Water and Wastewater Finance and Pricing pot

Gerry Wexelbaum, a personal friend and fellow partner fromour Ernst & Young days, authored Chapter 2 Capital and Financial Planning for Water andWastewater Utilities.. He chairs the Comm

Water and Wastewater

A Comprehensive Guide Third Edition

Water and Wastewater

A Comprehensive Guide

Third Edition

George A Raftelis

Published in 2005 by

CRC Press

Taylor & Francis Group

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Waster and wastewater finance and pricing : a comprehensive guide / edited George A Raftelis.

p cm.

Rev ed of: Comprehensive guide to water and wastewater finance and pricing / George A Raftelis

2nd ed c1993

Includes bibliographical references and index.

ISBN 1-56670-680-7 (alk paper)

1 Water-supply Finance 2 Water-supply Rates 3 Sewage Finance 4 Sewage Rates I Raftelis, George A II Reftelis, George A Comprehensive guide to water and wastewater finance and pricing III Title

disposal HD4456.R34 2005

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With gratitude and love in my heart,

I dedicate this book to my wonderful wife Eva She has been my partner, my friend, my sounding board,

and the “wind beneath my wings”

for 31 years of a beautiful marriage

I feel her presence and influence in all I do

Thank you, Eva.

Over the past 25 years, I have had the opportunity to work with over 300 water and wastewaterutilities across the country Most of my assistance to these utilities has been in the area of financialplanning and pricing There has been a need for a document that discusses and consolidates, in anunderstandable manner, some of the common themes and trends across the country in this field.Numerous approaches to water and wastewater financial planning and pricing exist It is important

to evaluate these different approaches and tailor a financial plan and pricing structure to addressthe unique requirements of each utility In this book, my co-authors and I want to share with theindustry our experiences in effective financial planning and pricing This book provides a framework

in which a utility professional can work in addressing financial planning and pricing objectives Inaddition, the book can be used as a management tool and a technical guide to effective financialplanning and rate-setting practices

Since the second edition of this book was published, numerous changes have taken place inthe water and wastewater financing and pricing environment This third edition of the book sub-stantially expands our discussion into emerging areas of finance and pricing We are excited aboutsharing our experiences and insights with the reader

George Raftelis

President and Chief Executive Officer Raftelis Financial Consultants, Inc.

Many of the co-authors are my fellow consultants at RFC Every day, these consultants liveand breathe the principles we discuss in this book Frank Davis, one of RFC’s best writers, authoredChapter 5 and Chapter 11 (System Development Charges and Identification of Revenue Require-ments) He provides his insights on how communities should develop and implement capitalrecovery charges, as well as identify the costs that provide the basis for rates and charges He is

an important part of RFC and is always dependable, helpful, and sincere, no matter how large orsmall the challenge Harold Smith, vice president with RFC, was the author of Chapter 7 (Overview

coworkers, and colleagues It has been a pleasure observing the growth of his skills in finance andpricing, as well as with public–private partnerships over the years at RFC

Lex Warmath, a vice president and my first consulting employee 11 years ago, authored Chapter

10 (Water and Wastewater Pricing Process) He has been a devoted consultant to the firm andinstrumental to its success He has vast consulting skills, which he uses in being highly responsive

to our clients Bill Stannard, a vice president and RFC’s chief operating officer authored Chapter

13 (Designing a Water and Wastewater Rate Structure) Our practice has been blessed with Bill’senergy, insights, and connectivity with the industry He has enormous experience in water andwastewater finance and pricing over his 27-year career

Peiffer Brandt, a vice president and deputy chief operating officer, authored Chapter 14 andChapter 15 (Conservation Pricing: An Alternative to Traditional Rate Structures and BenchmarkingWater and Wastewater Rates and Charges) His energy, intelligence, and responsiveness have beencrucial in providing our clients with superior quality and service Patrick Smyth, our secondconsultant, joining the firm ten years ago, authored Chapter 17 (Affordability) His commitment

to RFC and the contributions he has made to the practice cannot be described appropriately inwords He is also our technology manager, and his handy work is present in much that we do Finally, from RFC, Leta Hals, our recently named Certified Business Appraiser, authoredChapter 16 (Valuation of Water and Wastewater Utility Assets) She has brought to RFC boundlessinitiative, focus, and intelligence “Getting it done!” are the first words that come to mind when Ithink of Leta In summary, the book has been blessed with such a talented group of consultantswho have surrounded me over the years and who bring their experience and rich insights to thereaders

I have also been fortunate to develop a rich network of highly visible professional colleaguesduring my career They have expanded my knowledge, insights, and connectivity, and made mebetter able to serve our industry The selection of colleagues to author specific chapters was basedupon their expertise and backgrounds Gerry Wexelbaum, a personal friend and fellow partner fromour Ernst & Young days, authored Chapter 2 (Capital and Financial Planning for Water andWastewater Utilities) Gerry is president of Strategy Support Associates and works with our com-pany extensively in the areas of strategic planning and strategic financial management Gerry is

insightful and sensitive, a consummate entrepreneur and businessman, and always ready to exercisehis clever wit.

