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Introduction
HDR Engineering (HDR) was retained by the Southside Water and Sewer District (District) to conduct a water and sewer rate study. The objective of the rate study was to develop a financial plan and rates necessary to meet the utilities’ operating and capital improvement needs. This study determined the adequacy of the existing sewer rates and provides the framework for any needed future adjustments. This study is timely given the significant capital improvement projects facing the District, particularly as they relate to wastewater treatment.
Overview of the Rate Study Process
This rate study consisted of two interrelated analyses. Each utility was evaluated on a “stand-alone” basis. That is, no subsidies from other sources should occur. The need to adequately fund both operations and maintenance (O&M) and capital infrastructure was balanced against the rate impacts to customers.
Sewer Utility Revenue Requirement
The sewer revenue requirement analysis compares the sewer utility’s total revenues to its expenses. This analysis is used to determine the overall adequacy of the sewer utility rates. The revenue requirement, or financial plan, was developed for a six-year projected time period (fiscal year 2008–2014). This time period was selected since it captured the District’s major capital project, Phase I of the sewer utility treatment plant expansion, and the operational and debt service costs associated with that capital improvement. In projecting the revenues and operating expenses for the sewer utility, the primary inputs to the analysis were the District’s budget and accounting documents, capital plan and debt service obligations.
A “cash basis” revenue requirement was developed and the fiscal (FY) year 2008 budget was used as a starting point. Escalation factors were developed for various types of expenses and revenue that the District incurs. The escalation factors used within this analysis ranged from 1% to 8% per year. There are some shared expenses between the water and sewer utilities. Based on the District’s historical experience, those costs are allocated 34% to water and 66% to sewer. The total operating costs were $219,000 in FY 2008 and are projected to increase to approximately $270,000 by FY 2014. The total revenue requirement, which includes both operating and capital costs, was projected to be $219,000 in FY 2008 and increase to approximately $502,000 by FY 2014.
An important aspect of the sewer revenue requirement was the funding of Phase I of the treatment plant expansion. The District anticipates approximately $2.8 million in capital expenditures for the sewer utility treatment plant upgrades in FY 2009/2010. As a result of the magnitude of this capital expenditure, long-term borrowing is required to finance it. At the present time, the District does not have any outstanding debt service for the sewer utility. With the treatment plant expansion, an average annual debt of $115,000 is expected in the future years. It is anticipated that the District will use State low-interest loans to minimize borrowing costs.
It should be noted that the deficiencies shown in any single year are cumulative. That is, any adjustments in the initial years will reduce the deficiency in the following years.
The existing sewer utility rate revenue appears to be deficient the first two years of the review period, due to new treatment plant construction and operating costs. A phased-in approach was developed to cover the costs of Phase I of the treatment plant project, with a 47% rate adjustment in FY 2009, followed by a 38% increase in FY 2010. Additional rate adjustments are not necessary until FY 2014 when cost of living adjustment of 2% is necessary to keep up with inflationary pressures. The need for these adjustments is driven by the treatment plant expansion and the resulting debt service and additional (incremental) O&M expenses.
Sewer Utility Rate Design
The revenue requirement indicates the priority of the District should be to generate an adequate level of funding for the sewer utility with cost-based rates. With the top priority to adequately fund operations and capital, no adjustments to the rate structure were proposed at this time.
The utility has monthly flat rates of $52 per month per equivalent residential unit (ERU). With the proposed adjusted, these rates increase to $107.60 by FY 2014. This financial plan also includes a revision to the connection fees for new customers, as prepared separately by the District.
By implementing the calculated rate adjustments necessary for the utility to have adequate funding for operating and capital costs, in FY 2014 the utility rates will increase to $107.60 per month. This increase is due to Phase I costs of the sewer treatment plant expansion.
The results suggest that the issue of affordability will need to be addressed by the District. A common test of affordability is the annual user charge (AUC) as a percentage of median household income. Historically, this test has suggested that the affordability threshold may be in the range of 1.5% to 2.5% of median household income. Stated another way, if the annual sewer bill is greater than 1.5% to 2.5% of the median household income, then the rate is at the very least deemed “questionable” and possibly “unaffordable.” When a projected rate is found to be unaffordable, then the utility has a much stronger case for outside assistance in the form of grants and/or very low-cost (0% to 1%) loans.
HDR reviewed various resources to determine the median household income for Bonner County and more specifically for the City of Sandpoint area. Based upon our research, the median household income for the County and the City was fairly similar. For the County, based upon the 2000 census, the median household income was $32,803. A recent study of the City of Sandpoint placed the median household income at $33,100. Using this higher figure, that would suggest that the District’s rates may be “questionable” when they are in the annual range of $497 - $827. The annual rate projected is $624 at the existing rate of $52/month/ERU and increases to $1,291 in FY 2014. This clearly would be defined as an “unaffordable” rate, by any definition or test known to HDR.
Water Utility Revenue Requirement
A similar approach as described for the sewer utility was used to analyze the revenue requirements for the water utility. The time period reviewed captured the water utility’s major capital project, the water tank replacement, planned for FY 2011. In projecting the revenues and expenses for the water utility, the primary inputs to the analysis were the District’s budget, accounting documents and capital plan.
The “cash basis” revenue requirement (financial plan) was developed in the same fashion as the sewer utility, with escalation factors applied to the base year expenditures and revenue, to determine future year expenses and revenue. The escalation factors used were the same as those for sewer, ranging from 1% to 8% per year. The total operating costs were in FY 2008 are $66,000 and are projected to increase to $80,000 by FY 2014. The total revenue requirement for the water utility was $90,000 in FY 2008 and is projected to be $120,000 in FY 2014.
An important aspect of the water revenue requirement was ensuring the funding of capital improvements (tank replacement project). The District anticipates approximately $250,000 in capital expenditures for the water utility tank replacement project in FY 2011. This project will be funded by rates and reserve balances.
The water utility rate revenue appears to be slightly deficient through most of the review period, due primarily to the assumed escalation of costs (inflation) over this time period. As with the sewer utility, it is important to understand that the deficiencies shown in any single year are cumulative. That is, any adjustments in the initial years will reduce the deficiency in the following years. Therefore, cost of living rate adjustments of 2.5% per year for the first three years, and 2% for the FY 2012 and FY 2013 are recommended. These rate adjustments should provide adequate revenue to meet the projected operating and capital costs of the District. In FY 2012, the tank replacement project puts the utility into a temporary deficit position. In that particular year, the water utility will need to borrow funds from the sewer utility or LID accounts in order to fully cover all costs. That loan, of approximately $26,000, is repaid in FY 2014.
Water Utility Rate Design
With the proposed rate adjustments applied in each of the five years, the base rate will increase $3.85 per month and the consumption charge will increase $0.15/per 1,000 gallons by FY 2013, and remain the same in FY 2014.
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