 $16.92$11.42

$75.59

$10.94$7.21

$0.00

$10.00

$20.00

$30.00

$40.00

$50.00

$60.00

$70.00

$80.00

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Forecasted Capital Expenditures ($M)

Re-Investment Growth Average = $21.93M



approximately 75% of the total costs for all “growth-related” projects are attributable to growth and hence are intended to be recovered through the offsite levies.

• Grant funding. The Utility function has historically relied on grant funding to finance

capital expenditures (from 2004-2012 approximately $32.3 million was used.) Current capital forecasts continue to rely heavily on grant funding (from 2013-2022 approximately $29.8 million is budgeted.)

• Reserves. Four separate reserves (i.e. one for each Utility) are currently maintained.

The current reserve management practice is that all four combined are essentially treated as one common Utility reserve, whose net balance cannot go below zero. The implication of this is that the individual reserve balances may fall below zero, as long as the net is positive.

• Forecasted rates and revenue requirements. The Utility’s current rate making is

on a cash basis. That is, the Utility looks ahead to the forecasted financing required (i.e. for capital and operating and maintenance) and then determine the rates that are required in order to meet those future financial obligations.

• Price takers. Because the Utility buys potable water, sends wastewater externally

for treatment, and does not dispose of its own solid waste, it largely must “take” the prices that those outside service providers set (e.g. EPCOR for Water, ACRW for Wastewater), pending outcomes from rate reviews.

• Capital infrastructure. St. Albert’s Utility infrastructure is relatively “young”; that is, it

has required relatively little re-investment to-date in order to be maintained. However, as studied extensively by the American Water Works Association

5, each

municipal water and wastewater utility eventually faces a “wave” of infrastructure replacement requirements as the linear infrastructure ages and starts to fail more frequently (e.g. main breaks).

In addition, it was noted that the capacity of the existing St. Albert water and wastewater network has almost been reached. In other words, in order for the Utility to grow, additional investment will be needed to first increase the capacity of the existing infrastructure.

• Administration fees. Currently the Utility is required to pay a fee back to the

municipality with the stated purpose of covering the costs the municipality incurs to support the Utility. No “dividend” or return on top of this administration fee is provided.

5 American Water Works Association, “Dawn of the Replacement Era: Reinvesting in Drinking Water Infrastructure”, May 2001



3.2.2 Financial Projections: Baseline Scenario A “baseline” scenario was developed in order to compare the impact that alternative financial management strategies and techniques would have on the Utility. In order to provide a baseline, this base case scenario has been developed using similar financial management practices as described above (i.e. the current/existing financial management practices.) In subsequent sections of this report we will compare alternate scenarios to this baseline scenario, in order to demonstrate the potential impact various financial management practices will have.

Scenario Total estimated 2013-2022 rate


Average estimated 2013-2022 monthly rate

(per household)*

2012 Actual Rate**

Baseline Case

(Existing financing

practices)

$399.2 M $154.07 $111.41

*Estimated rates, provided for illustrative purposes only **2012 Actual Rate = actual average monthly rate per household for the past year, included for comparison purposes only

Key assumptions of this scenario included: • Zero inflation; • Utilize grants as forecasted (~ $29.8M); • Utilize off-site levies as forecasted (~$47.6M); • Combined Utility reserve opening 2013 balance of $7.15M allocated across each

individual Utility as follows: – Water: $3.66M; – Wastewater: $3.07M; – Storm Water: $9.64M; and – Solid Waste: (-$9.21M).

• Individual reserves closing balance >= 0; • Capital expenditures include funded and unfunded projects; and • Do not permit use of debt.

In this baseline scenario, an average monthly household rate of $154.07 would be required to provide the total $399.2 million to fund the Utility (including all four Utilities.) This rate would represent an increase of $42.66 (or 39%), on the average monthly bill for each household over the current 2012 rates ($111.41 monthly/household.) Note: This scenario and the additional scenarios which are presented in subsequent sections of this report are meant to provide a high level indication of the effect that various potential policy decisions will have – not to provide actual forward looking rates and revenue requirements.



