Utility Ratemaking &Management

2

Goal: Rates That Reflect Your Priorities

Rates should reflect each community’s balance of sustainability Social

Fair & equitable distribution of costs Promote public policy objectives (affordability and economic development)

Environmental Promote resource conservation Fund cost of regulatory compliance

Economic Satisfy operating costs Fund asset management Meet financial policies Provide fiscal stability Service existing & new debt

3

Ratemaking Process Helps Overcome Challenges to Sustainability

4

Actual Client’s Financial PlanBefore Hawksley engagement

Recent economic conditions set many communities back Accelerated trends of declining water usage Reduced revenues/lack of increases required deferral of

maintenance/capital Non-discretionary programs funded through reserves

Cost of operations and regulatory compliance continues to rise Recovery is very difficult given current environment

Political will and stakeholder resistance to increases in rates Deferrals of key programs are/will have significant consequences

in terms of level of service and quality of life Rate studies educate the public about the challenges facing

utilities and the consequences of the status quo Studies are done with stakeholder involvement and usually result

in sustainable solutions that are acceptable to the public

Core Steps of Utility Ratemaking Process

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Fundamental Components1. Revenue Requirement2. Cost of Service3. Rate Design4. Stakeholder Education

Revenue Requirement Analysis: Compares revenues to operating & capital costs to determine adequacy of existing ratesCost of Service Analysis: Allocates the revenue requirements of the system to customers in a fair and equitable mannerRate Design Analysis: Considers the level and structure of rates that will collect revenue requirements from each customer classStakeholder Education: Explains the status quo, key issues/objectives, drivers of adjustments, and comparisons to local and national trends

Consider Efficiency & Needs:May Not Need to Perform All Steps Each Year

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Analysis & Outreach

Revenue Requirements

• Operating Costs• Capital Costs• Financial Policies

• Debt Coverage• Reserves

Cost Allocation

• Define Classes of Users

• Fair & Equitable• Comparison to Current

Revenue Recovery

Rate Design

• Evaluate Objectives• Conservation• Identify Structures• Customer Impacts

• Fee & Policy Review• Adjustment Drivers• National Trends• Local Practices

Selecting the Right Rate Structure For You

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Identify structure that meets your needs: Conforms to industry practice Meets all legal requirements Easy to administer/understand Elasticity of demand & weather Conservation and affordability Stakeholder input/concerns

Critical considerations: Understanding the drivers and

distribution of system costs Integrating financial considerations

Reserve policies & revenue stability

Most Common Rate Structures

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Uniform Rate Structure Same rate regardless of usage Most common rate structure

Declining Block Rate decreases for higher levels of usage Typically used to encourage economic

development and minimize bills for large users Was a very common and successful way of

creating cost-based rates for customer classes within a single rate schedule

Usage

Rat

e

Usage

Rat

e

Most Common Rate Structures

9

Inclining Block Rate increases for higher levels of usage Intended to encourage water conservation Typically applied to single-family residential

customers due to consistent usage within the class and to irrigation-only meters

Rarely appropriate to apply to non-residential customers

Pyramidal Block Rate increases then decreases with higher usage Intended to provide water conservation at lower

usage levels and reduced impact on larger users Allows for single structure that accommodates

large users

Usage

Rat

e

Usage

Rat

e

Most Common Rate Structures

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Seasonal Higher rates in peak times of year May be appropriate for communities with

customer classed that demonstrate seasonal usage patterns

Unique Tiers or Water Budgets Forms of inclining block rates based on specific

customer behavior or pre-determined efficient use allowances

Different blocks based on usage allowance per customer, class, lot size, or other factors

Structure used to focus higher rates on peak usage or to encourage wise use of water

Usage

Rat

e Summer

Winter

Usage

Rat

e

North Carolina Rate Structures(Source: February 2015 UNC EFC Rate Survey)

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Our Conclusions:1. Many systems still have uniform rates2. Large systems have inclining block rates3. Non-residential structures are more varied4. Not many seasonal rate structures (Other)

