March 22, 1999

To: Budget Committee

From: Chief Financial Officer and Treasurer

Subject: Harmonization of Water and Water Pollution Control Rates

Purpose:

This report, in conjunction with the Background Study attached as Appendix "A", presents a review of the current practices and rate structure respecting the water and wastewater program, and recommends a strategy towards a harmonized rate structure across the new city.

Funding Sources, Financial Implications, and Impact Statement:

The harmonization strategy recommended in this report continues to provide full funding for the water and wastewater operations through the water and sewer rates. As such, the property tax supported budget is not impacted.

However, due to the significant variations that exist in the current rate structures, the implementation of any harmonization strategy will cause shifts in the revenue collected between the former municipalities and between customer classes. It is revenue neutral for the City as a whole. The recommended competitive rate strategy described under Option (3) of this report provides for a harmonized rate across the City, encourages water conservation, and ensures competitive pricing for the City’s commercial and industrial base.

Recommendations:

It is recommended that:

Council Reference:

At its meeting on June 3 to 5, 1998, during consideration of matters related to the 1998 Operating and Capital Budget for the Water and Water Pollution Control Programs (as contained in Clause 2 of Report No. 6 of The Strategic Policies and Priorities Committee), Council deferred the undertaking of water rate harmonization to 1999, to be part of a report on the harmonization of all fees and service level changes for the City. Council, however, adopted certain recommendations respecting the standardization of fees for water and wastewater services. These included, among other things, fees for water valve turnoffs and account certificates, to be effective as of July 1, 1998.

In regard to the same matter, Council further authorized the transfer of $18.7 million of expenditures from the tax levy to the water rate, reduced the combined program net expenditure in the amount of $14.9 million, and authorized a general water rate increase of 2.0 percent to fund the difference. The 2.0 percent rate increase was applied to the former area municipalities’ respective water, sewer and flat rates. Of the $18.7 million transferred from the tax levy to the water rate, $10.4 million was related to sewer costs in the former City of Scarborough, which was the only jurisdiction that did not provide funding for sewer costs within the water rate. The balance of the transfer was a result of a number of adjustments across all the municipalities to better reflect the allocation of costs between the rate supported and tax supported program areas.

In addition to differences in rate structure, other variations in policy continue to exist in the new City. These include differences in polices respecting early payment discounts, sewage surcharge rebates, and flat-rate billing, which are all considered in this report under the context of water and sewer rate harmonization.

Discussion:

Currently, no uniform rate or rate structure exists amongst the former local municipalities, which range from $0.7983 per cubic metre in the former City of Scarborough to $1.034 per cubic metre in the former City of East York (all rates quoted throughout this report reflect the effective discount for payment on or before the due date). These differences in rate structure and other policy matters are discussed in greater depth in Part I of the Background Study attached as Appendix "A". The purpose of this study is to provide an analysis of the impacts of rate harmonization, identify the relevant issues, and to present a strategy towards a harmonized rate across the new City. To this end, the 1998 water billing tapes were reviewed in order to characterize customer profiles and to estimate the impacts of various rate harmonization strategies. The assessment of each of the various options and strategies was made against the following harmonization principles:

Based on a review of the 1998 water billing tapes, approximately 393.0 million cubic metres of water was sold to 372,785 metered customers in the City. Water was also sold to an additional 86,700 customers without meters on a flat-rate basis, primarily in the former City of Toronto. The estimated revenue for 1998 was approximately $370.0 million (before high volume discounts of approximately $1.4 million) from the metered customers, with an additional $30.0 million in billing revenue from flat-rate customers.

The review of the accounts revealed general customer profiles within certain consumption ranges. Billing where consumption was less than 1,000 cubic metres per year consisted predominantly of single-family households. This class represents 75.0 percent of all accounts (342,627 accounts), however, it provides only 25.0 percent of water revenues ($98.0 million).

Accounts in the range of 1,000 to 10,000 cubic metres per year generally consist of small commercial/industrial/office buildings, small condominium and apartment complexes (i.e., less than 20 units), small strip malls and stand-alone restaurants. This class makes up 5.5 percent of all accounts (25,505 accounts), and generates 15.0 percent of the water revenue ($60.0 million).

