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Washington Municipal Treasurers Association (WMTA) Conference

Utility Rate StudiesPresentation by:Angie Sanchez VirnocheSenior Project Manager – FCS GROUP

April 2008

Redmond Town Center, 7525 166th Avenue NE, Suite D-215, Redmond, WA 98052; T: (425) 867-1802 F: (425) 867-1937 www.fcsgroup.com

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Presentation Outline Overview

Revenue RequirementOperation CostsCapital Costs

Cost of Service

Rate Design

Presentation of Results

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What is the Purpose of a Rate Study?

To meet the minimum financial requirements and commitments of the utility

To ensure that formal and informal financial policies can be met, such as meeting minimum operating and emergency reserves

To provide long-term stability To provide a secure funding program for

planned capital improvements, upgrades, betterments, and system replacements

To maintain the long-term health and integrity of the utility system

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What Are You Trying to Accomplish?

Reven

ue Req

uirem

ents

Connectio

n Char

ges

Cost o

f Ser

vice

Rate

Desig

n

Public P

roces

s

1. Revenue Sufficiency

2. Capital Funding Strategy

3. Fairness/Equity

4. Growth Pays for Growth

5. Policy Guidelines

6. Economic Development Incentives

7. Respond to Changing Customer Base

8. Satisfy Debt Requirements

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Rate Study Source Documents

Reven

ue Req

uirem

ents

Connectio

n Char

ges

Cost o

f Ser

vice

Rate

Desig

n

Public P

roce

ss

Capital Improvement Program (6-10 years)

System Planning Documents

Customer Base Growth Forecast

Historical Financial Records (1-3 years)

Current Year Beginning Fund Balances

Current Year Operating Budget

Debt Service Schedules

Bond/Loan Covenants

Fixed Asset Listing

Rate and Fee Schedules

Detailed Customer Billing Records

Water Production/Sewer Treatment Plant Records

Special Service Agreements

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CAPITAL FUNDING PLAN

ALLOCATE COSTS TO CUSTOMER CLASSES

RATE DESIGN

FUNCTIONAL COST ALLOCATION

REVENUE REQUIREMEN

T

CUSTOMER

PEAK

FIRE

BASE

CUSTOMER

STRENGTHFLOW

OPERATING BUDGETS

ECONOMIC ASSUMPTIONS

CUSTOMER STATISTICS

FISCAL POLICIES

DEFINE CUSTOMER CLASSES

VARIABLE CHARGES

FIXED CHARGES

CUSTOMER

QUALITYQUANTITY

RECYCLING

COLLECTION

CUSTOMER

YARD WASTE

Water Wastewater Storm Solid Waste

Overview of Rate Study Process

DISPOSAL

Revenue Requirement“Defining Overall Needs”

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A Successful Rate Study is…

A blend of data from ALL departments: finance, engineering,

customer service, administration

Not simply just a financial exercise!

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Revenue Requirement Elements Fiscal Policies

Target reserve levels; debt service coverage, system reinvestment funding

Forecast of Revenue (rate revenue + miscellaneous) Be careful not to start with beginning balance one time revenue

that can mask rate evaluation Ongoing revenue should support annual needs

Operating & Maintenance Expense Capital Program & Impacts of Capital Financing Plan

Identify capital needs Develop funding plan (rates/debt financing/connection

charges/reserves)

Revenue Requirement = Fiscal Policies + O&M + Debt Service + Rate Funded System Reinvestment (capital)Purpose: To determine the amount of annual rate revenue

necessary to fund all utility financial obligations.

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Operating and Capital Costs

Operating Costs Use historical/budget expenditures

Include known operational changes (staffing, regulatory programs, etc.)

Forecast future costs

Capital Costs Define capital needs

Identify available resources (grants, developer donations, connection charges, rate funding, reserves, bonds/loans)

Develop funding strategy

Identify annual financial impacts (sensitivity analyses)

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System Reinvestment Funding

To ensure ongoing system integrity through reinvestment in the system

To charge customers commensurate with the consumption of facility useful lives (rate equity)

To maintain rate stability

System replacement funding benchmarksDepreciation expenseDepreciation expense net of debt principalReplacement depreciation Sinking fund