Understanding Cost Allocation is Important in Selecting Rate Structures

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Analysis & Outreach

Revenue Requirements

• Operating Costs• Capital Costs• Financial Policies

• Debt Coverage• Reserves

Cost Allocation

• Define Classes of Users

• Fair & Equitable• Comparison to Current

Revenue Recovery

Rate Design

• Evaluate Objectives• Conservation• Identify Structures• Customer Impacts

• Fee & Policy Review• Adjustment Drivers• National Trends• Local Practices

Cost of Service Allocation Process

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Review Historical

Customer Data

• Examine customer class usage

• Identify peak use

Evaluate Customer Classes

• Evaluate existing customer classes

• Water: Peaking factors and type of customer

• Sewer: Strength and volume

• Consider industry practices & local issues

Allocate Revenue

Requirements

• Identify cost of service & offsetting revenue (misc. fees)

• Allocate to systems and then to functions

• Distribute costs to users in proportion to contribution to each system function

Analysis/Use of Output

• Compare allocations to current revenue

• Use as basis for setting rates by class

• Rate structure and/or level of rates unique to each class

Utilize Available Industry Resources

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AWWA Manual M-1 Includes methods of detailed cost allocations

to functions and ultimately to customers in proportion to their contributions to each system component

Very data intensive Commonly utilized by larger systems

AWWA Manual M-54 Costs are less granularly allocated to

customer classes through rate structure Data readily available from utility billing

systems, such as meter size, dwelling units, and annual and monthly customer use, are used to establish rate structures that more generally apportion costs to customers

Most common approach by small systems

Cost of Service Determines Revenue to Be Recovered By Customers

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Allocate costs to system functions & review customer types

Apply methods/criteria best suited for data, circumstances & goals

Review analysis collaboratively Key issues, allocation criteria,

sensitivity of assumptions, etc.

Establish revenue to be recovered by rates for each customer class Compare to current rates

Water Cost of Service Wastewater Cost of Service→ Source of Supply → Treatment & Disposal→ Treatment → Collection→ Transmission → Reclaimed Water→ Distribution → Chemical Oxygen Demand→ Meters & Services → Suspended Solids→ Billing & Collection → Phosphorus

→ Residential → Ammonia→ General Service → Residential→ Residential Irrigation → General Service→ General Irrigation → Reclaimed Water→ Wholesale → High-Strength/Industrial

→ Wholesale

Cost

Fun

ctio

ns

Cost

Fun

ctio

ns

Cust

omer

Cla

sses

Cust

omer

Cla

sses

Residential Commercial TotalRev (000's) Rev (000's) Rev (000's)

Water - FY16 Current Rate Structure 17,803 16,131 33,934 Inside 17,565 11,507 29,072 Outside 21 72 93 Irrigation 217 4,140 4,357 Hydrant - 412 412

Water - FY16 COS Allocation 18,207 15,727 33,934 Inside 18,000 10,941 28,941 Outside 23 87 110 Irrigation 184 4,330 4,515 Hydrant - 368 368

Trend: Ensuring Linkages of Cost of Service to Conservation Rate Structures

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Goal: Capacity costs to higher demands when they occur Can be easily done with seasonal or

inclining block structures

Goal: Price incentive to conserve when most discretionary use occurs Typically done in tandem with a fixed

charge for revenue stability Ensures cost recovery if demand

declines/changes

Water Cost of Service→ Supply→ Treatment→ Transmission & Pumping→ Customer Bil l ing→ Meters & Services

→ Base Demand→ Maximum Day Demand→ Maximum Hour Demand→ Customer Bil l ing→ Meters & Services

→ Base Demand→ Customer Bil l ing→ Meters & Services

→ Base Demand→ Maximum Day Demand→ Maximum Hour Demand→ Customer Bil l ing→ Meters & Services

Com

pone

nts

Func

tions

Non

-Pea

kPe

ak

Water Conservation Rate Features

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Most conservation rates are typically inclining block Ranges of usage, with increasing rates for higher levels of use

Other options: seasonal rates or uniform rate (if high enough)

Develop block ranges and pricing based upon your demographic and usage data, objectives, and costs

Consider carefully crafted temporary adjustments Drought/water use restriction surcharges to ensure adequate rev.

Consider designating “highest tier” revenues for incremental spending only once realized Don’t plan on revenue for any current year required costs

Examples of Sizing of Inclining Blocks

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Use available data/resources US Census EPA (indoor use) Local Property

Data/GIS TWDB, TCEG, Save

Water, etc.