Accounts in the range of 10,000 to 250,000 cubic metres per year generally consist of medium-size commercial/industrial/office buildings, medium condominium and apartment complexes (i.e., less than 100 units), larger strip malls and restaurants. As a whole, this class makes up less than 1.0 percent of all accounts (4,578 accounts), yet generates 42.0 percent of the water revenue ($167.0 million).

Accounts that consumed more than 250,000 cubic metres per year include several large office towers, a regional shopping centre, several very large apartment and condominium complexes, hospitals, but is predominantly made up of very large industrial properties. Most of the industries are located in the former cities of Scarborough and Etobicoke, while the officer towers were mostly located in downtown Toronto. There are 75 properties within this class (0.016 percent of all accounts), which generate 10.2 percent of total water revenues.

In addition to metered accounts, there are a number of flat rate accounts, predominantly in the former City of Toronto in which there are approximately 85,000 flat rate accounts verses 45,000 metered accounts. A customer on a flat rate account is generally charged in accordance with the number of rooms and fixtures installed in the building, or in some cases, on per-building basis. It should be noted, however, that while flat rate service accounts for 65% of the City of Toronto accounts, it only represents 22% of the revenues billed in that city. The former City of Etobicoke also has a few remaining flat rate accounts (less than 1,500), which is not significant compared to its 66,000 metered accounts. A preliminary review of the flat-rate accounts suggests that approximately 75,000 accounts are attributable to residential properties.

A detailed review of the customer accounts is presented in Part II of the Background Study attached as Appendix "A". Table 5 of the Background Study provides a summary of the profile of water customers in the City, and is reproduced in the following page.

Summary of Water Customer Profile

A comparative review of the 1998 water and sewer rates and rate structures for the cities and regions surrounding Toronto was undertaken. The Regional Municipalities of Durham, Halton and Peel have already harmonized their water and sewer services. The Region of Durham provides a tiered rate depending on consumption for all its customers, with the rate falling as consumption increases. The Region of Halton also provides a tiered rate structure, however, the water rate increases rises in three blocks as consumption increases to 60 cubic metres per month (720 cubic metres per year), then falls back to the original low-consumption rate when volumes exceed 460 cubic metres per month (5,500 cubic metres per year). In addition to the per-cubic-metre charge, customers in both regions must also pay a monthly service charge. Peel Region has no block structure, however, the sewer rate for residential customers is at 85.0 percent of the rate to non-residential customers. In the Regional Municipality of York, the lower tier municipalities set their own rate applicable to all users within that municipality.

With respect to residential customers, Toronto water and sewer costs are the lowest of the municipalities surrounding Toronto, with the exception of Peel Region as shown in Table 6 of the Background Study and reproduced below. However, such is not the case for higher-volume users (i.e., commercial/industrial sector), and this difference becomes more evident for consumption’s greater than 10,000 cubic metres per year even after the former discount policies were applied. A 50,000 cubic metre per year customer would find water and sewer costs to be 4 to 7 percent lower in the regions surrounding Toronto (with the exception of Scarborough, for which sewer costs were previously funded from property taxes). As consumption rises, the difference becomes more profound, and a 500,000 cubic metre customer would find the costs 40 percent lower in Durham than the average cost in Toronto, as shown in Table 7 of the Background Study and reproduced in the following page.

Monthly Water Cost - Residential Customers (Ascending Cost)

Annual Water Cost - Commercial / Industrial / Institutional Customers (Ascending Cost)

Harmonization is premised on the principle that water and sewage treatment are basic services for everyone in the City, and that all property owners (and all tenants through their rents) should pay for this basic service at the same rate.

Under a simple harmonization scenario, each former municipality’s rates would move to the current calculated average rate of $0.9416 per cubic metre. Such a move will cause shifts in the revenue collected between former municipalities, however, it would be revenue neutral across the City. The effect is most profound for the former Cities of Scarborough and Etobicoke, where water users would experience an increase in their bill of 18.0 percent and 4.4 percent, respectively, while water users in East York, Toronto, and York would see their bills decrease by approximately 7.0 to 9.0 percent. North York would be minimally affected, as its current rate is very close to the harmonized rate.

