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Item 5.1 - Water and Wastewater Rate Study and Public Workshoppo,, City of Pit COUNCIL AGENDA REPORT 1A' THS C°t DATE: October 15, 2019 TO: Honorable Mayor and Members of the City Council FROM: Aaron Beanan, Director of Finance CONTACT: Aaron Beanan, Director of Finance 858) 668-4411 or abeanan(c poway.orq SUBJECT: Water and Wastewater Rate Study and Public Workshop Summary: On March 19, 2019 the City Council directed staff to have Raftelis Financial Consultants, Inc. RFC) conduct a comprehensive cost of service study (COSS), evaluate the city's current water and wastewater rates, and develop several rate structures for consideration at a public workshop. The goals of these actions were to help ensure compliance with the law, ensure each rate payer class was paying their proportionate share of the water and wastewater costs, and ensure financial sustainability of both the water and wastewater enterprise funds. This staff report outlines the outcomes of these efforts for consideration by the City Council and the public during the first of two public workshops. Recommended Action: It is recommended that the City Council receive and file this report as an informational item. Discussion: During the City Council discussion at the January 8, 2019 Water and Sewer Rate workshop, the Council expressed interest in conducting a new water and sewer rate study prior to the 2020 rate setting process, as it had been many years since a COSS had been conducted. During the discussion the City Council also indicated the consultant and staff should evaluate different rate structures and how they impact different classes of rate payers. After issuing a Request for Proposal (RFP) on February 4, 2019 to conduct a comprehensive COSS, investigate and evaluate different rate structures and their impacts to rate payers, ensure financial sustainability, and ensure compliance with the law, the city hired RFC. A contract with RFC was recommended to the City Council for approval on March 19, 2019 based on their industry expertise, their extensive experience performing similar studies throughout California, and their familiarity with the city. As the goal of the workshops is to provide several different rate structures and information about how each structure impacts rate payers, multiple options are presented in this staff report. A total of nine different rate design options are presented for water along with four different rate design options for wastewater. Additionally, all rate design options reflect the proposed revenue increases for 2020 and 2021 to fully describe the impacts. The proposed revenue increases are independent of the rate design options and will be more fully discussed in January's Council meeting. The proposed revenue increases are determined by the costs to operate the water and wastewater systems while the rate design options represent different ways to allocate those costs of 30 October 15, 2019, Item #5.1 amongst rate payers. It was very important to Council that multiple rate designs were presented along with the associated impacts to ratepayers so that each potential option's impacts were easily understood. As a result, this staff report is substantially longer, more complex and more technical than normal staff reports. All information described in this report will be presented by staff at the workshops. Through the COSS process, RFC accounts for the costs of providing water and wastewater services and allocates these costs amongst the rate payer classes based on their current proportional use of the systems. This rebalancing of customer classes' impacts on the system means there will be uneven impacts to rates in year 1. The rebalancing occurs whenever a cost of service study is updated. The costs of providing services include the costs of importing water into Poway's water system, treating and testing the water, distributing the water to its customers, and transporting any resulting wastewater to San Diego for treatment along with the associated rehabilitation and repair costs for this infrastructure. This information is combined with the financial plans for water and wastewater to develop proposed rates and rate designs. The formal COSS report that outlines this information (i.e. the methodology, cost of service, financial plan, and rate design) is not part of this workshop. This report will be prepared once a water and wastewater rate structure has been selected, from either workshop one or workshop two. This is due to the amount of work that would go into compiling a report for the nine different options for water and four different options for wastewater that are presented in this report. This workshop represents the first step in a proposed two-year rate setting process. A two-year rate setting process strikes a balance between flexibility and efficiency. A two-year period is short enough to allow rate changes if future projections are different than anticipated while also reducing the costs of adopting new rates. The following graphic shows the proposed timeline for the first two-year cycle. Workshop 1: Workshop 2: Set Public Mail 218 Oct. 15, 2019 Nov. 19, 2019 Hearing: Notice: Jan. 7, 2020 By Jan. 17, 2020 Public Year 1 Rates Year 2 Rates Hearing: Effective: Effective: Mar. 3,2020 Mar. 3, 2020 Jan. 1, 2021 Legal Compliance Water and wastewater utilities are governed by numerous laws. Perhaps the most important, and well known, law governing water and wastewater came about with the passage of the Proposition 218 Omnibus Implementation Act in 1996. This proposition added Articles 13C and 13D to the California State Constitution. The following are some of the substantive provisions governing a property-related fee under Article 130: 1. Revenues derived from the fee or charge must not exceed the cost to provide the services, 2. Revenues derived from the fee or charge must not be used for any purpose other than that for which the fee was imposed, 3. The amount of the fee or charge imposed upon any parcel or person as an incident of property ownership must not exceed the proportional cost of the service attributable to the parcel, and 4. The fee or charge may not be imposed for a service unless the service is actually used by, or immediately available to, the owner of the property subject to the fee or charge. 