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2008 2009 2010 2011

CAPITAL FUNDBeginning Balance $905,600 $2,945,481 $5,059,679 $4,576,246plus: Rate Funded System Reinvestment 1,974,365 2,180,600 2,340,795 2,525,107plus: Grants / Developer Donations / Other 0 0 0 0plus: Transfer from SDC Fund 4,769,404 4,760,194 5,724,777 1,316,460plus: Proceeds PWTF Loans 1,355,000 1,781,000 0 0plus: Net Debt Proceeds Bond Funds 0 0 0 0plus: Interest Earnings 0 154,638 265,633 240,253

Subtotal Capital Funding Sources $9,004,369 $11,821,913 $13,390,884 $8,658,066

less: Capital Expenditures Improvement Upgrades & Expansions ($4,769,404) ($4,760,194) ($5,724,777) ($1,316,460) Repairs and Replacements (1,289,484) (2,002,040) (3,089,861) (4,312,504)Total Capital Projects ($6,058,888) ($6,762,234) ($8,814,638) ($5,628,963)

Ending Balance $2,945,481 $5,059,679 $4,576,246 $3,029,102

Minimum Target Balance $250,000 $250,000 $250,000 $250,000Policy met or not met Met Met Met Met

SYSTEM DEVELOPMENT CHARGEBeginning Balance $11,280,473 $9,494,451 $7,823,828 $5,298,594plus: Annual SDC Revenue 2,983,382 3,089,572 3,199,542 3,313,427less: Transfer to pay for Growth CIP (4,769,404) (4,760,194) (5,724,777) (1,316,460)Ending Balance $9,494,451 $7,823,828 $5,298,594 $7,295,561

Example Capital Fund

Transfer from Rate Revenue

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Total Rate Revenue ImpactsTotal Rate Revenue Impacts

0.0%

2.0%

4.0%

6.0%

8.0%

2007 2014 2021 2028 2035 2042 2050

Rate Increase w/ Annual Rate Funded Contribution

Rate Increases w/ Debt

Rate Increases with cash (pay as you go) funding only

Impact of Alternative Capital Funding Sources

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Debt Service Coverage Example

Alt A Alt B Alt CTotal Revenue $5,000,000 $5,500,000 $4,000,000

O&M expenses $3,000,000 $3,000,000 $3,000,000Taxes $1,000,000 $1,000,000 $1,000,000

Balance available for Debt Service $1,000,000 $1,500,000 $0

Debt Service Payment $1,000,000 $1,000,000 $1,000,000

Debt Service Coverage 1.00 1.50 0.00

Debt Service Coverage = Total revenue less O&M, less taxes, divided by Debt Service

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Putting It All TogetherRevenue Requirement

Forecast2008 2009 2010 2011

REVENUERate Revenue $1,180,000 $1,209,500 $1,239,738 $1,270,731Interest Earned 1,000 1,030 1,061 1,093Miscellaneous Revenue 2,000 2,060 2,122 2,185 Total Revenue $1,183,000 $1,212,590 $1,242,920 $1,274,009

COSTSCash Operating Expenses $800,000 $824,000 $848,720 $874,182Existing Debt Service 150,000 150,000 150,000 150,000New Debt Service 0 200,000 200,000 200,000Rate Funded System Reinvestment 200,000 225,000 250,000 400,000 Total Costs $1,150,000 $1,399,000 $1,448,720 $1,624,182

Net Surplus/(Deficiency) $33,000 ($186,410) ($205,800) ($350,172)Rate Increase Needed 0.00% 15.41% 16.60% 27.56%

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Rate Transition Planning

2008 2009 2010 2011Begin with Rate Deficiency $33,000 ($186,410) ($205,800) ($350,172)

Rate Adjustments as Needed 0.00% 15.41% 1.05% 9.35%Adjust for Revenue from Prior Increases 0 186,384 206,067 349,781Net Surplus/(Deficiency) $0 ($26) $267 ($392)

Rate Smoothing 0.00% 10.00% 7.75% 7.75%Adjust for Revenue from Prior Increases 0 120,950 229,661 352,128Net Surplus/(Deficiency) $0 ($65,460) $23,862 $1,956

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A lot of utilities look at the budget year and stop Too short a time frame, always playing catch up Ability to look ahead 3, 5, 10 years allows more

thoughtful planning and fewer surprises

Capital funding should be viewed independent from operating activities

Always looking forward, each adjustment makes the projection more certain

When possible, develop a rate transition plan that smoothes rates over the time period being reviewed

Summary of Revenue Requirement

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Common Reserves

Purpose Industry Standard

Operating

To provide a liquidity cushion to accommodate normal cyclical fluctuations

in addition to protect against adverse financial performance.