3.3 Key Utility Fiscal Objectives From the internal interviews conducted by Conroy Ross on October 21, 2012 a number of key utility fiscal objectives to be met from this study emerged. A number of key challenges and implications to these also emerged. These key objectives and challenges / implications have helped form the basis of the analysis and resulting recommendations and are provided in the table below:

Key Utility Fiscal Objectives Key Challenges & Implications

1. The primary focus for St. Albert’s Utility Function is to provide servicing for municipal constituents and customers.

• Although some regional / business development opportunities may exist, the primary focus for fiscal policy development is for customers within St. Albert’s municipal boundaries

2. Each of the four Utilities needs to be self-funding and financially sustainable

• Historic and projected future reliance on grants that could otherwise be used for municipal tax-supported programs is not sustainable

• Recent utility reserve cross service line subsidizations have been increasing

3. Managing utility revenues vs. revenue requirements needs to be “clean” and transparent

• Present method for allocating administration fees is not well known and potentially outdated

• There is no short-term interest in the Utility providing a “dividend” to help offset costs of municipal programs

• Need to improve alignment between approved capital budgets vs. actual expenditures

4. All utility services rates need to be stable, equitable, and affordable

• Not appropriate to permit “rate-shock” as a means to fund significant future capital expenditures

• Future utility rates and charges need to remain competitive in the region and affordable

5. Utility services need to support municipal plans for growth and economic development

• Pressure is now being applied from developers to lower payments as prescribed in the current offsite levy

• Future growth plans require a significant increase in capital infrastructure which has a significant capital cost associated



4.0 Analysis of Fiscal Policies The purpose of this section is to address and analyze each utility fiscal topic identified to be in scope for this review. To analyze each topic, input from the appropriate sources is used (i.e. background financial analysis and projections, interviews with internal subject matter experts, external scan, and industry leading practices).

4.1 Self-Sustaining Operation From the 2012-2014 Corporate Budget

6, the overarching principle for St. Albert’s Utilities

is that they be self-sustainable. Exact wording provided to prescribe how utility fees should be determined are as follows: “Utility fees are calculated using the following Council direction:

• Utilities are self-sustaining

• Account for future replacement of existing infrastructure” In discussing this principle with internal subject matter experts, the intent is that both annual operating costs and required capital costs are recovered 100% through the utility rates, fees, and levies. That is, there should be no reliance on the municipal tax base to cover these requirements. With the objective of achieving a self-sustaining operation, the following fiscal topics were analyzed:

4.1.1 Grant Funding From analysis of both recent and forecasted funding sources for the utility operating and capital costs, it was found that the Utility was not strictly self-sustaining. Specifically, utility capital projects have demonstrated both historical and forecasted reliance on a combination of provincial and federal grants. These include Federal Gas Tax (FGT), Municipal Sustainability Initiative (MSI), Alberta Municipal Infrastructure Program (AMIP), and New Deal for Cities and Communities (NDCC) grants. Historical and forecasted usage of the combination of these grants is provided as:

• 2004-2012: $32.3 million

• 2013-2022: $29.8 million It is noted that recent historical reliance on infrastructure grants was intended to minimize customer rate increases to a maximum of 9.5% per year. It was noted that since it was a practice to not utilize debt for the Utility, grants were used to ensure required capital projects were funded. Through discussions with internal subject matter experts, however, it was viewed that these grants can be applied for and used for municipal tax-supported infrastructure as opposed to utility-specific infrastructure. From the external scan, the overwhelming majority of municipal utilities are decreasing their reliance on infrastructure grants, particularly those which could be deployed for municipal tax-supported programs. The reasoning for this is twofold:

1. Grants are not viewed as reliable, sustainable funding sources; and

2. Grants which can be used for municipal-funded infrastructure are better served by alleviating the municipal tax burden given that utilities have the ability to generate self-sustaining funds.

6 City of St. Albert, “Proposed Corporate Business Plan and Budget”, October 31, 2011



It should be noted that all external scan utilities indicated they do use grants which are specific to utility purposes (e.g. Water for Life, Water / Wastewater Partnership, etc.). In these cases, it is certainly better to “use” the grants than “lose” them. In addition, it is noted that two municipal utilities do regularly use grants which could be used by municipal-funded programs to alleviate growth-related capital costs (Airdrie) and support landfill-specific capital expenditures (Calgary). A scenario analysis removing the use of grants to fund the Utility produced the following results:

Scenario Total estimated 2013-2022 rate revenue

requirement ($ Millions)


(per household)*

2012 Actual

Rate**

Grants

Removed $429.0 M $165.72

$111.41 Baseline Case $399.2 M $154.07

Difference $29.8 M $11.65 (7.6%)


The impact of removing all reliance on forecasted grants over the next 10 years will require the Utility to replace the planned $29.8 million in grants. Assuming the case of no debt and no changes to the existing offsite levy policy, this will translate into an average total monthly rate requirement (i.e. the utility costs which would be intended to be recovered through the utility rates) of $165.72 (see graph below for further detail), which will represent an additional $11.65 per customer per month as compared to the baseline scenario.

