Addressing Water Conservation Through Rate Design Burton Benkwith, Senior Manager

1. Addressing Water Conservation Through Rate Design Burton Benkwith, Senior Manager Jackson Thornton Utilities Montgomery, AL

2. Outline • Part 1 - Basics of Rate Development & Design • Part 2 –Current Rate Design Practices • Part 3 – Emerging Trends in Rate Design • Part 4 – Legal Considerations

3. How are water rates determined? How should water rates be determined? 3

4. How are Rates Determined? Believe it or not, there are actually many different publications that address the practice of allocating cost to rate-payers • Bonbright • NARUC • AWWA • WEF 4

5. Basic Principles/Goals of Properly Designed Rates • Practical (Realistic) • Uncontroversial as to Interpretation • Meet Revenue Requirements • Provide Revenue Stability and Sufficiency • Fairness and Equity (Fair is related to cross subsidies & Equity is related to Price=Cost) • Avoidance of Undue Discrimination Within Classes 5

6. Basic Principles/Goals of Properly Designed Rates • Provide Economic Efficiency - discouraging wasteful use of service while promoting all justified types and amounts of use • Develop True Cost of Service • Ability to Pay • Simplicity (Admin & Cust Understanding) • Legally Defendable • Provide What the Public Wants 6

7. Guidelines for Rate Making • “Cost of Service” is the cornerstone of the ratemaking process • But it is unlikely that the exact values derived from the cost of service study will be used in the final rates published • Practicality requires judgment calls and consideration of non-cost factors • Rate innovation is encouraged to address a specific problems or objective • Transitions to new rate structures and levels should be gradual to mitigate economic dislocation 7

8. Competing Objectives • Meeting Revenue Requirements vs. Having Low Rates • Social Issues vs. Cost of Service • Fairness & Equity vs. Behavior Modification 8

9. Rate Setting Process • Determine Revenue Requirement – Compare utilities expenses to current revenues to determine the overall level of rate adjustment • Cost of Service – Allocate the revenue requirement between various classes of customers (Residential, Small Commercial, Industrial, etc.) • Rate Design – Design rates that meet the goals of the utility (financial, political, debt, conservation, etc.) 9

10. Determination of Revenue Requirement • Two methods for calculating the revenue requirement • Utility Method • Cash Method 10

11. Developing Revenue Requirement Operations & Maintenance - $4,074,878 Taxes and PILOT - $0.00 Debt Service - $2,856,830 Rate Funded Capital - $1,659,400 11

12. Cost Allocation • Cost allocation is the process of allocating the system revenue requirement to each rate class • Fair & Equitable • Defendable • Developing the true customer cost and consumption cost • Matching fixed and variable expenses with revenue • Three step Process • Functionalization • Classification • Allocation 12

13. Functionalization • Grouping each component of the revenue requirement based on function • Treatment • Distribution • Pumping • Admin. & General Accounting systems typically do most of this for you 13

14. Classification • Classify each component of the revenue requirement based on cost driver • Typically, water studies classify utilizing either the Base-extra Capacity Method or the Commodity-Demand Method • Both recognize that the cost of service depends on volumes, peaking requirements and customers, fire protection and possibly revenue drivers 14

15. Allocation • Once an expense has been classified based on cost drivers, the expense will be allocated to each class • Water Plant Expansion from 10 MGD to 20 MGD – This would be a good example of a cost that could be imposed on that customer who caused you to expand the plant. Residential customers use 87% of annual water but 93% during the summer months. But what happens if they respond to your pricing signal? 15

16. Revenue Requirement by Class 16

17. Revenue Requirement per KGal 17

18. Recovery by Rate Class 18

19. Cost of Service Rates • COS studies determine the fixed and variable cost of the system • Fixed (A&G, Meter Reading, Postage, Debt Service) • Variable (Power, Chemicals, Maintenance) • This should drive how you structure your customer charges and usage charges 19

20. Rate Design • Rate design is the process of taking what the COS tells you about the true cost structure, and developing a rate that is supported by the COS study but also meets the financial, political and social goals of the utility. 20

21. Uniform Rate 21

22. Uniform Rate 22

23. Pro’s & Con’s of Uniform Rates Pro’s • Easy to understand • Easy to tie back to cost • The more you use the more you pay • Everyone is treated equal • Fixed vs. Variable match is easy to implement, less reliance on weather Con’s • Sends no signal • Treats everyone the same 23

24. Declining Block Rate 24

25. Declining Block Rate 25

26. Pro’s & Con’s of Declining Block Rates Pro’s • Encourages usage Con’s • Encourages usage • Not tied to COS (can you defend them) 26

27. Inclining Block Rate 27

28. Inclining Block Rate 28

29. Pro’s & Con’s of Inclining Block Rates Pro’s • Send pricing signal • Discourages usage Con’s • Discourages usage • Can be politically unpopular • Are they truly fair (special circumstances such as large families or family farms) • Difficult to administer if current rate classification practices are not good • Not tied to COS (Defensible) • Probably not properly recovering fixed vs. variable correctly • Weather sensitive • Leaks? 29

30. Breakpoint Considerations • Winter Usage • Number of minimum and zero users • Do you want to generate revenue or change consumption patterns? 30