In terms of monetary shifts, the largest impacts would result in the former City of Scarborough where water users would pay $11.7 million more in the aggregate across all customer classes, while customers in the former Toronto would be paying $9.7 million less in the aggregate. Users in the former City of Etobicoke would also be negatively impacted, paying $2.1 million more, while the remaining municipalities would benefit in the range of $0.9 million to $1.7 million from the lower average rate, as shown in Tables 8 and 9 of the Background Study and reproduced below.

Rate Impact of Immediate Harmonization

Total Impact by Customer and City of Immediate Harmonization ($000’s)

Residential Impacts:

Under simple harmonization, the average residential household in the former City of Scarborough would experience an increase in its water bill of approximately $3.26 per month ($39.11 per year), and the average household in the former City of Etobicoke would experience an increase of $0.60 per month ($7.23 per year), while the average households in the former cities of East York, Toronto, North York and York would experience decreases ranging from $0.32 to $2.68 per month ($3.86 to $32.12 per year). These impacts are shown in Tables 10 through 12 of the Background Study and reproduced below.

Average Per-Account Impact of Simple Harmonization – Residential Customer Profile

Increase Impact – Residential Customer Profile

Decrease Impact – Residential Customer Profile

Small and Medium Volume Customer Impact:

The small and medium volume user profile encompasses a wide range of users from small to medium commercial/industrial/office buildings, small condominium and apartment complexes, strip malls and stand-alone restaurants. Generally, the account is to a landlord or property management firm, which would allocate water costs to the tenants as provided for in their lease agreements. In such a case, potential increases or decreases would be shared amongst a number of tenants. This small volume user represents 5.5 percent of customer accounts (25,505 accounts) and generates 15.0 percent of the City’s water revenue ($60.0 million), and the medium volume user (10,000 to 250,000 cubic metres per year) accounts for 1 percent (4,578 accounts) and generates 42.0 percent of the City’s water revenues. This class would not qualify for high-volume discounts in any of the former municipalities.

Due to the wide variations in consumption amongst this customer profile, it is difficult to generalize about the potential harmonization impact. The impact of immediate harmonization ranges from minimal to more than a thousand dollars per year, of course depending on consumption. The impacts presented below are based on sample properties typical of this class. These sample properties include a free-standing restaurant, strip-retail with residential above, a small office building, and a medium-sized industrial building. The water consumption was based on an average derived from random samples of each property type.

Estimated Annual Impact of Simple Harmonization

Small & Medium Volume Users

Large-Volume Customer Impact:

The large customer profile encompasses a wide range of users from large industrial firms, large office buildings, large condominiums and apartment complexes, and large hospitals. For the purposes of customer categorization, large-volume is meant to include those customers whose consumption exceeds 250,000 cubic metres per year. There are only 75 customers in this category (less than 0.02 percent of all accounts), yet this class generates 10.2 percent of the City’s water revenue ($40.0 million). Under the present rate structure, these customers would qualify for high-volume discounts of 5.0 percent and 9.5 percent on volumes in excess of 272,766 cubic metres in the former cities of Scarborough and Etobicoke, respectively. In 1998, 10 customers in Scarborough, and 10 customers in Etobicoke qualified for high-volume discounts totaling $1.0 million per year. Customers in the former City of York would qualify for a high-volume discount of 23.2 percent on the entire volume if consumption exceeds 454,600 cubic metres per year. In 1998, two customers in York received high volume discounts, totaling $337.0 thousand.

In the former cities of Toronto, East York, and North York, this class would see a decrease of approximately $1.10 million as a result of rate harmonization. In contrast, the 32 high-volume customers in the former Scarborough, York and Etobicoke would be paying $3.02 million more on a net basis in the aggregate (assuming the elimination of approximately $1.3 million in high-volume discounts).

With respect to increases in the former City of Scarborough, the average customer in this class would experience an increase in its water bill of $12,583 per month ($150,999 per year). There would be 3 customers who would experience an increase of between $2,500.00 and $5,000 per month ($30,000.00 and $60,000.00 per year) under simple harmonization. A further 8 customers who would experience an increase of greater than $5,000.00 per month ($60,000.00 per year). All but one of these properties are industrial firms; the other is a large residential co-operative. The top 3 industrial firms would experience increases ranging from $110,000 to $673,000 per year.