Utility Policy Recommendations 1. To achieve a sustainable level self-sustainment and alleviate burdens on the

municipal tax base, it is recommended that the Utility plan to fund future capital programs through sources other than the municipal tax base or grants which could be deployed for municipal tax-supported programs.

4.1.2 Cross Utility Service Line Subsidizations In order for the Utility to be fully self-sustaining, each utility service line should match its ongoing revenue requirements (i.e. operating and capital expenditures) with sustainable

$155.76 $141.69$124.29

$205.05

$153.17 $151.18$132.80

$342.91

$131.08 $119.25

$-

$100.00

$200.00

$300.00

$400.00

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Estimated Rates Requirement (avg per customer per month)

Water Wastewater Storm Solid Waste



funding sources (i.e. user rates, levies, non-rate revenue charges, etc.). That is, each utility cost component should have a corresponding funding component which is deemed to be appropriate and equitable. This ideal state would feature zero cross service line subsidizations (i.e. either operating revenues or reserves from one service line being deployed to cover cost components of another service line) due to lack of sufficient funding. In analyzing the recent historical operating and reserve end-of-year balances, it was found that the Solid Waste Utility has been funded (i.e. subsidized) by the Water, Wastewater, and Storm Utilities. This is found in its present negative reserve balance condition. The table below describes the recent end-of-year balances for each Utility reserve and the estimated 2012 end-of-year balance

7:

Year Water Wastewater Storm Water Solid Waste Total

2009 $1,349,188 $4,155,679 $4,681,949 ($1,173,282) $9,013,534

2010 $1,854,733 $4,621,460 $6,557,098 ($2,559,070) $10,474,221

2011 $3,070,787 $5,561,980 $8,274,074 ($4,249,208) $12,657,633

2012 est. $3,657,493 $3,073,293 $9,635,422 ($9,212,003) $7,154,206

As can be seen from this analysis, the Solid Waste reserve has been growing increasingly negative since 2009 and its expenditures have been funded by the reserves from the other utility services. From discussions with internal subject matter experts, it was found that the primary funding requirement driving this was the Riel Park landfill remediation requirements. It was also found that this funding is viewed as an “internal loan” rather than a subsidy, with the intent that the funds will be paid back over time (i.e. the Solid Waste reserve fund balance will become positive) with a built-in $1.25

8 in the

Solid Waste flat fee with the purpose of paying for the Riel Park remediation requirements. Further analysis on the rate model and historical rate-making objectives confirmed that the present approach is based on ensuring that the projected end-of-year balance for the total sum of these reserves is always greater than zero (across the 100-year horizon). Although this method does provide flexibility to fund unexpected cost requirements as they occur, it does raise the risk in the Utility being able to achieve a desired state of complete financial self-sustainability. In this case, it creates the inequitable condition wherein customers from the Water, Wastewater, and Storm Utilities are subsidizing the costs of the Solid Waste Utility. From the forecasting model developed and the existing reserve balances, over the long-term there would be negligible combined cost difference from managing each utility reserve separately as opposed to continuing to manage them collectively. Instead, the impact would be felt at the individual utility revenue requirements, as the Solid Waste cost requirements would increase and equally offset the combined Water, Wastewater, and Storm cost requirement reductions.

Utility Policy Recommendations 2. To achieve an improved state of self-sustainability, it is recommended that cross

utility line subsidization not be utilized going forward. In addition, it is recommended planning is performed to correct the present negative reserve balance in Solid Waste

7 File document name “Utility_Model_2013-2015_v29”

8 In 2012, City Council approved and implemented an additional $1.25 to be added to the Solid Waste flat fee to pay for the Riel

Park landfill remediation requirements.



over time. The execution of this plan should take place over a sufficient duration that will both avoid excessive upward pressure on rates and balance individual reserve cash requirements.

