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In Honor of Chips
May 21, 2010
I’ve had the great privilege to work as a consultant in the water utility industry for the last 15 years, all of which from offices in the Denver area. It would have been impossible for me to not have known who Chips Barry was, and I didn’t need to know him closely or personally to know enough. I knew him because I do know, in some cases very well, many of the people who were close to him every day. I know the organization, Denver Water, that he led for some 20 years, and I know how that organization shines as an example in our water industry. I know the absolute respect that he earned from others, people I ended up working with at one point or another, or others less known who talked about the man with real admiration. I know the heartache that all of those people are feeling with Chips’ passing; I know because they’ve told me.
I know that our water industry has lost a great friend and leader in Chips Barry. We will miss him.
One of the great causes that Chips was involved with was Water for People. StepWise is also a supporter of this organization and we are glad that Water for People established a memorial donation site in honor of Chips Barry. We are not a big company here at StepWise, but from now until the end of May, StepWise will match every $25 donation made to Water for People through the Chips Barry Memorial Page at Water for People’s web site up to 100 such donations.
Comments (1)Indianapolis Mayor a Believer in Efficiencies of Public vs. Private Water
March 18, 2010
The City of Indianapolis, whose privately operated water system (Veolia has been the private owner/operator for several years) was ever so recently facing a 35% increase in water rates just 6 months after an 11% increase, has even more recently decided to scrap their private ownership model.
“With this agreement, I am rejecting private ownership of our water and wastewater system while embracing the benefits that come from private sector efficiency and expertise, and putting water and wastewater utilities under a public trust.” – Mayor Greg Ballard.
We can’t be sure if Mayor Ballard and other city leaders are regular readers of this blog, but the quotation is very much in line with several blog entries we’ve made here, including “Corporate Water Utility Rates – Show Me the Efficiencies” published in October 2009. The Indianapolis case was and is one of the great examples of how private water utilities are challenged to produce long-run efficiencies above those of public-sector owners. We have argued here before (and probably will again) that private owners would have to produce major long-run reductions in costs just to break even with the same utility operation under public ownership. Indianapolis now knows this to be true: funny how 46% water rate increases can change your mind so quickly.
Comments (0)NYT Story on Water Infrastructure is Telling
March 16, 2010
The latest NY Times article on water infrastructure does a good job of demonstrating the seemingly impossible issues between the great need for reinvestment in water and sewer infrastructure, the reluctance of the government owners of those systems to actually pay for that investment, and the increasing consequences of infrastructure failure. The article focuses on Mr. George Hawkins, whom the author describes as a well-educated environmental activist who wound up as the general manager for one of the largest utilities in the US in Washington DC. The article shows how Hawkins has done much to point out the obvious to the city’s leaders: that our capitol city’s water and sewer infrastructure built over 100 years ago is decaying to a point where line failures are a daily routine causing everything from loss of water service to raw sewage spilling into the Potomac River.
Yet, there in Washington DC, one of the most affluent cities in the US, the push back from local politicians and citizens has been as severe as anything we’ve ever described on this blog. That nobody wants to pay for the infrastructure issues even when it affects their own community is the major point that readers should take away from this article. As we’ve said before right here at the StepWise blog, the cost of addressing the infrastructure issue is enormous. In many cases, communities are relying for critical water and sewer services from a set of pipelines installed between 50 and 100 years ago. There is a $335 billion price tag out there just for our drinking water systems, it’s a bigger price tag when you factor in the sewer systems.
The cost may be “federally-sized” when added up, but the reality is that the total cost is the summation of those for thousands of communities across the country. Water and sewer infrastructure is a local issue requiring local responsibility and local funding. It is not a federal issue, nor should it be seen as such. To those communities who address their infrastructure issues smartly – like not waiting until the entire system is in cataclysmic failure – the reward is manageable costs over the long run. To those who are less prepared, the consequences are potentially large. Flooded homes and businesses, insurance losses, sewage backups, service losses, sinkholes, etc. Every community has a choice to make with respect to infrastructure investment. Waiting for the end is probably not the best option.
Comments (0)JM Eagle Whistle Blower Lawsuit
February 12, 2010
We are all well aware of of the expense to repair and replace water lines. Utilities expect these assets to last 50 years with little to no problem, but many are seeing failures in recently installed JM Eagle PVC water pipes. Nevada, Virginia, Delaware, Tennessee and over 40 water authorities in California experienced these failures and joined a pending whistle blower lawsuit against JM Eagle.
