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.