What Drives High Utility Rates?
Author: Jason Mumm
Author: Jason Mumm
News articles about increasing water utility rates are frequently found throughout the nations media. Still, there may be little understanding of the political dynamics that drive the water and sewer rate setting process. This process is unique in our public square. There is no question that water and sewer utility services are fundamental public goods. Whether these services are provided by a local government or by a private company, the factors driving the need for rate increases are common. And as we have seen in 2009, utility rates appear to be rising at an accelerating pace. Utility managers and
water utility consultants fight a daily battle to reduce water rate increases, but in the end, the forces putting upward pressure on consumption rates are often simply overwhelming. What is behind this trend? There appear to be about five major factors contributing to rapidly rising utility rates: Diminishing Growth
Disappearing Development Fees
Massive Capital Requirements
Increasing Supplier Costs
Waiting for the wrong Time Together, these factors contribute to the current environment of increasing fees for water utility service. Diminishing Growth
Because water and sewer utilities tend to have high fixed costs relative to total cost, referred to in the industry as high operating leverage, growth in the total number of customers can help keep rates down.As the number of customers and demand grows, total revenue increases. Should growth exceed inflation and real increases in costs, then rate increases are not normally required. Growth in many parts of the country has been one of the factors that helped keep utility rates in check. With the recession, however, some areas have experienced negative growth and some areas actually lost customers due to displacement (such as in Detroit). Overall demand has also fallen off, owing to conservation, or just because customers reduced consumption during difficult economic times. A reduced demand, regardless of the reason,spells trouble. Reduced demand means that the utilitys fixed costs are shared by fewer people, and that rates probably have to be increased. The utility can fight back by slashing operating budgets, but the reality is that many costs simply cannot be avoided. Once this point is reached, higher service rates are the only solution. Disappearing Development Fees
Utilities frequently charge a fee for connecting a new home or business to the service or system. Connection fees fall into two categories: a fee to cover the direct costs of simply Connecting a meter, as well as a larger amount intended to recover at least a portion of the capital the utility will need to invest in order to provide service capacity for that new connection. This second category of fees goes by many names but is frequently referred to as a development fee. In some areas, these development fees can be significantly large. Western areas in particular can have development fees for a single-family home can run as high as $20,000 or more. Although the purpose of these fees is to offset capital requirements (acquisition costs for pipes, pumps, tanks, etc.), revenue generated by the fees provides cash that utilities desperately need. When growth slows, revenue from these fees declines. As the revenue stream from these fees dries up, the Utility may need to replace it. This often translates into higher consumer rates. Massive Capital Requirements
Water and sewer utilities are exceptionally capital intensive businesses. These utilities are also natural monopolies. The extremely high amount of investment capital required for infrastructure before a single dollar of revenue is earned is a major reason for this. Utilities possess very large asset holdings. Pipes, pumps, tanks, treatmentplants all cost a great deal of money, not only to acquire but also to maintain repair, and replace when necessary. The cost to build or replace these assets is enormous.
In many parts of the US, these assets have reached the end of their useful service lives. Water main breaks and sewer back-ups are just a few manifestations of systems that are worn out and in dire need of repair or replacement. To facilitate the replacement, large amounts of new capital must be raised. That usually translates into higher debt payments for utilities themselves and big increases in customer rates to pay for it. In our capacity as Water Utility Consultants, we recently assisted on a project where a small community of about 2,000 customers was required to construct a new sewer treatment facility at a cost of about $13 million. The debt service on the plant comes to about $460/yr/customer the debt service alone would have caused the sewer bills to double. Increasing Supplier Costs
The costs of treatment chemicals, electricity, and fuel have all gone up substantially in the past couple of years due to a variety of factors that are well beyond the control of any local water/sewer utility. Some of these costs can be managed, but more often than not they have to be absorbed translating into a need for higher rates in many cases. Waiting for the Wrong Time
Is there ever a good time for a water/sewer rate increase when youre an elected official? Probably not, but some times are worse than others. Now would be one of those worse times. Unfortunately, when times are good the need for rate increases is not always obvious. There are untold thousands of stories out there about how communities have not addressed let alone increased their utility rates for years and years and are now faced with the need for a big increase to meet current needs. Avoiding major and sudden increases in water and sewer rates should be a major objective of utility managers. Solid management and planning can help avoid the bad timing as well as the large increases. Communities can help themselves be prepared by addressing utility rates on a frequent basis and making the small adjustments when they are necessary. When you wait until deficits start appearing, then all those small increases that were avoided in the past tend to compound into a much larger increase later.
StepWise Utility Advisors is comprised of highly efficient and experienced technical and financial planning experts focused on specific needs of water utilities and utility customers. Founder Jason Mumm brings over 15 years of experience analyzing the water utility industry and the needs of its customers. Visit the
StepWise Blog for the latest water and utility industry news.
About the Author:
Jason Mumm brings over 15 years of experience analyzing the economics and conditions surrounding the water utility industry and the needs of its customers.
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