An employee of JM Eagle, John Hendrix, uncovered substandard materials going into the production of pipes, as well as cost saving manufacturing techniques that diminished pipe quality and durability. After raising his voice to superiors, and refusing to accept “acceptable business risk” as an excuse, he was fired. Since his dismissal, Mr Hendrix has filed a lawsuit to stop the “intentional” production of faulty pipes. Mr Hendrix asserts that more than half of all pipes sold since 1996 are of substandard quality. If this is the case, many more utilities have seen and will see premature pipe failures. We recommend reviewing past and proposed water line projects to make sure your utility is not impacted by this lawsuit.
The news story can be found here:
Bursting Pipes Lead to a Legal Battle
Utilities are faced with tough decisions when it comes to capital replacements. First, many utilities struggle to identify, schedule and finance these system repairs to begin with. Stepwise recommends implementing an asset management program to ensure repair and replacement becomes a priority to your utility. This program can be as simple as having annual meetings with operations staff to identify aging infrastructure to be replaced, or as complex as implementing an electronic system to monitor the age, criticality and probability of failure for each individual asset. Small to medium size systems can use CUPSS (Check Up Program for Small Systems), which is a free software package available through the EPA (http://www.epa.gov/cupss/).
Assets don’t last forever and failure is inevitable. Once you can accept this hard fact, you can manage the associated costs. However, when suppliers don’t hold up their end of the bargain, an expensive, labor intensive process becomes even worse. We hope that JM Eagle is found to be free of impropriety, but in the meantime keep an eye on this trial and on your assets!
Comments (0)What’s Driving High Utility Rates?
December 1, 2009
If you’re a reader of this blog, you will have noted that we often cite news articles showing how utility rates are being increased in different parts of the US. We track these stories because we feel it’s important for our clients, our readers, and our own staff to understand the political dynamics that make water and sewer rate setting unique in our public square. There is no question that water and sewer utility service is a basic public good. Whether the services are provided by a local government, which is in our opinion to be preferred (see why), or by a private company, the factors driving the need for rate increases are common. We have noted before that utility rates appear to be going up at increasing frequency right now, and at a higher level. What’s behind the trend?
Diminishing Growth
Because water and sewer utilities tend to have high operating leverage (high amounts of fixed cost relative to total cost), growth in customers can help keep rates down. As the number of customers and demand grows, total revenue goes up. If growth exceeds inflation and real increases in costs, then rate increases are not necessary. In many parts of the country, growth has been one of the factors that has helped keep utility rates in check. With the recession, however, growth in some of these areas has decreased, and some areas actually lost customers due to displacement (think Detroit). Demand has also fallen off in general either due to overall conservation, or just because people tend to cut back on everything during difficult economic times. Less demand, regardless of the reason, means that the utility’s fixed costs are shared by fewer people, and that means that rates have to be increased. Utility’s can fight back by slashing budgets, but the reality is that many costs cannot be avoided. At a point, higher rates are the only solution.
Disappearing Development Fees
Many utilities charge a fee for connecting a new home or business to the utility system. Those fees fall into two categories: the first is a fee to cover the cost of just connecting a meter, the second is a larger fee that is meant to recover some portion of the capital the utility will need to invest in order to provide capacity for that new connection. This second category of fees goes by many names but we will just call it a development fee. In some parts of the country, these development fees can be quite large. In the West, in particular, development fees for a single-family home can run $20,000 or more. Although the purpose of the fees is to offset capital requirements (to acquire pipes, pumps, tanks, etc.), the simple truth is that the income generated by the fees provides cash that utilities need. When growth slows, the income from these fees dries up. As the income from the fees dries up, it may need to be replaced and that can translate into higher rate increases.
Massive Capital Requirements
It’s no secret that water and sewer utilities are two of the most capital intensive businesses anywhere. There is a reason why these utilities are natural monopolies, and the extremely high amount of capital that is required to be invested in infrastructure before earning a single dollar of revenue is that reason. Utilities have tons of assets. Pipes, pumps, tanks, treatment plants…it all costs money, not only to acquire them in the first place but also to maintain, repair, and replace those assets. The cost of these assets is enormous, and we are at a point in many parts of the US where these assets have have reached the end of their useful lives. We see examples of this daily with main breaks and sewer backups. As the assets are replaced, huge amounts of capital have to raised. That usually means higher debt payments for utility customers and big increases in rates to pay for it. For example, we recently assisted on a project where a small community of about 2,000 customers was required to construct a new sewer treatment facility at a cost of about $13 million. The debt service on the plant comes to about $460/yr/customer – the debt alone would have caused the sewer bills to double.