Review all customer usage profiles and property types

Consider local ordinances

Evaluate options w/understanding of impacts

Tier 1 - Typical Indoor Usage Amount Tier RangePeople per Household 2.57 Typical Indoor Use (Gallons per Capital per Day) 70 Typical Essential Domestic Use (Tgal/month) 5,472 First Tier Usage Amount (Total) 5,000 Up to 5,000 gal.

Tier 2 - Larger Family Indoor Usage Amount Tier RangeLarge Family - People per Household 5.00 Typical Essential Domestic Use (Tgal/month) 10,646 Second Tier Usage Amount (Total) 10,000 5,001 - 10,000 gal.

Tier 3 - Irrigation for Typical Property Amount Tier RangeSquare inches of area in 1/4 acre 1,568,160 % of area that is irrigable 33%Number of inches per watering 0.50 Gallons per cubic inch 0.0043290 Number of gallons per watering 1,131 Number of waterings per week 2.0 Gallons of irrigation per month 9,802 Third Tier Usage Amount 10,000 10,001 - 20,000 gal.

Fourth Tier Usage Amount All Add. Use > 20,000 gal.

Pricing Metrics of Inclining Block Rates

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Evaluate upon setting level of revenue recovered in usage rates & size/number of tiers

Example: 4 Block System1st Block

Affordability Rate: % of 2nd Block Local policy/objective

2nd Block Uniform Cost / TGAL

3rd Block Between 2nd and 4th Block rates

(equidistant or other)4th Block

Equal to full cost of new water supply, plus transmission

Review w/understanding of customer impacts

Table 2-3 – Top Block Water Cost Details

Cost Component

Unit Cost

(per 1,000 gal)

CAP Water $0.45

Water Purchase Rights $0.61

Plant Expansion $0.75

Debt Service Coverage $1.66

Credit for SDF Paid -$1.05

Total Marginal Unit Cost of Water $2.71

Unit Cost of Water Transmission $0.56

Total Top Block Rate $3.27

Key Financial Consideration:Mitigating Revenue Volatility

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Higher fixed charges provide stability, but reduce cost allocation and conservation message to high volume users

Use reserve policies to address declining demands, weather, conservation rates, and/or lower fixed charges

Consider local fixed cost recovery practices

Rating agencies starting to provide guidance Fitch: strong systems recover >=30% of revenue in fixed charges

% of Water Bill % of Sewer Bill % of Total BillDenton 28.8% 30.4% 29.5%

Min 12.7% 5.3% 12.6%Max 78.6% 100.0% 74.0%

Average 38.5% 39.4% 39.0%Median 37.6% 37.4% 39.5%

Description Fixed Charge %'s for 37 Entities Typical User

Level of Base Charges in North Carolina(Source: March 2016 UNC EFC Rate Survey)

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Larger systems have lower charges Residential affordability More non-residential users

Economies of scale

Consumption in Base Charge/First Tier(Source: March 2016 UNC EFC Rate Survey)

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2,000-6,000 TGAL in Tier 1 Not many w/use in base charges

If done, only nominal amount

Key Sustainability Challenge:Fixed Cost Recovery

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Difficult to increase % due to disproportionate impact to low volume users Develop a target and multi-year plan to achieve it

Components of FY 2015 Utility Costs Amount % of Total Amount % of TotalPersonnel Costs $1,044,517 21.7% $2,348,249 26.7%Variable Operating Costs $638,000 13.3% $1,153,650 13.1%Fixed Operating Costs $807,488 16.8% $1,240,033 14.1%Capital Outlay/Depreciation $230,000 4.8% $240,000 2.7%Administrative & General Expenses $1,685,520 35.0% $3,209,881 36.5%Engineering Expenses $408,812 8.5% $613,218 7.0%

Total Annual Costs $4,814,337 100.0% $8,805,031 100.0%

Water System Fixed Variable

Operating Expenses 76.5% 23.5%

Operating Revenue 50.0% 50.0%Avg. Fixed/Usage Fee Split of Other Local Entities

(Based on 6,000 Gal/Month Residential Bill) 35.7% 64.3%

Sewer System Fixed Variable

Operating Expenses 76.8% 23.2%

Operating Revenue 50.0% 50.0%Avg. Fixed/Usage Fee Split of Other Local Entities

(Based on 6,000 Gal/Month Residential Bill) 34.9% 65.1%

Variab le Operating Costs generally increase or decrease as system demand increases/decreases, and include power, chemicals, and sludge removal expenses. All other costs are generally fixed and independent of system demand.

