City of Santa Monica
California

Staff Report
1484

State of the Water Fund

Information

Department:Public Works, Water ResourcesSponsors:
Category:09. Public Hearings

Recommended Action

Recommended Action

Staff recommends that the City Council suspend part of the 9% water rate increase authorized by Council to go into effect on January 1, 2016 and authorize a 5% increase.  The partial suspension would reduce the water rate increase scheduled to go into effect on January 1, 2016 from 9% to 5%. This rate adjustment would be in effect until December 31, 2016.

 

Staff Report Body

Executive Summary

This report recommends the City Council adopt a 5% water rate increase for 2016 instead of the previously approved 9% increase. This is based on staff’s review of prior years’ expenditures and revenues, projected expenses and revenues and projected fund balances over the next 5 years. On February 24, 2015, Council approved annual 9% water rate increases for the 5-year period beginning March 1, 2015 and ending December 31, 2019.  The first 9% increase went into effect on March 1, 2015, with second 9% rate increase scheduled to go into effect on January 1, 2016.  The resolution approving these annual water rate increases authorized the increases to go into effect automatically each year unless Council suspended all or part of the increase, beginning with the January 1, 2016 scheduled rate increase.  Based upon review of Water Fund performance for Fiscal Year 2014-15, including greater than anticipated revenues, decreased operating expenses, and decreased capital project expenditures, staff is recommending a partial suspension of the 9% rate increase, and implementation of a 5% increase effective January 1, 2016.  The change in rate is only effective for 2016, returning to the adopted 9% increase authorized for subsequent years, evaluated annually.  Council can take action to adjust future rate increases at the next annual review.

 

Background

On February 24, 2015 Council approved the following schedule of rate increases:


Calendar Year

2015,

effective March 1, 2015

2016, effective January 1, 2016

2017, effective January 1, 2017

2018, effective January 1, 2018

2019, effective January 1, 2019

Maximum Projected Increase

9%

9%

9%

9%

9%

 

The rate increases go into effect automatically on an annual basis unless Council suspends a scheduled rate increase.  The circumstances which might demonstrate that a particular year’s increase is unnecessary include greater than anticipated revenues, decreased operating expenses, or decreased capital project expenditures.  Based upon staff review of Water Fund revenues and expenses for Fiscal Year 2014-15, staff is recommending a suspension of the yearly 9% rate increase and the implementation of a 5% increase which would go into effect for water consumption beginning on January 1, 2016.  Since water bills reflect the previous two month’s consumption (approximately), water bills prepared beginning March 1, 2016 would reflect the revised rate, if Council approves the recommended rate adjustment. 

 

Discussion

The multi-year rate adjustment schedule approved by the City Council in February 2015 was based upon projected revenue and cost estimates in the Water Fund through the year 2019.  The financial forecast approved in the 2015 Rate Study (Attachment D) submitted to Council on December 16, 2014 is presented in Figure 1 (Attachment A). For the first year, Council adopted a 9% increase, effective March 1, 2015, with direction to staff to return later in the year with a recommendation for the following year’s rate adjustment.

 

At the time rate increases were being considered by Council, reductions in proposed capital programs were deemed necessary to avoid higher increases than the 9% annual rate increases approved by Council over the 5-year rate period. In order to accommodate the series of 9% increases over the 5-year period, $2.5 million in water main replacements, and $5 million in Advanced Meter Infrastructure programs were eliminated (from the higher 13% rate increase option). 

 

Specifically, the revenue plan approved by Council at the February 24, 2015 meeting (Figure 1, Attachment A) projected that the water utility would collect sufficient revenue to cover fixed expenses, maintain cash reserves consistent with adopted Council policy, fund capital improvements on a pay as you go basis, and create a Water Fund balance in the later years of the planning period that would allow for future bond funding.

 

Past Year Water Fund Performance and the Implications for Year 2 Rate Suspension

In considering whether to suspend all or part of the scheduled 9% rate adjustment for calendar year 2016, staff analyzed the FY 2014-15 actual performance of the Water Fund. Using financial performance information from a full fiscal year basis coincides with the City’s financial reporting period, allowing the use of the ending fund balance to be considered along with the five-year projections in formulating a rate adjustment recommendation. Consequently, the ending Fiscal Year performance of the Water Fund, considered along with the five year projections of future operations and capital project expenditures are the key elements in determining future rate adjustment recommendations in the remainder of the 5-year planning period. 

