Water Finance and Ratemaking TIM 155 Spring 2017 Water Finance and Ratemaking How money flows through the water sector…

Water Finance Introduction $ $ Customers Water Utilities Investors

Water Finance Introduction $ $ Customers Water Utilities Investors Residential Commercial Industrial Government Wholesale Municipal Public Agency Private Company Mutual Funds Insurance Funds Retirement Funds Hedge Funds Large companies Individual investors

Water Finance Introduction $ $ Customers Water Utilities Investors Residential Commercial Industrial Government Wholesale Municipal Public Agency Private Company Mutual Funds Insurance Funds Retirement Funds Hedge Funds Large companies Water rates and fees Bond financing (mostly)

Water Finance Introduction Government grants $ $ Customers Water Utilities Investors Residential Commercial Industrial Government Wholesale Municipal Public Agency Private Company Mutual Funds Insurance Funds Retirement Funds Hedge Funds Large companies Water rates and fees Bond financing (mostly)

Water Finance Introduction Government grants $ $ Customers Water Utilities Investors Residential Commercial Industrial Government Wholesale Municipal Public Agency Private Company Mutual Funds Insurance Funds Retirement Funds Hedge Funds Large companies Water rates and fees Bond financing (mostly)

Water Finance Introduction A Bond: A formal way for an investor to loan money to a borrower. The investor makes money off the interest payments and the bond issuer gets to purchase something now and pay it off over time.

Water Finance Introduction A Bond: Bonds have very clear terms: - amount loaned - interest rate - payment schedule/maturity date - consequences if the bond isn’t paid back - reporting requirements - operating conditions that must be followed The interest rate is determined by how safe the investment is, how long the the payoff period is, and what the prevailing interest rate is for similar bonds.

Pay as you go financing Utility Revenues ($ millions) 30 20 10 Years ?

Pay as you go financing Utility Revenues ($ millions) 30 20 10 Years Big infrastructure project launches here. E.g., water treatment plant, reservoir, piping system, seismic upgrades.

Bond financing The utility raised rates this much to pay off the bond. The bond pays for the new infrastructure. Utility Revenues ($ millions) … 30 20 10 Years Big infrastructure project launches here. E.g., water treatment plant, reservoir, piping system.

… Bond financing Pay as you go financing Utility Revenues ($ millions) 30 20 10 Years Pay as you go financing Utility Revenues ($ millions) 30 20 10 Years

… Bond financing Which is better? Pay as you go financing Utility Revenues ($ millions) … 30 20 10 Years Pay as you go financing Utility Revenues ($ millions) 30 20 10 Years

Which is better? Which is least costly? Which is best for the utility? Which is most fair to the customer?

Increasing Block Rates Ratemaking and using water rates as an incentive to conserve Should we use the “price signal” to get people to cut back on water use? A common way to do this is: Increasing Block Rates

Different Water Rate Structures Per month Per year Per month Price Price Price Summer Quantity Quantity Quantity Increasing Block Rate Uniform Volume Rate Seasonal Rates

Different Water Rate Structures Per month Per year Per month Price Price Price Summer Quantity Quantity Quantity Increasing Block Rate Uniform Volume Rate Seasonal Rates Nearly all agencies have increasing block rate structures, ….including Santa Cruz

A challenge to Increasing Block Rates Prop 218: Agencies can’t charge more than the cost of water supply Practice: Increasing block rates as an incentive to conserve potentially pays an agency more than the cost of providing water. Outcome: A lawsuit and a California appeals court ruling… …throwing out the practice of increasing block rates Price Quantity Increasing Block Rate

Objectives of Rate Design

1 Adequacy of Revenues   Agencies first predict how much revenue they will need. They do this by projecting out both expected costs and revenues. Utilities use the concept of a Test Year, a hypothetical year of operations, in which to estimate and measure all costs and revenues.

2 Stability and predictability of revenues. This relates to how much of a bill is a fixed cost and how much is related to the amount of water used. If you study your water bill you probably find that some of the costs are the same from bill to bill while other costs vary according to how much water you used during the billing period. The more of your bill found in the fixed cost, the greater the stability of revenue to the agency, but the less the conservation incentive to water users.

3 Minimize unexpected changes to customer bills. This requires conservative estimates of future costs and possible over-charging customers just to be sure there is enough revenue if something unexpected and costly happens. If an agency is going to build a new water treatment plant, they would use bond financing and pay it off over two or three decades, thereby avoiding a big jump in water costs when the design and construction bills come in.

4 Discouraging wasteful uses and promoting justified uses Justified uses include public parks irrigation; public health; and public fountains during heat waves. One could choose to charge a lower rate for water uses like these. The agency could charge extra for wasteful uses, such as extremely high water consumption from some residences that don’t appear to need that much water.

