How does the cost of labour affect my rates?
The million dollar question!
Of course, the cost of labour has an impact on rates but how do we know how much?
Since you asked…
Regulatory oversight ensures that costs are reasonable, however not all of the players in the industry are subject to the same scrutiny when it comes to labour.
Most generating capacity in Ontario is not regulated
We can look at two cases from the regulated industry segment using some actual data from a major utility looking at total and incremental cost impact.
The unregulated portion of the industry is not compelled to publicly report details on labour cost.
First the basics
There are two different categories for labour costs – Operation, Maintenance and Administration (OM&A) and Capital. They each have different impacts on how much you pay for electricity.
Operation, Maintenance and Administration (OM&A)
The labour cost associated with day-to-day operations, maintenance and administration of the utility are recovered directly from rates. Your distribution company must demonstrate that those costs are fair and reasonable to the Ontario Energy Board through a formal rate approval process. If the OEB determines that the costs are not justified they cannot be recovered from ratepayers and comes out of the net revenue of the company.
Capital
The labour cost associated with construction projects becomes part of the finished asset value. The total cost is paid for over the useful life of the asset. If the asset has a 20 year life then the cost recovery is spread over 20 years. Work that leads to significantly increasing asset value through life-cycle extension is treated the same way. Labour cost associated with capital work has a much lower impact on rates than OM&A.
In order to determine the impact that labour cost has on any specific company’s rates, you must know how the costs are distributed between capital and OM&A. A company with a large capital spending program that utilizes its own workforce will have a lower rate impact than a company that spends the same amount on OM&A.
What does that mean to the ratepayer?
Unfortunately it makes it difficult for the average ratepayer to associate labour cost with rates. You need a financial specialist to interpret a company’s accounts to make that determination. Key components in the calculation include:
- overall labour cost for a group of employees
- split between capital and OM&A for the group of employees
- total operating costs to be recovered through rates
- average portion of the bill associated with the company
Case study #1 – total cost
In Toronto Hydro’s rate submission case EB-2010-0142 most of the essential data is provided by Toronto Hydro as evidence.
Using data for total costs and total OM&A labour cost from Toronto Hydro’s submission, the proportions look like:
Note:
This figure reflects the total Toronto Hydro cost for a year. Additional information is required to assess how this impacts a customer’s bill.
For a typical monthly bill
Viewing the cost of wages as a portion of a typical Toronto Hydro residential customer’s bill for 750kWh using the OEB bill calculator (12-10-2018):
For the specific case identified the cost of labour associated with Toronto Hydro is roughly 7.4%.
The portion of labour cost for any customer will vary over time and for different LDCs. This represents a single case for illustrative purposes only as it includes assumptions that may not apply to other situations.
Case study #2 – impact of wage increases
Lets see how a wage increase for a group of employees impacts a customer’s bill by working through a specific example.
The only item missing from the rate submission is the split between OM&A and Capital for the specific union that we will analyze. The split can be estimated for the first pass and we will see how sensitive the result is to this quantity.
Canadian Union of Public Employees (CUPE)
In the OEB submission by Toronto Hydro for the 2011 year it is indicated that there are 1402 full-time employees represented by CUPE and they account for 67.7% of total compensation costs. Lets take a hypothetical case where the union has negotiated a 3% wage increase and see what that does to the average residential ratepayer.
It is the OM&A cost that impacts rates directly. The total overall corporate compensation split between OM&A and Capital is:
The split between Capital and OM&A for each employee category has not been identified, however it can be approximated by the following assumptions:
- Executive and Managerial costs would be OM&A in accordance with International Financial Reporting Standards
- The OM&A labour cost would be split between Managerial/non-Union and Union. Assume 50% for each of those groups goes to OM&A
The OM&A totals by employee category would look like:
If the Union negotiated a 3% wage increase then it would need to be recovered through revenue. In the case-study year Toronto Hydro Revenue was $540 million. The incremental increase to Union compensation would be $2.3 million. That would require an increase of 0.43% on the total revenue to recover the wage increase.
Assume that the increased revenue is pulled proportionally from every source and therefore the residential customers must make up their share of the 0.43%.
In the case-study year, an average residential customer used 800kWh of energy per month. According to the OEB Rates Database the portion of the residential bill that goes to Toronto Hydro revenue is $29.94 per month. The billing impact of the Union wage increase is 0.43% of $29.94 which works out to 13 cents per month on an average residential bill or roughly the cost of one cup of coffee in a year.
I will concede that there are several assumptions made in this study, however I hope you see how the numbers work.
It is not worth while to calculate the rate impact of the wage increase on the capital portion because the costs are spread out over decades based on the life expectancy of the asset being built. Overhead lines typically last for 60 years and underground cables for 25 years.
Each company will have a different situation depending on the nature of it’s operations.
The takeaway…
The cost of labour for a single specific utility is a relatively small part of the overall residential ratepayer’s bill. Wage increases to individual groups that are part of the utility are extremely small and of minimal billing impact.
The next time the debate about wages and compensation comes up, keep in mind that it’s proportion of overall cost is small.
Cost management is an essential part of the regulated utility industry. Labour is only one element of what must be a multi-faceted strategy to ensure that costs are reasonable and justifiable.
Derek
