A Hole in the Budget – what can be learnt?

A hole in your budget needn’t be the end of the road!

In the previous post we looked at a city council’s response to a sudden $60m hole in its budget – and the consequent media storm.  Could this have been treated differently?

Put yourself in the City Council’s situation.   Faced with a sudden $60m hole in your budget through external circumstances, what are your options?

• You can cut back on services (but these are services that the community want and that you have already prioritised into your budget)
• You can borrow (and borrowing might be a short term option to maintain service continuation but only if there were expectations that the external cut would be reversed in the near future or that other revenue increases could be anticipated)
• OR, and this is the option that the City adopted, you could withdraw the funds from your fully owned subsidiary – in this case BC Hydro – in exchange for a city asset portfolio (city street lighting).

BC Hydro now needs to make a return on the assets it has bought and so it engages in a forward contract to maintain, operate and supply street lighting services to the council.

Bear in mind, that any profit made by BC Hydro reverts to its shareholder – the City Council.  If the costs of the contract are greater than the costs that would have been incurred by the City if it had retained ownership of the assets, then this will be reflected in a larger profit made by BC Hydro.  Conversely if the contract costs are less than the City would have otherwise paid, it saves on ratepayer funds but (unless BC Hydro can run the streetlighting more cost effectively) it will receive a lower return on its BC Hydro shareholder funds.

OK, so these are the financial facts.  The transaction enables the City to continue providing all the services that its ratepayers want and expect in the face of a sudden hole in its budget caused by the withdrawal of provincial funding. Out of one pocket into another but the same city coat!  This being the case, why did the question of how much that was paid for the contract become the major story?

I would suggest that there are a number of lessons to be learnt here:

1. The City could have sold this as a smart solution to the problem of continuing needed community service in the face of sudden withdrawal of funding by the Provincial Government. It could have promoted the idea of BC Hydro being in a better position to cost effectively manage street lighting given its expertise in lighting and power generally.  It could have used this problem to market the value of its ownership of BC Hydro.  In other words, on a PR basis, it could have got out in front of the story. But it didn’t. Instead it hid the contract details for 5 years before eventually acceding to Freedom of Information requests.  Whatever the facts of the case, this action itself makes the council guilty in the eyes of the public.
2. The public generally have very little understanding of the ratio of ongoing operations and maintenance costs to the initial capital costs.  If we don’t tell them – in ways that they can understand – their natural reaction is to see the annual payments in the light of (exhorbitant) interest payments.
3. The time to generate this greater understanding is BEFORE you need to use it to substantiate council decisions
4. In all likelihood, the councillors (and perhaps senior staff members) did not understand the full import of operations and maintenance costs either.   Their reaction in hiding the costs from public view suggests that they did not believe they were defencible.

Lesson 1 may not apply to you now, but Lessons 2-4 will always apply.

Comment:  What are you doing to ensure this level of understanding of O&M is generated in your council and staff (or in your senior management and board)