Water Cost Sewer Cost

0%

25%

50%

75%

100%

Water Cost Water Rev Sewer Cost Sewer Rev

Cost vs. Revenue DistributionFixed Variable

Key Financial Considerations:Reserve Policies

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General rules of thumb for reserves are provided by industry groups like AWWA: Operating reserve equal >= 2 months of O&M Capital reserve equal to the average annual cash

funded CIP over the next 3 to 5 years

Also, rating agencies publish criteria relative to reserves that they use to evaluate the creditworthiness of utilities Days of free cash (strong systems >= 365 days)

Reserve levels should be established considering risk from rates and weather: Use of water conservation rates = more risk Lower fixed charges = more risk Exposure to drought conditions = more risk

Result: Typically have separate Operating, Capital, and Rate Stabilization Reserves

Sustainable Rates Require Ongoing Proactive Financial Management

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Analysis & Outreach

Revenue Requirements

• Operating Costs• Capital Costs• Financial Policies

• Debt Coverage• Reserves

Cost Allocation

• Define Classes of Users

• Fair & Equitable• Comparison to Current

Revenue Recovery

Rate Design

• Evaluate Objectives• Conservation• Identify Structures• Customer Impacts

• Fee & Policy Review• Adjustment Drivers• National Trends• Local Practices

Key Financial Consideration:Impacts of Changes in Water Use

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Must consider to ensure adequate revenue Review multiple years of use and population data Gather economic data, rainfall, rate changes, timing of conservation, etc… Identify relationship of drivers of use & recent trends Model growth in population & use/person separately (decline in use/person) Include price elasticity factors in revenue forecast Compare actual results to projections to refine assumptions over time

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

-

10

20

30

40

50

60

FY 2007 FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 FY 2014

Gallo

ns

Inch

es

Axis Title

Water Consumption Irrigation Consumption Annual Rainfall (In.)

Fundamental Challenge of Ratemaking

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Price product such that it encourages customers to use less of it while at the same time recovering enough revenue and not overcharging customers

Best Practices in Summary

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Understand & prioritize objectives Adherence to cost of service Promoting conservation Financial sustainability

Identify rate structure of best fitDevelop sound financial policies based

upon risks of rate structure & system Utilize available industry resources

Use dynamic forecasting models Evaluate alternative policies/programs Integrate changes in customer demands Ensure revenue recovery at lowest cost

Model Example: Water Utility Financial Model Screen Capture

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FY 2015 FY 2016 FY 2017 FY 2018 FY 2019 FY 2020 FY 2021 FY 2022 FY 2023 FY 2024 FY 2025

0.00% 7.00% 7.00% 7.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 29.66% 46.93%

0.00% 7.00% 7.00% 7.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 30.19% 46.80%

2.13 2.40 2.08 1.98 1.91 1.90 2.06 2.11 2.00 1.91 1.84

1.40 1.65 1.50 1.47 1.45 1.45 1.55 1.60 1.76 1.70 1.64

100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%3.5 4.0 4.5 5.0 5.5 6.0 6.0 6.0 6.0 6.0 6.0

FINANCIAL ANALYSIS AND MANAGEMENT SYSTEM (FAMS) SUMMARYCumulative Change

Residential Rate Increases

Parity Indebtedness Key Scenarios/Inputs

Commercial Rate Increases

CIP Execution % ►Operating Reserve Mo ►

Total Debt Coverage

05

101520253035

15 16 17 18 19 20 21 22 23 24 25M

illio

ns ($

)

Long-Term Borrowing Current Plan

05

101520253035

14 15 16 17 18 19 20 21 22 23 24 25

Mill

ions

($)

Operating Current Plan Target

05

101520253035

15 16 17 18 19 20 21 22 23 24 25

Mill

ions

($)

CIP Spending Current Plan

SAVE CALC

05

101520253035

15 16 17 18 19 20 21 22 23 24 25

Mill

ions

($)

CIP Funding Bonds Tap Fees Revenue Vehicle

ROLL

010203040506070

15 16 17 18 19 20 21 22 23 24 25

Mill

ions

($)