2 of 30 October 15, 2019, Item #5.1 The COSS is the most common way for a local agency to determine what it costs to provide water and wastewater service, including the short and long-term operations, maintenance, financial, and capital expenditures of the systems. The COSS also helps ensure the proportional costs of the water and wastewater services are reasonably allocated to the city's rate payer classes based on the cost differentials required to serve each rate payer class. RFC's COSS analysis helps ensure the city is compliant with these laws. Cost of Service Through the COSS process, RFC accounts for the costs of providing water and wastewater services and allocates these costs amongst the rate payer classes based on their proportional use of the systems. The City of Poway's water and wastewater systems include $100's of millions in infrastructure necessary to provide associated services. This infrastructure includes water assets to transport water from the San Diego County Water Authority's (SDCWA) system to the city's system, assets to treat the water to safe drinking levels, and assets to deliver safe, reliable water on demand to each rate payer's property. The following are some facts about the water system: 294 miles of transmission and distribution pipelines 5,044 water valves, 21 pressure reducing stations and 14 pump stations (designed to raise water to higher elevations) 19 reservoirs (Lake Poway holds ~one billion gallons of water) One 24 million gallon/day water treatment plant, 2,435 fire hydrants Approximately 45,000 tests to ensure Poway water meets or exceeds the State and Federal standards for water quality This also includes infrastructure to transport wastewater from the city to various treatment plants within the County of San Diego in a safe and reliable manner including over 186 miles of wastewater pipes, five lift stations (designed to raise wastewater material to a higher elevation), and over 4,000 maintenance covers. To help ensure the city continues to provide safe, reliable, and affordable water and wastewater services, the city proactively invests in rehabilitation and repair of its infrastructure. For example, the city is proactively investing millions of dollars into the water system's Clearwell reservoir and its associated valves, originally constructed in 1964, to help ensure safe and reliable water continues to be delivered to rate payers while also helping reduce water loss. When a utility experiences water loss in its distribution system, the losses increase production costs and force the utility to buy more water than a rate payer requires. Therefore, reducing water loss helps reduce costs to rate payers. Another example is the city's proactive multi-million-dollar investment into upsizing a wastewater pipe on Martincoit Road. This will help ensure the health and safety of Poway's residents while reducing the risk of clean-up costs and fines that could result from a wastewater spill. A more detailed explanation of current water and wastewater infrastructure investment is discussed in the city's Fiscal Year 2019-20 Comprehensive Financial Plan. All this physical infrastructure requires highly trained and state-certified city staff to monitor, test, maintain, and repair the water and wastewater systems in an efficient and effective manner along with prudent long-term financial management to help ensure the sustainability of the systems. The city helps maximize the value to rate payers while minimizing the impacts to rate payers by sharing resources such as financial, human resources, information technology, legal, and executive staff with the city's General Fund that would normally be solely the responsibility of rate payers in standalone districts. In Poway, because these resources are shared, rate payers pay a 3 of 30 October 15, 2019, Item #5.1 fraction of the cost for these services helping save money each year. Staff is planning to ask Council for funding before fiscal year end to update the city's cost allocation plan during Fiscal Year 2020-21. The cost allocation plan identifies, documents, and allocates costs incurred by the General Fund that are the responsibility of other funds. Additionally, the city's long-term approach to prudent financial management allows the city to minimize the impacts of capital rehabilitation and renewal, changes in usage, and unplanned emergencies with advanced planning and appropriate reserve levels. As discussed in the legal compliance section, the proportional costs of the water and wastewater services need to be reasonably allocated to the city's rate payer classes based on the cost differentials required to serve each rate payer class. Part of this allocation is based on how a rate payer class uses the system. Factors such as number of rate payers in each class and the demand associated with each class are some examples of how their proportional use of the system is reasonably determined. The following chart shows how each class of water rate payer's use of the system has changed since the last comprehensive study was done in 2007, based on RFC's analysis. Cost of Service by Customer Class (Water) 10% IL MI0% r Sngle Famiy M1ut array Landscape City Potable Residentel Residential Irrigation Non-ResidentialUsage Recycled Water a 2007 70.0% 4.4% 1.8% 17.5% 1.0% 5.2% 2019 72.5% 3.7% 2.2% 15.9% 1.9% 3.7% Since 2007, the single-family residential rate payer class has increased its use of the water system, relative to some of the other rate payer classes. Based on cost of service principles, and to ensure compliance with the law, this means the single-family rate payer class bears a slightly larger share of the overall water system costs, relative to 2007, while the non-residential rate payer bears slightly less. This shift in cost of service between customer classes means some rates will increase while others may decrease, all else being equal. 4 of 30 October 15, 2019, Item #5.1 The chart below shows how each class of wastewater rate payer's use of the system has changed since 2007, based on RFC's analysis. Cost of Service by Customer Class (Wastewater) 60% 50% 40"- 30% 2036 10% 096 Single Family Residential Muti-Farnity Residential Non-Residentei Churches&Sch.: 2007 68.4% 9.2% 20.1% 2.3% 2019 66.4% 11.0% 20.0% 2. 6% Since 2007, the single-family residential rate payer class has used proportionally less of the wastewater system than, for example, the multi-family residential rate payer class. This means the single-family residential rate payer class bears a slightly smaller share of the overall wastewater system costs, relative to 2007, while the multi-family residential rate payer class bears slightly more. This shift in cost of service between customer classes means some rates will increase while others may decrease, all else being equal. Water Rate Design The rate design process develops rates and rate structures that generate revenue from, and within, the various rate payer classes and is completed once the cost of service has been determined and these costs have been allocated to the rate payer classes based on their proportional use of the system. Multiple rate design options may be developed; each compliant with the law. This is possible because each rate design option is balancing different pricing objectives within a broader legal framework. For example, one rate design option may favor sustainability over affordability by increasing the revenue generated from fixed charges. This is legally compliant as long as fixed charges were reasonably allocated to the city's rate payers based on the cost differentials required to serve each rate payer class. Based on City Council direction, RFC has developed several rate design options for Council consideration and public input. It was very important to Council that multiple rate designs were presented along with the associated impacts to ratepayers so that each potential option's impacts were easily understood. As discussed in the Cost of Service section above, the rebalancing of customer classes' impacts on the system means there will be uneven impacts to rates in year 1. This occurs whenever a cost of service study is updated. Subsequent years rate increases will be consistent across rate payer classes. Each option presented is compliant with the law. 5 of 30 October 15, 2019, Item #5.1 Water Residential Rate Payer Class Rate Design Options: RFC has developed several rate design options for the residential rate payer class. The other rate payer