Memorandum

City of Lawrence

City Manager’s Office

TO:	Diane Stoddard, Interim City Manager
FROM:	Brandon McGuire, Assistant to the City Manager
CC:	Casey Toomay, Bryan Kidney, Toni Wheeler, Charles Soules, Mark Thiel, Dave Wagner
DATE:	August 10, 2015
RE:	Ordinance 8597, Black Hills Energy Franchise Agreement

Background

Franchise agreements enable electric and gas utilities, cable television providers and wire telephone service providers to locate and operate infrastructure and equipment in city-owned rights of way. Significant City resources fund the acquisition and the ongoing management and maintenance of public right of way and the City recuperates a portion of those resources through franchise fees charged to private service providers in lieu of taxes. Franchise fees are established in each of the City’s franchise agreements and in total comprise 9.73 percent ($7.3 million) of the City’s 2015 General Fund budget.

The natural gas franchise agreement between the City and Black Hills Energy expired in 2014 although both parties still uphold the conditions of that agreement in good faith. The term of that agreement was 15 years and the franchise fee established by the agreement has not changed since it was executed in 2000. The current fee structure is not reactive to changes in the market and does not reflect changes in the City’s costs related to right of way ownership. A new natural gas franchise agreement is needed to replace the expired agreement, and City staff recommends using this opportunity to establish a new method for calculating the natural gas franchise fee based on best practices.

Overview of Franchise Agreements

Electricity: The City has granted Westar Energy an electric franchise and charges a franchise fee equal to 5 percent of Westar’s gross revenue, which is the same electric franchise fee imposed by most municipalities across the state. Fees collected from Westar represent 72 percent of the City’s total franchise fee revenue and account for the majority of growth in total franchise fee revenue since 2008.

Natural Gas: Natural gas franchises are granted to Black Hills Energy and Atmos Energy. Gas franchise fees comprise 13 percent of total franchise fee collections but gas fee revenue has remained flat for the past 15 years.

Cable and Phone: Cable television franchises have been granted to WOW fees account for 6 percent of total franchise fee revenue. Telecommunications franchises have been granted to AT&T, WOW and NextG. Combined, telephone and cable franchise fees account for 12 percent of total franchise fee revenue. The long-term trend in both of these categories is flat, although there was a spike in cable fees in 2014. The following graph illustrates franchise fee collections by category since 2008.

Current Natural Gas Franchise Fee

Under the current agreement, gas franchise fees are calculated using a tiered fee structure. The tiered fees are based on units of consumption (Mcf). The current natural gas franchise fee schedule is provided in the following table.

Customer Class	Description	Volumetric Fee
Residential Class	Any individually metered, single-family dwelling where service is primarily for residential use		$0.30/Mcf
Small Commercial	Any individually metered, non-residential customer with annual consumption less than 500 Mcf		$0.30/Mcf
Small Volume	Any individually metered, non-residential customer with annual consumption greater than 500 Mcf, but less than 5,000 Mcf		$0.15/Mcf
Large Volume	Any individually metered, non-residential customer with annual consumption greater than 5,000 Mcf: · 5,000 Mcf/Year · 50,000 Mcf/Year · 200,000 Mcf/Year		· $0.15/Mcf · $0.05/Mcf · $0.03/Mcf

The method of calculation has constrained long-term growth in gas franchise revenue. The following table reports actual gas franchise fee collections from 2010 to 2014. The year-over-year volatility of gas and electric franchise fee revenue is apparent in the table. For example, gas fee revenue spiked in 2013 and 2014 due to significant winter weather events. To smooth these year-over-year swings, the bottom half of the table provides a 3-year rolling average of gas fee collections. The rolling average provides a clearer picture of the long-term trend in this revenue source.

Evaluated in isolation, 2014 collections were $85,000 (9.8%) greater than 2010 collections but the 3-year rolling average demonstrates the more realistic trend. Collections decreased by $45,000 (-5.1%) when comparing the 3-year rolling average collections of 2014 against 2010. Evaluating collections from 2001 to 2014 confirms the flat-to-negative trend in natural gas fee collections. The attached table reports natural gas fee collections over the term of the Black Hills agreement. Gas franchise fee collections decreased by $12,000 (-1.4%) when comparing the 3-year rolling averages.

Proposed Natural Gas Franchise Fee Structure

A fee based on best practices would produce revenue that reacts to changes in the commodity market and the cost of right of way ownership. Staff recommends establishing a natural gas franchise fee based on a percentage of gross receipts plus a market-based volumetric rate on transport consumption. The following explains the two parts of the proposed fee schedule.

