PW15.5 REPORT FOR ACTION

Transcription

1 PW15.5 REPORT FOR ACTION Review of the Feasibility of Recyclable Materials Revenue Hedging Date: September 6, 2016 To: Public Works & Infrastructure Committee From: General Manager, Solid Waste Management Services Deputy City Manager & Chief Financial Officer Wards: All SUMMARY The purpose of this report is to advise City Council on the results of the study undertaken to review the feasibility of entering into price hedging agreements as a means of stabilizing Solid Waste Management Services (SWMS) annual revenue from the sale of its recyclable materials and to highlight options that may improve the sales process and revenues for these materials. RECOMMENDATIONS The General Manager, Solid Waste Management Services, and the Deputy City Manager & Chief Financial Officer recommend that: 1. The Public Works and Infrastructure Committee receive this report for information. FINANCIAL IMPACT There are no financial impacts arising from this report. DECISION HISTORY At its meeting of December 9 and 10, 2015, City Council adopted Item EX Rate Supported Budgets - Solid Waste Management Services and Recommended 2016 Solid Waste Rates, City Council requested the General Manager, Solid Waste Management Services and the Deputy City Manager & Chief Financial Officer to report back to the Public Works and Infrastructure Committee prior to the 2017 Budget process on the results of a study regarding price hedging agreements as a means of Recyclable Materials Revenue Hedging Page 1 of 6

2 stabilizing, directly or indirectly, Solid Waste Management Services annual revenue from the sale of its recyclable materials. The City Council Decision document can be viewed at: At its meeting of November 27, 28 and 29, 2012, City Council adopted Item EX Rate Supported Budgets - Solid Waste Management Services and Recommended 2013 Solid Waste Rates (Item Bu31.2), City Council directed the General Manager, Solid Waste Management Services and the Acting Deputy City Manager & Chief Financial Officer to consider price hedging agreements as a means of stabilizing, directly or indirectly, Solid Waste Management Services annual revenue from the sale of its recyclable materials. The City Council Decision document can be viewed at: COMMENTS In 2015, SWMS collected approximately 207,000 tonnes of Blue Bin Material from its curbside and multi-residential customers. This material is processed and separated into individual commodities at the City s contracted Material Recovery Facilities (MRF). Approximately 147,000 tonnes of various commodities were sold to end markets for further processing and recycle. In the past five years, revenue from the sale of Blue Bin Material has fluctuated between $19M and $26M annually. The marketed commodities consist of fibre, plastics, aluminum cans, steel, and mixed broken glass. Revenue from fibre is received as part of the contracts with the City s contracted processor. Markets and revenue for the remaining materials are secured through the City s competitive procurement process and are based either on a fixed price or on a price that fluctuates with an established commodity exchanges unit price (i.e. London Metal Exchange & American Metal Market). Sales contracts are awarded on a fixed term basis which vary in term from three months to one year. Pricing volatility in recycling markets has been an ongoing challenge. Recyclable commodities are subject to market and non-market driven pricing volatility as influenced by global economic trends. Fluctuations in pricing can occur as frequently as daily with a potential for extreme variation over longer periods. When assessing the length of term for a sales contract, staff consider some of the following aspects; present and future budgeted price, review of future value outlook for materials, the outlook for the markets affecting the particular commodity and the impact of projected currency values. Short term contracts allow staff to react more quickly to price changes. Long term contracts are usually employed when either the quoted price exceeds budget pricing or the market for processing is on the decline. Recyclable Materials Revenue Hedging Page 2 of 6

3 With the development of the SWMS operating budget submission beginning up to eight months in advance of the start of the fiscal year, it is challenging to forecast commodity markets and the global economic outlook over a potential 20 month period between the initial budget development and December 31 of the budget year. As a result, actual revenue variances (positive or negative) can be experienced each operating year due to unpredictable market fluctuations and pronounced revenue swings. As part of the 2013 budget deliberation, City Council requested that commodity hedging be investigated as a method to smooth out these unpredictable market characteristics and reduce revenue budget variances. Price Hedging Price hedging is a risk management strategy used in limiting or offsetting probability of loss from fluctuations in the prices of commodities, currencies or securities. In effect, hedging is a transfer of risk employing various techniques, but basically involves taking equal and opposite positions in two different markets. Price hedging as a means to stabilize revenues earned by the City from the sales of its collected recyclable materials would require the City to enter into future contracts for set quantities of materials. Hedging contracts have the effect of offsetting either potential gains or losses due to commodity price changes. Currently, price hedging is not recommended in part because Blue Bin Materials are not traded on any formal commodity exchange (the way oil or copper may be traded), any such hedging contracts would require the City to develop its own complex trading scheme. Project Scope of Work To ensure a balanced, professional opinion on the feasibility of hedging recyclable materials revenues, the services of Ernst & Young Orenda Corporate Finance Inc. (E&Y) were retained through a competitive Request for Proposal (RFP) process. In addition to a review of world markets and hedge options for its non-fibre recyclable materials, SWMS further utilized the RFP as an opportunity for a critical examination of its own sales practices with the goal of improving its process and potentially increasing revenues and/or encouraging more vendors to bid to purchase the City s non-fibre Blue Bin Material, regardless of the state of the economy. Highlights of the services required as outlined in the RFP included: - options to improve the ability to predict changes in the marketplace and/or present commodity pricing options (including hedge options) that mitigate the risk of exposure to market fluctuations throughout the operating year; - a jurisdictional review of other municipalities comparable to the City of Toronto and private industries to determine industry best practices as they relate to the sale of recyclable materials; - a gap analysis between current City recycling sales strategies and industry best practices; and, Recyclable Materials Revenue Hedging Page 3 of 6