45-90 Days Operating Expenses or % of

operating expenses

Contingency

To meet unexpected emergency outlays. Not intended to cover catastrophic loss. Cost of major repair/replacement (main

break, pump station).1% – 2 % of total Utility

Asset Value

CapitalTo provide a source of funding for

unexpected cost increases in the capital program and project cost overruns.

Average Annual Capital Costs or Multi-year

rolling average

Rate Stabilization

To off-set unplanned revenue shortfall or unexpected increases or non-recurring

expenditures by allowing gradual increases over a period of time.

Expressed as a percent of revenue (10-25%)

DebtTo meet requirements stated in debt issuance covenants or documents.

Typically =one annual debt service payment maintained for entire

term

Cost of Service“Equity Evaluation”

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Cost of Service Elements Group customers into classes (single family,

multi family, commercial, irrigation, etc.) Different customer classes place different

demands on the system An equitable distribution of cost shares that

considers District specific data: Measures of usage and demand (level and pattern) Planning, engineering and design criteria Facility requirements (fire protection/peaking)

Cost of service analysis determines total cost by class unit costs ($/customer, $/usage)

The fundamental question: Do cost differences exist to serve the various customer classes of service?

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Role of Cost of Service

Provides a rational basis for distributing the full costs of utility service to each class of customer Distributes utility costs amongst customer classes according

to the unique demand each class places on the system

An equitable distribution of cost shares that considers utility-specific data Measures of usage and demand (levels and patterns) Planning, engineering, and design criteria Facility requirements (fire protection, peaking, etc.)

End result Total cost by class Unit costs ($/customer, $/usage)

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Analytical Steps of a COSA

Step 1: Functionalize The preliminary arrangement of costs according to functions

performed by the utility. Major functions are defined by system of accounts (e.g. treatment, transmission, distribution, collection, disposal, customer service, administration, etc.).

Step 2: Classify The process of classifying functionalized costs to cost

components (e.g. base use, peak use, flow, customer). Use of “generally accepted” methodologies Discussion with staff Management objectives

Step 3: Allocate The assignment of classified cost to customer classes of

service.

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Cost Allocation

Customer $ 92,403

Fire Protection 51,071

Base Costs 988,325

Extra Capacity 855,989

By FunctionBy Function

TOTAL $ 1,987,788

By Customer ClassBy Customer Class

SF Residential $ 906,211

Low Income 9,067

Commercial 497,000

Multi-Family 532,045

Irrigation 43,465

TOTAL $ 1,987,788

Fire Protection2.6%

Extra Capacity43.1%

Base Costs49.7%

Customer4.6%

SF Residential46.1%

Commercial25.0%

Multi-Family26.8%

Irrigation2.1%

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Cost of Service Summary Equity Evaluation by Class

Existing Rates

Cost of Service

$ Change % Change

SF Residential

$912,527 $915,341 $2,814 0.31%

Commercial 499,750 497,924 ($1,826) -0.37%

Multi-Family 523,389 533,097 $9,708 1.85%

Irrigation 23,346 41,426 $18,080 77.44%

Total $1,959,012

$1,987,788

$28,776 1.47%

Rate Design“Collecting the Target Revenue”

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Goals of Rate Design Collect the target level of revenue

Cost-based (reflect the way cost incurred)

Ability to implement, administer, understand

Policy objectivesConservationRisks (revenue stability)Customer impacts

Social objectivesAffordabilityLifeline rates

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Flat Rates When Used:

No Water Usage Data Consistent Usage, Demand

Patterns

How Applied: Flat Monthly Charge per Customer

or Equivalent Customer

Advantages: Low Administrative Cost Stable Revenues

Disadvantages: Not Proportionate to Demand No Incentive to Conserve

Water

Single Family $20 /mo.

Multi-Family $15 /mo.

Commercial $75 /mo.

Example

$

Sewer

Single Family $40 /mo.

Multi-Family $30 /unit

Commercial $40 /mo./ERU

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Fixed Charge Plus Volume Rates When Used:

Water Usage (or Sewer Volume) Data Available

Consistent Usage, Demand Patterns Simplicity/Understandability are Highly

Valued

How Applied: Fixed Charge per Customer or per

Equivalent Customer (e.g. Meter Size) Volume Charge per Unit of Water

Consumption [ccf = 100 cubic feet = 748 gallons or 1000 gallons]

Advantages: Reflects Costs Proportionate to Use May Adequately Address

Efficiency/Conservation Concerns

Disadvantages: Less Stable Revenues compared to flat

rates Doesn’t Reflect all Cost Distinctions

Water

Fixed Charges $10/mo.

