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2018 Strategic Directions:Water Report

Rates: The "Existential Reality" Requires Innovative Balancing Act

The “existential reality” of managing declining revenue in the face of increasing investment needs has become the new norm for the water sector nationwide. Utilities consistently face competing pressures – changes in water use behavior and advances in water efficiency help sustain precious resources, but impact utility revenues. Addressing aging infrastructure and water quality needs enhances service reliability and public health but puts significant cost pressures on utilities.

This is compounded by external influences such as resistance to timely rate increases, and a continuing awareness gap on the value of water, leaving utility managers perennially facing a perfect storm. To navigate their reality, utility managers have to proactively explore alternative approaches to managing resources, building financial resiliency and optimizing utility costs.

Funding Adequacy and Cost Recovery

In Black & Veatch’s 2018 Strategic Directions: Water Report survey, utility leaders shared their insights on the main drivers of revenue decline. Consistent with what we see in many utilities, 47 percent of the participants say efficiency advances in fixtures and appliances have had the highest impact, up from 33 percent last year (Figure 1). Forty-two percent say conservation successes have impacted revenues, also a substantial increase from 2017. While drought also continues to be a key factor, only 33 percent this year cited drought as one of the revenue decrease factors, down from 42 percent last year.

Figure 1: Select the items that have negatively impacted your utility’s revenue stream during the last five years.

Select the items that have negatively impacted your utility’s revenue stream during the last five years.

The responses reflect an emerging phenomenon – utilities are placing greater emphasis on cost of service and rate analysis to transition from focusing on a “single benefit” outcome, such as funding adequacy, to a more holistic “multibenefit” outcome that addresses the competing needs of revenue stability for infrastructure investments, enhanced equity in cost recovery and opportunities for revenue enhancements.

Utility managers have to proactively explore alternative approaches to managing resources, building financial resiliency and optimizing utility costs.

According to the survey, more than 55 percent say they will focus on cost of service review and 40 percent cited the development of innovative rate structures as two key issues that they would focus on during the next two years. Interestingly, only 21 percent of the participants indicated a need to enhance overall funding adequacy in the immediate term (Figure 2).

Figure 2: What challenging user rate issues does your utility need to address in the next two years?

What challenging user rate issues does your utility need to address in the next two years?

While funding adequacy in the immediate term may not be a critical issue for many of the survey participants, approximately 44 percent of the participants state they do not have the funding adequacy to meet future service and infrastructure management demands. Within this category, 29 percent say they can cover current, but not future demands, while 16 percent say their funding structure is in more of a dire situation where it can cover neither.

Utility Management Strategy Trends

Effective utility management strategies and initiatives are critical to managing both the revenue and the cost side of a utility’s fiscal health, prompting the survey question about what strategies utility leaders have engaged in or are considering, to enhance funding capacity and service delivery.

On the revenue side of the fence, the following three strategies are noteworthy:

  • Regular User Charge Increases

    Ninety-one percent of the participants indicated they have adopted and/or are considering rate increases to sustain financial capacity. This approach is consistent with industry recommended financial best practices such as diligent multi-year financial planning and rate adjustment process.

  • Meter Replacement Program

    Recovering usage revenues commensurate with the actual water use is as important as managing costs. Eighty-four percent of participants indicate they have engaged in or are considering implementing a proactive meter replacement program to ensure meter reading accuracy and thereby mitigation of potential revenue loss.

  • Stormwater User Fee Funding

    Many water utilities that have stormwater management responsibilities still recover stormwater costs through sewer charges or other mechanisms, without an explicit stormwater user charge. However, utility leaders are recognizing the viability of a stormwater user fee both for generating adequate funding capacity and, more importantly, enhancing equity of cost recovery. Nearly 27 percent of participants indicate that they are actively considering a stormwater user fee funding mechanism.

To best manage costs, utilities are engaging in the following four key strategies:

  • Regional Cooperation

    The water utility service delivery is highly fragmented with more than 40,000 utilities, many of which serve small population centers. With most of the utility costs being fixed, mid-size and small communities face a greater challenge in managing costs because of lack of economies of scale. The concept of regional cooperation is beginning to take hold as 43 percent of the participants indicate that they are actively considering cooperation approaches.