Chapter 8 (Project Delivery Systems) was authored by Judy Bedard, a consultant with RedOak Consulting I have had the pleasure of working with Judy on several important engagementsfor large communities in the United States She brings a strong background in assisting governmentutilities to evaluate and implement traditional and alternative project delivery methods Teno West

of Holland & Knight authored Chapter 9 (Legal Aspects) He is the consummate attorney whopossesses strong technical credentials, brings an effective marketing and business approach to hisprojects, and has an effective “bedside manner,” which translates into strong communication withhis clients Chris Woodcock, president of Woodcock and Associates, is the author of Chapter 12(Determination of Cost of Service) He has been a friend, colleague, and true inspiration to meduring just about all of my 30-year career We have worked side by side on numerous client projects,

as well as on many finance and pricing assignments and committees for the American Water WorksAssociation and the Water Environment Federation I look to Chris as one of the most recognizedindustry leaders in water and wastewater finance and pricing, and a true visionary Last but notleast is Kevin Whitt, author of Chapter 18 (Department of Defense Utilities Privatization) He isthe utilities privatization program manager with the U.S Navy and has been a huge champion ofimplementing the utility privatization (UP) initiative for the Navy He has explained in veryunderstandable terms in his chapter the evolution of UP, the Department of Defense’s UP regula-tions, how the process was implemented, and the Navy’s approach in addressing UP requirements

In preparing his chapter, he used as a sounding board, reviewer, technical colleague, and editor,Vickie Jones, an important member of Kevin’s team in Norfolk RFC personnel have enjoyed ourworking relationship with Kevin, Vickie, Navigant Consulting, and the Navy in addressing numer-ous technical, financial, regulatory, and scheduling challenges related to UP

I would be remiss if I did not acknowledge the “real team” that has made this third edition areality My gratitude, praise, and respect go out to several key people who participated in organizingthe book and related process, and reviewed and edited countless drafts of the book, prepared thegraphics and tables which facilitate the understanding of complex concepts presented in the book,coordinated with the co-authors and CRC Press on a daily basis, and performed the necessaryquality control steps to make this edition a highly professional and cutting-edge document for theindustry Maria Adams from RFC organized the project with me and effectively coordinated it withthe authors and CRC Press Enough cannot be said of Elizabeth Cozad with RFC for picking upthe project in midstream and carrying it relentlessly to its final conclusion Her commitment andattention to detail in editing, proofreading, and final coordination will be a lasting legacy of the book.Quinn Marvin, a recent graduate with a degree in journalism and mass communication fromthe University of North Carolina, made significant contributions in preparing the many graphics inthe book and in assisting in carrying the book to completion Her creative insights and talents willserve her and RFC well in the future John Miller, my highly creative nephew, also contributed hisartistic talent by preparing several graphics early on in the process In addition, many RFCconsultants and administrative personnel have made tremendous contributions to the book byconducting research, preparing tables, editing, and proofreading These people include Tom Beckley,Janet Cureton, Jon Davis, Howard Hoover, Bart Kreps, Melissa Levin, Lisa Shabashow, and ElaineVastis

A special acknowledgement goes to our clients who have believed in us and given us theopportunity to serve them Our clients are very dedicated, intelligent, and personable individualswho strive daily, without expecting great recognition, to provide their customers with high qualitywater and wastewater services Most of the principles in the book relate to our client assistance.After going through the acknowledgments and recognizing the amount of hard work that hasgone into the third edition, I realize that this book is really about my immensely talented andqualified team and not about me I am grateful that I can be a facilitator for them to display their

knowledge and experience for the reader’s benefit I leave this book as their legacy, and tip my hat,with a gleam in my eye, to them as they prepare for the fourth edition.

George Raftelis, CPA, is president and chief executive officer ofRaftelis Financial Consultants and resides in Charlotte, NorthCarolina As president and CEO of RFC, he assists water andwastewater utilities in addressing financial, management, account-ing, and public policy requirements In addition, his clients includepublic and private sector organizations involved in other environ-mental disciplines such as solid waste, hazardous waste, and storm-water

He has over 29 years of consulting experience in the mental industry Prior to founding Raftelis Financial Consultants,

environ-he was director of Ernst & Young’s national environmental sulting practice He has provided environmental consulting assis-tance to over 300 utilities across the country His experience withsmall, medium, and large utilities includes the development of system development charges (impactfees), water and wastewater cost of service and rate structures, and water and wastewater financialplans In addition, he has conducted valuations and acquisition feasibility analyses, and providedlitigation support services related to water and wastewater pricing and finance, utility management,and organizational reviews

con-George received a B.S degree in mathematics with a minor in economics from Eckerd College

in St Petersburg, Florida, in 1969 As an Eckerd alumnus, he received the award for “Excellence

in Career Achievement and Outstanding Service Contributions.” Following 4 years of service as

an officer in the Military Intelligence Branch of the United States Army, he attended Fuqua School

of Business at Duke University and received a Master’s degree in 1975 After graduation fromDuke, he was elected president of the Alumni Council, Fuqua School of Business In 1975, hejoined Ernst & Young in Charlotte, where he established Ernst & Young’s environmental consultingpractice

manuals to include M34 alternative rates and M35 revenue requirements In addition, he hasdeveloped and conducted numerous technical workshops for professional organizations and envi-ronmental agencies such as the American Water Works Association, the Association of Metropol-itan Water Agencies, the American Bar Association, the Water Environment Federation, theEnvironmental Protection Agency, the Water Resources Research Institute, the GovernmentFinance Officers Association, the American Society of Public Administrators, the National League

of Cities, the U.S Conference of Mayors, and the International City Management Association

He is active in the American Water Works Association, the Association of Metropolitan WaterAgencies, the Water Environment Federation, and the American Institute of Certified PublicAccountants He chairs the Committee on Rates and Charges, American Water Works Association,and is a charter member of its environmental financial advisory board, which provides policyguidance on finance and pricing issues to the Environmental Protection Agency In addition, he has

Environ-mental Network.