With respect to increases in the former City of Etobicoke, there are 4 customers that would experience an average increase of approximately $795.13 per month ($9,541.59 per year), 6 customers that would experience an average increase of approximately $1,790.37 per month ($21,484.45 per year), 2 customers that would experience an average increase of approximately $3,230.09 per month ($38,761.13 per year), and 6 customers that would experience an average increase of approximately $12,792.11 per month ($153,505.35 per year). All but two of these properties are large industrial firms. The other two include a hotel and a condominium. The top 3 industrial firms would experience increases ranging from $145,000 to $236,000 per year.

With respect to the former City of York, one customer would experience a decrease of $2,220.07 per month ($26,640.86 per year), while two customers would experience an increase ranging from $7,500 to $11,000 per month ($90,000 to $133,000 per year). All three are large industrial firms. The decrease arises for the one customer who did not qualify for the high-volume discount, but would benefit from the harmonized rate which is lower than York’s existing undiscounted rate. It is noted that customers whose consumption surpasses 454,600 cubic metres qualified for a 23.2 percent discount on the entire volume. Consequently, an increase would arise under simple harmonization for these two customers.

Average Per-Account Impact – Large Commercial/Industrial Profile

Due to the wide variations in consumption amongst this customer profile, it is difficult to generalize about "average" harmonization impacts. A review of the property assessment and taxation data indicates no material change in the level of taxation as a result of re-assessment. For several of these properties, the water bill is comparable in magnitude or exceeds their property tax bill.

The former cities of Toronto, East York and York would be the primary beneficiaries of decreases amongst this customer profile. The impacts are shown in Table 20 of the Background Study and reproduced below.

Simple Harmonization Impacts – Large Commercial/Industrial Profile

Simple Harmonization Impacts – Large Commercial/Industrial Profile (continued)

Due to the significant variations that exist in the rate structure, the implementation of any harmonization strategy presents certain challenges. First and foremost is the concern of the rate increases and its potential impact on certain classes of users. This is of particular concern for the former City of Scarborough, where water consumers would experience an increase of 18.0 percent in their water bill under immediate harmonization. Other challenges include addressing the variations in the volume block structure discounts, the sewer rebate policy, and ensuring the City’s competitiveness with the surrounding regions for all classes of users. The following section presents various harmonization options, and their advantages and pitfalls.

Option (1) – Simple Harmonization:

One approach that has been discussed in this report that may be taken is that all users pay the same rate. This concept is premised on the notion that water provision is a basic service available to everyone in the city, and that all users should pay at the same rate. Under immediate harmonization, Scarborough, and to a lesser extent Etobicoke, are primarily negatively affected.

With respect to the residential (single-family household) class, the actual impact in absolute terms is not as large as given by the impression of an "18.0 percent increase". In real terms, simple harmonization of rates would mean an increase of less than $5.00 per month for eighty-four percent of households in Scarborough. City-wide, two-thirds of households will experience a change of less than $2.00 per month. Given that the typical household water bill represents approximately 10.0 percent of a household’s municipal expenditure (i.e., a $300.00 water bill versus a $3,000.00 property tax bill), this represents an impact of less than 0.06 percent on the overall cost of municipal services (rate and property tax supported). Furthermore, to the extent that the increases in former cities of Scarborough and Etobicoke are largely attributable to the transfer of water and sewer costs previously borne by the property tax base to the water rate, property tax impacts should be considered in conjunction with water rates.

It is noted that while customers of the former cities of Scarborough and Etobicoke will experience a water rate increase on average, the property tax burden has fallen, partly due to the implementation of CVA and the transfer of certain water and sewer costs to the water rate (for some households, the CVA impact above a certain threshold is being phased-in). These two factors, when taken together, should alleviate some of the concern of the impact of immediate water rate harmonization with respect to the residential class in Scarborough and Etobicoke. These impacts, and other potential harmonization impacts such as that which may arise from solid waste and snow clearing service level harmonization, as well as hydro rate harmonization, are discussed in a concurrent report of all rate and service harmonization impacts ("Service Harmonization", from the Chief Administrative Officer and Chief Financial Officer and Treasurer, dated March 22, 1999).