classes, such as non-residential, were not given multiple rate design options because their use of the system doesn't lend itself to multiple rate designs. As discussed in the legal compliance section, any rate designs must be based on how a rate payer class is served by the system. A total of nine residential rate design options have been provided for discussion purposes. There are three tier structures: a two tier, three tier, and four tier structure.Within each tier, three different fixed/variable ratios have been provided. The options are as follows: Option Residential Tiers Fixed (%) Variable (%) 1a 2 17% 83% 1 b 2 20% 80% lc 2 25% 75% Option Residential Tiers Fixed (%) Variable (%) 2a 3 1 83% 2b 3 20% 80% 2c 3 25% 75% Option Residential Tiers Fixed (%) Variable (%) 3a 4 17% 83% 3b 4 20% 80% 3c 4 25% 75% Tiers are related to the volumetric, or variable, revenue collected from rate payers and reflect the increasing costs of supplying more water to residential rate payers who use higher amounts of water. Only three total tier structure options are being presented because they most reasonably reflect an appropriate distribution of expenses. In Poway's case, a tier structure with five tiers, for example, would less reasonably reflect an appropriate distribution of expenses. The fixed/variable ratio reflects the amount of revenue collected between fixed charges which are not dependent on water usage and volumetric, or variable, charges which are dependent on water usage. This ratio is important for understanding the level of revenue stability. The more revenue is collected via a fixed charge, the less likely the water system will be impacted by changes in rate payer usage. For example, the more revenue is collected via fixed charges, the less likely a water system will be to increase rates in times of conservation as less of its revenue is affected by decreased demand, all else being equal. The first chart on the following page shows water is currently collecting 16 percent of its revenue from fixed charges, and 84 percent of its revenue from variable charges. However, as the second chart shows, the revenue being recovered via fixed charges does not align with water's fixed costs. As shown in the second chart on the following page, 53 percent of water's expenses are fixed costs. When the revenue collected from fixed charges does not match the level of fixed expenses, the water utility is susceptible to revenue volatility (i.e. less revenue stability). The greater the revenue volatility, the more likely rate increases will be required to ensure sufficient funding for operations. 6 of 30 October 15, 2019, Item #5.1 FYE 2019 Calculated Rate Revenue Fixed/Variable Split(Water) Fixed 4.2M,16% Variable 21.5M,84% xed Revenue Varabe Rerenue FYE 2019 Expenses Fixed/Variable Split(Water) 0.9M,4% 0.4M,1% 4.1M,17% 10.2M,42% 8.6M,36% xed SOC WA Costs(17%)Faed PcwW Ccs:s 36%) Varabe SDCWA Costs(42%) Varabe City of San Dego Costs(1%) e ayCosts(4:_. Fixed costs do not fluctuate with the amount of water purchased or used and represent 53 percent of all costs to Poway. The SDCWA portion of the fixed costs include all their charges to member agencies that do not fluctuate with water purchases including the Metropolitan Water District MWD) Readiness-to-Serve Charge, the MWD Capacity Charge, the Supply Reliability Charge, the Rate payer Service Charge, the Storage Charge, and the Infrastructure Access Charge. Poway's fixed costs include expenses such as salaries and benefits, maintenance costs and professional services, among others. Variable costs fluctuate with the amount of water purchased or used represent 47 percent of Poway water's expenses. The SDCWA portion the variable costs include the Untreated Supply Rate and Transportation Charge. Poway's variable costs include electricity and water purchases. The variable City of San Diego costs represent the recycled water purchases. Previous industry best practice guidance suggested a fixed/variable ratio of 30/70. However, this is being moved away from because, as the chart above shows, fixed costs often exceed the previously recommended 30 percent. Instead, best practices suggest balancing revenue stability with other pricing objectives like affordability. For this reason, three different fixed/variable ratios are presented to show the different impacts associated with increasing the amount of revenue collected from fixed charges. 7 of 30 October 15, 2019, Item #5.1 Water Rate Design Option 1a (2-Tier Structure; 17% fixed, 83% variable) Water rate design Option 1 a is most like the city's existing two-tier rate structure. The only difference is increasing the revenue collected via fixed charges from 16 to 17 percent. The table below summarizes the information for this option. Tier Tier Breakpoints (Units) % of Water Use of Bills 1 199 94% 98% 2 199 6% 2% Average Usage: j 37 units Fixed: 1 17% Average Summer Usage: j 56 units Variable: 83% A 3/ 4" meter is used for analysis purposes throughout the water analysis as it represents over 88 percent of residential meters. It should also be noted that 37 bi-monthly units represents average residential usage while 56 bi-monthly units represents average summer residential usage. A unit of water is —748 gallons which translates to roughly two hot tubs full of water or almost 50 loads of laundry with a high efficiency washing machine. The chart below shows the impacts across various usage levels for this option. SFR Impacts at Different Usage Levels: 3/4" Meter; 2-Tiered; 17%/83% F/V(Option la) 1,400 1,200 1,000 800 600 400 5200 95.88 $149.48 5240.60 $342.44 $578.28 $846.28 $1,116.57 10 units 20 units 37 units 56 units 100 unts 150 unts 200 units Current BiI 595.88 5149.48 5240.60 $342.44 5578.28 $846.28 51,116.57 Proposed BiI $105.06 5160.96 5255.99 $362.20 $608.16 $887.66 51,171.87 mpact(5)9.18 511.48 515.39 519.76 29.88 41.38 555.30 mpact(%)9.6% 7.7%0 64% 5.8% 5.2% 4.9% 5.0% Given that 94 percent of water usage and 98 percent of all bills fall within Tier 1, residential rate payers falling across all levels of usage see a similar increase and experience a uniform rate per unit of water used. A two-tier structure provides good revenue stability because of this. While similar increases occur across usage levels, lower volume users do see greater impacts which reduces affordability for them. When looking at the impacts to rate payers in a two-tier structure a fixed charge recapturing 17 percent of revenue increases financial sustainability while decreasing affordability for lower volume users. Also, in times of state mandated conservation, a two-tier structure makes it harder for a utility to encourage conservation because there is less pricing incentive to do so. 8 of 30 October 15, 2019, Item #5.1 Water Rate Design Option lb (2-Tier Structure; 20% fixed, 80% variable) In this option, the amount of revenue collected via fixed charges is increased to 20 percent. Tier Tier Breakpoints (Units) % of Water Use of Bills 1 199 94% 98% 2 199 6% 2% Average Usage: 37 units Foced:20% Average Summer Usage: 56 units Variable: 80% Increasing the fixed charges to represent 20 percent of revenue impacts the low volume users more than the high-volume users. This occurs because the amount collected regardless of water use (i.e. fixed charge) increases while the amount collected based on water use (i.e. variable charge) decreases. The chart below shows the impacts across various usage levels for this option. SFR Impacts at Different Usage Levels: 3/4" Meter; 2-Tiered; 20%/80% F/V(Option 1b) 1,200 1,000 800 600 400 200 -. 