February 10, 1998

TO: Special Committee to Review the Final Report of the Toronto Transition Team

FROM: Chief Financial Officer & Treasurer

City Solicitor

SUBJECT: TORONTO TRANSITION TEAM - FINAL REPORT

(RECOMMENDATION 110)

Purpose:

The purpose of this report is to respond to the request of City Council for clarification of the implications of adopting Recommendation 110 of the final report of the Toronto Transition Team concerning proposed amendments to the Toronto District Heating Corporation (TDHC) Act.

Funding Sources, Financial Implications and Impact Statement:

Present financial arrangements with the TDHC do not provide for timely repayment to the City of an existing $30.6 million loan. The amendments recommended by the Transition Team to the TDHC Act have not been supported by business plans to the satisfaction of City Works, Legal and Finance staff. Such amendments could jeopardize the repayment of the existing loan if care is not taken to give precedence to this loan in any future legislation. Future changes to the legal authority of the TDHC with respect to borrowing powers or service mandate must protect the interests of the City of Toronto. Further information with respect to TDHC business plans is required for a full evaluation of the impact of proposed legislative amendments.

Recommendations:

It is recommended that:

1) The TDHC be requested to submit business plans to the Chief Financial Officer and Treasurer of the City of Toronto to support the proposed expanded mandate of the TDHC, encompassing heating, cooling and co-generation, with such business plans to be the subject of a further report to the Strategic Policies and Priorities Committee;

2) In conjunction with recommendation 1, above, and before any legislative amendments, the TDHC be required to enter into a revised agreement to fully repay the existing $30.6 million loan, such agreement to be the subject of further review by the Strategic Policies and Priorities Committee;

3) The Province of Ontario be requested to ensure that any change to the TDHC Act require as a condition precedent an agreement satisfactory to the City for the repayment of debt that predates the legislative amendments and that until the City is no longer required to guarantee the long-term debt of the TDHC, no debt for capital purposes be issued without the express approval of the City of Toronto and title for property utilized by the TDHC rest with the City until all debt owed to the City is repaid;

4) A request of the former City of Toronto to the TDHC be reiterated, requesting the TDHC to recommend required changes to the composition of the TDHC Board to fulfil the proposed mandate of the Corporation.

Council Reference/Background/History:

In their final report entitled New City, New Opportunities the Toronto Transition Team recommended the following:

Recommendation 110:

Council should request the Province to amend the Toronto District Heating Corporation (TDHC) Act to include heating, cooling, co-generation and its associated by-products, and to clarify that it has full title to its property;

Council should appoint new members to replace the existing political members on the Corporation's board.

At its meeting of January 2, 6, 8 and 9, 1998, City Council adopted the following motion:

Recommendation 110 of the final report of the Toronto Transition Team not be adopted on an interim basis but be referred to the Special Committee to Review the Final Report of the Toronto Transition Team for consideration; and that the Chief Financial Officer & Treasurer and the Interim City Solicitor be requested to submit a joint report to the Special Committee on the implications for the new City with regard to such recommendation.

In order to determine the implications of the recommendation, it is necessary to review the current mandate of the TDHC, its financial position and the potential impact of proposed changes in legislation on the City, including effects on the City's environment, finances and strategic plan.

Discussion:

TDHC Mandate:

The Toronto District Heating Corporation Act (the Act) authorizes the Corporation to operate, maintain, extend, replace and manage steam plants and facilities within the City of Toronto for the purpose of supplying steam to users. The Corporation is not deemed to be a local board of the City, except for the purposes of the Ontario Municipal Employees Retirement System. However, the TDHC may only borrow for operating purposes if repaid within the year and for capital purposes with the approval of the City. It has the power to independently purchase steam from and trade steam with other suppliers of steam. It also has the power to carry on any other business capable of being conveniently carried on with the business of the Corporation or likely to enhance the value of or make profitable any of the property or rights of the Corporation. Notwithstanding this fairly general wording in the Act, the business of the Corporation has been legally determined to be restricted to steam related ventures under current legislation. The steam requirements of the hospitals have priority under statute over any other users of steam supplied by the Corporation. Other users include over one hundred buildings in the City's downtown core, including most recently the Metropolitan Toronto Convention Centre.