Part 1, Percentage fee on gross receipts: Under the recommended fee structure, the utility would be assessed a fee of 3.0 percent of gross revenue received from its Lawrence customers. This means that 3.0 percent of all revenue generated from the sale and transportation of gas and any other fees charged by the utility would be remitted to the City. This part of the fee structure would apply to the utility’s sales customers. Sales customers purchase their gas directly from the utility.

Part 2, Volumetric fee on transport consumption: A volumetric rate on transport consumption provides a method to assess the gas consumed by transport customers. Transport customers purchase their gas from wholesalers and utilize the utility’s infrastructure to transport that gas. As a result, the first part of the franchise fee (3.0% on the utility’s gross revenue) cannot be applied to the gas purchased by transport customers. Under the proposed fee structure, a volumetric fee would be assessed on the volume of gas consumed by transport customers, which provides for a more equitable franchise fee structure. The volumetric fee would be calculated using the New York Mercantile Exchange (NYMEX) natural gas futures settlement prices.

Overview of Other Cities

The recommended fee structure is consistent with best practices utilized by most Kansas cities. Among the 10 largest cities in Kansas, Lawrence is the only City that does not use the proposed fee structure.

The table below reports the gas franchise fees of the 10 largest Kansas cities. For comparison, the current gas fee structure in Lawrence produces revenue equivalent to a 2.61 percent fee on gross revenue plus a volumetric fee on transport consumption. This makes Lawrence’s gas franchise fee one of the lowest in the state. Prior to the current gas franchise agreement, the City’s gas franchise fee was 5 percent of gross revenue plus a volumetric rate. The proposed fee on gross revenue (3.0%) is still low compared to the 10 largest Kansas cities.

City	Natural Gas Franchise Fee
Wichita	5.0%
Topeka	5.0%
Olathe	5.0%
Salina	5.0%
Shawnee	5.0%
Lenexa	5.0%
Kansas City	5.0% - domestic meters 3.0% - industrial meters
Manhattan	4.0%
Overland Park	2.5%

Impact Analysis

Natural gas franchise fee revenue will change as a result of the new fee structure, but the net change will be relatively minimal considering that gas fee collections have been flat for the past 15 years and will possibly not change for the next 15 years. The proposed franchise fee structure would have generated an estimated $105,000 in additional revenue if it was applied in 2015 (see table below).

Natural Gas Franchise Fee Revenue	Current Fee Structure	Proposed Fee Structure	Annual Change
Total Estimated Collections	$831,799	$936,653	$104,854

Under the proposed franchise fee structure, fees assessed to residential meters would increase less than $1.00 annually. Franchise fees assessed to small commercial meters would decrease approximately $1.00 annually and fees assessed to small commercial transport meters would decrease around $8.00 annually.

Large volume transport meters would experience the largest increases. Those meters serve a small number of large commercial consumers within the city. Large transport meters are expected to experience franchise fee increases ranging from $1,400 to $2,500 annually. Kansas University operates a number of the large commercial meters, so the majority of those increases will be concentrated on the University’s various meters. Staff engaged the University in the process of determining the appropriate fee level to recommend to the City Commission. The largest private sector commercial consumer was also engaged in the process. The attached table reports the estimated change in gas franchise fees by each meter/customer classification if the fee were applied in 2015.

To ease the impact of changes in the franchise fee and to enable Kansas University to budget for those changes, the agreement is drafted so that the franchise fee would take effect on July 1, 2016.

Recommendation

The current Black Hills Energy franchise agreement has expired and a new agreement is needed. Staff developed Ordinance No. 8597 which assigns Black Hills Energy a non-exclusive franchise and the right to construct, use and maintain natural gas service lines in the public right of way. The terms and conditions of the proposed franchise agreement are substantially the same as the existing agreement with one exception. The proposed agreement includes a new method for calculating the natural gas franchise fee. The proposed fee structure was developed based on best practices utilized by most Kansas cities and it is designed to produce revenue that reacts to market factors. Staff recommends approving the proposed franchise agreement with Black Hills Energy by adopting Ordinance No. 8597.

Recommended Action

Adopt Ordinance No. 8597, granting Black Hills Energy a non-exclusive natural gas franchise and the right and privilege to construct, use and maintain natural gas service lines in City-owned right of way.