Arizona Water Issues Setting Rates for Regulated Water Utilities

1. Arizona Water IssuesSetting Rates for Regulated Water Utilities Nancy Scott Utilities Division ARIZONA CORPORATION COMMISSION June 30, 2011

2. Securities Legal Utilities Safety Administration Corporations Hearing Information Technology Arizona Corporation Commission (ACC) • Five person panel elected in statewide vote • Eight divisions:

3. ACC Authority (Utilities) • Regulation of public service corporations (PSCs) that provide water, telecommunications, electric, and gas service. • PSCs are regulated monopolies given the opportunity to earn a fair and reasonable return on their investments. • PSCs are primarily investor-owned; by definition, does not include government entities. • Responsible for ensuring reliable utility service at fair, just and reasonable rates.

4. Number of Utilities • Water companies 300+ • Sewer companies ~50 • Telephone companies 100+ • Electric companies 15 • Gas companies 6

5. Utilities Division Sections • Financial & Regulatory Analysis (FRA) • Telecommunications & Energy • Consumer Services • Engineering • Director’s Office & Administration

6. Water Utility Cases • Certificate of Convenience and Necessity (CC&N) • Rates • Financing • Tariffs • Complaints

7. Setting Rates Two-Step Process • Determine the utility’s revenue requirement. • Spread the revenue requirement over customer classes and consumption to set rates. Revenue Residential Commercial Industrial Requirement

8. Revenue RequirementCost-of-Service Method • Traditional Rate Base/Rate of Return • Revenue requirement composed of: • prudently-incurred operations and maintenance costs; • depreciation and amortization expense; • taxes; and • return on rate base (investment).

9. Test Year • The one-year historical period used in determining rate base, operating income and rate of return. • The end of the test year is the most recent practical date available prior to filing. • Pro forma and normalizing adjustments are made to test year data.

10. Rate Base • The investment base to which a fair rate of return is applied to arrive at the revenue requirement. • The total of the investor-funded plant, facilities, and other investments used by the utility in providing utility services to its customers.

11. Sample Rate Base CalculationOriginal Cost Rate Base Plant in Service $ 798,267 Less Accumulated Depreciation $ 456,078 Net Plant $ 342,189 Plant Advances $ 57,017 Service Line & Meter Advances $ 1,200 Less Total Advances $ 58,217 Gross Contributions $ 196,718 Less Amortization of Contributions $ 48,930 Less Net Contributions $ 147,788 1/24 Power $ 115 1/8 Operation & Maintenance $ 3,960 Inventory $ 0 Prepayments $ 0 Plus Total Other Items$ 4,075 RATE BASE$ 140,259

12. Rate of Return (ROR) • Represents the amount allowed to be earned, expressed as a percentage of rate base. • ROR is intended to allow the utility to: • Meet its obligations to present investors • Compete on reasonable terms in the financial markets for future capital requirements • Often the most controversial component of the revenue requirement.

13. Revenue RequirementDebt-Service or Cash Flow Method When little or no rate base exists Revenue requirement based on cash flow: • prudently-incurred operations and maintenance costs; • taxes; • refund payments; • principal and interest on debt; • reasonable allowance for contingencies; and • small allowance to build equity.

14. Rate CaseEngineering Review • Inspect physical plant facilities. • verify plant inventory • determine used and usefulness (including excess capacity) • Evaluate system condition/operation and identify any deficiencies. • Recommend depreciation rates. • Recommend meter/service line charges.

15. Rate CaseFinancial Review • Audit company’s books and records. • Establish recommended rate base. • Recommend allowable expenses. • Recommend revenue requirement. • Recommend rate design.

16. QUESTIONS???