4.1.3 Reserves Management Presently, the Utility maintains a capital reserve “to provide funds for the expansion, refurbishment or replacement of the City’s utility infrastructure, equipment, or to fund studies required for future planning purposes”

9. Funds from this reserve can be applied

to projects which are related to the Water, Wastewater, Storm, and Solid Waste Utilities. As previously discussed in the previous sections, the current rate-making approach is based on identifying rate revenue requirements such that the forecasted closing balance for this reserve is never less than zero. In addition, it is noted that the municipality has an overall “stabilization” reserve “to provide funds for non-recurring, one-time expenditures or losses of revenue that will not be built into the base operating budget in future years”

10 It is the current practice that this

reserve could be used to support the Utility should that case ever be required. It should be noted that since the Utility now annually budgets for transfers to its reserves from its operating budget (i.e. it is currently deemed as a “rate revenue requirement” and is budgeted for as any other required operating expense), the need to utilize a “stabilization reserve” has not recently occurred. Should the difference between operating revenues and operating expenses be less than budgeted, the result would be a reduction in the planned transfer to the capital reserve. According to the Government Finance Officers Association (GFOA), it is a best practice for municipal governments to maintain no less than five to fifteen percent of regular general fund operating revenues or no less than two months of regular general fund operating expenditures

11. In addition, it stresses the need to be transparent with the

need for reserves, their intended usage, and their targeted balance levels. From the external scan utilities interviewed, the following table denotes their individual approaches to reserves management:

Utility Reserves Approach Comments

City of St. Albert

• Maintain four separate reserves (one for each Utility)

• Reserve management practice is to ensure the net of all four reserves does not fall below zero

• Reserve management practice provides increased financial flexibility since all four are essentially treated as one

• Allowing individual reserve balances to fall below zero means individual utilities are not financially self-sustaining

City of Edmonton (Drainage Services)

• Retain end-of-year cash balances greater than the following year’s projected cash-financed capital expenditures

• Maintain Financial Stabilization Reserve to manage operating variability

• Ensures that cash-financed capital projects have sufficient funding and are not reliant on current year’s working capital

Strathcona County

• Creating an operating reserve to mitigate operating variability

• Maintain both a capital investment reserve and an sustainable infrastructure fund

• Final balances to be decided upon after completion of current financial plan exercise

9 City of St. Albert City Council Policy C-FS-01, “Financial Reserves, Schedule C5”, C181-2003

10 City of St. Albert, “Summary of Fiscal Policies, Practices and Policies”, January 2010

11 GFOA, “Appropriate Level of Unreserved Fund Balance in the General Fund (2002)”, Approved by the Executive Board,

February 15, 2002



City of Calgary

(Water Resources & Water Services)

• Target to retain 10% of annual utility revenues in combined operating & capital reserves to withstand operating contingencies

• Matches corporate fiscal policy and is aligned with GFOA guidance

City of Lethbridge

• Maintain 9-15% annual revenues in operating reserve to withstand rate fluctuations

• Do not maintain capital reserves (with exception of landfill)

• Caution that high reserve levels can be taken that management has over budgeted

• Budget based on “cash-needs basis”

City of Medicine Hat • Maintain capital reserve with current balances

between $5M-$6M

• Balances to be confirmed after completion of current COSS study

• Caution that municipality administration want to minimize reserve balances

Aquatera • Primary focus is cash flow from operations • Set up as a “for-profit” model

City of Airdrie

• Created $1M rate stabilization reserve to protect against rate hikes from City of Calgary

• Maintain capital reserves and contribute $300-$800k per year

• Rate stabilization reserve useful should Council not elect to pass on City of Calgary rate hikes to rate payers

• Contribute 2% of previous year’s capital asset value to capital reserves

City of Red Deer • Maintain both an operating and capital

reserve per utility

• Minimum operating reserve = 45 days of operations

• Maximum operating reserve = 45 days of operations + 12.5% of revenues

Halifax Water

• Targeting creation of operating reserves with 1-3% of annual operating reserves in balance

• Maintain separate capital reserve with developer charges only

• View is that GFOA recommendations are high for a utility which has a more predictable revenue stream

West Vancouver • Each utility has a combination operating /

capital reserve • In progress of determining required

reserve cash levels

Region of Peel

• Maintain working fund reserve at 5-10% of annual revenues

• Maintain separate capital reserves for each utility

• Capital reserve levels determined by 10-year capital plan

City of Ottawa

• Reserve fund balances should have a target balance equal to one year’s debt servicing costs for liquidity purposes