The TDHC was created as a separate corporate entity by statute in 1982 and was preceded by the Toronto Hospitals Steam Corporation from 1968 to 1982. It is overseen by a Board of Directors of ten members, four of whom are appointed by the City, two by the Hospitals, two by the Province of Ontario and two by the University of Toronto. Five directors constitute a quorum at meetings of the Board and a Chair is elected by the directors from among the persons appointed to the board by the City. The Board may appoint a vice-Chair, and it has the power to make by-laws governing its proceedings and generally deal with the management of the affairs of the Corporation.

In the context of the amalgamation of the six Municipal Hydro Utilities within the former municipality of Metropolitan Toronto, a report was received by the Toronto Transition Team from consultants hired to advise on hydro related issues. Appendix A provides an excerpt of the consultants' report as it pertains to the TDHC. The entire document is on file in the City Clerk's office. Entitled Final Report and Recommendations Concerning the New Toronto Hydro Electric Commission and Related Issues, it recommends supplementary legislation to provide for the transfer of the R.L. Hearn Generating Station to the TDHC and the reorganization of the TDHC's enabling legislation to permit it to operate on a more commercial basis. The reason provided for not recommending transfer of that facility to the new Toronto Hydro Electric Commission is that the Province of Ontario White Paper, Direction for Change: Charting a Course for Competitive Electricity and Jobs in Ontario, appears to prohibit the Hydro Commission from owning such a substantial generating facility. The President of the TDHC has indicated that the Corporation is supportive of the transfer of the R.L. Hearn Generating Station, as referenced in the consultants' report.

According to the consultants, the R.L Hearn Generating Station has been mothballed for some time. Their report does not address the financial investment required to convert the present facility into a revenue producing co-generation facility. It should be noted that in the new direction of district cooling, the Hydro Commission has proposed a project for the City which is in direct competition with a joint proposal of the TDHC and the former Metro Works department. There is no specific mention in the consultants' report of the use of district cooling technology by the Hydro Commissions or related strategies, but there is general reference to the desire for powers to enter into activities beyond the electricity area.

TDHC has been the subject of numerous reports to the former City of Toronto Council in early 1995 and more recently in the autumn of 1997, concerning the merits of proposed legislative changes to broaden the mandate and the financial flexibility of the corporation and clarify land title. Changes requested include a name change to the Toronto District Heating and Cooling Corporation, full title to property holdings, the power to issue debt independently from the City for capital purposes on the sole credit of the TDHC and the power to require developers to install district heating and cooling infrastructure. A number of sensitive issues are raised, and it is clear that great care should be taken before endorsing such basic changes to enabling legislation.

The separate corporate status of the TDHC limits the power of the City to influence legislative changes that may not be in the City's best interests. However, to date the City has monitored progress of discussions concerning potential legislative amendments. The main theme of the City staff reports has been that any changes in the TDHC's legal status must adequately protect the interests of the City, financially and otherwise.

Financial Position:

Appendix B illustrates the operating position of the TDHC over the past five years. After annual contributions of approximately $1.1 million to reserves for future capital asset replacement, major maintenance and repair, the Corporation has consistently maintained a small positive net income position. The balance in the capital reserves was $2,481,174 at December 31, 1996.

The audited 1996 financial statements of the former City of Toronto note that at December 31, 1996 the TDHC had an unpaid loan balance of $30.6 million payable to the City of Toronto. This loan is for the "Integration Project" which entailed construction of a system to integrate steam plants and steam distribution systems owned or operated by the Province of Ontario, the TDHC, Toronto Hydro and the University of Toronto.

Debentures in the amount of $16.4 million were issued for this project in May 1985 and were fully repaid by the City of Toronto on behalf of the TDHC by May 1995. The full cost of the Integration Project was $17.2 million, which is owed to the City by TDHC plus accrued interest. The value of the loan is made up as follows:

Due to City of Toronto As of July 31, 1990

Net proceeds from sale of density rights (6,458,064)

Since July 1990, the principal amount owing has been frozen, and the TDHC has been paying annual amounts in accordance with an agreement. These annual payments fall short of the interest accruing each year calculated using short-term interest rates. The difference in unpaid interest is forgiven each year. In the ten years ending December 31, 1996, a total of $8.3 million in interest payments had been formally forgiven, with additional foregone interest based on long-term interest rates which would normally apply. The agreements also provide for contributions from extraordinary gains, windfall profits or sale of assets towards the repayment of the debt. At December 31, 1997, the balance of the loan remains unchanged at $30.6 million.