However, such an impact-mitigating situation does not exist for the large industrial class. Through CVA, notwithstanding the 2.5 percent capping initiative adopted by Council, the average large industrial property will experience a decrease in property tax burden in all of the former municipalities. The average industrial property will see a property tax decrease, including the education component, ranging from $14,000 to $35,000 in the former cities of East York, Etobicoke and York, while the average industrial property in the former cities of North York, Scarborough and Toronto will see a property tax decrease in the range of $2,000 to $7,000. The impact of immediate water rate harmonization, however, presents a greater impact to this class. While the average industrial property in Scarborough will see a property tax decrease of approximately $1,700, the water rate impact is significantly larger at an average $150,999 for the largest industrial users. Thus immediate harmonization of water rates on a simple basis would be problematic for the large industrial class.

Option (1A) – Phase-in of Harmonization Impacts:

If the philosophy is that all users should pay at the same rate, then several tools are available to spread the impact out over time. These tools would include phasing-in of rate changes, and capping of increases. At the end of the phase-in, the total impact would still be the same.

The following Table presents the impact of a 3-year phase-in to a harmonized rate. The annual impact to the former City of Scarborough ratepayers would be 6.0 percent for three years (18.0 percent divided by 3 years), while the decreases for ratepayers in the former Toronto would be 3.0 percent for three years. The three-year phase-in impacts are shown in Table 21 of the Background Study and reproduced below.

3-Year Phase-In to Harmonized Rate (all users)

One of the primary reasons for differences in the water rate prior to amalgamation arises from the manner in which water and sewer costs were identified and allocated between the tax-supported and rate-supported program areas. This difference was most profound in the former City of Scarborough, which funded sewer costs through the property tax levy, resulting in an apparently lower water rate. Given such accounting differences, a consistent approach to costing, based on full-cost recovery, may be warranted if immediate harmonization is not followed. Such an approach might be considered fairer in keeping with the full-cost recovery principle. In this way, the first-year impact of harmonization for Scarborough would be 11.0 percent if full-cost recovery pricing is considered, as shown in Table 22 of the Background Study and reproduced below.

2-Year Phase-In to Harmonized Rate (all users)

(Based on Full-Cost Pricing in First Year)

Both of these approaches are viable, however, the impact is the same in the end. These approaches do not address the issue of competitiveness with the surrounding regions.

 Option (2) - Rate Structure to Mitigate the Impact of Harmonization on Large Customers:

The analysis of the impacts of simple harmonization has shown a negative financial impact of approximately $3.02 million on a net basis assuming elimination of the high-volume discounts ($1.7 million on a gross basis before high-volume discounts) on those 31 high volume customers in the former cities of Scarborough, Etobicoke and York. One approach to mitigate this impact would be to harmonize to Scarborough’s existing rate and high-volume breakpoint for all high-volume users. Scarborough’s existing rate structure provides for a discount of 9.5 percent from the rate of $0.7983 per cubic metre on volumes consumed above 272,766 cubic metres per year. The rate on volumes above the breakpoint would thus be $0.7225 per cubic metre. In this way, any increase to large customers in Scarborough would be eliminated, however, this would be at the expense of all users whose consumption was less than 272,766 cubic metres per year. High volume users in the other cities would experience win-fall gains as compared to straight harmonization. Such an approach would result in a rate of $0.9626 per cubic metre, or an additional 2.2 percent on top of the impact of simple harmonization for any customer whose consumption was less than 272,766 cubic metres. The rate structure and the total impact by former municipality are shown in Tables 23 and 24 of the Background Study, and reproduced in the following page.

Rate Structure to Mitigate Harmonization Impact to High-Volume Users

Total Impact of Rate Structure to Mitigate Increases to High Volume Customers ($000’s)

This rate structure has the advantage of eliminating any increases for high-volume users as a result of harmonization. However, there are a number of disadvantages with this approach. For one, it may have the inadvertent effect of discouraging water efficiency for those customers approaching the break point. For example, a customer whose projected annual consumption requirement is 240,000 cubic metres may be inclined to consume an additional 30,000 cubic metres (enough water for 100 household-years) in order to reach the break-point and save $14,000.00 in total water costs. For another, the existing breakpoint is arbitrary, and does not consider competitive pricing for the significant medium-use customer base.

