STANDING COMMITTEE ON FINANCE AGENDA REPORT

STANDING COMMITTEE ON FINANCE AGENDA REPORT Subject: ELECTRICITY & NATURAL GAS FRANCHISE FEES Recommendation(s): Administration recommends that the Standing Committee on Finance pass one of the following motions and recommend to Council on May 27, 2013: 1. That the Standing Committee on Finance recommends that Council maintains the status quo with no changes to electrical and natural gas franchise fees. OR 2. That the Standing Committee on Finance recommends that Council implement an electrical franchise fee of 20% and increase the natural gas franchise fee rate from 18.8% to 30% effective January 1, 2014 to offset cost increases in operating budget. To minimize the potential added costs to residents, non-profit and charitable organizations, Administration is directed to develop a Energy and Water Conservation Fund and report back on June 24, 2013. This fund is to provide rebates on utility appliances such as furnaces, hot water heaters, toilets, washer and also fund energy audits and improvements to reduce energy consumption. OR 3. That the Standing Committee on Finance recommends that Council develop a policy to reposition the revenue structure for the City using franchise fees to offset the cost increase of the base budget effective January 1, 2014. To minimize the potential added costs to residents, non-profit and charitable organizations, Administration is directed to develop a Energy and Water Conservation Fund and report back on June 24, 2013. This fund is to provide rebates on utility appliances such as furnaces, hot water heaters, toilets, washer and also fund energy audits and improvements to reduce energy consumption. City Council Agenda March 11, 2013/Page 1 File No.: 167-S2-2013

Legislative History: Electrical Franchise Fee: The City s current franchise agreement was signed in 2002 with Utilicorp Networks Canada (Alberta) Ltd. (now FortisAlberta ) and approved by Bylaw 31/2001 on April 2, 2002. The electrical franchise fee is currently set at 0%. Natural Gas Franchise Fee: On May 3, 2011 the agreement with ATCO was renegotiated and ratified by Council (Bylaw 45/2010) and included a franchise fee rate of 18.8%. Report: Finding new sources of revenue to fund services and capital requirements is a continuing challenge for City of St. Albert and other Alberta communities. Franchise fees are a user based alternative to property taxes that could be part of the answer to this dilemma. This report and Attachment 1 examine franchise fees and explore the merits and options to address this concern. Background A franchise agreement is a written agreement between a municipality and a utility that grants the utility an exclusive right to construct, operate and maintain a utility distribution system within the municipality. Franchise fees are a part of this agreement and are charged by the municipality to the company for: The exclusive right to operate the utility within the municipality Use municipal rights-of-way Compensation for the loss of taxable property due to utility corridors Franchise agreements are common throughout Alberta communities. The AUMA provides template agreements that are used by most communities in Alberta to negotiate franchise agreements with utilities. St. Albert currently has franchise agreements in place for electricity and natural gas: The natural gas agreement includes an active franchise fee, currently set at 18.8%. The rate can be changed but is capped at 35%. Standing Committee on Finance Agenda March 11, 2013/Page 2 File No.: 167-S2-2013

The electrical franchise agreement includes language providing for a franchise fee but the rate is currently set at 0%. The rate can be changed to the new agreement cap rate at 20%. The AUMA is negotiating a new electrical franchise agreement template and is currently seeking feedback from municipalities. The pending agreement template raises the franchise fee cap to 20%. Franchise Fees in Alberta Municipalities Surveys of Alberta communities provided by FortisAlberta and ATCO Gas and Pipelines indicate the following: Electrical Franchise Fees: 105 of 141 surveyed communities have franchise fee rates set at greater than 0%. Rates range from 3% to 35% and only 36 have rates set at 0%. Of 23 communities with populations above 10,000 only four have franchise fee rates set at 0% (St. Albert, Medicine Hat, Fort Saskatchewan, Chestermere). City of St. Albert is the only municipality in Alberta with population of 60,000+ not charging electric franchise fees. Natural Gas Franchise Fees: In a listing of 160 communities, rates range from 0.9% to 40%. Of the 23 communities with populations greater than 10,000 the average franchise fee rate is 21.74%. There are four communities roughly the size of St. Albert (Red Deer, Lethbridge, Grand Prairie, Airdrie) and rates in these cities range from 29.4% to 37.7% averaging 33.13%. The preceding data indicates that franchise fees are an under-utilized revenue source in City of St. Albert relative to other Alberta communities. Potential Benefits of Franchise Fees: 1. Provincial and regional consistency would be enhanced; 2. A reliable and growing revenue stream would allow the City to either: a. Re-position the City s revenue structure allowing for future property tax increases to be minimized. b. Use increased revenue to provide funding to important programs and services. 3. A user-pay system has a number of economic benefits compared to traditional property taxation; Standing Committee on Finance Agenda March 11, 2013/Page 3 File No.: 167-S2-2013

