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HomeMy WebLinkAboutStaff Report 402-10CMR: 402:10 Page 1 of 7 TO: HONORABLE CITY COUNCIL FROM: CITY MANAGER DEPARTMENT: UTILITIES ATTENTION: FINANCE COMMITTEE DATE: NOVEMBER 2, 2010 CMR: 402:10 SUBJECT: Water and Wastewater Utilities Rate Design Review This report is provided for discussion of alternative Water and Wastewater Utility rate structures and to assist the Finance Committee in providing feedback to staff on direction regarding the rate design proposals that staff plans to bring forward in future months. EXECUTIVE SUMMARY Staff hired an external consultant to perform a cost of service analysis (COSA) for the Electric, Gas, Water and Wastewater Collection utilities. Cost of service analyses are conducted to review utility rate structures and the alignment of revenues with the cost of providing service for each customer class. The water and wastewater COSA suggests that an increase in residential rates is warranted, as is a decrease in rates from other customer classes. Overall, including expected adjustments for gas and electricity, the COSA changes for an average residential customer would result in an increased cost of about $4.32 per month, or about 1.3% of the total monthly bill for these four services.1 Staff has used the results of the COSA, and reviewed water and wastewater utility rate structures, to analyze various alternative rate structures to ensure equitable rates for all customer classes. There are many different water rate designs that can be developed to collect the required revenue. To narrow the scope, staff developed preliminary rate design options in line with certain objectives, such as: rates should: 1) reflect the cost of service; 2) provide effective price signals to promote conservation of resources; and 3) avoid rate shock and undue financial hardship. Note that the first objective, which is rates by customer class reflect cost of service, is a requirement under Proposition 218. Under Proposition 218, rate schedules must be based on the best evidence available to the City of cost incurred to serve each customer class. 1 Note that Refuse and Storm Drain rates are not part of the information presented in this report. Other policy questions that warrant discussion include:  How much revenue should be collected with fixed charges versus charges based on actual usage of water?  How many usage blocks, or rate tiers, are appropriate to encourage conservation?  How should the implementation of COSA and rate design changes be phased in over time? BACKGROUND During Fiscal Year (FY) 2010 staff initiated a Cost of Service Analysis (COSA) for the Water, Wastewater, Gas and Electric Utilities. A COSA is conducted to review utility rate structures and the alignment of revenues with the cost of providing service for each customer class. Water and wastewater are subject to Proposition 218 related requirements for setting rates and providing the public notice and opportunity to comment. The use of a COSA for rate setting fulfils these requirements, and staff’s schedule for review of water and wastewater rate structures ensures public notification requirements will be met in time for a proposed FY 2012 rate adjustment. Based on the results of the COSA, and a review of Water and Wastewater Utility rate structures, staff analyzed water and wastewater customer use patterns and various alternative rate structures in preparation for revisions to rate structures to ensure equitable rates for all customer classes. DISCUSSION Cost of Service Analysis Staff hired Utility Financial Solutions, LLC (UFS) in October 2009 to conduct a COSA for the Electric, Gas, Water and Wastewater Utilities. UFS has experience in completing over 300 rate studies for municipal utilities around the nation, including experience in serving as expert witness on rate issues and delivering testimony and depostions to legal and regulatory agencies. The analysis involved an in-depth review of utility financial data, customer class load profiles, and the specific costs associated with providing utility services. It was conducted based on industry-recognized procedures involving functional classification of utility assets and expenses, and allocation of costs to customer classes based on cost of service. Specific customer class attributes included: o quantity of service and/or resource consumed; o variability of use during the year; o peak demands created on the system by each class. The result of the COSA is a recommended adjustment to rate schedules to accurately align future revenues collected from each customer class with the costs attributable to serving that class. Table 1 presents the summary of the COSA results for Water, Wastewater Collection, Gas and Electric Utilities. Although the current focus is on the water and wastewater rate design, the results for all utilities are provided to show the overall impact of these COSA adjustments to each customer class. CMR: 402:10 Page 2 of 7 Table 1 Rate Schedule Customer Class COSA Adjustment Water Utility W-1 Residential 7% W-4 Commercial -9% W-7 Irrigation -1% W-3 Fire Hydrants 94%(*) Total 0% Wastewater Utility S-1 Residential Single Family 13% S-2L Residential Apartments 13% S-2O Commercial -8% S-2R Restaurants -14% S-2XL Large Commercial -29% Total 0% Electric Utility E-1 Residential 0% E-2 Small Commercial -2% E-18 Municipal 4% E-4 Medium Commercial 1% E-7 Large Commercial -2% Total 0% Gas Utility G-1 Residential -4% G-2 Small Commercial 0% G-3 Large Commercial 11% G-6 Municipal 3% G-8 Cooperatively Owned Back-up Generator (COBUG)-2% G-10 Compressed Natural Gas (CNG) -18% Total 0% (*) The W3 Private Fire Hydrant suggested adjustment