Judy Bedard, PE, DEE is a senior associate in Malcolm Pirnie’sRed Oak Division She has more than 20 years of experience inassisting municipal clients on a broad range of water, wastewater,and solid and hazardous waste management projects She specializes

in serving as an owner’s representative in the implementation ofalternative delivery systems to procure public works projects, as well

as performing utility performance assessments, organizational tiveness studies, and workshops Her experience includes system-wide planning, preparation of requests for qualifications, review ofstatements of qualifications, preparation of requests for proposals,contract negotiations, contractor selection, and financing support forfunding and bond issuance processes

effec-She is a past president of the Delaware Engineering Society and a member of the National Society

of Professional Engineers and AWWA She graduated summa cum laude from Villanova University

in 1979 and received her Master’s degree in civil engineering (environmental engineering and science)from Stanford University in 1984 She is also a Diplomate of the American Academy of EnvironmentalEngineers

Peiffer Brandt is vice president and deputy COO of Raftelis cial Consultants He has managed a variety of projects to assist waterand wastewater utilities in addressing economic and financial issues

Finan-He has also gained a broad knowledge of water and wastewater ratestructures and rate-setting practices as the project manager for variousrate surveys, including the 2000, 2002, and 2004 Water and Waste-

AWWA–WEA Finance and Management Committee In addition, herecently conducted a workshop titled “Utility Finance 101” for theNorth Carolina AWWA–WEA, which focused on the rate-settingprocess and the appropriate methodology for developing cost ofservice allocations He received a B.S.E in chemical engineeringfrom Princeton University in 1994 and an M.S.P.H in environmental management and policy fromthe University of North Carolina in 1997

Frank Davis as an employee of Raftelis Financial Consultants, hasbeen involved in numerous projects for public utilities He has beeninvolved in a variety of studies involving transitions to new ratestructures designed to address specific pricing objectives, includingfinancial sufficiency, water conservation, and high strength wastecharges These types of studies often include other related analysis,including calculations of development impact fees, outside-city ratedifferentials, and wholesale pricing studies He has also providedassistance to professional associations by presenting the technicalaspects of the utility rate-setting process, alternative methods forassessing impact fees, and implementing impact fees in South Caro-lina He has extensive financial modeling experience He holds aB.A degree in political science from the University of South Caro-lina–Columbia, a B.S.B.A in finance from the University of South Florida–Tampa, and an M.B.A.from the Babcock School of Management at Wake Forest University.

Leta Hals, CBA is a manager with Raftelis Financial Consultantsand is RFC’s director of valuation services Since 1999, her workwith RFC has included valuation, economic feasibility, rate andutility pricing, privatization, bond feasibility, and other financialservices for utilities She has also provided expert witness testimonybefore the Illinois Commerce Commission Prior to joining RFC,she served as a consultant with Andersen Consulting in Atlanta,Georgia, and Oslo, Norway She holds a B.S degree in biology fromthe College of William and Mary in Virginia and an M.B.A fromthe University of Tennessee She is a member of the Institute ofBusiness Appraisers and has been designated as a Certified BusinessAppraiser (CBA) by this organization

Harold Smith vice president of Raftelis Financial Consultants, iscurrently chair of the Competitive Practices Committee, AWWA

He is a nationally recognized expert in water and wastewaterfinance, management, and pricing His broad based experienceincludes development of comprehensive financial plans, cost ofservice and pricing analyses, revenue bond feasibility studies, stra-tegic planning, privatization procurement and feasibility, regional-ization and consolidation, utility valuation, and groundwaterresource management

Patrick Smyth, CPA is technology manager at Raftelis FinancialConsultants Patrick has been with RFC since 1994 and serves as

a financial and technical consultant on projects ranging from ability and cost of service development to privatization and litiga-tion support Patrick graduated magna cum laude from the Univer-sity of North Carolina at Charlotte with a B.S degree in earthscience, and he has a B.S in business administration from Appala-chian State University He is a Certified Public Accountant

afford-William Stannard, PE is vice president and COO of RaftelisFinancial Consultants He is a nationally recognized expert in waterand wastewater finance, management, and pricing His more than25-year career has focused on advising municipal water and waste-water utilities throughout the United States His broad based expe-rience includes development of comprehensive financial plans, cost

of service and pricing analyses, revenue bond feasibility studies,and strategic planning He has appeared in federal and state courts

as an expert witness on numerous water and wastewater rate cases

He has served as chairman of the Water Environment Federationtask force, which has developed a manual of practice on wastewaterutility pricing, and is a member of the American Water WorksAssociation’s (AWWA) Finance, Accounting, and ManagementControls Committee He received a B.S degree in business administration and in civil engineeringfrom Kansas State University in 1975

Alexis Warmath a vice president at Raftelis Financial Consultants,

is a nationally recognized expert in water finance, management, andpricing His broad-based experience includes development of com-prehensive financial plans, cost of service and pricing analyses, rev-enue bond feasibility studies, and strategic planning He has over 13years of consulting experience and has been with RFC for over 10years He has served RFC as project manager or lead consultant in

a variety of projects to assist government utilities in addressing cial, management, and public policy requirements He is currently amember of the Rates and Charges Subcommittee of the AWWA’sFinancial Management Committee, where he participated in the

