The Importance of Proactive Rate Analysis for Water and Wastewater Utilities

By Travis J. Long, CEP

DID YOU CONDUCT A RATE ANALYSIS THIS YEAR?

With the first quarter of a new calendar year well underway, it is time to ask some important questions, such as, did the annual budget adequately address rates as part of the budget planning process? Are funds available to implement capital improvements, unexpected system issues, or adequately build reserve for the system? Did such efforts focus solely on the adjustment of expenditures to balance the budget?

Far too often, these important and routine considerations regarding water or sewer rates are never really discussed until a capital improvements project is required or major issues arise within a system, which undoubtedly is the inopportune time to have such discussions. If the rate adoption process is going to attract public outcry and add stress to the project or crisis unfolding, this is when it will happen. Discussing and adopting a thorough and well-understood rate schedule or rate policy beforehand will often reduce heated meetings and help properly inform those paying the rates of the planned and preferably gradual increases to their rates.

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Financial planning is key and those financial goals to be identified by any service provider are: examining customer equity; establishing and forecasting rates that sufficiently recover the costs of providing service and address pricing objectives; and developing a long-term financial plan for the utility that addresses future infrastructure investment requirements.

• Rate analysis or studies should become part of the budget planning process and be adjusted annually. However, it is never too late to analyze rates and adjust as necessary to most effectively and efficiently serve the customer and manage the utility. What key questions should be asked when addressing budgets or reviewing the income and expenditures monthly?
• Is the utility willing to minimize rate increases at the expense of adequately funding capital replacements?
• How does the utility make tradeoffs between revenue stability and system sustainability?
• Is the utility accumulating sufficient reserves to position themselves to issue new debt?
• What components or portions of the system are reaching the end of their useful life, and has the utility adequately budgeted?

Let’s discuss those practical procedures to consider before causing the public to bring the “torches and pitchforks” to those heated debates about rate increases. It is difficult to objectively examine and evaluate important policies in the midst of a heated meeting when the over-riding concern is the size of the rate increase. At that point, most of the audience, as well as elected officials, cannot focus on anything else. But broader (and maybe more important) issues get lost in the face of strong public opposition to rate increases. Is anyone asking what the guiding policies are that contributed to the increases? Likely not. Carefully constructed plans that establish a rational and consistent approach to the financial health of the system should be key factors in budgeting and associated rate analysis, in conjunction with the long-term financial goals. Public outcry can easily be minimized by routinely addressing rates. Identifying potentially contentious rate concerns well ahead of the rate study simply makes sense, and open and transparent communications with customers is paramount to success.
Raising rates on customers will always meet some level of rate-payer hostilities. So, resolving or at least openly discussing specific criteria for raising rates in a rational and calm setting prior to rate adoption can minimize the surprise, anger, and pressure from customers. For example:

• Do the rates allow for timely replacement of system assets, or do they by default follow a “wait until it breaks to fix it” mentality?
• Should the utility minimize rate increases for capital improvements by issuing more debt?

Pros and cons can abound to each of these questions. Costs and often the winners and losers in terms of rate impacts can be evaluated and contribute to a rational decision by the elected officials, if that discussion takes place before a rate increase is implemented. Being fully informed and having reviewed short- and long-term needs of the system is the foundation to building a defensible basis for rate increases and is always more effective earlier in the process. A proactive, forward-thinking process should incorporate a review and discussion of key rate-related policies first, followed by financial analysis and development of rate alternatives. The bottom line is to be proactive and thoughtful in order to minimize controversies at the most critical point in the process (that would be the night that elected officials vote to adopt or reject rate increases).

Here are some general concepts to consider while reviewing income/expenditures and/or plan the next
utility rate study:

• Identify financial and pricing objectives
• Identify revenue requirements and demand projections
• Allocate costs
• Design rate structure
• Assess the effectiveness of addressing pricing objectives

Within all aspects of rate analysis, it is highly recommended to provide advanced warning to customers. The best approach is to thoroughly assess the alternatives and the levels of rate increases with decision-makers in one or more study sessions so that everyone is fully informed and on-board prior to the final public meeting in which the rates are presented and finalized.

Rate and budget planning should demonstrate an understanding of what it takes to create and maintain a well-run and professionally-managed utility. These are fundamental guidelines that should be used during the rate-setting process, and should be available to rate payers so that they understand the rationale for the financial decisions an agency will be making. Unfortunately, utility providers are seeing larger rate increases than ever before:

• Grant money to build infrastructure is no longer as readily available as it was 15-20 years ago.
• System assets are approaching the end of useful life and such assets are simply wearing out; not replacing worn out pipes, tanks, mechanical equipment, etc. not only risks system failures, but can create huge financial liabilities as well as public perception nightmares.
• Generally poor economic conditions, which are likely to continue for the foreseeable future, create an even more difficult environment for passing rate increases.
• Rate-related policies can play a significant role in minimizing resistance to higher rates.

Remember, revenue derived by “Users” of the system receiving service is not unlike any other service business. An expense is derived from providing those services, and cash flow is king to sustainability and long-term asset management. Involve policymakers in the rate development process. Clearly define specific charges and review the type of rate structure being used in billing; consider fixed fees to stabilize cash flow; consider more frequent billing (monthly vs. quarterly); codify rate increase ordinances; consider professional third party assistance in rate studies. Use the full cost of service model to evaluate cash flow: Cost of water/wastewater (producing, treating and/or conveying); administrative (billing, permits, HR, dues, penalties, etc.); operators and operations; commodities (electric, fuel, materials, professional services, etc.); and capital funding debt service.

Therein, charge what is REQUIRED to operate and maintain the system in good working order, and meet all permit requirements. This also means to ensure adequate fund reserves are on hand for emergency capital or operations funds and funding shortfalls (economic downturns or arrearage). “Industry Standards” recommend reserves to be 25% of operating expenses (not inclusive of capital or debt services) and further suggest higher reserves based on experience or infrastructure needs.

Utility companies can rely on help from many avenues to ensure proper planning is implemented and that fiduciary responsibilities are attained. One of the most important elements of any rate study is to ensure that a utility generator’s revenue is sufficient for the operation of the system.

JHA Companies offers services to assist utility companies in implementing a rate analysis to ensure that financial planning is in place to adequately meet the short- and long-term needs of these systems. JHA also is available to work with a customer base in the exchange of information and policy implementation.