JOHN A. MAYER
UTILITY RATE CONSULTANT
MEMO
To: Ed Nokes
From: John A. Mayer
Subject: PSC Approved Rates
Date: Wednesday, June 13, 2007
I spoke with Dave Sheard of the PSC
today and asked him the questions in your email. He discussed this with the PSC’s legal counsel and with PSC staff member Kathy Butzlaff who performed the financial review for the rate
increase. Dave called me back and basically said the following.
1. Your question as to
“From a legal standpoint, what if they (
2. There is no option to
phase-in the increase over two or three years.
3. Since the new rates
are considered to be in effect,
4. IF the
City petitioned for a rate reduction (which would be accomplished by reducing
the rate of return) the preliminary review by Staff indicated that they would
not accept anything lower than a 5.75% return on rate base. That translates to
an 11% increase versus the 15% approved.
5. Dave said that if the
City is that concerned about the magnitude of the increase, the City should
reduce the $650,000 tax equivalent it charges the utility to zero and include
that with the petition to reduce rates.
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My feeling on the tone of the conversation is that the PSC staff
does not feel lower rates are warranted. They consider it strange that the City
approved the filing in December for a 15% increase and now that it has been
review by the PSC and determined after staff review to be needed, that the City
feels it should be reduced.
I feel that the Council does not understand the need of the
utility to generate cash to pay for normal and ordinary capital replacements
with cash generated from rates. Failure to do this will result in continued
increases in debt and continued increases in rates to pay for the new debt.
• 28 years assisting municipalities with
water & sewer rates. Water & sewer rate studies for
• Recommending a water rate
increase of 15%; Recommending a sewer
rate increase of 18%
• To keep this increase in perspective,
average residential customer 1˘ more for every 11 gallons of water –
delivered, and 1˘ more for every 12 gallons of sewage removed
• 6 yrs since the last rate study.
Frankly the size of the increase is not surprising to me. 3
major factors
• #1: Water and sewer volumes are
decreasing, they are not offset by population growth, and this trend is not
temporary. 2001 - present: water customers
+6.5%; water sales -7.5%. Sewer customer +5.3%; volumes -9.3%
• Aging of the population fewer
people in each home. Usage per household is decreasing. Remodel w/ low flush
toilets, low flow shower heads, water saving laundry appliances. Price
elasticity
• Basically water and sewer utilities are
facing a scenario of a slow but steady decrease in number of volume units
sold.
• #2: Increases
in labor and non-labor costs will continue. Merit / longevity increases. Prices for
electricity, natural gas, pipe, and all other items will increase. Federal
Reserve target 2%-2˝% inflation rate. No money saving technological
breakthrough likely. No electronic chip to fix water main break. Can’t
outsource water or sewer mains repairs nor send our water tower out for
painting to some developing country with cheaper labor. Basic industries - not
changed since Romans except on the treatment side.
• #3: EPA continue to tighten
restriction on pollutant levels. Un-funded mandates will continue to
drive local water and sewer rate increases.
• Given decreasing number of units sold
(i.e. revenues) & increasing expenses, water and sewer rates will need to
increase so utility can pay its bills.
• I cannot recommend strongly enough
the wisdom of a program of small, annual increases in both water and sewer
rates. Delaying the increase only makes it larger and less understandable
by the customer, and each year of delay makes it financially more difficult for
the utility.
• Annualized increase in net cash
requirements from the last time rates were reviewed until now is 3.03%
for water and 2.39% for sewer. That is why I said I am not surprised
at the level of increase. No unusual changes other than industrial revenue
decrease of $285K water and $250K sewer. Ponderosa Pulp
& 7-Up Bottling.
Water Utility
• Regulated by the Public Service
Commission of
• Utility-financed water plant investment
in 2001 was $71.8 MM. Now $88.5 MM. $16.7 MM in added water
facilities (23.3% incr.) but no increase in water rates to pay for them.
• Goal - level of rates so that utility
can pays all of its bills, all of its debt service, and still have a net
cash flow sufficient to cash finance a “normal level” of capital expenditures without
having to borrow.
• Excluding large construction projects
in 1999, 2001 and 2005, normal level of capital is about $2 MM each year.
Generating this level of cash may not be possible due to oversight by the PSC
since their definition of adequate rates based on a “fair rate of return” on
utility assets.
• PSC typical ROR of 6.50% provides cash
flow that is reasonably close to the level of net cash flow that I deem
appropriate. Using ROR of 6.50% the recommended increase for the water
utility is $1,536,000 or 15%. This will provide a net cash flow for
construction of about $1,983,000. [ROR 6.75%, rev. +$166K or 1.65%; ROR 7.00%,
rev. +$332K or 3.3%]
• Utility needs $2 MM per year for
capital projects. Recommended rates will generate that amount, but for the next
5 or so years $700,000 of that will be going for meters. Leaves
only $1.3 MM for typical projects.
• Water debt service in 2007 = $5.1 MM; 48˘
of every dollar taken in from water bills goes for debt service. The best
way to contain future rate increases is to keep new borrowing to a minimum.
• If utility had been able to
cash-finance all water utility additions since the 2001 rate study, P&I for
2007 would be $3.6 MM vs. the actual amount of $5.1 MM. The difference of $1.5
MM is just about the entire increase recommended. Utilities with the lowest
rates are those with the least debt. If revenues
inadequate for capital projects, utility forced to borrow more money.
• The only thing to reduce increase is to
request a lower ROR from the PSCW. Not recommend.
• Recommended increase will raise the
avg. resid. bill $3.42
per month; 11.2˘ per day; $10.25 per quarter.
Switching to WASTEWATER
Sewer Utility
• Not regulated by PSC. City
Council action is all that is needed.
• Utility-financed sewer plant investment
in 2001 - $57.7 MM. Now - $72.7 MM. Added $15.0 MM in sewer facilities (25.9%
incr.) but no increase in sewer rates to pay for them.
• Not unlike water, the $15 MM over 6
years computes to $2.5 MM per year of capital additions.
• If I use same PSCW criteria of a 6.50%
ROR, recommended increase would be 23.6%. That would provide a $654,000
cash flow + replacement fund for a total of $1 MM for capital projects.
This is still short of recent historical capital project need. [In 2001 the rates
provided a $542,000 cash flow + replacement fund for a total of $816,000.] [For
xtra $500K, rates +6.5%; for $100K, rates +1.3%]
• Sewer debt service in 2007 = $4.0 MM; 51˘
of every dollar taken in from sewer bills goes for debt service. The best
way to contain future rate increases is to keep new borrowing to a minimum.
• If utility had been able to
cash-finance all sewer utility additions since the 2001 rate study, P&I for
2007 would be $2.9 MM vs. the actual amount of $4.0 MM. The difference is $1.1
MM. [79% of
the entire increase].
• While I feel that 24% increase is the
better financial choice and might be too low, concerned about the “sticker
shock” of a 24% increase resulted in somewhat of a compromise recommendation.
• Suggesting that
• Recommended sewer revenue increase
of $1,400,000 or 18%. Cannot reduce any more do to concerns about meeting bonding
agreement coverage ratio.
• Recommended increase will increase avg.
resid. bill $3.12 per
month; 10.3˘ per day; $9.36 per quarter.
• Combined water & sewer avg. resid. bill $6.54 per month;
21.5˘ per day; $19.61 per quarter.