 

It is important to note that FY 2014-15 information only reflects performance of the fund through June 30, 2015.  Accordingly, the effects of the rate increase approved at the February 24, 2015 meeting (which became effective for water use beginning March 1, 2015) are not fully reflected in the FY 2014-15 numbers.  For example, the first bills at the new rates were sent out May 1, 2015.  As a result, any impact on revenues which may have been due to the rate increase generated by the 2015 rate adjustment were limited to only one billing cycle.  Similarly, the end-of-year ramp-up of conservation programs and implementation of the City’s stage two drought response measures show very little effect on the FY 2014-15 financial results due to timing.

 

Going forward, the ending fund balance of the Water Fund following a full Fiscal Year’s performance, in combination with newly projected five year forecasts, typically prepared in December, will serve as the most up-to-date projections upon which to base a potential rate adjustment recommendation to be implemented annually at the beginning of March.

 

Considerations to Suspend a Part of the 2016 Rate Increase

Utilizing FY 2014-15 actuals, the fund balance projection has been updated to show the implications over the remainder of the 5-year planning period of suspending all or a portion of the 9% rate increase previously authorized for 2016. Current and proposed rates are listed in Table 4 (Attachment C).  In all options, it is assumed the suspension remains in effect only for 2016 followed by the full 9% increase authorized for subsequent years, evaluated annually.  Each option is included in Figure 1 (Attachment A), which indicates the projected performance (ending fund balance) of the Water Fund for the total suspension (Table 1, Attachment B), partial suspension resulting in 5% versus the full 9% increase (Table 2, Attachment B), and the full 9% increase automatically authorized unless suspended (Table 3, Attachment B) relative to the 5-year rate plan (the February 2015 revenue plan) without any suspension of rates as indicated in Figure 1. For all three options presented, the ending fund balance estimates project the changes in revenue realized with the respective proposed change in the rate.  For all options, projections in operating and capital expenses are the same.    

 

It should be noted that the actual ending fund balance for FY 2014-15 begins at a point higher than envisioned in the rate study forecast (Figure 1).  This is due to actual revenues being higher than projected, as the impact of conservation programs had not fully taken effect in FY 2014-15; operating expenses being lower, and capital budget amounts decreasing through review of projects and programs which eliminated substantial amounts from the Capital Improvement Program (CIP). Also contributing to the fund balance was a one-time infusion of $33.4 million in MTBE settlement funds transferred into the Water Fund at the end of FY 2012-13.  These funds had been kept in a separate Charnock/Arcadia-only fund; upon completion of treatment plant improvements they were transferred into the Water Fund. These funds are used to offset certain water treatment costs, and in doing so, they effectively subsidize a portion of the water rates.

 

Total Suspension of the 9% Increase (0% Increase)

Suspension in its entirety of the previously authorized 9% rate increase for 2016 leaves water rates unchanged from those effective as of March 1, 2015. This is represented graphically in Figure 1 and Table 1.

 

Advantages:

·         No increase in rates for 2016; rates are not increased beyond the increase adopted by Council in March 2015.

 

Disadvantages:

·         As indicated in Figure 1 and Table 1, the minimum recommended reserve fund balance of $7 million is not achieved for the last two years of the planning period.

·         Financial conditions are not met which would allow the City to bond for future Capital projects.

 

Partial Suspension Resulting in a 5% vs. 9% Increase For 2016 (staff recommendation)

As indicated in Figure 1 and Table 2, a 5% increase in year 2 of the planning period shows a forecast of fund balances in the later years of the planning period at levels less than the projections for the full 9%.  Ending fund balances through FY 2019-20 meet the minimum reserve level of $7 million.

 

Advantages:

·         Lower increase in unit price compared to the 9% increase option discussed below.

·         Bond issuance criteria for future capital projects (revenues exceeding expenditures by 20% or more) are met by FY2018-19.