According to the agreement, annual payments of $725,000 are due until December 2001, and $1,239,000 each year thereafter until the loan is fully repaid. At that rate, no principal is expected to be repaid for at least another thirty years, with full repayment taking much longer. Such loan repayment terms can be characterized as financial relief in view of an inadequate revenue stream and should not be considered a long-term debt repayment arrangement under an enhanced mandate for the Corporation. Revenue enhancement is the solution. The question is how this is best achieved.

The property holdings of the corporation serve as collateral for the loan. It is therefore important that these same properties not be used as the underlying credit for new, independent ventures to the extent that they are required to secure present loans. In previous reports, the former City Solicitor has raised concerns that if legislation is changed to clearly attribute title of all TDHC associated property to the TDHC, and at the same time repeal Section 17(2) of the TDHC Act which outlines the current purposes of the corporation including the obligation to repay sums raised by loans or debentures of the Corporation, the net effect would be the elimination of the TDHC debt to the City. Clearly, this would not be a desirable result of legislative change to broaden the mandate of the TDHC, but it serves to outline the risks of speedy endorsement of vaguely worded recommendations.

To date there has been no response to requests for a business plan to support the broader mandate requested by the TDHC. A business plan was requested in January 1995 to support the range of new activities requested by the TDHC and again in September 1997, specifically regarding the district cooling initiative. Business plans are required to conduct an evaluation of the financial exposure presented by new projects. This is impossible to do without business plans which include information on required capital and operating costs, financing, marketing, price structure and profitability. The response to date from the TDHC has been a request for legislative change to allow them to borrow for capital purposes (i.e., issue debentures) on their own credit secured by a mortgage on the new facilities and backed by the revenue stream expected from the projects. This "project financing" arrangement could be accomplished without legislative change if the City were willing to accept the risk of project failure.

Project financing arrangements are relatively new to Canada, but have been used quite commonly in Great Britain in recent years with mixed success. The key to their success is a sound, detailed business plan which ensures a secure client base and revenue flow unencumbered by market pressures from alternative service options. Insufficient facts are available to do the required risk analyses on proposed TDHC ventures.

Project financing has been reviewed by Metro staff in the recent past as a potential approach to financing capital projects. Investment dealers are quite eager to launch such projects in Canada. The fixed link to P.E.I. is one example. However, any serious contemplation of this option must consider the public expectation that where the City is an approval agent a potential moral obligation exists to make the investor whole in times of weak project revenue flows. For example, if road tolls are insufficient to repay the debt, should the City taxpayers bear the shortfall to ensure the success of the project rather than default on payment to those who originally invested in the project? While the City would not be responsible legally, its credit rating might suffer by association. The credit rating agencies have not assured us that the City's credit would be protected in such cases. Therefore, there is a risk that the City's cost of borrowing could increase for all City purposes, in the event of a failed TDHC venture where the City had approved the venture, regardless of whether the City had guaranteed the debt on a specific project or not.

Alternatively, if the TDHC wishes to be completely independent from the City to operate as a utility with the legislative authority to issue debt on its own credit, without recourse to the City, it would be important to make satisfactory arrangements for the immediate repayment of the existing loan. Title to properties used for TDHC purposes could be transferred to TDHC, to in turn allow the Corporation to issue debt to pay off the loan. Insufficient information concerning TDHC business plans is available to assess the advisability of this course of action, (i.e., the ability of the TDHC to assume full responsibility for existing debt and planned new ventures on its own).

A hybrid arrangement where the City guarantees some but not all TDHC debt is not recommended.

Environmental Impact:

Previous reports from the Works Commissioners of both the former City of Toronto and Metro attest to the desirable environmental impact of moving in the general directions proposed by the TDHC regarding heating, cooling and co-generation. The main issues in dispute relate to the financial protection of the City with respect to past and future debt and the legal relationship required to ensure that protection.

TDHC Board Membership:

Under current legislation the City is authorized to appoint four members of the ten member Board. Of these four members, at least one must be a representative of a user of steam purchased from the Corporation, other than the Hospitals, the City, the University or the Province of Ontario.