31. Rate Considerations • Can’t forget that at the end of the day the utility has a set of costs that it needs to recover • It really doesn’t matter how you get there, just as long as you get there • Is it more important to get you fixed cost up front or put it on higher users and run the risk of a wet season • Are you willing to have one group subsidize another? That will most likely happen if you try to elicit a behavioral response • Got to meet your revenue requirement but what happens if you make too much money? 31

32. Other Rate Considerations • Are lifeline rates needed? • Does low income correlate with low usage? • Do we have competition? • Should ratemaking seek a “social” as opposed to a “economic” or “business” objective 32

33. System Development Charges • System development charges are a critical component to a water utilities overall funding plan • Necessary if the utility has taken a “growth pays for growth” philosophy • Forces new customers to pay upfront • Allows the utility to have capital available when capacity increases are needed • Keeps utility from having to raise retail rates to meet growth demands 33

34. System Development Charges • There are three broadly recognized structures of system development charges • (1) Equity (Buy-in) Method – Based on existing facilities, the goal is to achieve equity between existing and new customers. Typically best used when there is available capacity • (2) Incremental approach – Assigns new development the cost of system expansion needed to serve new development. Best used when capacity is limited • (3) Combined approach – Considers both existing and planned future facilities 34

35. System Development Charges • SDC’s can play an important role in conservation initiatives if properly used • If a customer is required to pay, up-front, for his potential impact to the system, meter size and facilities may be looked at in greater detail (Car Wash) • May be viewed as a hindrance to growth in a geographic area 35

36. Other Rate Options • One direction that is commonly taken is to remove the usage included in the minimum. • This can be done in phases to minimize the effect on smaller customers • 2007 drought to 2009 monsoon has caused rate design to come full circle • Irrigation only rates are becoming more popular • Can be developed in a way that the cost matches that of the residential tail blocks 36

37. Ratchet • A ratchet is something that has been used in the electric arena for years. The basic premise is that the utility has to construct assets to meet you peak day needs, therefore they are going to charge you based on your beak day needs 37

38. Ratchet Example • “Billed consumption will be the greater of actual monthly usage or 80% of max month during the prior eleven months” 38

39. Economics Behind Rate Design ($14.38 customer - $2.09 per kGal) 39

40. Traditional Uniform Rate 40

41. Declining Block Rate 41

42. Inclining Block Rate 42

43. Bottom Line • The bottom line with traditional conservation measures is that they can be effective but there are always unintended consequences • There will always be some group of stakeholders that do not like the proposed rates • Most utilities have a built out system and they need to generate revenues to operate. Conservation may end up raising rates 43

44. Policy • Some policy initiatives that can be taken to address conservation include: • Irrigation system policy – many utilities have implemented policies regarding the type of irrigation systems that can be installed • Waive connect fees and SDC’s on separate irrigation meters (may also save on sewer) • Try to push capacity expansion out into the future through conservation (80% capacity rule on plant design) • Promote efficient appliances, shower heads 44

45. Reuse or Grey Water • Utilities across the country are investing in “grey water” or “reuse” systems for irrigation of sports complexes, golf courses and large retail areas • Not something you would get into to “make money” but if certainly could reduce your irrigation requirements significantly • Unintended consequence however is that some bodies of water rely on the effluent from a sewer treatment plant to maintain water levels and flows • Looking into closed loop systems – out the back of the wastewater treatment system and into the front of the water plant 45

46. Integrated Water Resource Plan • Many municipalities have started the process of developing an integrated water resource plan (IWRP) • Challenges the traditional approach of running a water and sewer system - “Build to meet needs” • IRWP brings together all stakeholders to develop a long term approach to the water resource management of an area • Tie every decision back to a focus point such as “health of the river” • Treat or buy • Discharge or reuse • Retention ponds vs. pollutant collection 46

47. Water Budgets • A rate design approach that has made a comeback in parts of the country to address conservation is the water budget concept • A water budget is “a quantity of water that would be required by an efficient level of water use” (AWWA Research Foundation –”Water Budgets and Rate Structures) • City of Boulder Colorado – “ A water budget is the amount of water you are expected to need for a specific month. Each customer’s water budget will be different based on their water needs. Water budgets may vary monthly based on seasonal watering needs.” 47

48. Water Budgets • Also known as “individualized” or “goal based” rates, these rates are traditionally inclining block rates where each block represents a degree of excessive use Family of 4: • $15.00 per month includes 2,000 gallons • Next 6,000 gallons are $4.50 per KGal (normal usage) • Next 4,000 are $5.50 per KGal (mild waste) • Next 8,000 are $7.50 per KGal (moderate waste) • All Additional Usage is $10.000 per KGal (extreme waste) 48

49. Water Budgets • Family Size • Fixtures • Lot size (landscape) • Plant type • Evapotranspiration (ET) • Can be difficult to implement. May needs aerial mapping. • Goes back to the economic efficiency concept – Provide for needs but discourage waste 49

50. Summary • Conservation is a major concern and focus in the water industry today • Especially in areas where there is not an abundance of water (Middle TN) • The drought of 2007 really brought this issue to light and put it at the forefront of rate design • It can have its drawbacks • Can be unpopular • May lead to higher rates • The single biggest problem is the lack of understanding on the value of a gallon of water (it should be free) 50