  • Energy Performance

    Energy costs are a significant component of a utility’s operations and maintenance (O&M) budget. While effective energy performance contracts are still in their infancy, 39 percent of the participants indicate that they are considering this as one of the cost management strategies.

  • Resource Recovery

    Complimenting energy management initiatives, resource recovery initiatives such as waste to energy, biosolids reuse, and aquifer recharge not only help optimize resources and cost but also provide some revenue-generation opportunities. While resource recovery is still a nascent phenomenon, nearly 37 percent of the participants are considering such strategies.

  • Alternative Capital Program Financing and/or Delivery

    Utilities that have scalable programs are beginning to explore alternative financing and delivery options, such as communitybased public-private partnerships (CBP3) and other forms of partnership, to address multiple aspects including capital funding, risk management, and execution capacity. The survey indicates that while only 15 percent are engaged in private partnerships, 36 percent are considering them for the future.

As Figure 3 indicates, utilities overall — relative to the responses of the previous year — seem to indicate a slightly lower reliance on debt financing through municipal bonds and state revolving fund loans, and an increasing focus on alternative delivery approaches such as publicprivate partnerships. One plausible reason is that utilities are beginning to realize that traditional debt financing approaches can only go so far and that alternative capital funding mechanisms that also ensure performance must be examined.

Figure 3: Has your utility adopted, or is currently considering, any of the following strategies and tactics to help finance and/or deliver services and major capital programs?

Has your utility adopted, or is currently considering, any of the following strategies and tactics to help finance and/or deliver services and major capital programs?

Financial Policies

In utility financial planning and rate development, well-defined financial policies with financial metrics, especially those authorized by charter, provide a defensible and compelling basis for rate increases and a utility’s financial health. These metrics that ratings agencies value typically include debt service coverage of 1.2 or higher, rate stabilization funds to protect rate volatility and manage unforeseen costs, and equity enhancement through some level of cash financing of capital expenditures.

Most participants indicate adhering to basic principles such as revenue requirement being supported by user charges, and at least 60 percent indicate having a reasonable operations and maintenance reserve balance. However, only one-third to less than half of the participants indicate achieving metrics on financial indicators that rating agencies typically use in assessing fiscal health.

This indicates a continuing need to educate utility administrators and decision-makers on the critical roles financial policies and financial performance play in building and maintaining financial resilience.

The road ahead in effective utility fiscal management would involve holistic planning and an implementation approach that focuses on multi-benefit initiatives and outcomes.

Stakeholder Engagement

Insights were sought on the following three factors pertaining to stakeholder engagement and customers, namely communication, rate approvals and customer assistance:

  • Communication: Utilities appear to continue to stick to the conventional means of engaging with decision-makers and elected officials. Over 60 percent of the participants indicate using facility tours, workshops and briefings, and only 40 percent of the participants appear to leverage technologies such as web portals to disseminate information and engage with stakeholders. As councils, boards and commissions begin to include a more techsavvy generation of leaders, it would be prudent for utilities to take advantage of available technologies for a more interactive and responsive stakeholder engagement.
  • Rate Approval: Proactive stakeholder engagement can help garner multi-year rate approvals, which provide for funding certainty for the operations and capital initiatives in the immediate term. It is noteworthy that more than 71 percent of utilities report they are able to get approval for at least two consecutive years or more of rate increases. In contrast, almost 30 percent of utilities indicate they are unable to seek any multi-year rate approvals.
  • Customer Assistance: Balancing rate increases with customer assistance programs could not only enhance customer experience but also help navigate the rate approval challenges. The survey indicated that nearly half of the participants offer low-income programs, and only 31 percent offer even payment plans. The recovery of revenue loss associated with any customer assistance is a challenging phenomenon as some state regulations may explicitly prohibit the recovery of such revenue loss from other ratepayers that do not qualify for customer assistance.

Overall, utilities are beginning to engage in strategies and practices that help address revenue and cost management, evaluate alternative capital program funding and delivery mechanisms, and navigate the rate approval process. The road ahead in effective utility fiscal management would involve holistic planning and an implementation approach that focuses on multi-benefit initiatives and outcomes.

 

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