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US Conference of Mayors Foresees Major Spending on Water and Sewer Utilities

March 19, 2010

In a report published in February, the US Conference of Mayors is predicting that spending on water and wastewater systems will increase by by as much as four times.  Depending on how fast the country’s population grows, spending could double, triple, or quadruple, according to the report.  We’ve posted the full report here, which is an interesting read at just 56 pages.  Toward the end of the report, the author cites the Congressional Budget Office’s so-called best management practices for utilities to reduce costs thereby, presumably, opening up financial resources to pay for the identified infrastructure needs pointed out earlier in the report.  Among these best management practices:

• Demand management – conservation and the like.
• Labor productivity – automation and cross-training are mentioned
• Consolidation of systems - this sometimes goes by the name of “regionalization” and is probably one of the best recommendations to come from Washington in a long time.  Physical consolidation of small systems, where possible, is a money saver.
• Asset management planning – a topic to itself, but the CBO cites increased equipment life, reduced O&M, and elimination of redundant assets as benefits to be gained.
• Innovative construction contracting - alternative contracting like design-build-operate (DBO) offer some cost savings over traditional contracting approaches.

In all, the US Conference of Mayors’ report is more on point with the issue than most reports we’ve seen.  The report correctly identifies the need for increased water and wastewater utility infrastructure, estimates the annual spending at reasonable assumptions for growth, addresses the existing gap in infrastructure (between functional infrastructure and dilapidation), and correctly characterizes the funding issue as primarily a local one with a limited role in funding from federal and state sources.

Local utility rates will be the battleground where the funding issue get sorted out.  Firms  like StepWise, are already immersed in these issues.  Understanding the need is one thing, but getting local communities to get into a “willing to pay” mode is easier said than done.  Water and wastewater rate consultants know that even small increases to utility rates can lead to big problems for communities on a political and even an affordability level.  We see affordability as a major issue for most utilities going forward.  Making sure your water and sewer rates meet the actual costs of service, are transparent , and are clearly equitable to rate payers are principles that will be core strengths for utility managers in an era where spending is predicted to quadruple.

Click to Download “Trends in Local Government Expenditures on Public Water and Wastewater Services and Infrastrcuture: Past, Present and   Future”

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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.

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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.

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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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StepWise Ratemaking Course for Elected Officials

September 20, 2009

The following links will take you to PDF files for the 4-hour seminar on water and sewer rates.  The seminar is a short course that we present from time to time with the targeted audience being elected officials and general managers.  It’s not a hands-on course that teaches the ins and outs of utility rates and the rate setting processes, but it is a broad overview of these issues with special emphasis on how elected officials can manage the risk of rate shock through competent rate setting processes tied to effective communications strategies.  The seminar addresses four key areas:

1. Why water and sewer rates are important.
2. The right way to adjust water and sewer rates.
3. How to get communities/customers to more readily accept needed rate increases.
4. How to make rate setting part of a utility’s normal processes.

click to download Part 1	Part 1 – Intro & Why Rates Are Important -  The first segment in the seminar addresses the importance of utility rates in the normal governance of any publicly owned water or sewer utility. The concept of risk is introduced with changes in rates being described as an event with a high probability of occurrence and a potentially high consequence that depends on the magnitude of the change in the rate.  We introduce the concept of utility ownership and how customers’ reactions to rates can be compared to corporate shareholders’ reactions to low returns. We conclude the session by suggesting that managing the rate setting process is akin to managing customers expectations and,therefore, is a most effective tool for managing risk.
click to download Part 2	Part 2 – The Right Way – The second segment of the seminar addresses the rate setting process.  Starting with alignment of financial plans and strategic plans (like a utility master plan, or other long-range plan), this second and longest segment describes how rate setting starts with sound planning and financial policies before moving on to cost-of-service allocations and, ultimately, rate design.  The intent of this segment is provide elected officials with exposure to rate making processes; we provide some simple examples to help the information sink in.
click to download Part 3	Part 3 – Making it Work -  The final session focuses on using the information gained during the rate setting process to communicate more effectively with customers.  General communication strategies are discussed,with more attention given to the process of ongoing customer relations.  The session demonstrates how to tie-in the rate making process to the communication plan.  The final segment in this session talks to the implementation of rate setting as a normal business process for the utility; it shows where the the rate setting process fits and talks to some of the challenges facing utilities for implementation.

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