• Separate reserve for Water vs. Sewer

• Prepared 10-year financial plan

• Are planning to increase reliance on debt and want to retain good credit rating

Town of Markham • Focused on operating cash flows and

accumulated surplus vs. projected operating and capital requirements

• Prepared 6-year financial plan

• Forecast to operate at an annual surplus of ~ 15%

From review of the reserves management practices, the following key insights on best practices are:

i. Long-term capital and financial planning is a key requirement in ascertaining the sufficient capital reserve levels (used for capital asset acquisition or replacement);

ii. The most straightforward explanation for setting end-of-year reserve balances is to link it with following year’s projected expenditures to ensure sufficient liquidity;

iii. Where possible, a minimum amount is maintained in the reserves to avoid “overcharging” rate payers;



iv. It is easier to support long-term financial planning and more transparent to maintain individual reserves for each utility (with little additional administration costs required);

v. The majority of utilities maintain their own rate stabilization reserves (as opposed to shared reserves with their municipal owners) with target balances set mitigate rate revenue and operating fluctuations (e.g. reduction in variable rate revenues received due to decreases in consumption); and

vi. The majority of utilities closely monitor the actual amount of annual capital expenditure vs. budgeted in order to ensure that approved, allocated funds are spent as required / when required and to increase confidence in their forward-looking capital plans.

Utility Policy Recommendations 3. It is recommended that the Utility adopt practices to manage each utility reserve (i.e.

Water vs. Wastewater vs. Storm vs. Solid Waste) independently with the objective to ensure that each utility service line is financially self-sustaining.

4. It is recommended that each Utility Reserve address both “Rate Stabilization” and “Capital” component requirements sufficiently in order to further reinforce the objective that each Utility be financially self-sustaining. A minimum balance would need to be established to recognize variable rate stabilization or other operating requirements based on an evaluation of variability. This would also protect required contributions for capital expenditures should the Utility continue to be budgeted based on the “cash-needs basis”.

5. To promote transparency on target end-of-year balances and ensure sufficient cash

on hand, it is recommended that the end-of-year balances be targeted not less than the following year’s projected cash-financed capital expenditures.

4.1.4 Administration Fees Given the objective for the Utility to be self-sustaining, an annual revenue requirement included in the calculation of customer user rates is the corporate administration fee. This is intended to cover the “overhead” costs represented by the municipality’s shared services such as human resources, corporate communications, legal services, information technology services, financial services, etc. Recent administration fee costs are indicated as:

• 2011: $3,476,600 (actual)

• 2012: $3,799,200 (budget) The origins for how this administration fee is determined were originally developed in 2002-2005

12. An activity-based-costing (ABC) analysis was originally planned to

determine the specific administration costs which should be allocated to the Utility. Due to resource constraints, the full ABC analysis was abandoned in favor of developing a cost allocation method based on appropriate cost drivers and estimates based on interviews with department directors. Allocated costs were determined using this method in 2005, and in all future years it was determined based on proportional budget increases. During interviews with the internal subject matter experts, there were several questions in regard to the awareness and level of appropriateness of this cost allocation method.

12

Ed Kaemingh, “Utility Administration Fee Memorandum”, Nov. 5, 2012



Since this fee has been proportionally adjusted on a year-to-year basis, the basis for the original cost allocation model is not well known or communicated. A leading practice in this area was noted in the external scan. Several of the municipalities interviewed indicated that they have a shared services cost allocation model (similar to that developed by St. Albert in 2002-2005). However, they also use this model to determine the appropriate allocated costs on an annual basis based on actual changes to the unique cost drivers it specifies (e.g. headcount, number of computer terminals, etc.). In this way, the administration “shared services” costs are transparent and communicated to appropriate finance and utility-specific staff. From the external scan, the following administration fees as a percentage of the respective annual operating budget were noted:

*Data source: Publicly available financial documentation and employees of the respective municipalities.

As can be noted in the above table, the administration fee as a percentage of operating budget varies greatly across municipalities. This is largely due to the significant difference in the organizational make-up of each utility and the resulting costs each considers “administrative”. (For example, in one municipal utility they may consider engineering as an administrative cost, while in another they may have engineering “in-house” in the utility.) To fully understand the specific activities and respective costs included in each municipality’s “administrative fee,” a more purposeful activity based study would be required than that which was in scope of this study.