represents an adjustment to meter charge based on meter size. For example, for a 4 inch meter, the current monthly customer charge of $4.20 must be increased to $7.20 to properly recover utility costs. Additionally, the suggested adjustment for Public Fire Hydrant service is an annual charge of $78,253 for the Municipal Class. Currently the City is not charged for public fire hydrant service. The impact of the COSA-related alignment of revenues on residential customer bills is presented in Table 2. Note that Table 2 shows the rate adjustments due to COSA alignments for Electric, Gas, Water and Wastewater Funds. Any possible changes to the Refuse or Storm Drain rates are not part of the information presented in this report. As discussed below, moving rates to reflect these COSA alignments may be done over more than one year. Additionally, there may be other changes to utility rate schedules as part of the FY 2012 budget process due to increased revenue requirements that are not known at this point and are not reflected in Table 2. CMR: 402:10 Page 3 of 7 Table 2 Impact of COSA Adjustments Average Residential Monthly Utility Bill Utility (Usage levels) Current Bill Bill After COSA Adjustment $ Difference % Difference Electric (650 kWh/mo) $ 76.33 $ 76.33 $0.00 0.0% Water (14 CCF/mo) $ 72.01 $ 77.05 $5.04 7.0% Gas (100 therms/mo winter, 30 therms/mo summer) $ 99.42 $ 96.45 ($3.98) -4.0% Wastewater $ 24.65 $ 27.85 $3.20 13.0% Refuse $ 32.86 $ 32.86 TBD TBD Storm Drain $ 11.23 $ 11.23 TBD TBD Utilities User Tax $ 12.39 $ 12.44 $0.05 0.4% Total Monthly Bill $328.89 $333.21 $4.32 1.3% Table 3 presents the impact of COSA related alignment of revenues on the City’s General Fund. Due to the COSA alignments, the General Fund will see increases in the utility bill for City- owned facilities for water and wastewater services, but decreases in the utility bill for gas and electric services. The General Fund will also see an increase in revenues from the Utilities User Tax. However, the increased cost for public fire hydrants is substantial. The overall impact on the General Fund of all these changes is a relatively small ($9,700 per year) increase in costs. Table 3 Impact to City’s General Fund FY 2011 Budget Utility User Tax Revenues $7,966,000 FY 2011 Budget Utility User Tax post COSA $8,009,051 UUT gain /(loss) $ 43,051 GF Water Bill (Increase)/Decrease $ 103,517 GF Wastewater Bill (Increase)/Decrease $ 12,400 GF Gas Bill (Increase)/Decrease $ (8,923) GF Electric Bill (Increase)/Decrease $ (81,532) GF Total Utilities Bill (Increase)/Decrease $ 25,463 Fire Hydrants gain /(loss) $ (78,253) Total Impact gain /(loss) $ (9,738) Rate Design Objectives Staff used the following objectives to guide the development of the preliminary rate design alternatives:  Revenues collected from a customer group should reflect the cost to serve the customer group and meet the requirements of Proposition 218.  Rates should provide effective price signals to promote conservation of resources.  Rates should avoid rate shock and undue financial hardship. CMR: 402:10 Page 4 of 7 Water Utility Rate Design Issues Additional water rate design policy questions include: What is the appropriate level for the monthly fixed charges? Customer bills include both a fixed monthly charge, which is independent from the amount of water used, and a volumetric charge, which is based on the amount of water used. Collecting revenue through a fixed charge provides for more revenue stability, but volumetric charges encourage more conservation. The water utility currently has much lower fixed monthly charges than neighboring utilities. Currently, about 94% of the total revenue is collected from volumetric water charges, but the COSA recommends that the fixed charges should increase so that the revenue from volumetric charges would represent 88% of the total revenue. The figure below shows the Palo Alto’s current fixed charges compared to benchmark cities and the fixed charge suggested by the COSA. To encourage water conservation and comply with the best management practices, the California Urban Water Conservation Council recommends that revenue from the volumetric charges should constitute at least 70% of the total revenue. Should residential rates have more water usage blocks? Palo Alto currently has two water usage blocks (tiers) for residential customers. Most neighboring utilities have two, three, or four tiers for residential customers. Adding more tiers gives more flexibility to collect required revenue, as appropriate, from the higher tiers and keep CMR: 402:10 Page 5 of 7 average monthly bills stable for customers who use the least amount of water, even with the increased fixed charge component. In addition, in droughts, the cost in the highest use tiers can be increased to encourage more conservation among the highest water use customers. Should tiered rates be introduced for non-residential customers? Currently tiered rates are in place for residential customers only and all other customer classes have a volumetric charge that does not vary by usage level. Commercial customers are a less homogenous class than the residential customers, therefore developing a tier design that captures base usage vs higher usage levels that are equally representative for the class as a whole is more difficult. However, if commercial customers are grouped by meter size, water usage among such grouping is relatively more homogenous. Many of the neighboring utilities have tiered rates for commercial customers. How should the implementation of COSA and rate design changes be phased in over time? Implementing the full COSA adjustment in Fiscal Year 2012, along with anticipated commodity