It seems like gas prices are always rising. Food prices are up. Clothing prices are up. Energy prices, yeah, up. Chances are, so are your expenses.
Yep, it’s crunch time. Economic crunch, that is.
With prices and expenses rising all around you, it may be time to re-evaluate your utility’s rates. Are your current customer rates sufficient? Are you short of funds to make basic infrastructure repairs? Should you charge full-cost pricing or try to supplement the costs with outside sources?
Bill Heinrichs of Community Resource Group, the southern affiliate of the Rural Community Assistance Partnership, recently gave a presentation on setting water rates at the Annual Conference and Exposition of the Arkansas Water Works & Water Environment Association. Bill touched on financial distress, full-cost pricing, rate structures and how to sell all this to the customer.
In this edition of eBulletin, we’ll review some of the definitions, rates, rules and tips Bill offers to rural water systems. We’ll even toss in the presentation at the end.
Trouble brewing?
It’s been a tough year so far, and it doesn’t look to get easier anytime soon. Droughts in some areas of the country and floods in others have led to increased costs for water systems as they attempt to shore up supplies and repair damaged infrastructure. That’s compounded by rising costs in almost every industry, which means supplies and repair parts are going up as well.
So what do you do? Can your system handle the increased costs, or should you raise water rates? On the one hand, with residents feeling the strain as well, they might not be eager to cough up more money for water. On the other hand, with prices rising everywhere else, an increase in utility costs probably won’t come as much of a surprise.
Bill simplifies the thinking in his presentation by providing a quick checklist of financial distress indicators.
- Do you have billing and collection procedures?
- Do you keep records of assets and depreciation?
- Are your financial records organized?
- Do you follow purchasing procedures?
- Are controls exercised for expenditures?
- Are controls in place to ensure the budget isn’t exceeded?
- Is your operating ratio less than 1.0?
- Is your coverage ratio less than 1.25?
- Are you lacking a long-range plan, asset management plan and/or preventative maintenance plan?
- Do you have a five-year budget projection?
- Are you lacking written policies?
If one or two of these are a concern, there’s room for improvement. If several are concerns, your utility may need some serious restructuring and financial assistance.
Remember, rates shouldn’t just cover maintenance and operation costs. They also must be enough to pay down debts and provide adequate reserves in case a disaster strikes.
Additional Resources
EPA’s Small Public Water systems and Capacity Development: Financial Help
http://www.epa.gov/safewater/smallsystems/financialhelp.html [1]
Covering the costs
It may be time to change your rates, or change your rate structure completely. Bill offers a few important suggestions before raising your rates, such as having the system board identify the reasons why a rate increase is needed; ensuring all board members and system managers know those reasons; and making sure the customers know and understand those reasons. It might be useful to have an outside source, such as RCAP, perform a rate analysis. (RCAP performs this service at no charge.)
The EPA suggests the use of full-cost pricing not only to cover all the costs of running a water system but also to encourage water conservation. The EPA believes that higher costs can curb excessive water usage. It notes that Americans used an average of 10 gallons of water a day 100 years ago, as opposed to about 100 gallons a day now.
Today, some water systems have their budgets mingled with other city services, or local governments control the rate settings. The result is the true costs of running the water system are supplemented from elsewhere rather than paid by the water customers.
With full-cost pricing, the water rates to customers cover everything from the water and its treatment to repairs, operations (including salaries, insurance, etc.) and capital costs. This can apply to nearly every rate structure, so long as those rates cover the system’s entire costs.
Some structures can encourage conservation, such as increasing prices during peak demand times or imposing surcharges on “excessive” water use. Uniform rate structures and flat fees don’t encourage conservation as well, the EPA states.
Full-cost pricing may mean a significant increase in water rates to customers, but it can bring financial stability to water systems that have just scraped by for years on minimum rate billing. Not only will full-cost pricing take care of overall water costs, but it also ensures that staff and maintenance are well kept and that some funds are set aside for future projects or emergency repairs.