As a result, it is not practical to derive a quantitative benchmark from this data since we are not comparing “apples to apples.” Rather, it is more accurate to note the qualitative best practice that municipal utilities utilize appropriate cost drivers to accurately determine and pay an appropriate administrative fee.

Utility Typical Administration Fee*

(as a % of operating budget)

Comments

City of St. Albert 12% • Average of actual admin fees 2008-2012

City of Airdrie 20% • This represents both an administrative fee and a return – it was not further detailed

City of Edmonton (Drainage Services)

6% • Use a shared services cost allocation model to determine actual cost allocations on a yearly basis

Strathcona County 12% • Based on 2010 budget

Aquatera (Grande Prairie)

5% • Historic number - no longer provide administration fees to the City as they are now staffed completely separately

City of Halifax 7% • This amount includes admin and pension

City of Lethbridge 4% • Use a comprehensive cost allocation method

City of Medicine Hat 18% • Utility is provided an allocation from the municipality

City of Red Deer 3% • Activity-based cost allocation between departments

Region of Peel 17% • Comprehensive cost allocation method which includes an allocation of corporate overhead

City of West Vancouver

2% • Historically was set at 2%, now have frozen amount at 225k annually (which = 2% in 2012)



Utility Policy Recommendations 6. It is recommended that the administration fee calculation method be updated,

confirmed, and communicated based on appropriate cost drivers and value for money. Further, it is recommended that this method be used at appropriate time intervals as determined by St. Albert to determine appropriate administration fee costs to allocate to the Utility based on actual cost driver values.

4.2 Financing Techniques Based on the objectives to be financially self-sustaining and achieve rate stability, the focus on how the Utility funds both its operating and capital requirements becomes paramount. Based on the ongoing annual expenditures and planned investments identified in the approved 10-year capital plan, it is clear that a balanced financing approach will be required. In this section, relevant financing techniques are discussed and analyzed. These include cash financing, debt financing, and growth financing perspectives and implications to the Utility’s capital structure (i.e. debt to equity ratio).

4.2.1 Debt vs. Cash Financing Presently, the Utility has a no-debt policy. This requires that all operating and capital expenditures be paid for using available cash which include current revenues and reserves. The key underlying objectives for this practice is to minimize the total costs of expenditures (i.e. by avoiding debt interest charges) and maximize fiscal flexibility (i.e. it keeps credit ratings intact and preserves borrowing capacity). The challenge in maintaining this practice is managing rate stability. If no debt is permitted, capital projects must be paid for with available cash-on-hand or grant funding

13. This requires the Utility to “save up” for large, expensive capital projects.

Practically, this can only be achieved through raising rates in advance of the scheduled investments and saving these additional funds in the reserves. However, this would run counter to the key objective of achieving rate stability, as the 10-year forecasted capital plan now specifies $219.9 million to be spent and would be approximately triple the annual capital amount spent during the previous decade. In addition, a significant concern with this approach is its lack of intergenerational equity or its ability to support a “pay-as-you-benefit” policy for rate payers. If cash financing is used for long-lived assets, the current generation of rate payers bear the entire funding requirements. This effectively subsidizes future generations who pay nothing for the investment yet still realize the benefits provided by the asset. Conversely, advocates for debt financing can point to the benefit that it provides in supporting intergenerational equity. It accomplishes this by spreading the costs of expensive, long-lived assets over an appreciable portion of their useful life. This enables future generations who will also benefit from this investment to contribute financially through principal and interest costs. In speaking with internal stakeholders it was also noted that utilizing debt to finance large capital projects would allow for more prudent long-term capital planning. This would enable sufficient funding for larger rehabilitation or replacement projects that would provide a long-term “fix” (i.e. significantly increasing the useful life of a capital asset) instead of less costly projects that would provide a shorter-term “band-aid” solution. 13

Historically St. Albert has relied on grants (e.g. MSI, Federal Gas Tax, etc.) as an alternate source of revenue to finance capital expenditure. The previous “Grant Funding” section in this report explores in detail why this is not a suggested sustainable financing option.



In regard to setting policies for appropriate uses of debt vs. cash financing, industry research into general “winning conditions” was performed and identified in the Canada West Foundation’s sourcebook for the financing, funding, delivery of urban infrastructure

14. Specifically, it references appropriate financing mechanisms for the

following infrastructure investment situations:

Debt Financing Cash Financing

Pre-Project Stage Costs, i.e.