Volume Charge $1.00/ccf

Example

$

Sewer

Fixed Charges $5/mo.

Volume Charge $3.00/ccf

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Fixed Charge with Allowance Plus Volume Charge

When Used: Water Usage Data Available Consistent Usage, Demand Patterns

How Applied: Fixed Charge Includes Volume

Allowance Volume Charge For Usage Over

Allowance

Advantages: Charge Increases for High Usage Base from Fixed Charge

Disadvantages: Higher Charges for Low Volume

Customers Reduced Incentive to Conserve

Water

Fixed Charges $15/mo.(includes 5 ccf)

Volume Charge $1.00/ccf(for usage over 5 ccf)

Example

$

Sewer

Fixed Charges $30/mo.(includes 7 ccf)

Volume Charge $5.00/mo.(for usage over 7 ccf)

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Increasing Block (Tiered) Rates

When Used: Water Usage Data Available To Reflect Peak Capacity Costs As Conservation Incentive

How Applied: Volume Charge Increases as

Thresholds are Crossed

Advantages: Encourages Conservation Better Relationship to Costs

Disadvantages: Can be Unfair to Large, Stable Users Highly Unstable Revenues

Water Volume Charge

0-10 ccf $1.00 / ccf

11-20 ccf $2.00 / ccf

Over 20 ccf $3.00 /ccf

Example

$

Sewer (rarely used)

0-10 ccf $3.00 / ccf

11-20 ccf $6.00 / ccf

Over 20 ccf N/A

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Seasonal Rates

When Used: Water Usage Data Available To Reflect Peak Capacity Costs As Conservation Incentive

How Applied: Volume Charge Varies by Season May Combine Other Rate Forms

Advantages: Encourages Conservation Better Relationship to Costs

Disadvantages: Can be Unfair to Large, Stable Users Highly Unstable Revenues

Water Volume Charge

Winter $1.00 / ccf

Summer $2.00 / ccf

Example

$

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Other Rates Volume Based Sewer Rates

Rate based on estimated sewage volume Winter water use used as volume basis Supports water conservation goals

Outside City Rates - Commonly a rate multiplier ( 1.10 - 1.50) Premised on “Renter” rather than “Owner” Higher costs due to location Benefits of utility government w/o costs

Wholesale Rates Reflect limited service commitment Includes a return on utility investment May include charges for unique services, facilities Usually lower rates than retail rates

Industrial Rates Large Customer w/ unique characteristics Often “tailored” to directly reflect service costs

Presentation of Findings

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Presentation of Findings Workshop vs. Regular Council Meeting

More interactive/casual Allows for more detail Best if first rate study process

Tell the Story - Step by Step Keep it at a higher level Avoid too many details Highlight key areas – cause of increase Summarize results early on in the presentation

Use Sample Bill Comparisons Different customer classes at varying usage levels

Identify Policy Decisions Required

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Public Communications Tie to Important Public Policy Issues

Environment & Habitat Preservation Resource Conservation Responsible Management Equitable Treatment of Citizens Safe and Reliable Water Economic Development Opportunities Stewardship and Legacy

Link Rates to Key Outcomes Improved Service Reliable, Secure Systems More Stable Rates Responsible Stewardship Foster Growth; or Growth pays for Growth

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What’s Right for You?

What do you wish to accomplish?

What information can you use?

What structures can your system handle?

Will the message be received?

Is it worth it?

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About the Speaker

ANGIE SANCHEZ - SENIOR PROJECT MANAGER B.S., Business Administration, Oregon State University

Angie Sanchez is a senior project manager and shareholder for FCS GROUP with over 14 years of experience. Angie has provided financial services for water, sewer, stormwater, solid waste and electric utilities. Her project work includes multi-year financial planning, cost of service studies, rate design restructuring, capital/infrastructure planning, funding alternatives, cost benefit analyses, reserve analysis, and community education and involvement.

Angie is often asked to speak at state and national professional conferences and has recently given presentations on topics such as Rates for Small Systems, Utility Rate Strategies and Techniques, Indirect Cost Allocation, and Asset Management Systems. She is a member of the American Water Works Association (Rates and Charges Subcommittee and the Standards Committee); the Washington Finance Officers Association, and the Oregon Municipal Finance Officers Association.

Angie can be reached at 425-867-1802 x230 or angies@fcsgroup.com.