Additional Resources
EPA: Water and Wastewater Pricing
http://www.epa.gov/waterinfrastructure/pricing/About.htm [2]
Structuring rates
The key to water rates is ensuring you have the correct rate structure. There are several ways rates can be set, but it’s important to determine which is right for your system. Using a fixed structure when a variable one is needed could lead to financial strain. On the other hand, excessive fees and rates from an outdated variable structure could turn customers off and discourage industries from relocating to the area.
Our presenter Bill provides specific examples of costs and revenue sources. One important topic he touches on is how much a system should add to its reserves.
? Operating reserves should be at least an eighth (1/8) of the annual expenses
? Debt service reserve should be 10 percent of the annual loan payment, accrued over 10 years
? Capital repair and replacement (depreciation) should be figured at a minimum 5 percent of total revenue annually. (The American Water Works Association recommends this figure be 2 percent of capital costs.)
System reserves are important for emergency repairs, future improvements and sustainability in economic crunches.
Bill provides a few formulas for calculating rates and needed revenues, but it basically comes down to subtracting revenue from cost. If you have a big figure left, it may be time for a rate change.
Once all that’s hammered out, you have to determine which type of rate structure is best to achieve your goals. There are advantages and disadvantages to each type of rate structure, but it’s important to find the best fit to avoid more problems later.
Some small systems may prefer to use a flat fee, for instance. This eliminates the need to install water meters, but it also gives customers free rein to use however much water they want. It makes it difficult to promote water conservation. It also can mean some customers pay too much for their actual consumption while others pay too little.
Variable rates are an easy solution, but there are several ways to apply this. Should you charge the same rate per gallon? Should you decrease the rate as more water is used? Or should you increase the rate per gallon for heavier users?
The key here is to figure out your main customer base and what you hope to accomplish with the rates. If you’re in a drought-ridden area and need to curb excessive use, then it might be a good idea to charge higher rates per gallon as the customer exceeds a certain use level. For example, you may charge $2 a gallon up to 5,000 gallons, $2.50 for up to 10,000 gallons and $3 a gallon after 10,000 gallons.
Those with a strong agricultural base might consider lowering costs the higher you go. Making the water too pricey could hurt the industry, which already faces other costly obstacles such as destructive weather patterns and damage from disease or insects.
Taking it to the streets
Once the rate structure is complete, you should know whether a rate increase is necessary. If so, see if it’s feasible to introduce the rate incrementally. Customers, both residential and commercial, tend to balk at large increases. If your increase must be approved by city officials, there’s a chance that increase could be denied, leaving the water system in some serious trouble. You might even consider setting a permanent, annual increase, similar to a cost-of-living increase. If the increase isn’t necessary one year, then suspend it that year. It’s a nice bonus for the customer. Just make sure that year’s suspension won’t come back to haunt you later by putting you behind on costs.
The first step is to make sure water operators, board members and city officials know an increase may be necessary and why. Then you must let the customers know about possible rate changes. It’s important to explain simply and directly why an increase may be needed. Provide a few numbers if you can, but don’t go into long, complicated explanations. It’s vital the customers understand exactly what you’re saying and exactly what you’re asking of them.
Check with nearby water systems to see what they’re rates are, then compare those rates to your own. Provide a percentage on the increase of costs over the last few years. These may help the customer see why a rate increase is necessary.
It’s also good to stress the importance of clean, safe water to them, their families and their businesses. Safe water is one of life’s keystones, and the rising costs of keeping that water safe necessitates a rate increase.
Convincing customers about a rate increase may be easier if the communication is well established. Let customers know what’s happening with your system by providing monthly reports and reporting on operations, maintenance, sudden changes in costs, unexpected revenues, and so forth. It may be a lot easier for customers to understand your needs if they’re kept aware of changes in the water system.
It’s not easy to determine which rates, and rate systems are best. But not having a firm financial plan can put water systems in serious jeopardy. Worse comes to worse, there’s no harm in asking for help. People like Bill and other RCAP members are available to help water systems survive an economic crunch, be it a national crunch or one of the system’s own making. You can reach them easily by clicking the Ask The Expert link on the Safe Drinking Water Trust site.