Uni-versity He also received an M.B.A from the Fuqua School of Business and a Master’s degree inenvironmental management from the Nicholas School of the Environment and Earth Sciences, both

at Duke University

Teno West, JD is a partner practicing in the areas of publiccontracts, government law, water law, solid waste law, governmentprocurement, project delivery, infrastructure development, projectplanning and finance, public finance, and intergovernmental rela-tions His experience has included representing water, wastewater,and solid waste agencies in structuring public–private partnerships

as well as developing regional service solutions

His practice includes representing local, regional, and federalgovernments with alternative project delivery arrangements such

as design–build and design–build–operate procurements His native project delivery representation has included water, waste-water, combined sewer overflow, cocomposting, material recovery,waste–to–energy, as well as other similar environmental infrastruc-ture projects He has been involved in a number of such projectsranging in size from a 1.5 MGD wastewater plant to a water andsewer system comprising in excess of 200 water and wastewater plants He has assisted governmentswith the drafting and enactment of legislation necessary for such alternative delivery methods to

alter-be lawfully implemented

He has been town manager of Hardwick, Vermont, and town administrator of Carlisle, chusetts In his capacity as a municipal manager, he served on a regional solid waste districtgoverning boards in both states

Massa-He has been admitted to practice in New York and New Jersey and is a member of the AmericanBar Association, the New York State Bar Association, and the New Jersey State Bar Association

He earned his bachelor’s degree cum laude in political science and American studies in 1984 fromSaint Michael’s College, and he earned a master’s in public administration in 1987 from theUniversity of Vermont He earned his law degree cum laude from the New England School of Law,

Gerald Wexelbaum is president of Strategy Support Associates,

a consulting firm dedicated to helping clients become more cessful through strategic management During his 30-year career

suc-as a management consultant, he hsuc-as worked with over 100 clients

in developing and implementing strategic plans Since resigning

as a consulting partner with Ernst & Young to establish StrategySupport Associates in 1992, he has helped several water and waste-water utilities in strategic planning These clients have ranged fromsmall rural utilities to large complex urban water and wastewaterproviders Outside of the water and wastewater utility industry, hehas worked with many business organizations in strategic planningincluding large financial institutions, Internet retailers, telecom-munications providers, manufacturers, sports facilities, and others, and brings business techniquesand practices utilized in these industries to address issues faced by public utilities He holds a B.S.degree in marketing from Pennsylvania State University and M.B.A degree in marketing andbusiness economics from the University of Chicago

Kevin Whitt is utilities privatization program manager for the U.S.Navy’s Naval Facilities Engineering Command–Atlantic He has 8years’ experience in privatization of military utility systems Hemanaged the Navy’s first transaction under the privatization statuteand is considered the principal architect of the Navy’s privatizationprocess He is a licensed professional engineer with a background

in utility service contracting, power generation, and industrial plantsystems He has received numerous awards including the presti-gious Navy Meritorious Civil Service Award He has a B.S degree

in mechanical engineering from Virginia Institute of Technologyand is studying for an M.B.A at the College of William and Mary

Chris Woodcock, PE is president of Woodcock & Associates, Inc.,

a firm that provides water and sewer rate and financial consultingservices to municipal and investor owned utilities During his career

he has prepared some 300 water, wastewater, and stormwater rateand financial studies for clients from Maine to Florida to California

as well as overseas He has testified as an expert witness on related matters before state utility commissions and in court pro-ceedings numerous times He is the former chairman of AWWA’sfinancial management committee and AWWA’s rates and chargessubcommittee He holds degrees in both civil engineering and eco-nomics from Tufts University

Chapter 1 Introduction to Water and Wastewater Finance and Pricing 1

George Raftelis

Section I: Financing Water and Wastewater Services 7

Chapter 2 Capital and Financial Planning for Water and Wastewater

Utilities 9

Gerald Wexelbaum

Chapter 3 Public Sector Financing Options — Long-Term Financing,

Short-Term Financing, and Credit Enhancements 37

Section II: Alternative Delivery Methods and Public–Private Relationships 103

Chapter 7 Overview of Delivery Methods 105

Chapter 10 Water and Wastewater Pricing Process 175

Section IV: Other Topics 257

Chapter 15 Benchmarking Water and Wastewater Rates and Charges 259

Appendix B Case Studies 341

Appendix C Water and Wastewater Survey Results 349

Appendix D Survey of Water and Wastewater Affordability Programs 365

Appendix E 10 USC 2688 375

Index 379

to provide service in the most cost-effective manner Consultants assist utilities in addressingfinancial, economic, engineering, and other professional requirements Clearly, as Figure 1.1 high-lights, a broad spectrum of Americans plays a major role in ensuring that appropriate water andwastewater services are provided to customers.

The operations and management of water and wastewater systems have changed significantlyover the last 35 years At one time, providing water and wastewater operations services wasreasonably simple Water quality did not appear to be a high-priority concern for most Americans

In the late 1950s, however, the public became increasingly concerned about protecting the ronment Through the efforts of many concerned Americans, the U.S Environmental ProtectionAgency (EPA) was formed in December of 1970 to address environmental quality issues Sincethat time, there has been an increased focus on providing high-quality potable water and ensuringthat wastewater is treated to appropriate levels to protect the quality of streams and waterways In

envi-1972, one of the most comprehensive water quality laws was passed Public Law 92-500, or theWater Pollution Control Act Amendments of 1972, was targeted towards ensuring water qualitystandards throughout America and mandated one of the largest public works programs in history.All water and wastewater utilities were affected by this law, and billions of dollars in grant fundsbecame available to governmental utilities for constructing facilities to address water quality