0 $ 95.88 $149.48 $240.60 $342.44 $578.28 $846.28 $1,116.57 10 units 20 units 37 units 56 units 100 unts 150 unts 200 unts Current Bii $95.88 $149.48 $240.60 $342.44 $578.28 $846.28 $1,116.57 Proposed Bil $111. 29 $ 165.19 5256.82 $359.23 5596.39 $865.89 51,139.49 impact($)15.41 15.71 16.22 16.79 18.11 19.61 22.92 impact(%)16.1% 10.5% 6.7% 4.9% 3.1% 2.3% 2.1% Option 1 b differs from Option 1 a in that it further increases financial sustainability while further decreasing affordability for low volume users. Similar to Option 1 a, this rate option variation does not send a strong conservation signal which makes conservation efforts more difficult in times of mandated conservation. 9 of 30 October 15, 2019, Item #5.1 Water Rate Design Option lc (2-Tier Structure; 25% fixed 75% variable) In this option, the amount of revenue collected via fixed charges is increased to 25 percent. Tier Tier Breakpoints (Units) % of Water Use of Bills 1 199 94% 98% 2 199 6% 2% Avow Usage: 37 units IFoxed:25% Average Summer Usage: , 56 units i Variable: 75% Increasing the fixed charges to represent 25 percent of revenue impacts the low volume users even more than the high-volume users who see a reduction in their bill. The chart below shows the impacts across various usage levels for this option. SFR Impacts at Different Usage Levels: 3/4" Meter; 2-Tiered; 25%/75% F/V(Option 1c) 1,200 1,000 800 56 0y0 400 200111 II IIIIIII 595.88 $149.48 $240.60 $342.44 5578.28 $846.28 $1,116.57 10 units 20 units 37 units 56 units 100 unts 150 unts 200 units Current BE $95.88 5149.48 $240.60 5342.44 $578.28 $846.28 $1,116.57 Proposed Bal $121.72 5172.32 $258.34 5354.48 $577.12 $830.12 51,086.20 impact($)25.84 22.84 517.74 512.04 51.16 516.16 -530.37 impact(96)27.0% 15.3=- 7.4' 3.5% 0.2% 1.9% 2.7% Between all Option 1 variations, this option creates the greatest financial sustainability for water, though it is also the least affordable option for low volume users. Affordability is decreased for low volume users because the amount of the bill they can control (i.e. that portion based on water usage) decreases significantly. As with the other Option 1 variations, this rate option variation does not send a strong conservation signal which makes conservation efforts more difficult in times of mandated conservation. 10 of 30 October 15, 2019, Item #5.1 Water Rate Design Option 2a (3-Tier Structure; 17% fixed, 83% variable) Water rate design Option 2a creates a three-tier rate structure as shown in the table below. Tier Tier Breakpoints (Units) % of Water Use of Bills 1 20 42% _49% 2 56 29% 35% 3 16% Average Usage: 37 units Fixed:17% Average Summer Usage: 56 units Variable: 83% In a three-tier rate structure, the tiers more appropriately reflect the costs of providing water based on how the water is being used. If residential rate payers had consistent water usage throughout the year, the entire water system (e.g. pipes, pump stations, treatment plant, reservoirs, etc.) would be sized a certain way. However, residential rate payers do not use water consistently. Average usage is 37 units of water while average summer usage is 56 units of water. As a result, the entire system size must be increased to accommodate this higher level of usage, even though the usage is inconsistent. The costs associated with the increased system size are proportionally allocated to the higher tiers of water creating a nexus between cost and use. Conservation measures are supported with a three-tier structure. Tier 1 corresponds to —60 gallons per capita per day (GPCD) for a 4-person average household. The 20 units of water represents the amount related to the cost of basic indoor water use, such as for drinking, cooking, and washing. Tier 2 represents the progressively higher cost of providing more water to rate payers for less essential uses, such as watering landscapes, and is reflective of average residential summer usage. Tier 3 represents high water usage and the costs associated with providing water for this type of use. The chart below shows the impacts across various usage levels for this option. SFR Impacts at Different Usage Levels: 3/4" Meter;3-Tiered; 17%/83% F/V(Option 2a) 1,600 1,400 1,200 1,000 800 600 400 200 Ell0 .$ 95.88 $149.48 $ 240.60 $342.44 S578.28 $846.28 $1,116.57 10 units 20 units 37 units 56 units 100 unts 150 unts 200 unts Current Bil S95.88 $149.48 5240.60 $342.44 $578.28 $846.28 $1,116.57 Proposed Bit $95.86 $142.56 $236.74 $342.00 $692.24 $1,090.24 $1,488.24 Impact(5)0.02 6.92 3.86 50.44 113.96 $243.96 $371.67 Impact 1%)0.0% 4.6% 1.6% 0.1% 19.7% 28.8% 33.3% Lower volume users see small reductions in their bill while higher volume users see increases in their bills. This occurs because the costs of larger system capacity are more closely aligned with the rate payer usage patterns that created the need for it. 11 of 30 October 15, 2019, Item #5.1 Water Rate Design Option 2b (3-Tier Structure; 20% fixed, 80% variable) In this option, the amount of revenue collected via fixed charges is increased to 20 percent. Tier Tier Breakpoints (Units) % of Water Use of Bills 1 20 42% 49% 2 56 29% 35% 3 56 29% 16% Average Usage: 37 units Fixed:20% _ AverageSummer 56 units Variable: 80% Because fixed charges are increasing, the lowest volume users see a moderate increased impact while the highest volume users see a reduced impact when compared to Option 2a. Low (users falling into the essential water use category) and average users effectively have no impact. The chart below shows the impacts across various usage levels for this option. SFR Impacts at Different Usage Levels: 3/4" Meter; 3-Tiered; 20%/80% F/V (Option 2b) 1,600 1,400 1,200 1,000 800 S600 S400 200 all i I IISO $ 95. 88 $149.48 $240.60 $342.44 $578.28 $846.28 51,116.5 10 units 20 units 37 units 56 units 100 unts 150 unts 200 unts Current Bin $95.88 $149.48 $240.60 $342.44 $578.28 $846.28 $1,116.57 Proposed Bill $103.29 $149.19 $240.14 $341.79 $669.59 $1,042.09 $1,414.59 _ Impact($)7.41 0.29 0.46 0.65 91.31 $195.81 $298.02 Impact(%)7.7% 0.2% 0.2% 0.2% 15.8% 23.1% 26.7% ' When looking at the impacts to rate payers in a three-tier structure, a fixed charge recapturing 20 percent of water's fixed costs helps provide an equitable balance between revenue stability, which helps support financial sustainability, and affordability. While a higher fixed charge would provide more revenue stability, increasing the fixed charge all at once instead of incrementally over time increases the impacts to rate payers. This option, like Option 2a, makes it easier to support conservation during periods of mandated conservation because higher water use is easily discernable through the rate structure tiers (i.e. consumption levels) and pricing. However, there is some risk of demand hardening. Demand hardening is a phenomenon generally described as the reduction in the ability of a rate payer to further reduce demand because the more cost-effective water reductions (e.g. low-flow appliances) have already been implemented. It is believed to occur as a result of long-term conservation measure such as education, water restrictions, rebate programs, and price structure changes (e.g. tiers) which make it harder to induce further water use reductions during drought/mandated conservation periods. 