4. Franchise fees allow the City to receive compensation for loss of taxable property and granting exclusive right of way access; 5. A user-pay system also has non-economic benefits such as the encouragement of conservation; and 6. Franchise fees are supported by the City s provincial association and are not considered a tax. 7. Tax exempt property owners that benefit from municipal services would contribute to the City s revenues. Potential Drawbacks of Franchise Fees: 1. Consumer utility bills would be affected. Generally, light and moderate utility users would experience savings from tax reductions. Heavy users of electricity and natural gas would experience cost increases; and 2. Institutional and not-for-profit facilities would not realize the benefit of minimized tax increases. 3. The data from Fortis shows that the $4.29 million franchise fee revenue breaks down as follows: Residential $ 2,624,995 61.2% Non-Residential $ 1,663,975 38.8% Using this revenue to reduce the existing tax bases would affect the existing property tax split between residential and non-residential as indicated in the following chart. After Current Franchise Fee Residential 82.5 83.8 Non-Residential 17.5 16.2 This would not be recommended as the City s current policy is to lock the tax split so that it can never reduce from its existing split regressively. Financial Implications: Franchise fee revenue has the potential to significantly impact City finances. The following charts indicate the revenue that could be generated at various fee rates for both electrical and natural gas franchise fees and the related impact on property tax rates: Electrical Franchise Fees: Standing Committee on Finance Agenda March 11, 2013/Page 4 File No.: 167-S2-2013

3% Fee $ 643,345 Approximate 0.87% tax equivalent 5% Fee $ 1,072,242 Approximate 1.44% tax equivalent 8% Fee $ 1,715,587 Approximate 2.31% tax equivalent 10% Fee $ 2,144,484 Approximate 2.89% tax equivalent 15% Fee $ 3,216,725 Approximate 4.33% tax equivalent 20% Fee $ 4,288,967 Approximate 5.77% tax equivalent *Based on 2012 property taxes Natural Gas Franchise Fees: Note that the natural gas franchise fee rate is currently set at 18.8%. The amounts indicated in the following chart show the impact beyond the current rate. 20.0% Fee $ 147,290 approximately 0.20% tax equivalent 25.0% Fee $ 761,000 approximately 1.02% tax equivalent 30.0% Fee $ 1,374,710 approximately 1.85% tax equivalent 35.0% Fee $ 1,988,420 approximately 2.68% tax equivalent *Based on 2012 property taxes Analysis indicates that the impact on residential electricity bills would be minimal and the increase in electricity costs due to a franchise fee would be more than offset by an accompanying reduction in property taxes. The following chart shows the effect on electricity bills from a selection of possible franchise fee rates. Impact on Utility Rates - Residential Residential Selected Franchise Fee Amounts Usage Estimate 3% Monthly 5% Monthly 8% Monthly 10% Monthly 15% Monthly 20% Monthly Low use 417 kwh $1.12 $1.87 $2.99 $3.74 $5.60 $7.47 Mid use 625 kwh $1.38 $2.30 $3.67 $4.59 $6.89 $9.18 High use 833 kwh $1.63 $2.72 $4.36 $5.45 $8.17 $10.89 Impact on Utility Rates - Non-Residential Non-Residential Selected Franchise Fee Amounts Usage Estimate 3% Monthly 5% Monthly 8% Monthly 10% Monthly 15% Monthly 20% Monthly Restaurant 36,500 kwh $45.62 $76.04 $121.66 $152.08 $228.12 $304.16 Industrial 182,500 kwh $225.69 $376.15 $601.85 $752.31 $1,128.46 $1,504.62 However, to reposition the City s revenue structure in order to align with provincial/regional practices and to minimize tax increases, the City could implement franchise fees and apply franchise revenue to offset property tax increases. Standing Committee on Finance Agenda March 11, 2013/Page 5 File No.: 167-S2-2013

