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More Private Water Company Rate Problems

October 27, 2009

Privatization is thought by many to be a panacea for lowering costs for water and wastewater systems.  Yet, here we have again another example of how a private owner/operator, in this case Indiana American (subsidiary of American Water, NYSE: AWK), seeking a very large increase in rates (click here for the news story).  We have reported on this same issue a couple of times already in just the past few months.  In “Corporate Water Rates – Show Me the Efficiencies” we cited a case involving Illinois American (also a subsidiary of American Water); and in “Private Does Not Mean Better Water Rates” we discussed the huge increase proposed by Veolia (NYSE: VE) as the private owner/operator of the water works in Indianapolis, IN.

The predominate cost of owning and operating a water or sewer utility is the cost of capital.  Municipal entities have access to low-cost and tax-exempt debt, private operators may or may not have such access.  Private owners can issue stock to raise capital, which could be an advantage except those stockholders expect a return on their money that is higher than the interest rate paid on debt, and the private utility gets to include those returns in the rate you pay (they have a constitutional right to do it).  In order for a private operator to produce lower rates in the long-run, they would have to drive operating costs down significantly.   They would have to generate about 20% savings just to account for the additional cost of income taxes that private owners have to pay (your municipal system does not pay taxes), and then they would have to save even more to account for profits paid to shareholders.

A perfectly good question to ask if your community is looking to privatize is whether the private owner/operator really can lower your bills and sustain those savings over time.  We are seeing evidence right now that private owners are not able to perform any better than public owners, and the cost savings do not appear to be sustainable either.

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Corporate Water Utility Rates – Show Me The Efficiencies

October 21, 2009

We have previously commented on the fact that having a private water utility does not necessarily translate into lower water rates.  In that post, we discussed the woes of the Indianapolis experience with Veolia being the private contractor in charge of the water utility’s operations.  In the news today is yet another example where private utility operators have proven, yet again, that they are as beholden to the laws of economics as any municipally-owned water system.  The Illinois American water company serving about 10,000 customers in the Chicago area has asked the Illinois Commerce Commission to approve a 30% increase in water rates and a 50% increase in sewer rates.   The company states that the reasons for the increase include the usual suspects: the costs of repairing and maintaining infrastructure, and to cover the increasing costs of employee benefits.  About 350 of the company’s customers (from the cities of Homer Glen, Orland Hills, and Lockport) showed up at a public hearing to protest the increase which would make the company’s rates triple those of the municipally-owned utilities in nearby communities.

What the protesters probably don’t understand, and what everyone who thinks substituting public ownership of their water/sewer utilities with private (corporate) ownership needs to know is that the private utility owner has a constitutional right to charge rates that will allow it the opportunity to earn a reasonable profit.  That right has been established in US case law since the 1898 case in Smyth v. Ames . Of course, there are certain protections offered to determine just what is a “reasonable profit” and the Illinois Commerce Commission in this case, or its equivalent in any other state, has the charge to make sure that the rates are indeed reasonable.  Still, if the real reason for the increases comes down to infrastructure repair costs and employee benefits, the company is very likely to have its request for higher rates approved.

On top of those costs, the company is allowed to profit from operating the utility.  Meanwhile, a municipally-owned utility would not include profit in its rates.  Instead, municipal systems allow whatever “profit” exists in the utility’s operations to flow directly back to its customers by way of lower rates (read more about this topic here).  Increasingly, we see that private operators are unable to provide the economic efficiencies that they like to claim they can provide in anything but the short-term.  They tend to realize short-term savings by deferring rather than eliminating costs as the Illinois American and Indianapolis stories both suggest.

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A Case of Politics vs. Practicality

October 15, 2009

We’ve been following the story in Oceanside, CA for several weeks now and were not surprised to awake to today’s headline that the city council rejected the water rate increases that had been proposed by the utility managers (Council Rejects Water, Sewer Rate Increases).  As this story has unfolded, we’ve learned a few things: a) Oceanside purchases 80% of the water it sells to its residents from the Metropolitan Water District, b) the rate charged by MWD was recently increased by 18%, c) Oceanside has water revenue bonds outstanding that require the utility to meet certain requirements called debt service coverage (more on that in bit), and d) the city council is not convinced that the utility’s costs are appropriate.