12 of 30 October 15, 2019, Item #5.1 Water Rate Design Option 2c (3-Tier Structure; 25% fixed, 75% variable) In this option, the amount of revenue collected via fixed charges is increased to 25 percent. Tier Tier Breakpoints (Units) % of Water Use of Bills 1 20 42% 49% 2 56 29% 35% 3 56 29% 16% Average Usage: 37 units Fixed:25% Average Summer Usage: 56 units Variable: 75% Because fixed charges are increasing, the lowest volume users see an increased impact while the highest volume users see a reduced impact when compared to Option 2b. Low (users falling into the essential water use category) have a moderate impact while average users have a small impact. The chart below shows the impacts across various usage levels for this option. SFR impacts at Different Usage Levels: 3/4" Meter;3-Tiered; 25%/75% F/V(Option 2c) 1,400 1,200 1,000 800 600 400 20 11111111 . 0111 95.88 $149.48 $240.60 $342.44 $578.28 $846.28 $1,116.5 7 10 units 20 units 37 units 56 units 100 unts 150 unts 200 unts Current BII $95.88 $149.48 $240.60 $342.44 $578.28 $846.28 $1,116.57 Proposed Bdl $115.62 $160.12 $245.46 5340.84 $631.24 $961.24 $1,291.24 Impact(5)19.74 510.64 4.86 1.60 52.96 $114.96 $174.67 Impact(%)20.6% 7.1% 2.0% 0.5% 9.2% 13.6% 15.6% While increasing the revenue collected from fixed charges helps increase the financial sustainability of the utility, it also impacts low volume users more significantly than Option 2b. Compared to Option 1 c (2-tier structure; 25% fixed, 75% variable), it does impact low volume users less. This option also supports conservation though it could lead to demand hardening as described in Option 2b. 13 of 30 October 15, 2019, Item #5.1 Water Rate Design Option 3a (4-Tier Structure; 17% fixed, 83% variable) This option is like a three-tier rate structure with the nexus for Tiers 1 and 2 being the same as a three-tier rate structure. In a four-tier structure, higher water use is broken out into two tiers instead of only one. An additional high water use category has been added to account for just under 10 percent of residential water use. This four-tier rate structure further aligns the costs associated with the increased system size to higher water use, further aligning the nexus between cost and use. Staff and RFC agreed looking at a tier structure with five or more tiers would be unwise given the challenges and data required to legally create tier structures greater than four tiers. The chart below shows the impacts across various usage levels for this option. Tier Tier Breakpoints (Units) % of Water Use of Bills 1 20 42% 49% 2 56 29% 35% 3 150 20% 13% 4 150 9% 3% Ave 37 unitsFixed:17% Average Summer Usage: 56 units i Variable: 83% In a four-tier structure, the impacts at lower water usage levels (i.e. 56 bi-monthly units or less) will mirror the three-tier structure. As the consumption increases in a four-tier structure beyond 56 bi-monthly units, the impacts to the higher volume users will slowly shift because the per unit cost of water, or volumetric rate, increases. SFR Impacts at Different Usage Levels: 3/4" Meter;4-Tiered; 17%/83% F/V(Option 3a) 1,600 1,400 1,200 1,000 800 600 400 200 i ION 0 $ 95. 88 $149.48 $240.60 S342.44 $578.28 $846.28 51,116.3 10 units 20 units 37 units 56 units 100 unts 150 unts 200 unts in Current Brei $95.88 $149.48 $240.60 $342.44 $578.28 $846.28 $1,116.57 Proposed Br( $95.96 $142.76 $237.62 $343.64 $651.64 $1,001.64 $1,486.64 impact($)0.08 6.72 52.98 1.20 73. 36 $155.36 $370.07 impact(%)0.1% 4.5% 1.2% 0.4% 12.7% 18.4% 33.1% A four-tier structure does not offer materially greater benefits than a three-tier structure. Option 2a and Option 3a share very similar impacts across the various usage levels. One risk in a four- tier structure as compared to a three-tier structure is there is a greater risk of demand hardening. A higher chance of demand hardening increases the potential to see reduced revenue which would put upward pressure on rates. This could occur if the amount of anticipated revenue is not realized due to self-selected conservation. 14 of 30 October 15, 2019, Item #5.1 Water Rate Design Option 3b (4-Tier Structure; 20% fixed, 80% variable) In this option, the amount of revenue collected via fixed charges is increased to 20 percent. Tier Tier Breakpoints (Units) % of Water Use of Bills 1 20 42% 49% 2 56 29% 35% 3 150 20% 13% 4 150 ----- - 9% 3% Average Usage: 37 units Faced:20% Average Summer Usage: j 56 units Variable: 80% Similar to a three-tier structure, and because fixed charges are increasing, the lowest volume users see a moderate increased impact while the highest volume users see a reduced impact when compared to Option 3a. Low (users falling into the essential water use category) and average users effectively have no impact. This option does increase revenue stability due to higher fixed charges which increases the financial sustainability of the utility. The chart below shows the impacts across various usage levels for this option. SFR Impacts at Different Usage Levels: 3/4" Meter; 4-Tiered; 20%/80% F/V(Option 3b) 1,600 1,400 1,200 1,000 800 600 400 200 NM. II 95.88 $149.48 $240.60 $342.44 $578.28 $846.28 $1,116.57 10 units 20 units 37 units 56 units 100 unts 150 unts 200 units Current Bil $95. 88 $149.48 $240.60 $342.44 $578.28 $846.28 $1,116.57 Proposed Bil $103.29 $149.19 $240.65 S342.87 $634.15 $965.15 $1,413.65 mpact(S)7.41 0.29 0.05 0.43 55.87 $118.87 $297.08 Tact(%)7.7% 0.2% 0.0% 0.1% 9.7% 14.0% 26.6% Similar to Option 2b, a fixed charge recapturing 20 percent of water's fixed costs helps provide an equitable balance between revenue stability, which helps support financial sustainability, and affordability. While a higher fixed charge percentage would provide more revenue stability, increasing the fixed charge all at once instead of incrementally over time increases the impacts to rate payers. However, a four-tier structure has increased potential to create demand hardening when compared to a three-tier structure. As discussed in Option 3a, a higher chance of demand hardening increases the potential to see reduced revenue which would put upward pressure on rates. This could occur if the amount of anticipated revenue is not realized due to self-selected conservation. 15 of 30 October 15, 2019, Item #5.1 Water Rate Design Option 3c (4-Tier Structure; 25% fixed, 75% variable) In this option, the amount of revenue collected via fixed charges is increased to 25 percent. Tier Tier Breakpoints (Units) % of Water Use of Bills 1 20 42% 49% 2 56 29% 35% 0315020/o -a 13% 4 150 9% 3% Usage: uiAverage37 s Fixed:25% 1 Average Summer Usage: 56 units Variable: _75% Similar to a three-tier structure, and because fixed charges are increasing, the lowest volume users see an increased impact while the highest volume users see a reduced impact when compared to Option 3b. Low (users falling into the essential water use category) have a moderate impact while average users have a small impact. Revenue stability and financial sustainability is increased as compared to the previous four-tier options. The chart below shows the impacts across various usage levels for this option. SFR Impacts at Different Usage Levels: 3/4" Meter;4-Tiered; 25%/75% F/V (Option 3c) 1,400 1,200 1,000 III I800 600 5400 200 II11111$ 95.88 $149.48 $240.60 $342.44 $578.28 $846.28 51,116.57 10 units 20 units 37 units 56 units 100 units 150 unts 200 unts Current 811 595.88 $149.48 $240.60 $342.44 5578.28 $846.28 $1,116.57 Proposed Bal $115.62 $160.12 $245.97 $341.92 $605.04 $904.04 $1,291.54 impact(5)19.74 10.64 5.37 0.52 26.76 57.76 $174.97 moa:t 1%)20.6% 7.1% 2.2% 0.2% 4.6% 6.8% 15.7% While increasing the revenue collected from fixed charges helps increase the financial sustainability of the utility, it also impacts low volume users more significantly than Option 3b. Compared to Option 1 c (2-tier structure; 25% fixed, 75% variable), it does impact low volume users less. Further, a four-tier structure has increased potential to create demand hardening when compared to a three-tier structure. As discussed in Option 3a, a higher chance of demand hardening increases the potential to see reduced revenue which would put upward pressure on rates. This could occur if the amount of anticipated revenue is not realized due to self-selected conservation. 