• Initial Project Identification, Assessment & Approval

• Project Design

Construction & Start-up Phase, i.e.:

• Construction & Installation

• Commissioning

Capital Replacement

Operations and Maintenance, i.e.:

• Operations

• Minor Maintenance

• Major Maintenance

• Rehabilitation

• Renewal

• Decommissioning & Salvage

In addition, the topic of cash vs. debt financing was discussed at length with the external scan utilities. The overwhelming majority of these utilities incorporate debt financing as a standard and strategic piece of their infrastructure funding approach. In general, their decisions to use cash financing vs. debt financing adheres to the following conditions:

i. Cash Financing:

• Used for annual operating costs and ongoing, predictable capital maintenance and reinvestment requirements (e.g. pipe repair and replacement programs) or less expensive capital investments which provide benefit for a relatively short period of time (e.g. construction equipment, computers, etc.).

ii. Debt Financing:

• Used for unique, expensive, and long-lived (i.e. beyond 10 years) capital investments (e.g. plant upgrades, reservoirs, pump stations, etc.)

Based on this approach for cash vs. debt financing and discussions with internal stakeholders in regard to specific types of projects which may be appropriate for debt, a scenario was run in the financial forecasting model with the following assumptions:

• Only unique (i.e. non-reoccurring capital reinvestments) projects of at least $10,000,000 or greater would be debt financed, which would include the following specific projects:

i. Water Utility: South Water Reservoir and Pump House ($39.1M);

ii. Water Utility: Sturgeon Heights Pump House Rebuild ($22.2M); and

iii. Wastewater Utility: Coal Mine Road Trunk Sewer ($12.1M).

• The debt term would be 25 years;

• The annual interest rate would be equal to 4%;

• Grant funding would be eliminated; and

• Projected offsite levy revenues would support paying off the debt principal for projects which would incur it (see section 4.2.4 Financing Growth).

14

Casey Vander Ploeg, “New Tools for New Times: A Sourcebook for the Financing, Funding, and Delivery of Urban Infrastructure”, September 2006



The results of this scenario are displayed below:

Scenario Total estimated 2013-2022 rate



(per household)*

2012 Actual Rate**

Debt financing

utilized $388.9 M $150.14

$111.41 Base Case $399.2 M $154.07

Difference - $10.3 M - $3.93 (-2.6%)


The result of this scenario reduces the total rate revenue requirement to $388.9 million (down $10.3 million as compared to the baseline scenario) and reduces the average total monthly rate to $150.14 (down $3.93 per customer per month as compared to the baseline scenario). Effectively, the combination of eliminating the planned usage of grants and utilizing debt financing for the three specific projects noted above result in almost the same level of revenue requirements for 2013-2022 as the baseline scenario.

With respect to the amount of the total monthly user rates, at an average value of $150.14 this would represent approximately 2.0% of the present median household income within St. Albert. This would remain approximately half a conservative industry benchmark

15 for rate affordability of 4%. With respect to comparing this rate against St.

Albert’s Capital Region neighbors, this rate would make it the most expensive (of the municipalities selected) based on 2012 rates. However, if a reasonable assumption can be made that each of the municipalities will increase their utility rates by a modest average of 2-3% (on top of inflation) per year over the next 10 years, then this rate would likely remain as being very competitive within the Capital Region. Although the estimated rate revenue requirements for 2013-2022 are not significantly different than those estimated in the Base Case scenario which assumes current financial management practices, this scenario is based on more sustainable funding practices and improves the likelihood that funding can be obtained when to execute the large

15

Gregory Baird, “Water Affordability: Who’s Going to Pick Up the Check?”, American Water Works Association Journal, December 2010

$155.76$141.69

$123.44

$171.77$157.15 $154.37

$127.60

$180.35

$151.16$138.13

$-

$50.00

$100.00

$150.00

$200.00

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Estimated Rates Requirement (avg per customer per month)

Water Wastewater Storm Solid Waste



infrastructure projects. It also should be noted that given municipal debt limit preferences and specific project funding requirements, the Utility may consider using debt for additional capital projects below the $10M threshold assumed in this scenario.

Utility Policy Recommendations 7. It is recommended that Utility debt finance capital projec

standing committee on finance agenda...

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