Options The following three options should be considered: 1. Maintain status quo with no changes to electrical and natural gas franchise fees. This option leaves the revenue sources intact with no changes to be communicated to tax payers and utility customers. On the other hand, this does not address the City s inconsistency in revenue structure. With a heavier reliance on property tax, the City has held the highest or second highest property tax position among comparable municipalities. It forgoes an opportunity to utilize additional revenue sources that would help alleviate the fiscal pressure on taxpayers, particularly residential taxpayers. 2. Implement an electrical franchise fee of between 15% and 20% and increase the natural gas franchise fee rate from 18.8% to 30% to offset cost increases in operating budget. Introducing an electrical franchise fee and increasing the current natural gas franchise fee rate allows the City to broaden its revenue base and reduce the reliance on property taxes. This is consistent with other Alberta municipalities, most of which have franchise fees in place and are augmenting their revenue base with income from these sources. With this additional revenue the City would have the option of minimizing future property tax increases thereby helping to address St. Albert s high tax reputation. Alternatively, additional funding could be allocated to key programs and services. The cost impact to most utility customers is minimal and payers would not be subject to the market fluctuations of energy commodity prices because franchise fees are based only on delivery costs. They would also have more control over costs relative to property taxes and franchise fees have the added benefit of encouraging conservation of electricity. A franchise fee is not a tax, a position that is supported by the AUMA and AUC. Consumer electricity and natural gas bills would be affected. Although the impact on residences and most small businesses would result in moderate savings, heavy energy users would see more of a cost increase. Institutional and not-for-profit facilities would also bear a cost increase without the property tax relief should the City choose to offset franchise fee revenue by reducing future property tax increases. 3. Develop a policy to reposition the revenue structure for the City using franchise fees to offset the cost increase of the base budget. This allows the City to formalize a plan to begin the process of changing the current revenue structure and take advantage of alternative revenue Standing Committee on Finance Agenda March 11, 2013/Page 6 File No.: 167-S2-2013

sources. The majority of Alberta communities are already using franchise fees to a greater degree than St. Albert which helps to explain why St. Albert tax rates are higher than most of the comparable municipalities. Franchise fees can be used to offset the cost increase of the base budget while reducing or even eliminating property tax increases and still maintaining current levels of service. This process provides the opportunity for a dialogue to address stakeholder issues and gradual implementation of the initiative. 4. To offset the potential added costs to residents, non-profit and charitable organizations, it is recommended that a Energy and Water Conservation Fund be developed. This fund is to provide rebates on utility appliances such as furnaces, hot water heaters, toilets, washer and also fund energy audits and improvements to reduce energy consumption. And costs in the long term. This fund would especially help seniors and young couples who live in the older parts of St. Albert. For non-profits and chartable organizations which would be affected by increase in utility bills without offset tax savings, this fund will provide them financial support to conduct energy audits and improvements to reduce utility consumptions and costs. Legal Implications: The Municipal Government Act permits municipalities the right to impose a Franchise Fee. Franchise agreements currently exist between the City and FortisAlberta (electrical) and ATCO Gas and Pipelines Ltd. (natural gas). With Council s approval the City can adjust the franchise fees within the terms of those agreements. Report Date February 19, 2013 Originating Department Financial Services Prepared by: Stephen Graham Approved by Anita Ho City Manager Review Patrick Draper Standing Committee on Finance Agenda March 11, 2013/Page 7 File No.: 167-S2-2013

Franchise Fees

Purposes To minimize property tax increases while maintaining the City`s fiscal sustainability To identify alternative revenue sources to sustain services and fund future growth This report examines franchise fees and explores the merits and options of franchise fees to help address this concern 2

Franchise Agreements A common tool used by many municipalities across the province, supported by AUMA and others. Signed with utility companies to build, own, operate and maintain the local distribution system. Municipal Government Act s. 45(2), 61(2) and 360 provide legal authority. Franchise fees are identified within the agreement, charged to the company for the right to use municipal rights-of-way and as compensation for the loss of taxable property due to utility corridors. 3

Franchise Fee Benefits City receives compensation for loss of taxable property due to granting exclusive right of way access. Consistency is enhanced municipal revenue structure. User pay systems with economic and non-economic (i.e. conservation) benefits compared to property taxation. A reliable and growing revenue stream would allow the City to either minimize future tax increases or enhance programs and services. Franchise Fees are supported by the AUMA and are not considered a tax. Tax exempt property owners that benefit from municipal services would contribute to the City s revenues. 4

Franchise Fee Drawbacks Institutional and not-for-profit facilities would not receive the benefit of minimized tax increases. The franchise fee would add costs to heavy utility users. Application of franchise fee revenue to offset tax increase would contradict to City s current policy is to lock the tax split so that it can never reduce from its existing split regressively. 5

Electrical Franchise Fees History in St. Albert 1928 agreement with Calgary Power Ltd. - to supply electricity with incorporating a franchise fee. Sept. 2001 Council resolved 8% franchise fee accompanied by a corresponding reduction in property tax. Decisional reversal after a change in Council. 2002 to now, a franchise agreement with FortisAlberta with 0% franchise fee. 6