16 of 30 October 15, 2019, Item #5.1 Water Financial Plan The financial plan for providing water services is an important component of the COSS process. It looks at the financial policies for providing water service, such as how reserve levels are determined or when debt issuance is appropriate. The financial plan also looks at the current and projected level of expenses and examines the amount of revenue required to meet the operational goals of providing water service. The amount of revenue required influences the proposed revenue, or rate, adjustments needed over time. Financial Policies: According to the Government Finance Officers Association (GFOA), financial policies provide guidelines for financial decision making and set the strategic intent for financial management and are central to a strategic long-term approach to financial management. As the water utility has no existing debt and no immediate plans to issue debt, only the reserve policies were examined. Based on the American Water Works Association 2018 Cash Reserve Policy Guidelines, the level of reserves maintained by a utility is an important component of short and long-term financial management and is a key consideration in the rate-setting process. Defining appropriate reserve levels is important because reserves have the potential to impact rates or tie up current rate payer dollars that could otherwise be used towards current expenditures. The current reserve policy for water is to maintain a minimum working capital balance equal to 20 percent of operating expenditures. However, the Water Environment Federation recommends three months of operating costs, or 90 days, as a minimum reserve for water utilities. They also indicate higher levels of reserves may be needed based on the actual operational experiences of water utilities. Therefore, 90 days of operating costs is the recommended minimum for Poway's water utility. However, setting a reserve target of six months, or 180 days, is prudent given Poway's bi-monthly billing cycle. Having a higher target equal to twice the recommended minimum helps moderate the cash flow associated with a bi-monthly billing process. Capital reserves generally have less defined guidelines given capital investment varies so much between utilities. The variation occurs because factors such as the age of the system can vary greatly. RFC analyzed the water utility's near-term capital plan to find a reserve target appropriate for Poway. Based on this analysis, a minimum reserve is being recommended at 10 percent of net capital assets. The following chart shows the estimated operating and capital reserves over the next 5 years. Operating&Capital Reserves(Water) 20 0 18 2 $ 16 S14 12 S10 8 6 4 52 SO FYE 2020 FYE 2021 FYE 2022 FIE 2023 FIE 2024 Total Reserves — Minimum Reserve Target Reserve 17 of 30 October 15, 2019, Item #5.1 These reserves will help mitigate potential risks, mitigate revenue fluctuations, and smooth rates. They are also important to mitigate emergencies such as emergency repairs, droughts, natural disasters, and unforeseen economic influences. Revenue Adjustments: Costs to operate a water utility increase over time. San Diego County has a semi-arid climate. Before 1947, the San Diego region relied on rainfall and groundwater to meets its water needs SDCWA, Urban Water Management Plan 2010). As the economy and population grew, local water resources became insufficient to meet the region's water supply needs and required imported water from hundreds of miles away to support the growth. Importing water is very energy intensive. Over-time, the cost to transport this water increases as factors like energy prices increase. Investment by SDCWA into regional water supply and infrastructure projects to reduce reliance on imported water and mitigate the effects of natural disasters, such as earthquakes, is also expensive. For example, SDCWA's investment into the Claude "Bud" Lewis Desalination Plant cost close to $1 billion, but it gave the region a new drought-proof, locally controlled supply of water. General inflation and commensurate wage growth also tend to increase over time. The 20-year rolling average increase in the CPI All Urban Consumers — Los Angeles index was over 2.5 percent annually. As such, revenue adjustments are needed to cover the increasing costs of providing safe, reliable water on demand to a rate payer. These estimated increases are necessary to fund the costs of imported water, operational expenses, capital expenses, and appropriate reserve levels and will be discussed in more detail with the operating financial plan later in this report. The chart below shows the current estimated increases over the next five fiscal years. Revenue Adjustments(Water) 6.0 140% 5.0% 120% 10096 E4.090 m 0 ` u t 3.0% 60% 1; 2.0% 40% 1.0% 20'c 0.0% 0% FYE 2020 FYE 2021 FYE 2022 FYE 2023 FYE 2024 MINIM Revenue Adjustments(Water)— — Debt Coverage n Required Cc.erage Coverage Alert A two-year rate setting process is being recommended. For the first two years, 4.5% revenue increases are being recommended. These increases are being recommended regardless of which rate design option is chosen. The rate design options discussed previously determine how the costs are apportioned and, thus, how the revenue is collected. The revenue, or rate, increases are based on the funds required to cover anticipated expenses. Based on the financial/operational performance of the water utility during the first two-year period, the rate increases proposed for the next two-year period (2022 and 2023) could increase or decrease; currently estimated at 5.25 percent. 