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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.