2 Water and Wastewater Finance and Pricing

standards Later, the Safe Drinking Water Act Amendments of 1986 mandated significant ments applicable to thousands of public water purveyors across the country In the 1990s, the EPAand state environmental agencies worked effectively to fully implement the Clean Water and SafeDrinking Water State Revolving Funds (SRF) programs The future promises that the environmentwill continue to be a priority, and new laws and requirements will ensure that the public will enjoyhigh-quality water and wastewater treatment

require-As a result of increased focus on environmental quality, the water and wastewater industrieshave become more sophisticated More technically advanced treatment facilities have been con-structed to provide high-quality potable water and to ensure that wastewater is treated to appropriatelevels More sophisticated equipment has been developed to provide better support to operations.Highly advanced information technology ensures that proper management and accounting infor-mation is provided to management, operators, and others involved in providing water and wastewaterservices More highly trained operators are necessary to run more advanced equipment and utilityfacilities Highly educated and experienced managers are required to deal with complex manage-ment, financial, engineering, and political issues As a result, many people have decided to dedicatetheir careers to this expanding industry

A major challenge confronting the water and wastewater industries is acquiring adequate funds

to finance and operate capital equipment and facilities and implementing appropriate pricingstructures to ensure the self-sufficiency of the utility Capital financing is important because itensures that appropriate facilities will be constructed to address environmental regulations and meetthe service needs of the customers The financing vehicle that is used by the utility and the timing

of the financing is crucial in ensuring that each generation of water and wastewater customers isappropriately paying for facilities that it needs, and not inappropriately financing facilities for othergenerations of customers It is a major goal of an effective financial plan to “match” economicimpacts on customers with benefits received by those customers, creating “intergenerational” equity

Figure 1.1 Water and Wastewater Stakeholders

Utility Managers

Utility Governing Bodies

Utility

Employees

Federal Regulatory

American Consumers

Attorneys

Environmental-State Regulatory Agencies

Introduction to Water and Wastewater Finance and Pricing 3

Water and wastewater pricing, typically referred to as user rates or charges, provides a directform of communication with the customer Rates generate the major source of utility revenues anddefine the customer’s obligation to recover the costs of operating and maintaining the utility Whenrates become excessive, the public provides feedback to the utility about paying higher charges.Virtually everyone in our society is affected by water and wastewater financing and pricing.Residential customers are affected in that water and wastewater connection charges and rates have

to be factored into their personal finances and budgets Studies have been conducted to evaluatethe affordability of water and wastewater services One result of these studies indicates that servicesmay remain affordable if the annual water or wastewater bill is not more than 1.5 to 2.5% (3 to5% for both services) of median household income As discussed later on in Chapter 17, percentageranges result from differences in the financial strength, poverty levels, and other economic factorsamong various communities For example, a 5% water and wastewater residential bill may beappropriate for a community with a strong economy and growing customer base, whereas 3% may

be an appropriate threshold for communities with major financial challenges

Commercial and industrial establishments also have to consider water and wastewater utilitycosts in pricing their services to the public Manufacturing companies closely scrutinize these rates

as they are under pressure to provide manufactured goods at the lowest possible prices to competewith other companies Overall, as water and wastewater quality has improved, the cost of providingwater and wastewater services has increased As a result, charges for these services have become

a more significant part of the budget of each customer, regardless of customer class

With additional scrutiny by customers, one of a water and wastewater utility’s major objectives

is to provide service at the most affordable price At the same time, the utility must ensure that itcomplies with appropriate government regulations and that adequate funds are raised to maintainthe utility on a financially self-sufficient basis In addition, the utility must consider the cost ofproviding service and how to allocate this burden equitably to users

As depicted in Figure 1.2, this book is organized into four parts Section I (Chapter 2 to Chapter6) deals with the financial planning challenges of a utility Specifically discussed is an appropriateprocess for developing a financial plan using effective financing methods Chapter 2 provides anoverview of this process and discusses major components of the process, focusing on strategicbusiness, capital, and financial planning for water and wastewater utilities Chapter 3 discussespublic sector financing options, including short-term financing techniques such as fixed-rate demandnotes, tax-exempt commercial paper, and variable-rate demand notes Also discussed in Chapter 3are credit facilities for short-term financing, and long-term financing methods such as generalobligation bonds, revenue bonds, and double-barreled bonds In addition, Chapter 3 discussescontemporary techniques that have become popular in the long-term and short-term debt markets(variable rate bonds, put options, zero coupon bonds, etc.) Chapter 4 discusses private sectorapproaches as an alternative to public sector financing options Included in this chapter are evolvinginternational finance and short- and long-term financing techniques typically embraced by theprivate sector Chapter 5 elaborates on system development charges, an increasingly popular source

of revenue related to financing capital facilities Specifically, Chapter 5 discusses the background

of system development charges, objectives of an effective charge structure, the advantages anddisadvantages of system development charges, methods of calculating and assessing these charges,state legislation, and other considerations related to their development and implementation Chapter

6 recommends a process for selecting an appropriate financial plan, considering such factors asshort-term and long-term interest rates, costs and time frames of long-term debt issuance, risksassociated with changing market conditions, the degree of public acceptance of the financingprograms, potential tax law changes, debt capacity, and timing of capital improvements

Chapter 7, Chapter 8, and Chapter 9 in Section II discuss delivery methods for designing,constructing, and operating major water and wastewater facilities These chapters consider boththe traditional design–bid–build approach, as well as alternative delivery approaches such asdesign–build, design–build–operate, construction manager-at-risk, and contract operations In addi-

4 Water and Wastewater Finance and Pricing

tion, legal aspects of embracing various delivery methods are addressed Specifically addressed areprocurement procedures, state laws and enabling legislation, labor considerations, environmentaland other regulatory issues, reversion of assets, and binding future governing bodies