When you read the latest story (see the link above), you see the City manager and the utility director’s concern that the council’s rejection of the proposed increase would result in the utility failing to meet its “coverage.”  Coverage refers to something called “debt service coverage” and it is a covenant provision contained in  most municipal revenue bond agreements.  In short, the debt service coverage provision requires a utility to achieve net revenue (gross revenue less operating & maintenance expenses) to be some percentage equal to and, in most cases, greater than the annual principal and interest payments on the utility’s outstanding debt.  A typical debt service coverage requirement is 1.25, meaning that net revenues must be 125% of the annual debt payment. If you fail to meet those requirements, the bondholders’ lawyers have the right to step in and seek legal remedy to enforce the covenants.

The problem that has emerged for Oceanside and many other utilities in the country is that costs have continued to increase even in the current stagnant economy while political tolerance for rate increases has evaporated.  In this particular case, we see the utility’s wholesale rate going up 18%.  In other cases, we find the costs of electricity, gas, and treatment chemicals as the main culprits. Increases in costs alone would have been enough to force a rate increase to maintain compliance with the bond agreements, but Oceanside like many California utilities got hit on the revenue side as well.  As drought conditions persisted, mandatory water restrictions took effect and water use declined and, along with it, the utility’s revenues.  As a result, Oceanside is looking at decreased revenue as well as significant increases in costs, neither of which are variables that the utility can conceivably control.

The political reaction of the city council is unfortunate.  The politics are understandable, but not implementing necessary rate increases is impractical.  The consequences could be severe and could impact the utility’s credit rating, which would result in higher borrowing costs down the road.  In turn, that could limit their access to credit markets and constrain access to debt capital to invest in system repairs and replacements; that all points to even higher rate increases in the future.

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Conservation Doesn’t Always Pay

October 5, 2009

The typical thinking among most utility customers is that if they conserve their water use, they will save money.  By extension, they believe also that the utility will save money resulting in lower water rates.  The thinking isn’t irrational.  After all, one might reasonably think that if the utility provides less of its water service that costs would be lower overall.  Unfortunately, the numbers don’t add up that way.  Water (and Sewer) utilities have both high operating leverage and, usually, high financial leverage.  That means that a big majority of the utility’s costs are fixed and have little bearing on how much water is provided.  Utility revenue is a function of quantity times price; when customers cut back on usage it results in less quantity sold and therefore lower revenue for the utility.  In the short run, customers benefit by paying less overall, but the utility loses money resulting in increases to rates in order to make up the shortfalls.  The unfortunate result is that customers can feel “punished” for conserving.

That’s the case we find here in this Sonoma County story about water rate increases. The residents in this example did a good job of conserving, according to officials, but they were still greeted with an 8% rate increase.  The first line from the news story: “apparently conserving water won’t necessarily save you money.”

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Private Does Not Mean Better Water Rates

October 1, 2009

We often hear how private utility companies can achieve efficiencies in their water and sewer operations that will result in community benefits (like lower water and sewer rates).  For a period of time in the US there was an active market where major cities were selling their utility concessions to private corporations.  Veolia was one such company, and one of the concessions they purchased was Indianapolis Water.  Fast forward several years, and we get this latest story about the company requesting a 35% water rate increase .  The increase, we are told, comes on the heels of yet another 11% increase implemented just a few months ago.

The question worth asking now is whether or not the City of Indianapolis would have been better off with or without Veolia.  Even if you believe that government is inherently inefficient, you still have to ask whether a private company can operate a utility service so much more efficiently as to produce a water or sewer rate that is less than it would have been even with an inefficient (i.e. government) operation.  Before you answer though, you should understand that the rates set by the private company are not set at absolute cost; the rates include cost as well as profits and taxes.  That means that the private company would have to produce surplus efficiencies  in order for it to outperform a supposedly inefficient government utility.  One of the ways that private companies “produce” so-called efficiencies is to defer  investment in infrastructure and maintenance.  Defer those things long enough and you are bound to get a big rate increase at the end of the road.  Is that what has happened in this particular case?  Maybe not, but the story does say that the increase is needed for “necessary upgrades to the system.”

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