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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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With Asset Management, Money Comes First

September 25, 2009

Dealing with the consequences of aging infrastructure is one of the largest challenges facing the water and sewer industry and there has been no lack of reporting on that topic. A recent look through the national papers immediately gives at least four major examples:

  • Los Angeles - 35 main breaks in three weeks!
  • Tampa - water main break closes major street.
  • San Diego - raw sewage spills into ocean causing beach closure.
  • Macon, GA – old concrete sewer main breaks during recent flooding.

The water and sewer industries have rightly focused attention on the issue of infrastructure.  However, you can’t separate the issue of aging infrastructure from the issue of financial capacity.  In truth: to manage infrastructure is to manage money.  One of the biggest hurdles existing right now for utilities who want to do something about their aging infrastructure problem is that they don’t have the money they need to do much of anything.  Too many in the industry just assume that problem away.  After all, if it has to be done, then ratepayers will need to pick up the financial impact, right?  Well, it just isn’t that easy. Those of us who have had the luxury of making major adjustments to water and sewer rates for a community can tell you that the reasons for the increase, as good as they may be, fall on deaf ears in many cases.

When it comes to the aging infrastructure issue, there are not many in the rate-paying public who are ready to see the massive price tag.  The bottom line is that, as an industry, we are playing catch up to this problem.  We are catching up from the perspective of physically replacing these assets, and we are trying to catch up to the money too.  The best place to start dealing with the money is to start quantifying the replacement requirements and getting those expenditures accounted for in a comprehensive financial plan.  This is really the only way that utilities will be able to see the financial impacts to their ratepayers and develop replacement plans that will manage their customers’ expectations as smartly as they are trying to manage the utility’s assets.

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Connection Fees Anyone?

September 22, 2009

Utility managers should understand that you only get one chance to charge new customers connecting to your system for the capital costs of providing them the capacity they need for service.  Connection charges (aka.  system development fees, impact fees, tap fees, capacity charges, etc.) are the right way to ensure intergenerational equity between existing customers and new ones.  If designed and applied correctly, these fees can help keep rates lower in the long run while the utility continues to expand its system for a growing customer base.  However, once the customers are already connected, your opportunities are reduced like they were for this small utility in Indiana.  To avoid a big rate increase like the one in the Indiana example, this utility could have been charging all their new customers a cost-based connection charge all along.  Instead, they get to explain to their users why system growth (double the planned capacity) is going to cost them a 23% rate increase.

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What Not to Expect from a Water or Sewer Rate Consultant

September 17, 2009

Many times, elected officials have the wrong ideas about what a water or sewer rate consultant will bring to the table.  In this example from Fort Smith, AK we see an elected body that questions why the city would spend so much on the consulting contract.  Their rationale for going ahead?  The consultant might find a way to increase revenues by $4 million without having to increase rates.  This is a case where the rationale is wholly irrational.

Water and sewer utilities get their funding from up to three sources: user charges, development fees and, in decreasing cases, taxes.  In the Fort Smith example, the news report says that the problem is that the revenues are short of the operating expenses by $4 million.  If so, the only two rational solutions are to: a) increase revenues by way of increasing the user charges  by $4 million, or b) to decrease operating expenses by $4 million.  Of course, the city could find any middle ground between rate increases and cost reductions too.

These kind of shortfalls are not uncommon and, in fact, they are increasing in their frequency and magnitude.  As existing infrastructure wears out and has to be replaced, the capital costs of replacing those assets is high – think of it like having to replace your house after you’ve already repaid the mortgage – and those costs are going to be reflected in the water and/or sewer rates.

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Water Rate and Sewer Rate Increases are Sign of Times

September 14, 2009

A scan through the news from across the country will reveal that water and sewer rate increases are accelerating and are increasing in magnitude.  A closer examination of these individual situations will reveal that the increases are necessary mostly because of issues that could have been prevented with some planning.  However, some increases are headed your way soon for things that can’t be foreseen, like regulatory action.  In this sewer rate example from Missouri we see a small community’s plight when faced with a regulatory action.  In this case, the State regulator caused the the city’s residents to abandon their septic systems and to connect to the city’s sewer system.  The costs of compliance included the costs of the initial connections, but are now continuing to escalate in the form of treatment chemicals, etc.

Regulatory action is likely to increase rather than decrease during the term of the current federal administration.  If the President’s agenda from his campaign is any indicator, we can expect to see more regulatory actions on water and wastewater systems, especially in the area of energy use, and greenhouse gas emissions.

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The Value of Simple Rates Cannot be Overstated

September 4, 2009

Intricate rate designs can be helpful in reaching certain community goals, but elected officials in particular should never underestimate the value of simplicity. In this example from Frankfort, KY (http://bit.ly/11h0OB) we see how customers can become easily confused with their utility bills and how that confusion can increase when multiple utilities are billed together. In this case too, each of the utilities implemented rate increases at the same time, further compounding the issue. Simplicity is not only valuable, but it is also many times the best rate structure alternative as discussed in a presentation we made at the American Water Works Association earlier this year.

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California Gov. Letter to Salazar: “We are Trapped…”

September 3, 2009

Governor Schwarzenegger’s letter to Interior Sec. Ken Salazar is a telling story of the kind of frustration that comes with trying to balance environmental, agricultural, and municipal water supply interests of a state’s finite water resources.  The situation in California is a serious one and you can see the Governor’s frustration in this letter.  The point to be made for this blog, however, is that Gov. Schwarzenegger’s frustrations are nothing new to anyone who has ever had to plan for long-term water supplies for his/her community.  Ten to twenty-year lead times between concept and construction are the rule and longer waits abound.  These water supply projects, too, are among the very most expensive that any community, be it Los Angeles or Hometown USA, will ever consider.  These are major capital expenditures that communities can plan for and although the costs of these things are fuzzy when looking 20-years ahead, one important thing to do is to start letting your ratepayers know what is in store them.  Aligning long-range financial planning with long-range resource plans is essential; it’s a process that will help you figure out your financing options and understand clearly just how much will be required from ratepayers.  That way, when the time for design and construction approaches and rates have to be adjusted, there is less surprise for everyone.

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Elementary Rate Design

September 2, 2009

Many water and sewer utility managers look to their closest consulting engineer as their “expert” on water and sewer rates.  Usually, the query is because there is an emergency of some kind, as is the case in this Vermont example.  What we see in this case is a community whose water and sewer demand rates have dropped for whatever reason, resulting in a shortfall of revenue required to operate both utilities.  The recommendation from the engineer is to increase the “base” rates in order to stabilize revenue.  It’s not a terrible recommendation, but it’s also not necessarily a fair solution.  A financial expert, like those here at StepWise, would have provided other options in this case.  For example, the residents of this Vermont town might be interested in knowing just how much of the sewer costs are incurred to treat excessively strong wastewater the kind of which is normally discharged by commercial customers (things like mortuaries, bakeries, breweries, etc.); perhaps one solution would have been to identify those costs and cause those creating high-strength sewer water to pay the full cost of its treatment.  The point is that consulting engineers, unless they have both the education and experience in utility rates, are probably not a utility manager’s best option for solving these kinds of problems.  With water and sewer rates, the quick solution is rarely the best one.

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Planning for Rates Means Planning for Success

September 1, 2009

Water and sewer rates can sneak up and damage your utility if you aren’t actively managing ratepayer expectations. Planning ahead, using projections of simple recurring costs like water and sewer rehabilitation and replacements is just one example. In this example, we see what happened to one community that didn’t plan: 122% sewer rate increase, 67% water rate increase. These are things that can easily be avoided with solid alignment of long-range vision, engineering plans, and financial plans.

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