18 of 30 October 15, 2019, Item #5.1 Staff would only return to Council for rate approval if the second-year rates were too low to sufficiently fund operations. Under the law, any increases beyond the previously approved maximum rate increases require a new public hearing process. If the required second-year rate increase was lower than the approved rate increase, staff could administratively reduce the rate increase. If this were to occur, staff would notify Council and rate payers of the change. Setting two-year rates is more cost-effective. It costs upwards of $10,000 to set rates based on the printing costs associated with the Proposition 218 notice, the postage costs of mailing the notice, the staff time involved in administering the process, among other reasons. Moving to a two-year rate setting process strikes a balance between flexibility and efficiency. A two-year period is short enough to allow rate changes if future projections are different than anticipated while also reducing the costs of adopting new rates. The chart below shows the projected expenses over the next five fiscal years, along with the current revenue, and the projected revenue based on the proposed increases: Operating Financial Plan(Water) 40 35 30 25 20 15 S10 5111SO 5 FYE 2020 FYE 2021 FYE 2022 FYE 2023 FYE 2024 Mall Operating Expenses Water Purchases mow Rate Funded Capital Nola Debt Service Net Cashflow rent Revenue D'oposed Reve^ue Several factors are currently driving the need for revenue increases over the next several years. First, the costs of imported water continue to increase. Imported water costs represent approximately 60 percent of operating expenditures for Poway's water utility. The SDCWA untreated water rate is increasing 4.8 percent even though SDCWA is using reserves to mitigate the rate increase necessary. Had they not used reserves, the rate increase for untreated water would have been greater. Some drivers in SDCWA's rate increase are Metropolitan Water District rate increases and Quantification Settlement Agreement (QSA) increases of 6.4 percent. The QSA was part of SDCWA's supply diversification strategy and will provide up to 200,000 acre- feet of water to the San Diego County region not previously available. Second, rate funded capital is increasing over the next five years as the city proactively invests in rehabilitation and repair of its water infrastructure to ensure is continues to provide safe, reliable, and affordable water. A more detailed description of current infrastructure investment is discussed on the city's Fiscal Year 2019-20 Comprehensive Financial Plan. 19 of 30 October 15, 2019, Item #5.1 The chart below shows the cost of the anticipated capital expenditures over the next five years. Capital Funding Sources(Water) 3.5 53 22 0 53.0 2.81 2-5 52.07 2.0 51.44 51.5 1. 011150.5 50. 0 FYE 2020 FYE 2021 FYE 2022 FYE 2023 FYE 202 Debt Funded Rates/Reserves Funded •Total CIP Continued investment into operations and system rehabilitation and renewal, along with long- range prudent financial management, will help ensure the City of Poway continues to provide safe, reliable, and affordable water on demand to its rate payers. Wastewater Rate Design The rate design process develops rates and rate structures that generate revenue from, and within, the various rate payer classes and is completed once the cost of service has been determined and these costs have been allocated to the rate payer classes based on their proportional use of the system. Based on City Council direction, RFC has developed several rate design options for Council consideration and public input. Each option presented is compliant with the law. Wastewater Residential Rate Payer Class Rate Design Options: RFC has developed several rate design options for the residential rate payer class. The other rate payer classes, such as non-residential, were not given multiple rate design options because their use of the system doesn't lend itself to multiple rate designs. As discussed in the legal compliance section, any rate designs must be based on how a rate payer class is served by the system. A total of four residential rate design options have been provided for discussion purposes. There are two different structures: a fixed residential rate and a fixed plus variable residential rate. Within the fixed plus variable structure, three different fixed/variable ratios have been provided. The options are as follows: Option Structure Fixed (%) Variable (%) 1 Fixed N/A N/A 2a Fixed + Variable 20% 80% 2b Fixed +Variable 25% 75% 2c Fixed + Variable 30% j 70% A fixed, or uniform, residential rate is independent of winter water usage; all residential rate payers are charged the same bi-monthly rate. In the fixed plus variable rate structure, all rate payers are billed a fixed charge, similar to water, and have a variable component tied to their winter water usage. This information will be discussed in more detail on the following page. 20 of 30 October 15, 2019, Item #5.1 Three different fixed/variable ratios are provided because, similar to water, this is an important component of rate design. The fixed/variable ratio reflects the amount of revenue collected between fixed charges which are not dependent on wastewater flow and volumetric, or variable, charges which are dependent on wastewater flow. This ratio is important for understanding the level of revenue stability. The more revenue is collected via a fixed charge, the less likely the wastewater system will be to changes in usage by its rate payers. For example, the more revenue is collected via fixed charges, the less likely a wastewater system will be to increase rates in times of conservation as less of its revenue is affected by decreased demand, all else being equal. The chart below shows wastewater is currently collecting 20 percent of its revenue from fixed charges, and 80 percent of its revenue from variable charges. FYE 2019 Calculated Rate Revenue Fixed/Variable Split(Wastewater) Fixed 1.7M,20% Variable 6.7M,80% Fxed Revenue Varabe Revenue Similar to water, the revenue being recovered via fixed charges does not align with wastewater's variable and fixed costs. The variable costs, such as chemicals and treatment, vary based on how much wastewater is produced. As shown in the chart below, approximately 50 percent of wastewater's expenses are fixed costs. Fixed costs include expenses such as salaries and benefits, maintenance costs and professional services, among others. FYE 2019 Expenses Fixed/Variable Split Wastewater) Variable Fixed 4.2M,49.8% 4.3M,50.2% Fred •Var 8 Similar to water, best practices suggest balancing the various pricing objectives versus having a set fixed/variable ratio. As such, three different fixed/variable ratios are presented showing the different impacts associated with increasing the amount of revenue collected from fixed charges. 21 of 30 October 15, 2019, Item #5.1 Wastewater Rate Design Option 1 (Fixed residential rate) Wastewater rate design Option 1 is a fixed residential rate. All residential wastewater rate payers would pay the same bi-monthly amount for wastewater services regardless of winter water use, which is different from the City's current tiered structure. A fixed residential rate structure is easy for the city to administer helping reduce costs. Revenue stability is increased with this structure because of the uniform rate. However, this structure does not account for variation in wastewater flow which can raise questions of fairness and equity. The chart below shows how this structure visually compares to the current structure. Bi-Monthly SFR Bills (Wastewater) 5160 5140 5120 60 40 s—Current e—Proposed-New Structure 520 SO 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 Bi-MonthlvWinter Water Use (units) Under a fixed residential wastewater rate structure, low volume users will see a significant increase in their bill and higher volume users will see a significant decrease in their bill. These impacts are shown in the chart below at various usage levels. The usage levels shown represent the tier breakpoints in the current wastewater rate structure. SFR Impacts at Different Usage Levels: Option 1 160 140 120 MO 5100 580 560 540 20 50 5 units 12 units 19 units 26 units 37 units 50 units 60 u Current BiI $50.88 573.46 599.79 $107.33 $122.38 5137.43 $148.73 Proposed BiI $88.76 