cost increases could result in a residential water rate increase of 14% or higher. To mitigate this rate impact, the COSA adjustments can be phased in over two or three years. Wastewater Utility Rate Design Issues Additional wastewater rate design policy questions for the Committee are: How should the implementation of COSA adjustments be phased in over time? Similar to the water rate adjustment, the wastewater adjustment could be phased in over two or three years. Should industrial surcharges be eliminated? Currently, wastewater rates for industrial customers include special surcharges for “high strength” discharges. Due to the changes in customer profiles over time, the wastewater treatment plant has indicated that no significant strength differences are being observed between customers in the industrial rate class. Staff recommends that rate schedules be revised to remove these surcharges and recover costs based on water usage. NEXT STEPS Staff anticipates presenting the final rate schedule changes to the City Council for adoption by June 2011 as part of the overall FY 2012 Budget Process. To do so, staff has outlined the following steps: Sep 2010 – Review of Water and Wastewater Rate Design with City Manager and Utilities Risk Oversight and Coordinating Committee – (Complete) Oct 2010 – UAC Study Session: Water and Wastewater Rate Design – (Complete) Nov 2010 – Finance Committee Study Session: Water and Wastewater Rate Design Feb 2011 – Request UAC to recommend Council adoption of proposed changes to Water and Wastewater Utility rate schedules. Mar 2011 – Request Finance Committee to recommend Council adoption of proposed changes to Water and Wastewater Utility rate schedules. CMR: 402:10 Page 6 of 7 UAG Study Session: Financial projections and alternative rate design options for Electric and Gas Utilities. Finance Committee Study Session: Financial projections and alternative rate design options for Electric and Gas Utilities. Apr 2011 Proposition 218 Customer Notification Letters for W /WW Rate Adjustments. May 2011-Request UAC to recommend Council adoption of proposed changes to Electric and Gas Utility rate schedules. -Request Finance Committee to recommend Council adoption of proposed changes to Electric and Gas Utility rate schedules. Jun 2011 Rate Adoption -Request Council adoption of proposed rate schedule changes for Water, Wastewater, Gas and Electric Utilities for FY 2012. BOARD/COMMISSION REVIEW AND RECOMMENDATIONS The UAC discussed staffs water and wastewater rate design alternatives at its October 6, 2010 meeting. The Commission discussed the level of revenue collected through fixed charges versus volumetric charges, adding additional tiers to the residential and commercial water rates, and phase-in of the COSA adjustments over two or three years. The Commission also discussed the elimination of industrial surcharges for wastewater rates. Draft notes from the UAC's October 6, 2010 meeting are provided as Attachment A. ATTACHMENT A. Excerpted Draft Minutes from the UAC October 6, 2010 meeting PREPARED BY. REVIEWED BY: DEPARTMENT APPROVAL: CITY MANAGER APPROVAL: CMR: 402:10 IPEKCONNOLLY lv Senior Resource Planner DEBBIE LLOYD 17L- Acting Assistant Director, Resource Management VALES ;P::;w~Cp .c:r;(~AMESKEENE '\ "/" City Manager Page 7 of7 .ATTACHMENT A EXCERPTED DRAFT MINUTES OF UTILITIES ADVISORY COMMISSION Meeting of October 6,2010 ITEM 5: DISCUSSION: Water/Wastewater Rate Structure Senior Resource Planner Ipek Connolly presented the overall cost of service analysis (COSA) study results for all four utilities including Electric, Gas, Water .and Wastewater Collection. The COSA studies present the share of total costs that are associated with serving each customer class. These costs are compared to the share of the revenues from each customer class and shifts are suggested if the revenues and costs to serve are not in alignment. Overall, the COSAs show that revenues from residential water and wastewater customers should be increased, while revenues from other customer classes should be lower. For the electric COSA, no COSA alignment is needed for residential customers. For gas, revenues from residential customers are higher than required to match the costs to serve. Overall, the COS A changes for an average residential customer would result in an increased cost of about $4.32 per month, or about 1.3% of the total monthly bill. Connolly explained that the City of Palo Alto Utilities (CPAU) has three rate design objectives: • Reflect updated cost of service • Provide effective price signals to promote conservation of resources • Avoid rate shock and undue financial hardship In addition, the key questions for water design are: • What is the most appropriate level for the monthly fixed charges? • Should CPAU residential rates have more tiers? • How should the tiers be established -what should be the size of each tier and pricing level for each? • Should tiered rates be introduced for non-residential customers? • How should the implementation of COSA and rate design changes be phased in over time? Regarding the fixed monthly charges, CPAU currently has much lower fixed monthly charges than the neighboring utilities. Besides alignment between customer classes, the COSAs suggest that the fixed charge component of the rate should be increased. Currently, about 94% of the total revenue is Collected . from volumetric charges, but the COSA recommends that the fixed charges should increase so that the volumetric charges would represent 88% of the total revenue. To encourage conservation and comply with the best management practices, the California Urban Water Conservation Council (CUWCC) recommends that