HomeMy WebLinkAbout1996-05-30 City Council (9)I UDGET 1996-98
City of Palo Alto
City Manager’s Report
TO:HONORABLE CITY COUNCIL
ATTENTION: FINANCE COMMITTEE
FROM:CITY MANAGER DEPARTMENT: ADMINISTRATIVE
SERVICES
AGENDA DATE: MAY 30, 1996 CMR:284:96
SUBJECT:ALTERNATIVES OR OPTIONS TO PROPOSED 1996-97 WATER
RATE INCREASE
REQUEST
This report responds to the Finance Committee’s request to provide options to the propos¢d
1996-97 rate increase in the Water Fund.
RECOMMENDATION
Staff recommends the Finance Committee approve the original staff proposal for a 6 percent
water rate increase in 1996-97, with a full equity transfer to the General Fund. Staff
continues to recommend that a complete review be undertaken of all of the components of
the water rates during 1996-97 to ensure competitiveness. This will include an analysis of
what impact the accelerated infrastructure program has on the rates compared to other cities,
and a cost/benefit analysis of debt versus pay-as-you-go financing for infrastructure
improvements.
EXECUTIVE SUMMARY
The proposed 1996-97 Water Fund budget includes a 6 percent increase in rates, which
would generate approximately $665,000 in revenue. Rate increases are needed periodically
to cover the revenue requirements of the Water Utility. These requirements include:
purchasing water, operating and maintaining a reliable distribution system, financing capital
~nprovement projects, funding prudent reserve levels, and providing a reasonable equity
transfer to the General Fund. During discussions of the proposed Water Fund budget,
concerns were expressed by members of the Utilities Advisory Commission (UAC) and
members of the Finance Committee over the magnitude of the proposed rate increase, the
General Fund equity transfer, and the methodology used to calculate the transfer. Discussion
ranged from discomfort with raising rates while customers are curbing water usage to
CMR:284:96 Pagei of 7
concern with the transfer to the General Fund while a General Fund surplus is projected, at
this time, for 1996-97. Staff received direction from the Finance Committee to develop
options or alternatives to the short-term issue of the proposed rate increase and the increase
in the equity transfer of $422,000. Long-term concerns, including an analytical comparison
of Palo Alto water rates to those in surrounding communities, will be analyzed and presented
to the UAC and Council before the next budget process. This review will look at all
element of the rates, including a comparison of the Water Fund’s level of infrastructure work
compared to the other benchmark cities, and a cost/benefit analysis of the traditional pay-as-
you-go financing approach to bond financing for capital work.
Possible Options for Water Rate Increase and Water Equity. Transfer
Table One shows a variety of possible rate and equity transfer scenarios for the Water Fund
for 1996-97 and 1997-98. The table also shows the projected funding of the Water Rate
Stabilization Reserve in each year.
Based on revenue and expenses through April 1996, the Water Fund’s Rate Stabilization
Reserve is projected to equal $6.7 million at the end of 1995-96. This anticipated reserve
level is $.4 million above the 1995-96 target and $2.5 million above the 1995-96 minimum
level. The 1996-97 Proposed Budget projects an ending reserve balance of $5.3 million
which would be $.1 million below the target level and $1.7 million above the minimum
balance. The minimum reserve level has been established by Council policy. It is derived
by a formula that is the sum of 15 percent of water sales revenue plus an estimated annual
net sales revenue decline due to abnormal weather. The maximum reserve level is calculated
by doubling the calculated minimum level and the target level is set at the midpoint between
the minimum and maximum levels.
CMR:284:96 Page 2 of 7
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Discussion of Options
Option 1 Current Staff Proposal - Increase rates by 6 percent in 1996-97 and
potentially 7 percent in 1997-98, with full equity transfers in both years.
This option spreads the anticipated .rate increase over two years,
avoiding the need for a double digit rate increase in either year. In
addition, no rate increase would be required in 1998-99, a year in which
rate increases are projected in four other funds. Due to other funds’
rate decreases in 1996-97, this is a prudent year to implement a rate
increase for the Water Fund. The current staff proposal also allows the
General Fund to continue building reserves, in anticipation of large
future infrastructure expenses. Finally, this proposal allows staff time
to review the various components of the water rates and the
competitiveness of the rates, and return in 1997-98 with a full review
of long-term issues.
Option 2 Use Reserves to Fund the Equity Transfer - This option provides a 0 percent
rate increase in 1996-97, a probable 15.5 percent rate increase in 1997-98, and
equity transfers at the full level of $2,044,000 in 1996-97 and $2,187,000 in
1997-98.
This option uses the Water Rate Stabilization Reserve to help fund the
equity transfer and proposes no rate increase in 1996-97. This proposal
draws the Water Reserves close to the minimum level by the end of
1997-98 and probably requires a 15.5 percent rate increase in 1998-99.
This option does not impact the General Fund as the equity transfer is
at the full level.
Option 3 Reduce the General Fund Equity Transfer
Freeze Water Equity Transfer at 1995-96 Level - No increase in
rates in 1996-97 and freeze equity transfer at $1,622,000 (1995-96
level). Increase rates potentially by 9 percent in 1997-98 and provide
a full equity transfer at $2,187,000.