 

Disadvantages:

·         Reduced ability to address unforeseen emergency situations due to the lower fund balances in the outer years than the 9% option.

 

No Suspension 9% Increase

Based on the five-year forecast prepared annually in December, the ending fund balance for the Water Fund with a 9% increase this year (effective January 1) and 9% increases in the following years is indicated in Figure 1 and Table 3. 

 

Advantages:

·         Creates the strongest financial position (ending fund balances) throughout the planning period in excess of adopted minimum reserve levels.

·         Bond issuance criteria for future capital projects are met by FY 2018-19.

 

Disadvantages:

·         Highest increase in water rates, compounded over the maximum increase in the prior year.

 

Summary and Recommendation

Attempting to forecast revenues from water sales to support the utility’s objective of producing potable water, meeting capital project goals, and supporting ongoing conservation and drought response plans includes the challenge of accounting for an uncertainty of water usage throughout the service area.  Various factors come into play in consideration of the recommended rate adjustment.

Water Conservation: Although the City has experienced a sizeable water use reduction starting from approximately March 2015 to present, for FY 2014-15 (period ending June 30, 2015) water use was only reduced 4% from the prior year.  In comparison, water conservation city-wide has averaged beyond 20% for the period from March 2015 and January 2016.  The full effect of this accomplishment will be considered in next year’s analysis and subsequent rate recommendation.

Revenues: Revenue projections assumed a water use pattern which included increased water demand in a rebounding economy, a 10% level of conservation throughout the year, and a 9% rate increase.  However, since water demand did not fall as much as anticipated during FY 2014-15, revenues came in higher than projected. Revenue from water sales were $3 million higher in FY 2014-15 than projected in the rate study.

Capital Expenditures: After significant review and scrubbing of capital program expenditures, which had previously included rollover amounts from prior years’ CIP, there were $6.8 million in savings from projects completed under budget or deferred to later years.

Operating Expenses: Operating expenses were less than anticipated by $2.7 million. Conservation Program ExpensesImplementation of conservation programs, for which additional funding was approved by Council in order to accelerate carrying out the Stage 2 Water Shortage Response Plan, took several months to implement and it was not until late summer 2015, during FY 2015-16, that they became fully operational.  The Water Fund-budgeted expenses were $1.9 million less than budgeted in FY 2014-15. 

 

In comparing full implementation of the 9% increase previously authorized by Council in February 2015 versus a partial suspension of that increase amounting to a 5% increase over rates in place as of December 31, 2015 clearly creates a stronger fund balance at the end of the planning period, as would be expected with a higher rate increase.   However, the 5% increase option does increase fund balances in later years, while still meeting minimum reserve balances and debt issuance criteria. Additionally, the bond issuance criteria is met by the 5% increase, similar to the conditions established by the 9% increase.

 

The 5% water rate increase for 2016 allows the City to continue the current fiscal management of the water utility while ensuring the operation, maintenance, and infrastructure investments necessary to continue the delivery of safe drinking water to the community.

 

The adjusted rate, if approved by Council, will be effective for water use commencing January 1, 2016.  Billings for water use beginning this date will begin March 1, 2016, and will reflect the adjusted rate.  Council complied with Proposition 218 public notice requirements when it approved a schedule of rate increases (up to 9% per year) in February 2015.  Since the rate adjustment does not exceed the maximum 9%, the Proposition 218 public notice period of 45 days is not required.

 

Cost of Service Analysis

Subsequent to the adoption of the City's latest 2015 water rate increases, the Court of Appeal, Fourth Appellate District, issued its opinion in the case Capistrano Taxpayers Association, Inc. v. City of San Juan Capistrano (2015) 235 Cal.App.4th 1493.  In its decision, the court held that for tiered water rates to be valid under Proposition 218, the various water tiers must correspond to the actual cost of delivering water.  Because the City of Capistrano could not demonstrate that its tiers followed this principle, the Court ruled against the city.  While the court’s decision has been criticized by many, including the Governor, who is considering proposing an initiative to modify Proposition 218, and while the court's opinion runs counter to the statewide practice of using tiered rates to encourage water conservation, the court did not reject tiered pricing altogether. 

