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.