Break-points that result in a reduced cost on the entire volume, such as that offered by the former City of York and discussed above, is inconsistent with water efficiency. An alternative would be to provide a discount on volumes above the break-point, an approach similar to the high-volume discounts offered by the former cities of Scarborough and Etobicoke. Based on the same break-point, such a rate structure would be $0.9595 for the first 272,766 cubic metres, and $0.6590 (31.3 percent discount) on volumes in excess of the break-point. Although this strategy is impact neutral for high-volume users as a whole in the former City of Scarborough, the high breakpoint benefits only two of the ten high volume users, who will see decreases in their water costs, while the remaining eight will experience increases, albeit less than straight harmonization. The rate structure and impacts of this alternative is shown in Tables 27 and 28 of the Background Study and reproduced in the following page. Again, this break-point is arbitrary, and makes no consideration of competitiveness with the surrounding regions.

Alternate Rate Structure to Mitigate Harmonization Impact to High-Volume Users

Total Impact of Alternate Rate Structure to Mitigate Increases to High Volume Customers ($000’s)

Option (3) – Competitive Rate Structure:

An alternate approach involves consideration of various rate structures for various customer classes. Such an approach is not unique. The former cities of Etobicoke, Scarborough and York provided for a discount on the price of water after certain consumption milestones are surpassed. The Regions of Halton and Durham also utilize block structures with pricing dependent on the volume of water consumed. The Toronto Hydro Electric Commission also provides general service to its residential customers in a block structure, with the energy charge generally falling as electric consumption rises.

Since the water rate must provide for full funding for the water and wastewater program, this approach will result in shifts in burden between customer classes. Variations in the rate structure can be designed to mitigate the potential impact of harmonization, or to ensure competitiveness with the surrounding regions. Currently, the average cost of water in the amalgamated Toronto is lower for the residential (low-volume) user compared to the surrounding regions, and higher than the surrounding regions for high-volume users. Thus, there is room for cost-reallocation that would enhance the City’s competitiveness with the surrounding regions. A discussion and comparison of rate structures in Toronto and the surrounding regions was previously discussed and shown in Tables 6 and 7, with additional information presented in Part III of the Background Study.

Amalgamation presents a unique opportunity for the City to re-examine its water pricing strategy with respect to all customers. This option considers a pricing strategy that provides for fairness, encourages water efficiency, and improves the City’s competitiveness amongst the various customer classes with the surrounding regions. Using the comparison of water pricing with the surrounding regions as a guideline, a new pricing structure was developed that meets the above objectives, as shown in Table 32 of the Background Study and reproduced below. The effective rate for various consumptions is shown in Table 33 of the Background Study and also reproduced below.

Option (3) Pricing Structure

Option (3) - Effective Rate for Various Consumption

Such a pricing structure provides an opportunity for a reduced rate for residential customers, compared to the rate that would be derived from simple harmonization, encourages water conservation for residential homeowners who tend to consume more than average, and ensures competitive water pricing for the City’s commercial and industrial base. The total impact to the various customer profiles and across cities is shown in Table 36 of the Background Study and reproduced in the following page. As can be seen, such a strategy results in a shift in the water burden between the low- volume and high-volume users.

The impact of this pricing structure is not significantly different to the residential customer in comparison to the impact of simple harmonization, as shown in Table 34 of the Background Study and reproduced in the following page.

Residential Impact of Option (3) Competitive Pricing

Option (3) – Competitive Rate Structure

Total Impact by Customer and City of Harmonization ($000’s)

The competitive pricing strategy results in a greater cost for low volume users (than would exist under simple harmonization), for which the old pricing was generally lower than the surrounding municipalities, and a lower cost for the medium and large volume customers, for whom the old pricing was generally higher than the surrounding municipalities. Such an approach results in a shift in water rate burden to the residential and small commercial class in order to reduce the impacts to the medium and large volume users, for whom a competitive water rate is provided relative to the surrounding regions. The estimated impact of the competitive pricing strategy on the small business class is shown in the following table. As can be seen, the decreases under simple harmonization for low-volume users in Toronto, East York, North York and York is somewhat reduced, while the increases are raised in Scarborough and Etobicoke.

Estimated – Annual Impact of Option (3) Competitive Pricing on

Small & Medium Volume Users