Electricity Franchise Fee Calculation Calculated as a percentage of the company s transmission and distribution gross revenue. AUMA agreement provides a fee ceiling of 15% without seeking the Alberta Utilities Commission s approval. AUMA currently drafting a new agreement proposing a fee ceiling of 20% Change in franchise fees requires 45-60 days notice 7

Electrical Franchise Fees in Alberta Electrical franchise fees are common throughout Alberta A survey of 141 Alberta communities indicates that 75% have an electrical franchise fee > 0% Of the 23 surveyed communities with populations greater than 10,000 only four have a franchise fee of 0% (St. Albert, Fort Saskatchewan, Chestermere, Medicine Hat) Franchise fees range from 5% to as high as 35% Some communities have more complex franchise fees based on a combination of distribution and consumption revenues 8

Electrical Franchise Fees Potential Revenue Impact 3% Fee $ 643,345 approximately 0.87% tax equivalent 5% Fee $ 1,072,242 approximately 1.44% tax equivalent 8% Fee $ 1,715,587 approximately 2.31% tax equivalent 10% Fee $ 2,144,484 approximately 2.89% tax equivalent 15% Fee $ 3,216,725 approximately 4.33% tax equivalent 20% Fee $ 4,288,967 approximately 5.77% tax equivalent 9

Electrical Franchise Fees Residential Property Tax Rates 10

Electrical Franchise Fees Residential Property Tax Rates Residential Tax Rates 2012 with Electrical Franchise Fee 14.0000 12.0000 10.0000 Education Municipal Municipal mill rate for St. Albert reflects a reduction of 5.77% based on a 20% Electrical Franchise Fee St. Albert Municipal Mill Rate 7.2770 Mill Rates 8.0000 6.0000 4.0000 2.0000-11

Electrical Franchise Fees Non-Residential Tax Rates 12

Electrical Franchise Fees Non-Residential Tax Rates 13

Impact on Electrical Bills Impact on Utility Rates - Residential Residential Selected Franchise Fee Amounts Usage Estimate 3% Monthly 5% Monthly 8% Monthly 10% Monthly 15% Monthly 20% Monthly Low use 417 kwh $1.12 $1.87 $2.99 $3.74 $5.60 $7.47 Mid use 625 kwh $1.38 $2.30 $3.67 $4.59 $6.89 $9.18 High use 833 kwh $1.63 $2.72 $4.36 $5.45 $8.17 $10.89 Impact on Utility Rates - Non-Residential Non-Residential Selected Franchise Fee Amounts Usage Estimate 3% Monthly 5% Monthly 8% Monthly 10% Monthly 15% Monthly 20% Monthly Restaurant 36,500 kwh $45.62 $76.04 $121.66 $152.08 $228.12 $304.16 Industrial 182,500 kwh $225.69 $376.15 $601.85 $752.31 $1,128.46 $1,504.62 14

15 Impact of Electrical Franchise Fee

History in St. Albert Natural Gas Franchise Fees 1950 agreement with ATCO, renewed in 1971 and 1983 granting an exclusive right to construct, operate and maintain a gas distribution system. 2006 a new agreement with franchise fee of 5.26% 2001 renegotiated agreement and included a franchise fee rate of 18.8% 16

Franchise Fee Calculation Calculated as a percentage of the company s gross delivery revenue. AUMA agreement provides a fee ceiling of 35% without seeking the Alberta Utilities Commission s approval. Change in franchise fees requires 45-60 days notice 17

Natural Gas Franchise Fee in Alberta City current fee is set at 18.8%. 159 Alberta communities with a natural gas franchise fee ranging from 0.9% to 40%. Of the 23 surveyed communities with populations greater than 10,000, the average franchise fee rate is 21.74% Franchise fees in municipalities of similar size (population from 45,000 to 95,000) ranging from 29.4 to 37.7% Potential to increase franchise fee 18

Natural Gas Franchise Fees Potential revenue impact from additional franchise fees: $1,897,241 at 18.8% in 2013 budget from 18.8% to 30% - additional $1,374,710, approx. 1.85% tax equivalent 19

Impact of Increase in Natural Gas Franchise Fee 20

Options 1. Maintain status quo with no changes to electrical and natural gas franchise fees 2. Implement an electrical franchise fee of between 15% and 20% and increase the natural gas franchise fee rate from 18.8% to 30% in place of tax increases 3. Develop a policy to reposition the revenue structure for the City using franchise fees to offset the cost increase of the base budget 4. Set up a Energy Conservation Fund to assist residents, non-profit and charitable organizations to reduce energy consumption and costs. 21