 

In light of the Capistrano opinion, staff has reviewed the cost assumptions in the 2015 rate study.  Even taking into consideration the Capistrano decision, staff has concluded that the City's rate structure meets Proposition 218 requirements.  In performing its analysis, Staff compared current water rates with updated FY 2014-15 cost-of-service data, which is the most recent data available, as well as with the data utilized in the development of the Rate Study.

 

As demonstrated in the tables and attachments, the water rates paid by the City’s water customers are below the City’s cost-of-service. This is true at each Tier breakpoint (the point at which the price for each additional unit of water usage increases) in each customer class, as indicated in Tables 5 and 6 in Attachment E. 

 

Moreover, the effective water rate paid by water customers – that is, the actual water rate paid for water used, which takes into account the progression of rates through the various Tiers is also below the actual cost of service. An example helps to illustrate.  A single family residential customer, who uses 40 hundred cubic feet (HCF) of water, where 1 HCF = 748 gallons, would pay $2.73/HCF at the Tier 1 rate, for the first 14 HCF, and $4.09/HCF at the Tier 2 rate, for next 26 HCF (based upon 2015 prices). The combined or effective blended rate paid for all the water purchased is $3.61/HCF, for 40 HCF of water.  However, the actual cost of service to provide 40 HCF to a single family residential customer in FY 2014-15 was $5.51/HCF, based upon the data provided in the 2015 rate study.  Thus, a single family customer using 40 HCF of water paid $1.90/HCF less than the actual cost-of-service. 

 

The difference between the City’s actual costs-of-service and the amount paid by each customer class represents essentially a subsidy.  The subsidy is being funded from $33.4 million in Charnock settlement proceeds and $56.1 million in Olympic Basin settlement proceeds from FY 2014-15 through FY 2018-19, as indicated in Table 5B of the Rate Study.[1] The settlement proceeds are offsetting certain capital and operation and maintenance costs that otherwise would need to be funded by water sales.

 

As represented by the example above, tiered pricing is a form of progressive or blended pricing. Customers in Tiers 2 and above pay a water rate that is a combination or blend of rates.  A Tier 2 customer, for instance, pays Tier 1 pricing for the first 14 HCF of water used and then pays Tier 2 pricing for the balance of the water used.  Because of the tiered pricing and the subsidy of rates provided by the various settlements, lower tier water users are benefitted and subsidized more heavily by the Water Fund reserves than higher tier users in each classification. Water users that primarily pay lower tier rates are those with the lower water consumption.  As consumption increases, water users graduate to the higher tiers and lower subsidies. However, rate payers at the higher tiers still benefit from paying a blended rate that remains partially subsidized at all tier levels. Nothing in Proposition 218 prevents subsidies of water rates and nothing in Proposition 218 requires the City to subsidize all water customers in the same amount. 

 

It must be acknowledged, however, that the 2015 Rate Study assumes certain cost-of-service savings that cannot be anticipated with precision.  Because of this, and given that the current rate structure anticipates partial or whole suspension of rates on a year to year basis, staff anticipates that actual revenue and cost scenarios can be adjusted to ensure that the implementation of the annual 9% rate increase authorized in 2015 is warranted on a year to year basis.   Furthermore, the legal status of tiered pricing may be further clarified by future court decisions or possible changes Proposition 218. 

 

Task Force on the Environment Action

At its January 25, 2016 meeting, the City’s Task Force on the Environment approved the following motion:

The City of Santa Monica Task Force on the Environment recommends a 5% rate increase for the coming year and requests revisiting the rate structure within the next year, particularly in regards to a conservation based block rate structure and fixed charges.

Financial Impacts and Budget Actions

The revenue budget established at account 25671.402310 will be reduced by $300,867 in FY 2015-16 and reduced by $776,064 in FY 2016-17 to reflect implementation of the partial suspension of water rates for calendar year 2016.

 

 

 

 


[1] See, e.g., footnote (d) of Table 5B of the 2015 Rate Study (Attachment D).

Meeting History

Feb 23, 2016 5:30 PM  City Council Regular and Special Joint Meeting
draft Draft