revenue from the volumetric charges should constitute a minimum of 70% of the total revenue. Currently, the water rates for all customer classes include fixed and variable charges. Tiered rates are in place for residential customers only currently. All other customer classes have a volumetric charge that does not vary by usage level. Palo Alto currently has two tiers for residential customers. Most neighboring utilities have two, three, or four tiers for residential customers. The histonc justification for not having tiered rates for non-residential rates is that residential customers are a more homogenous class than the non­ residential customers. Alternatives to current rates are to add one or more tiers to the residential rates and to create tiers for the non-residential rates. One way to get around the non-homogeneity nature of commercial customers is to group them by meter size. Many of the neighboring utilities have tiered rates for commercial customers. Commissioner Berry noted that, even if the wholesale rate from the SFPUC is volumetric, the costs are all fixed and, lowering usage will not lower cost for the regional water system. Those costs will ultimately be passed on to the wholesale water users. Commissioner Melton stated that he supports moving towards COS for the fixed costs, more tiers for residential customers and creating tiers for commercial customers. Commissioner Foster agreed with Melton's recommendations. Chair Waldfogel cited price elasticity studies that showed that raising rates for large water users will not necessarily result in saving water, but lowering water rates for users who use little water may encourage additional \A,later use. Council Member Scharff disagreed that residential customers are a homogenous group since some live in condominiums and some on half acre lots. The latter, who presumably are higher income residents, will always use more water and high rates for higher use tiers is tantamount to charging people with higher income more. Commissioner Eglash supported getting as much revenue as possible from the volumetric rate component to maximize the incentive to conserve water. Commissioner Keller agreed that the rate signal is important and will result in giving customers choices. Higher volumetric rates will encourage customers to consider making choices to save money such as whether to take out lawns. CPAU should show the public the rate increase trajectory and prices of rate tiers so they can plan investments. Chair Waldfogel asked staff to provide more data on fixed costs and show how much of the total costs for the water utility are fixed, not just the amount of fixed costs that are included in the fixed charge recommended by the COSA. He also asked for data showing how tiers would impact higher water users so that it doesn't just seem like a tax on higher water users. The commissioners summarized their positions on the key, questions: • Commissioner Keller said that the COSA alignment should be phased in over three years. She also supported adding another tier for residentialcustomers and creating a tier for commercial customers. • Commissioner Melton leaned towards mEwing to the full COSA class alignment in two years. He supported moving to add an additional rate tier for residential and commercial next year. • Commissioner Cook supported moving to the COSA alignment over two years. He indicated that he would like more rate tiers, but is concerned with the impact on commercial customers. • Commissioner Foster supports adding one tier to residential and commercial customer rates, maximizing the volumetric charge (minimizing the fixed charge), and keeping prices low for small water users. • Chair Waldfogel indicated that he supports moving to the COSA alignment over two years. He supports adding additional rate tiers if analysis shows that it would result in increased efficiency since it is tantamount to a charge for large properties. • Commissioner Eglash said he supports moving to the COSA alignment in two years. Resource Planner Eric Keniston presented current rate structures, and possible changes to consider in the Wastewater Collection Utility. Keniston noted that current residential wastewater rates are flat and not based on water use. Current non-residential wastewater rates have a monthly minimum charge and a volumetric rate based on water usage. Large industrial users are currently charged a fee for certain high strength discharges. The Wastewater Treatment Plant is recommending to eliminate the surcharges for permitted industries. Due to changes in customer profiles, they have observed no significant strength differences between customers in the industrial rate class. Elimination of surcharges will result in the full cost recovery on a volume of discharge basis rather than using both volume and strength of discharge. Staff recommends eliminating these charges. Keniston identified the wastewater rate design options: • Implement COSA adjustment over one, two, or three years • Eliminate industrial surcharges and collect revenues based on volume of discharge • For the commercial customers, the current minimum charge could be changed to a fixed charge, thus lowering the volumetric charge component. Commissioner Eglash stated that he didn't see any imperative to change anything in wastewater rates, except to implement the COSA alignments. Commissioners Melton, Cook, and Foster agreed that no big changes are needed to the wastewater rate structures. Commissioners Eglash and Keller expressed concern over the elimination of the industrial surcharges. Commissioner Melton suggested that the industrial surcharge should be kept as an alternative if needed in the future.