Water Rate Proposal for

Trout Gulch Mutual Water Company

Report to Board of Directors

                

Prepared by Brent Haddad, PhD, Consultant

November 28, 2010

 

Background

 

Trout Gulch Mutual Water Company (TGW), located near Aptos, CA, has 186 members, nearly all homeowners in the service territory.  It was established in 2008, taking over the infrastructure of the previous private owner of the company.  The system has roughly one-third metered customers and two-thirds unmetered.  It is an exclusively-groundwater system.  The Board of Directors sought assistance in developing a rate plan that would:

 

-           provide sufficient income to TGW,

-           recalibrate current rates in the interest of equity and parity, and

-           reflect the values of the members of TGW.

 

To carry out this task, the Consultant (Brent Haddad, PhD), met with the TGW Board of Directors, met with TGW’s Vice President for Finance and Operations Manager, led two Member’s Meetings on rate reform and budget priorities, and communicated via email and phone with members.  The consultant also inquired into the cost of manganese removal from one of the TGW wells.  Based on the input from these sources, a rate modeling spreadsheet was produced and forwarded to the Board of Directors.  The spreadsheet provided a basis for discussing the impacts of different aspects of rate design, and based on this feedback from the Board, the Consultant generated a final proposed rate structure.

 

Rate Proposal Specifics:

 

Two options are provided. Option 1 is based on a 12-month revenue goal of $350,328.  A large part of the revenue goal is a capital expense of $140,000 divided equally between a manganese removal project and a meter installation project.  Option 1 spreads the total cost of these projects ($420,000) over three years.  Option 2 is based on a 12-month revenue goal of $234,523.  It includes financing the $420,000 capital cost over 20 years at 6% fixed interest, an annual cost of $36,108.12.  These terms are close to what is actually available to TGW.  Option 2 lowers annual water bills but has a longer pay-off time (20 years vs. three years), and ultimately more money is paid (about $300,000) since interest is paid on the outstanding loan balance.

 

Option 1:  3-year payback on two capital projects

 

12-month Revenue Goal:                                                  $350,328.00

RTS fee system-wide (bi-monthly):                                        $253.86

2-tier water rate (bi-monthly):

                0-6,000 cubic feet:                                                                $0.0127 per cubic foot

                6,001+ cubic feet:                                                                $0.0255 per cubic foot

Water-use surcharge, fixed-rate customers:                              $61.65

 

Option 2:  20-year payback on two capital projects

 

12-month Revenue Goal:                                                  $234,523.00

RTS fee system-wide (bi-monthly):                                        $148.70

2-tier water rate (bi-monthly):

                0-6,000 cubic feet:                                                                $0.0127 per cubic foot

                6,001+ cubic feet:                                                                $0.0255 per cubic foot

Water-use surcharge, fixed-rate:                                              $61.65

 

Rate Design Considerations

 

Among the considerations of rate design were:

 

  1. The system will transition to an all-metered system over the next three years.

 

Analysis: this is reflected in the rate structure Option 1 as 35 meter installations per year at an average of $2000 cost per meter, over three years.  In Option 2, the three-year total is financed over 20 years.

 

  1. Currently, roughly two-thirds of members pay a fixed bi-monthly fee for water, and one-third pay a combination ready-to-serve fixed cost and a cost based on water use.  Of the metered customers, roughly one sixth have 2-inch diameter pipes, the rest 1” diameter pipes.

 

Analysis:  the cost to all customer categories is brought into closer alignment in the rate proposal.  All accounts pay the same “Ready to Serve” charge.  All metered accounts pay the same 2-tiered water fee.  Non-metered customers pay an average water fee that is based on water use system-wide.  As non-metered customers become metered customers, they will switch from the average water fee to the 2-tiered water-use fee.

 

  1. TGW has ongoing infrastructure upgrade costs.  The previous owner did not upgrade the system for many years, so there is a backlog of capital replacement and upgrading necessary.

 

Analysis:  There is a substantial capital investment overhang facing TGW.  This includes installation of meters, replacement of water lines, and upgrading of water tanks and pumps.  It could also include removing manganese through water treatment at one of the wells.  This work effort will take at least three years.  By forming a mutual water company, the members have avoided paying additional costs, such as profit margins, on the ongoing capital investments.  They are also benefiting from oversight efforts by the Board of Directors, some of which would have been assigned to salaried personnel.        However, the direct costs of capital replacement and upgrades will increase water fees at least over the next three years.