Section III of the book deals with water and wastewater pricing In Chapter 10, an overview

of the three-step cost determination and rate-setting process is presented, with subsequent chaptersdealing with each step of the process Establishing water and wastewater revenue requirements isdiscussed in Chapter 11 Specifically presented are the development of revenue requirements underthe utility and cash needs approaches, including the determination of operating and maintenanceand capital costs Chapter 12 deals with allocating revenue requirements to various cost componentsand classes of water and wastewater customers In Chapter 13, rate design is presented Specificallydiscussed are how to structure a minimum (fixed) and volume (usage) charge, and different types

of rate structures that are used by various utilities Chapter 10 through Chapter 13 also provide anexample of how revenue requirements are identified, how costs are allocated to customer classes,and how rates are developed Chapter 14 discusses conservation rates as an alternative to traditionalrate structures Included in this discussion are seasonal rates, uniform rates, inverted block rates,and marginal cost pricing

Miscellaneous topics related to finance and pricing are presented in Section IV Chapter 15discusses rate-setting trends across the country and presents the results of the 2004 Water andWastewater Rate Survey, published by the American Water Works Association and Raftelis FinancialConsultants, Inc Chapter 16 discusses various issues related to valuing water and wastewater assets.Affordability, a major emerging issue in the water and wastewater industries, is discussed in Chapter

17 In Chapter 18, the Department of Defense’s (DoD) approach to privatizing utility systems onDoD bases is discussed

Figure 1.2 Overview of Book

Section One

Water and Wastewater Financial Planning

Strategic Financial Planning and Implementation

Public and Private Financing Options

System Development Charges

Selecting an Appropriate Financing Plan

Section Two

Alternative Delivery Methods (ADMs)

Overview of ADMs Description of ADMs Legal Aspects of ADMs

Section Three

Water and Wastewater Pricing

Overview of the Rate-Setting Process

Establishing Revenue Requirements

Determination of Cost of Service

Designing a Pricing Structure

Section Four

Miscellaneous Topics

Rate-Setting Trends Across the

Country Results of the 2004 Rate Survey

Valuing a Utility Affordability Issues

Introduction to Water and Wastewater Finance and Pricing 5

Numerous complex issues are involved in water and wastewater financing and pricing Thisthird edition expands on many of the concepts identified in the second edition, which were notcovered in detail Specifically, these expanded topics include:

Even with the significant broadening of topics covered, the third edition will mention severalimportant pricing concepts but not discuss in detail developing wholesale rates, alternative methods

of measuring water returned to the sewer for purposes of billing wastewater, and the development ofinterruptible rates These topics will be the subject of separate texts and future editions They wereexcluded not because they lack importance but to focus this book on major components of the financingand pricing process Additional authoritative texts that could be referenced include the AmericanWater Works Association’s Manuals of Water Supply Practices Specifically, the AWWA M1 manual,

* Principles of Water Rates, Fees, and Charges, 5th ed., 2000.

† Water Utility Capital Financing, 2nd ed., 1998.

‡ Developing Rates for Small Systems, 1st ed., 2004.

Section I

Financing Water and

Wastewater Services

Planning for Water and

Wastewater Utilities

Gerald Wexelbaum

CONTENTS

Wastewater Service 14

2.2.1.10 Community Planning and Legal Restrictions 142.2.1.11 Human Resource Considerations 15

10 Water and Wastewater Finance and Pricing

Revenue Requirements 31

In this environment, virtually all utility managers are faced with increasingly complex interlockingchallenges involving the environmental quality of life in their communities; increasing capitalconstruction requirements in a time of economic scarcity; a desire to control rates and charges; thedemands of their customers for improved services; economic development needs of their commu-nities; requirements of state and federal regulators; and many others To meet these challenges,managers of utilities must prioritize the allocation of limited resources and focus the organization

on the factors most critical to success

As depicted in Figure 2.1, this chapter presents a description of the three key elements of acomprehensive and integrated planning process to help utility managers in this effort: (1) strategicbusiness planning, (2) capital planning, and (3) financial planning

This process helps ensure that all relevant factors are considered and that the capital and financialplans are consistent with the business objectives of the utility and the customers it serves Theplanning process will vary between small and large utilities, investor-owned and governmentalutilities, and utilities with “steady state” operations (low or stagnant growth) and those addressingrapid growth and economic development The utility should identify the appropriate participants

in the three phases of the overall planning process — strategic business planning, capital planning,and financial planning — and ensure that all political, economic, financial, legal, regulatory, andoperational issues are addressed This comprehensive process is discussed in the remainder of thechapter

2.2 STRATEGIC BUSINESS PLANNING

The first phase in the comprehensive planning process is strategic business planning, which is thebusiness management response to the dynamic environment and the key challenges that must beaddressed Through this process, the utility carries out the following activities:

Capital and Financial Planning for Water and Wastewater Utilities 11

achieving those goals

imple-mentation costs and financial benefits expected

committed to achieving short- and long-term success

ongoing basis

To best meet the challenges of today and the future, utilities should begin their planning process

with a strategic management plan that will drive the capital and financial planning processes An

effective strategic planning process consists of the three key steps illustrated in Figure 2.1 and

described in the following text

2.2.1 S TEP 1: C ONDUCT B USINESS E NVIRONMENT A NALYSIS

The strategic management planning process begins with a review of the business environment in

which the utility must operate Figure 2.2 depicts most of the factors that should be evaluated

during the process

2.2.1.1 Customer Demand and Economic Development

Probably the most important factor motivating utility capital expansion is growth in demand

Because new customers must be served, pressure is placed on a utility to provide additional water