Increasing Supplier Costs
The costs of treatment chemicals, electricity, and fuel have all gone up substantially in the past couple of years due to a variety of factors that are well beyond the control of any local water/sewer utility. Some of these costs can be managed, but more often than not they have to be absorbed translating into a need for higher rates in many cases.
Waiting for the Wrong Time
There’s never a good time for a water/sewer rate increase when you’re an elected official, but some times are worse than others. Now would be one of those “worse” times. Unfortunately, when times are good the need for rate increases is not always obvious. There are untold thousands of stories out there about how communities have not addressed let alone increased their utility rates for years and years and are now faced with the need for a big increase to catch themselves up (look at a recent example). Avoiding large and sudden increases in water and sewer rates should be a major objective of utility managers. Solid management and planning can help avoid the bad timing as well as the large increases. Communities can help themselves be prepared by addressing utility rates on a frequent basis and making the small adjustments when they are necessary. When you wait until deficits start appearing, then all those small increases that were avoided in the past tend to compound into a much larger increase later.
Comments (3)Utility Rates and Legal Defensibility: A High Hurdle
November 5, 2009
I’m not sure what’s going on in Naples, FL when their water rate consultant is telling the City Council that the City’s water rates are not legally defensible, but we can speculate if only to illustrate a point. There are lots of reasons why utilities should address their rates on an ongoing basis, but legal defensibility is probably not very high on the list . It’s not that defensibility isn’t important – it is. It’s that the courts tend to give wide latitude to municipal utilities (owned by cities, counties, districts, etc.) to the point where in order to prove that utility rates are “illegal” is to prove that they are inherently unsound. In many jurisdictions we hear the words “arbitrary” and/or “capricious” as characteristics of such “inherently unsound” rates. That standard may not sound like such a tough burden of proof, but it is. If you’ve done any calculations at all to determine a rate, you are probably in good shape as far as the courts are concerned. Obviously, there are differences by state and if you have any questions as to the legal defensibility of your rates, you should find competent legal counsel – someone who practices in municipal utility law - to guide you.
And here’s a word of caution for city leaders and elected officials reading this right now: just because the burden of proof favors you doesn’t mean that you don’t have hundreds of other, better, reasons to take a hard look at rates on a frequent basis. Making rates cost-based on one hand, and fair and equitable on another is something that requires time and expertise. In addition, poorly designed rates can lead to disaster. Consultants can be very helpful in sorting through the maze and coming up with good solutions; the best consultants can provide you with options for you to consider, each of which is safe from a revenue and legal perspective.
StepWise is working on a new service package called Rate Lock that will allow utilities to have a professional rate study completed every year at a fixed price based on the number of customers served. With Rate Lock, you’ll be able to keep your rates up to date as your costs change and your system grows. You’ll be able to do this in a way that is easy on your budget too. We plan to release Rate Lock nationally in 2010. Stay tuned.
Comments (0)How to Sink a Water Utility
November 2, 2009
City governments have long admired the money making ability of a water or sewer utility. The enterprise funds are not tax based and, after all, they are natural monopolies where the cities could charge nearly anything they wanted. Plundering enterprise funds to shore up budgets elsewhere is an old practice, and it’s one of the reasons why water and sewer utility infrastructure is so very underfunded right now in America. Case in point today: Augusta, Georgia.
Here is a utility with a tidy reserve fund of about $65 million and, with the City in a big budget crunch elsewhere, the fingers are already in the pie. The real shame here is that this is a city with experience – bad experience – in what happens when you spend your water revenues on other things and, by default, fail to fund needed infrastructure improvements. In the 1990′s, the City saw lots of main blow outs and similar problems while the City was pilfering the water reserve funds. At least one councilman remains on the Council from that time and he’s warning his colleagues NOT to make history repeat.
It will be interesting to see what happens, but once the raiding starts it usually takes something severe to make it stop. Once you go to the cookie jar, it’s hard not to go back. Why do the tough things to balance the budget when you can raid the enterprise fund instead and increase water rates instead of taxes? These situations seldom end well. Let’s hope Augusta gets it right.
Comments (0)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.
Comments (0)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.
Comments (0)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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