Rev Vs. Exp Cash In Cash Out Cash Out Excl. CIP

05

101520253035

14 15 16 17 18 19 20 21 22 23 24 25

Mill

ions

($)

Contingency/RS Current Plan Target

Larger near-term increases to achieve reserve and debt coverage targets

Leads to inflationary increases in the

future

Preserves funds to address revenue stability issues

Multi-year plan to achieve target balance

Serves to reduce future borrowing needs

Keeps system sustainable

FY 2015 FY 2016 FY 2017 FY 2018 FY 2019 FY 2020 FY 2021 FY 2022 FY 2023 FY 2024 FY 2025

0.00% 5.75% 5.75% 5.75% 5.75% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 29.55% 46.83%

0.00% 5.75% 5.75% 5.75% 5.75% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 30.19% 46.80%

2.09 2.29 2.07 1.90 1.93 1.90 2.05 2.09 1.98 1.89 1.82

1.38 1.57 1.49 1.41 1.46 1.45 1.54 1.59 1.75 1.69 1.63

100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.0 6.0 6.0

FINANCIAL ANALYSIS AND MANAGEMENT SYSTEM (FAMS) SUMMARYCumulative Change

Residential Rate Increases

Parity Indebtedness Key Scenarios/Inputs

Commercial Rate Increases

CIP Execution % ►Operating Reserve Mo ►

Total Debt Coverage

05

101520253035

15 16 17 18 19 20 21 22 23 24 25M

illio

ns ($

)

Long-Term Borrowing Current Plan

05

101520253035

14 15 16 17 18 19 20 21 22 23 24 25

Mill

ions

($)

Operating Current Plan Target

05

101520253035

15 16 17 18 19 20 21 22 23 24 25

Mill

ions

($)

CIP Spending Current Plan

SAVE CALC

05

101520253035

15 16 17 18 19 20 21 22 23 24 25

Mill

ions

($)

CIP Funding Bonds Tap Fees Revenue Vehicle

ROLL

010203040506070

15 16 17 18 19 20 21 22 23 24 25

Mill

ions

($)

Rev Vs. Exp Cash In Cash Out Cash Out Excl. CIP

05

101520253035

14 15 16 17 18 19 20 21 22 23 24 25

Mill

ions

($)

Contingency/RS Current Plan Target

Model Example: Water Utility Financial Model Screen Capture (Alternative)

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Preserves funds to address revenue stability issues

Slightly lower near-term increases to achieve reserve and debt coverage targets

Still leads to inflationary increases in the future

Extended Multi-year plan to achieve target balance

Keeps system sustainable

Continues to reduce future borrowing needs

Implementation of Sustainable Solutions Requires Communication

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Analysis & Outreach

Revenue Requirements

• Operating Costs• Capital Costs• Financial Policies

• Debt Coverage• Reserves

Cost Allocation

• Define Classes of Users

• Fair & Equitable• Comparison to Current

Revenue Recovery

Rate Design

• Evaluate Objectives• Conservation• Identify Structures• Customer Impacts

• Fee & Policy Review• Adjustment Drivers• National Trends• Local Practices

Be Able to Identify Key Challenges to Financial Sustainability & Drivers of Rates

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Compare Historical and Projected Increases to National Trends….

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0%

20%

40%

60%

80%

100%

120%

140%

160%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Cum

ulat

ive

Incr

ease

US CPI - Water & Sewerage Maintenance Seriesvs. Manistee Total W/S Rate Increases

W&S CPIManistee HistoricalNew Structure

FY 2015 - 2017 Recommendation

City has been consistently lower than the industry in water/sewer rate adjustments through 2014 Average annual increase of 7% per year for Water & Sewerage Series; City at 5% per year Recommendations would fund needed improvements with rate adjustments lower than the industry

Consider Preparing Key Issue Materials and…(Provided by Payne Communications)

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Identify Ways For Customers to Conserve(Provided by Payne Communications)

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Sustainable Solutions Are Possible

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What it Requires:Explicit and reality-

based assumptions With ongoing review

Inclusion of relevant staff/experts Consider all impacts Ensure cost recovery

Use of available industry resources

Real stakeholder communication Involving key groups

early and often Dedicated education

Contact Information

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Andrew BurnhamUtilities Financial Solutions Director

Hawksley ConsultingPhone: (904) 631-5109

Email: Andrew.Burnham@Hawksley.com