Tag Archives: water rates

Davis Should Set Its Utility Reserve Targets with a Transparent and Rigorous Method

The City of Davis Utilities Commission is considering on February 19 whether to disregard the preliminary recommendations of the Commission’s Enterprise Fund Reserve Policies subcommittee to establish a transparent, relatively rigorous and consistent method for setting City reserves. The Staff Report, written by the now-departed finance director, ignored the stated objectives of both the Utilities and Finance and Budget Commissions to develop a consistent set of policies that did not rely on the undocumented and opaque practices of other communities. Those practices had no linkage whatsoever to risk assessment, and the American Water Works Association’s report that the Staff relied on again to reject the Commission’s recommendation again fails to provide any documentation on how the proposed targets reflect risk mitigation—they are simply drawn from past practices.[1]

The City’s Finance & Budget Committee raised the question of whether the City held too much in reserves over five years ago, and the Utilities Commission agreed in 2017 to evaluate the status of the reserves for the four City enterprise funds—water, sanitation/waste disposal, sewer/wastewater, and stormwater. A Utilities Commission subcommittee reviewed the current reserve policies and what is being done by other cities. (I was on that subcommittee.) First, the subcommittee found that the City was using different methods for each fund, and that other cities had not conducted risk analyses to set their targets either. The subcommittee conducted a statistical analysis that allows the City to adjust its reserve targets for changing conditions rather than just relying on the heuristic values provided by consultants.

The subcommittee’s proposal adopted initially by the Utilities Commission achieved three objectives that had been missing from the previous informal reserves policy. Two of these would still be missing under the Staff’s proposal:

  1. Clearly defining and documenting the reserves held for debt coverage. While these amounts were shown in previous rate studies, the documented source of those amounts generally not included and the subcommittee’s requests brought those to the fore. The Staff method appears to accept continuance of that practice. The Staff proposes to keep those separate, which differs from past practice which rolled all reserves together.
  2. Reserve targets are first set based on the historic volatility of enterprise net income. In other words, the reserves would be determined transparently with a rigorous method on the basis of the need for those reserves. The method uses a target that is statistically beyond the 99th percentile in the probability distribution. And this target can be readily updated for new information each year. The Staff report rejects this method to adopt a target that refers to the practice of other communities, and none of those practices appear to be based on analytic methods from research done by the subcommittee.
  3. Reserve targets are then adjusted to cover the largest single year capital improvement/replacement investment made historically to ensure enough cash for non-debt expenditures. Because the net income volatility is a joint function of revenues, operating expenditures and non-debt capital expenditures, the latter category is not separated out of the analysis. However, an added margin can be incorporated. That said, the data set for the fiscal years of 2008/2009 to 2016/2017 used by the subcommittee found that setting the target based on the volatility has been sufficient to date. The Staff report appears to call for a separate, unnecessary reserve fund for this purpose based on annual depreciation that has no relationship to risk exposure, and implicitly duplicates the debt payments already being made on these utility systems. This would be a wasteful duplication that sets the reserves too high.

The Finance and Budget raised at least two important issues in its review:

  1. Water and sewer usage and revenues may be correlated so that the reserves may be shared between the two funds. However, further review shows that the funds have a slight negative correlation, indicating that the reserves should be held separately.
  2. The water fund already has an implicit reserve source when a drought emergency is declared because a surcharge of 25% is added to water utility charges. I agree that this should be accounted for in the historic volatility analysis. This reduces the volatility in fiscal years 2014/2015 and 2015/2016, and reduces the water fund volatility reserve from 26% to 21%.
  3. Working cash reserves are unnecessary because the utility funds are already well established (not needing a start up reserve), and that the volatility reserves already cover any significant lags in the revenues that may occur. This observation is valid, and I agree that the working cash reserves are duplicative of the other reserve requirements. The working cash reserves should be eliminated from the reserve targets for this reason.

Finally, the Staff proposal raises an issue about the appropriate basis for determining the sanitation/waste removal reserve target. The Staff proposes to base it solely on direct City expenses. However, the enterprise fund balance shows a deficit that includes the revenues and expenses incurred by the contractor, first Davis Waste Removal and then Recology. We need more specificity on which party is bearing the risk of these shortfalls before determining the appropriate reserve target. Given the current City accounting stance that incorporates those shortfalls, I propose using the Utility Commission’s proposed method for now.

Based the analysis done by Utilities Commission subcommittee and the recommendations of the Finance & Budget Committee, the chart above shows the target % reserves for each fund without the debt coverage target. It also shows the % reserve targets implied by the Staff’s proposed method.[2] The chart also shows corresponding dollar amount for the proposed total target reserves, including the debt reserves, and the cash assets held for those funds in fiscal year 2016/2017. Importantly, this new reserve target shows that the City held about $30 million of excess reserves in 2016/2017.

[1] It appears the Staff may have misread the Utilities Commission’s recommendation memorandum and confused the proposed targets policies with the inferred existing policies. This makes it uncertain as to whether the Staff fully considered what had been proposed by the Utilities Commission.

[2] The amounts shown in the October 16, 2019 Staff Report on Item 6B do not appear to be consistent with the methodology shown in Table 1 of that report.