Figure 2.1 Strategic Business, Capital and Financial Planning Overview

Approved Plan

Capital Planning

Financial Planning Step 1

Develop a Comprehensive Facility Master Plan

Determine and Schedule Capital Requirements

Determine Annual Operating and Capital Requirements

Calculate Fees and Charges

Evaluate Impact

on Customers

REEVALUATE REEVALUATE

REEVALUATE REEVALUATE

12 Water and Wastewater Finance and Pricing

and wastewater services This growth can be achieved by economic development (whereby new

customers are attracted to a service area); redevelopment of older areas, thereby impacting demand

and its geographical dispersion; addition of new customers; and regionalization that requires the

utility to serve new areas beyond its traditional borders In addition, other factors must be considered

in estimating demand for a particular service area These factors include per capita water usage,

unaccounted-for water (water utility), infiltration or inflow (wastewater utility), price elasticity of

demand (how customers will react to water and wastewater rate increases), and long-term

environ-mental impacts

2.2.1.2 Political Factors

The needs and desires of the political body governing the utility must be considered Some are

focused primarily on rates, others on economic development issues and availability of water service

to accommodate economic growth, and still others on quality of water and the environment It is

incumbent on the utility management team to fully understand the relative importance its governing

body places on these and other issues

2.2.1.3 Affordability

Ensuring that senior citizens and economically disadvantaged families and individuals have access

to safe and affordable water supply has become increasingly important and should be addressed

in a utility’s strategic business planning process

Figure 2.2 Factors in Evaluating the Strategic Planning Process

Conservation and Demand Management

Demand Growth

Customer Demand for Improved Service

Capital and Financial Planning for Water and Wastewater Utilities 13

2.2.1.4 Conservation and Demand Management

In recent years, conservation has become a high priority in many communities Conservation is focused

on ensuring efficient use of water resources by influencing customer demand, eliminating water loss,

mandating the installation of water-saving devices, sending a conservation consciousness message,

and reducing peak demand by shifting water consumption to different periods of usage Even in

communities with abundant water resources, conservation and demand management can be effective

in delaying or avoiding costly capital programs and should be carefully considered

2.2.1.5 Decline in Economic Growth

Decline in economic growth and a downward shift in population in various regions of the country

have an impact on the planning process for utilities In addition, in many manufacturing-focused

areas, plant closings, changes in the industrial base, and new manufacturing technologies have

reduced and may continue to reduce water demand The utility may have to face the difficult task

of planning and financing necessary capital improvements while selling less water, and while

community leaders are considering reductions in operating budgets It is especially difficult for

small- to medium-size utilities to develop an effective capital and financing plan without being able

to forecast growth These factors should be taken into consideration in planning for the future

2.2.1.6 Deteriorating Infrastructure

In many service areas, the water and wastewater infrastructure is old and deteriorating, requiring

replacement Varying conditions from jurisdiction to jurisdiction, such as growth, weather, soil

types, elevation, water quality in discharge streams, and water quality of sources of supply, require

unique infrastructure maintenance Some areas of the country, such as parts of Arizona, California,

and other Sunbelt areas, are experiencing rapid growth Utilities serving these areas typically have

a large percentage of their capital investment in new facilities As a result, these communities will

not be confronted with major infrastructure deterioration in the near future However, in parts of

New England and industrial areas of the Northeast and Midwest, it is not uncommon to have

facilities built in the late 1800s and early 1900s that require major rehabilitation In these areas,

one often finds combined sewers with stormwater being processed at the wastewater treatment

plants Replacing specific infrastructure items can be as costly as constructing facilities for

expan-sion Many utilities facing significant infrastructure costs in the relatively near future have not set

aside reserves sufficient to replace aging plants and equipment In these cases, infrastructure

planning must be a critical outcome of the strategic business planning process

2.2.1.7 Increasingly Stringent Environmental Regulations

Since its inception in the 1960s, the Environmental Protection Agency (EPA) has been focused on

protecting and improving environmental quality To achieve its goal of upgrading water quality,

the EPA has developed numerous environmental regulations, which have been imposed upon

government and investor-owned utilities, industries, owners of environmental facilities, and other

entities involved in activities that could affect water quality In addition, state environmental

agencies have been formed to enforce federal regulations and, in some cases, have developed more

stringent state requirements Increased environmental regulation has forced many water and

waste-water utilities to upgrade existing facilities or to build new ones that meet much more stringent

environmental requirements Evolving environmental legislation will continue to have a profound

impact on most utilities’ capital and financial planning processes For example, regulation of

industrial discharges into publicly owned treatment works, disposal requirements of treatment

residuals, and water quality will all continue to be areas of major environmental scrutiny Increasing

14 Water and Wastewater Finance and Pricing

regulation will translate into more costly capital improvement programs Furthermore, due to

economies of scale, increased regulation will impose a significant burden on small, economically

disadvantaged communities, which will make financing capital improvements an even greater

challenge

2.2.1.8 Customer Demand for Improved Water and Wastewater Service

While capital facilities are becoming more costly, customers are demanding improved services

from their water and wastewater utilities This is largely due to the fact that the public has become

more aware of environmental issues and is insisting that utilities exercise wise environmental

stewardship Water taste, odor, and appearance are a continual concern to many residential and

commercial customers Industrial customers continue to insist on improved water and wastewater

services for their manufacturing processes in order to improve the quality of their industrial output