This option freezes the 1996-97 equity transfer at the 1995-96 level of
$1,622,000. Freezing the equity transfer would eliminate the need for
a rate increase in 1996-97. However, a 9 percent rate increase would
probably be required in 1997-98 and a 9.9 percent rate increase would
CMR:284:96 Page 4 of 7
be required in 1998-99. This option requires rates to be ramped up
after 1996-97 to compensate for the frozen equity transfer and zero rate
increase in 1996-97. The General Fund would lose $422,000 in
revenue in 1996-97, reducing the amount of funding available for
infrastructure investments.
Freeze the Water Equity Transfer in 1997-98 at the 1996-97 Level
With No Rate Increase in 1996-97 - No rate increase in 1996-97, a
potential 9.9 percent rate increase in 1997-98 and 1998-99, and an
equity transfer in each year of $2,044,000.
This option proposes no rate increase and an equity transfer of
$2,044,000 in 1996-97. This option benefits the Water Fund only in
1996-97, as additional rate increases of 9.9 percent are probably
required in 1997-98 and 1998-99 to compensate for no rate increase in
1996-97. As mentioned, because rate increases are projected in four of
the other enterprise funds, 1998-99 is not the preferred year to
implement a water rate increase. This option benefits the General Fund
by maintaining the equity transfer in 1996-97 and only benefits
ratepayers in 1996-97.
Calculate the 1996-97 Equity Transfer at the 1995-96 Rate of
Return - This option includes rate increases of 4 percent in 1996-97
and possibly 8 percent in 1997-98. The equity transfer would be
calculated based on the 1995-96 rate of return and would equal
$1,937,000. In 1997-98 the equity transfer would equal $2,187,000.
This option spreads the rate increase over two years, and would not
require a rate increase in 1998-99. It lowers the equity transfer to the
General Fund by $107,000 in 1996-97. This option still requires a rate
increase in 1996-97 that is somewhat below the 6 percent rate increase
proposed in Option 1. This lower rate increase is recovered in 1997-98
by a somewhat higher rate increase than that proposed in Option 1. The
General Fund loses $107,000 in 1996-97 but still maintains a
substantial portion of the equity transfer.
Staff believes 1996-97 is the preferred year for a rate increase, given the rate decreases
recommended in the Gas and Wastewater Collection Funds. Moreover, the water rate
increase follows a series of water rate reductions in 1995-96 (10 percent), 1994-95 (15
percent), and 1993-94 (7 percent).
CMR:284:96 Page 5 Of 7
Table 2 (below) illustrates the projected rate increases in each of the enterprise funds in
1996-97, 1997-98 and 1998-99 and the overall rate changes that would be required
depending upon which water rate option is selected. It is important to note that in some of
the options sizable rate increases are projected for 1998-99, a year in which rate increases are
anticipated in four other enterprise funds. As mentioned above, the rate increases shown in
1997-98 and 1998-99 may be adjusted should the cost of service study recommend an
alternative to pay-as-you-go financing for the accelerated infrastructure program.
Table 2
Rate Adjustments
Electric Fund
Gas Fund
Refuse Fund
Storm Drainage Fund
Wastewater Collection Fund
Water Fund Scenarios
Option I (Staff Proposal)
Option 2 (Reserves to fund equity
transfer)
Option 3A (1995-96
dollar amount)
3B (1996-97 and i997-
98 at 1996-97 dollar
amount)
3C (transfer at 1995-96
rate of return)
1996-97
6.0%’1"
1997-98
Note 1
9.0%~"
5.o%’I"
35.o%’I"
8.o%
9.9%~
4.0%’1"
9.9%’1"9.9%’1"
Note 1: Possible rate increase for Calaveras Reserve to cover stranded investment.
CMR:284:96 Page 6 of 7
Impact on the General Fund of Reducing the Water Equi .ty Transfer
The 1996-98 City Manager’s proposed budget discusses the enormous infrastructure needs
facing the City’s General Fund, as well as a number of as yet unfunded programs in their
final stages of development. The City Manager has recommended that the $1.3 million
surplus be considered as a "down payment" for these needs, pending completion of a
comprehensive infrastructure report. While the actual costs of the infrastructure work are
unknown, in CMR 165:96, "Budget Issue: Conceptual Framework for Consideration of the
1996-98 Capital Improvement Program," staff identified millions of dollars of unfunded
infrastructure needs. Reductions in the equity transfer from the Water Fund will reduce
resources available to fund General Fund infrastructure needs.
It is important to consider the impact to the General Fund over the long-term when making
a decision to reduce the Water Fund tr.ansfer. The possibility of sales tax fluctuations is very
real, and the desire to dedicate resources to new programs and to fund long-term
infrastructure needs are all reasons to exercise caution in making decisions that may reduce
the availability of long-term General Fund resources.
PREPARED BY: Virginia Harrington, Budget Manager
DEPARTMENT HEAD APPROVAL:~. ~
Emhy Harrison
Deputy City Manager,
Administrative Services
Ed
CITY MANAGER APPROVAL:
Manager
CC: n/a
CMR:284:96 Page 7 of 7