Using an event to measure energy savings program effectiveness (again)

Koichiro Ito again has used a discrete event to develop a “control” for an economic experiment. In this case, he has studied PG&E’s 20/20 rebate program in 2004. The “event” he uses is the eligibility date for the program–he uses new customers who connected to service just before and after that date. He finds that the program had almost no effect on coastal customers but that it was effective in reducing energy use for low-income inland consumers. 

Previously, he had looked whether tiered-block rates were better at inducing conservation across the entire pool of customers. The final version of his paper was published February in the American Economic Review. Discerning the true effects of tiered-rates has been very difficult due to the endogeneity problem–consumers essentially set their own marginal price by choosing their consumption level. Many studies have been conducted in both water and electricity trying to tease out this effect, but the results have always been questionable for this reason. 

Ito was able to use two key facts in his latter study: 1) the 2001 California electricity crisis caused rates to rise rapidly and 2) the SCE and SDG&E service areas are closely interlocked across similar communities in southern Orange County. He was able to run an after-the-fact experiment with two treatment groups that had similar socio-economics and were exposed to the same media market. It’s as if two groups of customers were presented with two different sets of rates from the same utility–a truly unique situation that probably can’t be duplicated. He found that the tiered rates induced no more change in energy use than simple average rates.

These well-done studies can cause policymakers to ask whether complicated proposals that seem to mitigate various concerns are truly effective. In these two cases, the answers are largely “no”. 

Setting Davis water rates in the most fair manner

The City of Davis adopted an innovative rate structure in 2012 to fund a new surface water supply project. The new framework, called “consumption-based fixed rate” or CBFR, originally was structured to provide a stable revenue source for recovering debt costs while allowing customers to reduce their bills when conserving. Instead of having a fixed, constant readiness to serve or demand charge, the summer demand charge would be recomputed each year by dividing the fixed debt service (about $10M per year) by the total summer usage of all customers. When a customer reduced their share of overall summer usage, their bill would go down. However, the total revenue would remain stable year to year because the summer demand charge would be recomputed to ensure meeting the overall revenue target. The CBFR mutated to a more standard fixed demand charge for various political and legal reasons and it lost some of its revenue stability features.

The City has faced several challenges to the water project and the rates. All had lost up until June 3 when Measure P passed by a small margin and rolled rates back to 2011. The Utility Rates Advisory Committee (URAC), of which I am a member, is redesigning rates on an accelerated schedule to ensure viability of the water project. The Measure P proponents missed several key facts in their arguments, so the URAC will need to ignore some of those errors. However, the most important factor in the defeat of the proposed water rates was in the lack of simple communication and understanding by the public. “CBFR” just doesn’t cut it as a simple saleable concept.

I believe that Davis needs to move toward a more efficient water pricing scheme that signals consumers when they should be using water given costs and environmental impacts. The first fairness criterion is that people should pay prices that best reflect the cost to serve them so there are no unjustified subsidies flowing among customers.  The second fairness criterion is that those with less means can receive a subsidy from those with more if the subsidy can be structured to minimize misallocations of resources.

What doesn’t meet a fairness criterion is having everyone pay a single average annual price that doesn’t reflect how the cost of water varies over the year.  Someone who uses the same amount of water year round should not pay the same average annual rate as someone who uses much more water during the summer, even if they use the same total amount for the year. There are several reasons for this.

The most important centerpiece of the Woodland-Davis water project is the 10,000 acre-foot a year (or 3.25 billion gallons) water right acquired from Conaway Ranch. Based on terms of that agreement and depending on the period used to recover the investment, this water supply costs at least $0.50 per CCF.  But the most important fact is that this cost is only for water delivered in the summer. The purchased water right only runs from April 1 to October 31. Water used in the winter is free. That means that customers using water in the summer should pay at least $0.50 per CCF more just to cover the ongoing costs of the water supply.

Further we need to consider how to allocate the costs of delivering that water to Davis. The reason why Sacramento River water is expensive in the summer and free in the winter is that water is scare and in high demand during the summer. How best to allocate costs when most of the demand happens over a short period can be best illustrated by looking at parking in downtown San Francisco. Parking structures are built with capacity to meet demand during work hours on weekdays. Work hour parking can cost upwards of $30 per day, but on a weekend night when the area is empty, parking typically costs $5. These rates are set by private operators who are recovering their investments as efficiently as they can.

For the same reason, Davis must recover most of its investment in the water conveyance facilities from summer users—the plant capacity was built to meet their demand.  A plant built to an annual average capacity won’t be sufficient in August. The current rate structure properly recovers those costs from those individuals who create the need for such a large investment.

Fortunately, the second fairness criterion of reducing costs for those of lesser means can be met through higher summer pricing because they tend to live in multi-family dwellings or have lower irrigation needs.

Summer water bills could increase dramatically, but a solution is to create an Easy Pay plan where a large portion of the summer water bills are spread over a 12-month period. PG&E offers its Balanced Pay Plan to achieve the same ends. Customers should be placed in this bill payment plan on an opt-out basis, as that opt-in options are usually undersubscribed even when the opt-in benefits are large.