4 - recommendations for changes to the City s current strategy to market recyclable materials that will incorporate industry best practices and potentially improve revenues received from the sale of Blue Bin Material. Project Findings and Recommendations The City of Toronto team that worked with E&Y and reviewed the findings for this project included staff from SWMS, Corporate Finance, and the Purchasing and Materials Management Division. E&Y preformed an in depth analysis of the City s current sales practices. This included benchmarking our current state, a gap analysis which compared the City to peer municipalities, and a review of marketplace expectations. This analyses found that, the City: - sets the standard for customer contact and in-person facility visits; - receives prices at or above market pricing for most materials marketed by Ontario municipalities. The average market price obtained for products by Ontario municipalities is calculated and reported monthly by the Provincial Continuous Improvement Fund (CIF). The following chart illustrates these findings. $3,000 January to July 2016 City of Toronto Average Container Market Prices vs. Ontario Municipalities Average Container Market Prices $2,500 $2,000 $1,500 $1,000 $500 $0 Polycoat Containers PET HDPE Mixed Plastics Film Plastics Aluminum Steel Cans All Container Products Ontario Municipalities 2016 Average Monthly Market Price Ontario Municipalities (Excluding Toronto) 2016 Average Monthly Market Price City of Toronto 2016 Average Monthly Market Price - in order to minimize financial risk, requires a security deposit in order to enter a sales agreement while 66% of its peers did not; and Recyclable Materials Revenue Hedging Page 4 of 6

5 - is consistent with municipal respondents in that no form of market based price hedging is performed, other than the natural hedging as a result of varying contract durations. The review of the volatility surrounding the sale of recyclables in the global marketplace concluded that hedging of Blue Bin Materials is not available through normal commodity exchanges, and if viable, would add a high level of risk to the City while garnering few positive enhancements to recyclable material sales. Further, E&Y determined that the current recyclable commodity market is insufficient in size to make the proposed use of hedges economic or practical. The additional review conducted by E&Y at the request of SWMS showed that, though the City is currently excelling with its sales of recyclables with both pricing and customer service, potential changes to the process may further enhance our sales by reviewing alternate mechanisms including: - Performance security alternatives: the level of security required by the City may be a barrier to bidding by potential customers as it can be a significant cost for smaller companies and for companies which are growing. The City could review alternatives, such as credit checks, to the current security requirements to encourage a greater number of potential bidders; - Price variability options: the use of fixed price contracts may be a barrier to bidding by more than one potential customer. It can be a significant level of risk for smaller firms. To encourage a greater number of potential bidders, the City could review alternatives such as contracts with upside price sharing and downside floor pricing; - Ongoing monitoring and contact with new entrants into the marketplace: the City could review procedures to keep the bidder contact list updated by scoping out, networking, monitoring, and adding new market entrants to the bidder database; - Ongoing marketing strategies: the City could review strategies including allowing bidders to accept sample loads of materials to establish expectations within the marketplace and media options including preparing promotional videos for significant product streams and marketing campaigns to increase awareness of our products; - Barriers to Bidders: the City should continually monitor barriers to bidders and identify options to eliminate or mitigate them, where possible; - Appropriate sales contracts: as the City primarily deals with the purchase of goods and services, the City review and revise, where applicable, its sales tender contracts to be more reflective of sales contracts specific to the industry; and, - The City review the addition of a dedicated position responsible for the implementation of the above alternate mechanisms. Staff will review each of the above options in consultation with other City Divisions, where applicable, to determine the viability of the option, its impact on other Divisions, and any procedural and/or policy changes required prior to developing a strategy for implementation. Recyclable Materials Revenue Hedging Page 5 of 6

6 Implementation of these mechanisms will not mitigate City Council s initial concern of the unpredictable and uncontrollable pricing volatility within the recyclable material marketplace. It is expected though, that this will foster a sales focussed culture, especially critical given the volume and value of the annual revenues generated from the sale of non-fibre Blue Bin Material and further, may ultimately encourage more bidders and more competitive pricing. CONTACT Derek Angove, Director, Processing & Resource Management, Solid Waste Management Services, Telephone: , Fax: , dangove@toronto.ca Joe Farag, Executive Director, Corporate Finance, Telephone: , Fax: , jfarag@toronto.ca SIGNATURE Jim McKay General Manager Solid Waste Management Services Roberto Rossini Deputy City Manager & Chief Financial Officer Recyclable Materials Revenue Hedging Page 6 of 6