5 Assign the cost of risk management equitably Customers should pay for the services they are getting but not more or less. Customers should also pay for the risk reduction they are getting. Risks could include the possibility of interruption of service or reduction in water quality. This issue often applies to manufacturing or refining companies that require water of a certain quality to carry out crucial processes. Residential users might want to lower their risk of cutbacks in a drought. We have seen that water reliability is costly to provide. The lower the risk someone desires, the higher their water will cost and the more they should pay.

6 Avoid discrimination For example, against people with large families.

7 Simplicity, certainty, convenience, feasibility, and freedom from controversy Feasibility means that the agency should be able to implement the rate structure. For example, you can’t have a usage-based rate structure if you don’t have meters. An agency without meters would be forced to use a flat rate design. But sometimes the simplest rate design, a flat rate for everyone, might be controversial. This could be the case if some people in an agency service territory use far more water than others yet everyone is paying the same flat rate

8 Compliance with the law No water agency elected official, manager, or employee wants a rate structure that is breaking the law. Some states, like California, have laws that require water agencies to transition from flat rates to metered, variable rates, so customers can get information about how much water they are using and how much it costs. With that information, they will have greater incentives to conserve water. In California, that law is AB2572; requiring all California cities to have water meters and usage-based billing by 2025.

Summary list of the 8 objectives of water ratemaking 1 Adequacy of Revenues 2 Stability and predictability of revenues. 3 Minimize unexpected changes to customer bills. 4 Discouraging wasteful uses and promoting justified uses 5 Assign the cost of risk management equitably Avoid discrimination 7 Simplicity, certainty, convenience, feasibility, and freedom from controversy 8 Compliance with the law

Summary list of the 8 objectives of water ratemaking 1 Adequacy of Revenues 2 Stability and predictability of revenues. 3 Minimize unexpected changes to customer bills. 4 Discouraging wasteful uses and promoting justified uses 5 Assign the cost of risk management equitably Avoid discrimination 7 Simplicity, certainty, convenience, feasibility, and freedom from controversy Compliance with the law As a class, which 3 do we think are the most important?

Summary list of the 8 objectives of water ratemaking 4 Discouraging wasteful uses and promoting justified uses 7 Simplicity, certainty, convenience, feasibility, and freedom from controversy Compliance with the law As a class, which 3 do we think are the most important?

Types of Water Rates, Fees, Charges, and Taxes

Fixed Rates: These typically cover meter reading and billing; minimum charges; and “readiness-to-serve charges” that cover near-house maintenance of meters and piping. Also drought recovery fees.   Variable Rates: These are costs based on how much water one uses. Many US cities bill in units called “units,” which are 100 cubic feet of water each – or 1 ccf. - uniform, declining block, increasing block, seasonal

During the recent drought, Santa Cruz switched from a variable water charge to a quota system. Any customer that exceeded their quota was charged a fee (penalty) in addition to the water cost. They were given the opportunity to avoid the fee by going to “Water School.”

Special Rates: apply to smaller segments of a service territory…   Low Income/Lifeline for those on minimal incomes Negotiated Contracts for those with special reliability needs or unusual demand patterns. Economic Development – discounts to provide incentives to build new businesses. Standby Rates – Water is not currently demanded but the customer doesn’t want to be cut off completely. This may apply to someone who has a summer home that is empty the rest of the year.

Special Charges - one-time charges that provide additional revenues Special Charges - one-time charges that provide additional revenues. They often are connected to expanding the capacity or otherwise developing the water system.   Connection Fees: if someone wants to build a new house, they are charged a connection fee to hook up to the system. These can run to several thousand dollars. Water Service Extension Fees­: more than simply connecting a customer to the existing piping infrastructure, these fees cover the cost of extending piping to the customer. These fees come into play when a region develops a new source of water such as reclaimed water, that requires new piping.

More charges… System Development Charges –charged to real estate developers that require water service for a new subdivision. The anticipated new demand for water will exceed the capacity of the system so the developer is charged the cost of increasing capacity. In some cases, the expansion has already occurred and the developer or new resident is paying for costs already incurred in anticipation of their joining the system. Dedicated-Capacity Charges – if only one or a few clearly-identified customers require expansion of service, they can be charged for it rather than having all customers share in the cost. Fire Service Charges – cover the cost of hydrants and other fire-related system capacity. In some cases, utilities will provide additional infrastructure and water pressure to certain customers for an added fee.

Taxes are added to fees and charges. Franchise Tax: Pays the municipality for the right to use roadways and other thoroughfares to lay down pipes. Utility Tax: equivalent to business/occupation taxes charged to private sector businesses in a municipality.