By its adoption, as amended, of Clause No. 1 of Report No. 1 of The Striking Committee, headed "Appointment of Members of Council to Standing Committees, Other Committees and Task Forces, Special Purpose Bodies and Special Positions", Council on January 2, 6, 8 and 9, 1998, reappointed Councillor Adams to the Board, and appointed Councillors Bossons and Fotinos.

By its adoption, as amended, of Clause No. 4 of Report No. 1 of The Special Committee to Review the Final Report of the Toronto Transition Team, headed "Interim Policy for Citizen Appointments", Council on February 4, 5 and 6, 1998 included the one remaining appointment (the representative of the steam users) to the list of citizen appointments that the City Clerk is authorized to proceed with through the Nominating Committee process.

The former City of Toronto had previously requested the TDHC to make recommendations to the new City of Toronto as to whether the legislated composition of the Board should change to support the proposed mandate of the TDHC. City Council may wish to reiterate this request.

Conclusions:

In the absence of detailed business plans from the TDHC, it is impossible to assess the full impact of Transition Team Recommendation 110. The issues are complex and the risks of inadequate attention to the ramifications of legislative change are potentially great. However, the promise of environmentally safe and energy efficient means of heating, cooling and power generation is also great, if the benefits can be determined to equal or outweigh the costs. The natural competition which exists between the Hydro Commission and the TDHC should be recognized in future evaluations of energy options. There may be opportunity for joint ventures or pricing strategies. To move this matter forward, it is worth repeating earlier requests made by the former City of Toronto to the TDHC for business plans to support the proposed expanded TDHC mandate, and a viable debt repayment strategy for the current loan of $30.6 million under a new mandate. Decisions on land title must ensure the successful repayment of the current loan and/or future TDHC debt guaranteed by the City. Finally, Council may wish to request recommendations from the TDHC on legislative amendments required to the composition of the Board to fulfil the proposed mandate of the Corporation.

Contact Name and Telephone Number:

Louise Eason Mary Ellen Bench

Finance Department Legal Services Department

392-8065 392-7245

W.A. Liczyk H.W.O. Doyle

Chief Financial Officer City Solicitor

& Treasurer

(A Report to the Toronto Transition Team from Consultants on Hydro Matters)

Regarding the recommendation to transfer ownership of the R.L. Hearn Generating Station from Ontario Hydro to the Toronto District Heating Corporation ("TDHC") for its redevelopment into a source of electricity and heat with reduced environmental impacts and long term capital cost savings for the Toronto Hydro Electric Commission (THEC):

This particular recommendation is not, strictly speaking, necessary to complete the Municipal Electric Utility (MEU) amalgamation process. It is, however, necessary to prevent the possible loss of use for co-generating purposes of a highly desirable site within the City of Toronto.

The main attraction of such a dual purpose redevelopment is its very high efficiency resulting in more effective use of fossil fuels. This, in turn, benefits the community through:

R.L. Hearn has not been seen as particularly valuable as a conventional generating station but it is a unique facility in that it has all the necessary approvals for its use as a generating station at its present location. It also has an existing connection to the transmission system

with significant electrical capacity which would be very difficult and expensive to provide elsewhere in an urban environment.

While these advantages have been recognized for many years, three organizations that might have been expected to realize them in the public interest--Ontario Hydro, Toronto Hydro, and TDHC--have failed to find a way to work together to do so. Given the enhanced competition to be created by the White Paper, these three parties are even less likely to work without rivalry in the near future. The formation of the new City of Toronto at a time when massive changes are occurring in the electrical industry provides an ideal opportunity to realize this potential as a benefit of municipal amalgamation.

While it might appear more logical to transfer the plant to THEC rather than to TDHC, the White Paper appears to prohibit THEC from owning such a substantial generating facility.

The price of the transfer to TDHC should be at fair market value, to be determined by negotiation between the parties, and failing agreement by the parties, by binding arbitration. The other terms and conditions of the transfer should generally be in accordance with the Municipal Utility Boundary Extension Act (Bill 185) which provides for transfer with all associated staff, inventory, tools and equipment. Since the purpose of the transfer is for community betterment, several conditions should be put on the transfer as follows:

APPENDIX B

TORONTO DISTRICT HEATING CORPORATION

STATEMENT OF OPERATIONS

YEAR ENDED DECEMBER 31