Wastewater odors and the health impact of insufficiently treated wastewater discharged into streams

and waterways are major quality issues As a result, capital facilities are often included in a capital

program for addressing customers’ quality concerns

2.2.1.9 Declining Federal Assistance

At a time of more stringent environmental regulation, the EPA and the states have moved toward

having local governments finance water and wastewater facilities with less federal and state grant

assistance Public Law 92-500, the Water Pollution Control Amendments of 1972, was one of the

largest public works grant programs in U.S history This program has assisted numerous wastewater

owners in building facilities to address more stringent environmental quality requirements In the

1980s, funding for this public works program was significantly reduced, but the environmental

regulations that water and wastewater service providers must address are still very much in place

In many cases, water and wastewater utilities must address environmental regulations with limited

federal and state grant assistance To provide some financial relief for the diminishing grant program,

the EPA provided “seed money” to states for establishing state revolving loan funds (SRF) programs

in the late 1980s The Clean Water and Safe Drinking Water SRF programs have made providing

a source of low-interest-rate loans or other assistance for financing water and wastewater

construc-tion requirements a key objective Even though SRF programs provide some assistance to qualifying

utilities, they must repay these loans as if a bond issue were used In addition, in response to

declining and more restrictive federal and state assistance, alternative funding methods,

consolida-tion, and construction of regional facilities will be encouraged in the future

2.2.1.10 Community Planning and Legal Restrictions

A community’s utility-planning goals and any legal restrictions that exist play an important role

in driving the utility’s strategic management plan The utility must address several important

business and legal questions such as the following:

be developed to encourage conservation?

paper, lease or purchase, tax increment financing, etc.)?

be financed?

disadvantaged, etc.)?

• Should the utility be used as a mechanism to channel growth to a particular part of theservice area?

by the utility?

2.2.1.11 Human Resource Considerations

As complex business enterprises with increasingly complex infrastructure and operations, and withcustomers demanding a high level of quality service, today’s utilities require a competent, motivatedworkforce Issues such as recruitment, education and training, motivation, employee retention,internal communication, diversity of workforce, and many others must be addressed in the planningprocess Also, labor unions are becoming increasingly involved in water and wastewater industries,and the utility must be prepared to deal with issues related to labor unions Last, the appropriateness

of outsourcing either mission or nonmission critical activities and the impact that outsourcing wouldhave on the utility’s workforce and employee relations should be considered in the strategic businessplanning process

2.2.2 S TEP 2: U NDERSTAND THE E LEMENTS OF A S TRATEGIC P LAN

After the business environment has been evaluated, the next step in the process is to understandthe elements of a strategic plan for utilities As depicted in Figure 2.3, the key components of astrategic plan are the mission, goals, objectives, strategies, and implementation plans Each of these

is described in the following text

2.2.2.1 Mission

The utility’s mission should be the central focus of its operations and decisions The mission is thefundamental, unique purpose that sets the utility apart from other organizations and identifies itsscope of operations It is an enduring general statement of the utility’s intent and describes theareas of emphasis for the organization in a manner that reflects the values and philosophies of thegoverning body, management, and other key decision makers

The three basic components of the mission statement are the following:

day-to-day behavior

it is striving to achieve (i.e., what future success looks like)

(stake-holders), including political leaders, customers, the community, regulators, and others

A small city in North Carolina that serves its residents and those in the surrounding region hasrecently undergone a strategic planning process Its mission is to provide quality water and waste-water services to the region, which will protect the environment, promote public health, improvethe quality of life, and maintain the public trust

the utilization of resources and enab

This mission does not imply that other issues such as cost control and customer service arenot important; however, it does indicate that the central focus of this utility is quality and thatappropriate resources and strategies should focus on maintaining and improving its service topromote the quality of life in the region It is important to note that other utilities in differentcircumstances should have different emphases in their mission statements Some will focus onefficiency, others on facilitation of economic development, and still others on adequate water supply.

2.2.2.2 Goals and Objectives

To drive the strategies and evaluate achievement of an organization’s mission, greater specificityconcerning what is to be achieved needs to be expressed in terms of goals and objectives.Goals are qualitative statements that, in their totality, represent achievement of the mission.Goals should direct the application of the utility’s resources in key areas such as operations, rates,public health and environment, regional development, customer service, human resources, andstakeholder communications A sample goal statement for the category of rates is: to manage theutility in a manner that optimizes the utilization of resources and enables it to charge competitiveand affordable rates, while providing for capital and operational needs

Objectives are quantitative performance measures that measure the achievement of each goal.Objectives are critically important because they provide the important element of accountability tothe strategic business planning process and also provide a means of assessing the degree to whichthe organization has adhered to its strategic plan Senior utility management is responsible to itsboard, city council, city manager, or other governing body for achievement of measurable objectives.Other members of management should be held accountable for performance relative to specificobjectives they are responsible for achieving In many organizations, compensation and otherrewards are tied to the achievement of specific measurable objectives stated in the organization’sstrategic business plan, or the strategic plan for their particular organizational unit

The following are sample objectives measuring achievement of the rates goal:

community’s median household income

2.2.2.3 Strategies

Strategies are allocations of time, money, and effort, and are designed to achieve various goals andobjectives The strategies selected must reflect the priorities of the utility as expressed by themission, goals, and objectives, and they should collectively be both necessary and sufficient toachieve each of the defined goals and sets of objectives They must be necessary because, in times

of economic scarcity, it is important that utilities not waste resources on programs that will notcontribute to achievement of their strategic plans Furthermore, strategies must be sufficient, other-wise the goals will not be achieved A sample set of strategies addressing the rates goal andobjectives is presented in the following list:

use this information to make optimized decisions based on cost control, design, struction, and operational considerations

them in over time, and ties in with the financial planning/rate model

demand-management tool