 

Recommendation 1:  A complete list of TGW infrastructure and its installation date, expected use-life, and cost of purchase and installation should be created.  These depreciation costs should then be added as a cost to future budgets so that capital replacement funds are available when it is time to replace the unit.  I’m not recommending this be part of the coming budget since the immediate needs for capital replacement are so large.

 

  1. TGW may be required or may choose to treat one of its wells to remove naturally occurring manganese.  The cost of the treatment device is roughly $210,000.

 

Analysis:  In Option 1, this capital expense is charged at $70,000 per year over three years.  This schedule is possible given the Agency’s ability for short- and medium-term lending at its bank.  In Option 2, this amount is financed over 20 years at 6% interest.

 

The following additional consideration emerged from the members’ meetings and directors’ meetings.

 

  1. All members should be treated the same in terms of provision of service.  This includes upgrades to existing infrastructure.

 

Analysis: Implementing this principle is straightforward throughout most of the system, but will need clarification in situations where homeowners historically installed their own piping, which was attached to what is now the current TGW system but not transferred to or owned by TGW.  This member-owned infrastructure also requires upgrading.  This proposal provides for a 50-50 cost share to start upgrading these systems, followed by their ownership transfer to TGW.  That is, TGW will purchase these systems from their owners at half the cost of upgrading them to acceptable quality.

 

  1. Water charges should provide an incentive for water conservation.

 

Analysis: Water charges typically consist of “ready-to-serve” fixed charges and variable charges based on water use.  This is the approach used for metered members of TGW.  A two-tier system is proposed for all metered water users.

 

More rate structure explanation

 

The proposed rate structure includes the following:

 

  1. A roughly 80-20 split between ready-to-serve and water-use fees is proposed in Option 1.  Option 2 has a 70-30 split.  The reason for the difference is because the two-tier water-cost recommendation is the same in both options, and the ready-to-serve change is reduced in Option 2.  Keeping the ready-to-serve charge as a high percentage of total cost is recommended since the records on water deamnd go back only two years.  TGW cannot forecast water use with confidence.  It is therefore wise to generate most of TGW’s revenue from fixed fees until a better prediction of water-use behavior is available.  A predominantly fixed-fee system generates a more predictable revenue stream to TGW.
  2. An equal ready-to-serve charge to all accounts in the system.  This makes one system-wide rate; previously there were separate rates for 1” and 2” connections, plus a different rate for unmetered customers.
  3. Charge unmetered customers a ready-to-serve charge plus a water-use charge based on system-wide average water use among metered users.
  4. A fixed-rate customer who can demonstrate that they do not reside in the district can opt out of the fixed water surcharge.  The Board will set the details of this option.
  5. Future per-period water use is estimated to be an average of 2008 and 2009 use.  A comparison of metered water use to monthly rainfall shows that much of the water-use behavior is based on rainfall – the more rainfall, the less water use, consistent with landscape irrigation uses.  2008 and 2009 rainfall (with the exceptions of March and April) was either close to the long term averages or bounded the averages, one higher, one lower.  March and April of 2008 and 2009 both were somewhat drier than the long-term averages.  Differences were close enough to merit using the average of the two years as the expected future use of water.  As more data is generated, TGW can refine its expected water use.
  6. No new member fee revenue is counted on in budget projections.
  7. For new members, any special infrastructure needed to attach them to the system, such as pipes crossing under a road, should be charged at cost in addition to the New Member fee.

 

Adjusting the rate structure

 

The spreadsheet provided can be used to model alternative rate designs.  For example, the Board might decide to postpone some capital projects, or may learn of grant opportunities, cost sharing, or new member fees.  Alternatively, the Board may decide to accelerate payment on its loan, increase the pace of capital improvement, or launch a depreciation fund immediately.  These changes can be modeled using the spreadsheet.

 

Option 1 assumes that two major capital projects will be completed and paid for within three years:  manganese removal and meter installation.  This should reduce TGW’s annual budget by 40% ($140,000/$350,000).  However, other capital replacement and improvement projects plus creation of a capital depreciation fund may result in less than a 30% reduction in water cost.  Option 2 spreads the $420,000 over 20 years, so there will be no reduction in these capital expenses after three years.