88.76 88.76 88.76 88.76 88.76 88.76 Impact(5)37.88 15.30 11.03 -518.57 -$33.62 -$48.67 -$59.97 Impact(%)744% 20.8% 11.1%17.3%27.5%35.4%40.3% 22 of 30 October 15, 2019, Item #5.1 Wastewater Rate Design Option 2a (Fixed + variable rate structure; 20% fixed, 80% variable) This wastewater rate design option includes a fixed plus variable component and mirrors the existing wastewater structure. In the fixed plus variable rate structure, all rate payers are billed a fixed charge, similar to water, and have a variable component tied to their winter water usage. The chart below shows how this structure visually compares to the current structure. Bi-Monthly SFR Bills (Wastewater) 5140 5120 5100 580 560 Sao t Proposed-Netr Structure 520 53 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 Si-Monthly Winter Water Use (un `sl Based on an analysis of winter water use by RFC during this COSS, the average residential rate payer's wastewater flow is 15 units bi-monthly. Further, they found that residential wastewater flows should be capped at 24 units bi-monthly. Capping water consumption when determining wastewater use provides a reasonable estimate of indoor water use that actually enters the wastewater system and is ultimately processed at the treatment plant. This helps minimize the impacts of outdoor irrigation-related water use and is a more fair and equitable approach to rate payers. To calculate winter water usage on an ongoing basis, the City uses a three-year rolling average of winter water use data for a residential property covering the November through April bi-monthly billing periods. This approach provides a less volatile change in annual rates to the property year over year. The lowest winter billing period for each of the three most recent years is selected and averaged together. This amount represents the winter water use, or essential water use, for the property. To reflect that not all indoor water use is returned to the wastewater system, a factor of 85 percent is used. This factors in water use for cooking, cleaning, and other activities that don't put water down the drain. To calculate the wastewater rate applicable to a rate payer in this type of structure, the winter water use for the property is multiplied by the variable rate to provide the variable component of the wastewater bill. The variable component is then added to the fixed component to provide the bi-monthly wastewater charge for the rate payer. While this process mirrors the existing wastewater rate calculation process, it differs in an important way. Previously, when a rate payer moved into a house, they were placed in Tier 3 because they did not have an individual winter water use history. The rate payer was placed in Tier 3 because that represented the average usage of all residential customers based on the last analysis of usage. As shown in the chart above, that could lead to over-charging or under-charging an individual in many cases. As the new rate payer established winter water use history, their 23 of 30 October 15, 2019, Item #5.1 actual wastewater bill would slowly adjust to their usage patterns. In many cases, this could take up to three years to mirror their usage patterns. Based on feedback surrounding the existing residential wastewater rate calculation process, staff look for a more fair and equitable way to determine a rate payers winter water usage without significantly increasing the administrative process, and thus cost to rate payers, of doing so. As such, the calculation of winter water use, which is foundational to determining a rate payer's wastewater rate, will now focus on the property and not the individual rate payer. This approach places more value on wastewater flow patterns being a function of the property characteristics than the rate payers occupying the property. For example, a rate payer moving into a one-bedroom house is more likely to mirror the wastewater flow pattern of the previous occupant in that one-bedroom house than a rate payer in a four-bedroom house. The ratepayer in this example will start at the winter water usage associated with that one-bedroom property under the new approach. While there will still be fluctuations in wastewater flow patterns, this is a more fair and equitable approach because it reduces the likelihood of an individual rate payer paying more or less than they should. The chart below shows the impacts across various usage levels for this option. SFR Impacts at Different Usage Levels:20%/80% F/V (Option 2a) 160 140 120 100 S80 560 540 01 ik 520 SO 5 units 12 units 19 units 26 units 37 units 50 units 60 units n Current Bits $50.88 73.46 99.79 $107.33 5122.38 $137.43 5148.73 Proposed BaI $42.75 77.74 112.74 $137.73 $137.73 $137.73 $137.73 Impact(S)8.13 4.28 12.95 30.40 15.35 0.30 511.00 Impact(%) -16.0% 5.8% 13.0% 28.3% 12.5% 0.2% 7.4% This option collects 20 percent of the revenue through fixed charges which is consistent with the city's existing tiered wastewater rate structure. Lower volume users and higher volume users will see decreases in their bill, while users in the middle will see increased impacts. This is a function of how a tiered wastewater structure operates compared to a fixed plus variable structure. The chart on the previous page can help visually explain this phenomenon. The revenue stability is good under this option and the affordability for the lowest volume customers is high. 24 of 30 October 15, 2019, Item #5.1 Wastewater Rate Design Option 2b (Fixed + variable rate structure; 25% fixed, 75% variable) In this option, the amount of revenue collected via fixed charges is increased to 25 percent. Increasing the revenue collected from fixed charges helps increase the financial sustainability of the utility. The chart below shows the impacts across various usage levels for this option. SFR Impacts at Different Usage Levels:25%/75%F/V (Option 2b) 160 140 5120 100 580 560 5401 1 II 11 II II520II111SO 5 units 12 units 19 units 26 units 37 units 50 units 60 units Current BSI $50.88 73.46 99.79 $107.33 $122.38 $137.43 $148.73 Proposed BaI $45.62 78.43 111.24 $134.67 $134.67 $134.67 $134.67 Impact($)5.26 4.97 11.45 27.34 12.29 2.76 14.06 Impact(%) -10.3% 6.8% 11.5% 25.5% 10.0% 2.0% 9.5% This option increases the revenue stability over Option 2a by increasing the amount of revenue collected via fixed charges while still offering good affordability to the lowest volume rate payer. Users with usage in the middle will start to see some reduced impacts as compared to the impacts in Option 2a. This occurs because the variable rate per unit decreases as the fixed charges increase. The more usage occurs, when compared to Option 2a, the lower the per unit cost. 25 of 30 October 15, 2019, Item #5.1 Wastewater Rate Design Option 2c (Fixed + variable rate structure; 30% fixed, 70% variable) In this option, the amount of revenue collected via fixed charges is increased to 30 percent. Increasing the revenue collected from fixed charges helps increase the financial sustainability of the utility. The chart below shows the impacts across various usage levels for this option. SFR Impacts at Different Usage Levels: 30%/70%F/V (Option 2c) 160 5140 120 100 580 5: iiiIIISO 5 units 12 units 19 units 26 units 37 units 50 units 60 units Current 5 I $50.88 73.46 99.79 $107.33 $122.38 5137.43 $148.73 Proposed Bill $48.50 79.12 109.74 $131.61 $131.61 5131.61 5131.61 Impact(5)2.38 5.66 S9.95 524.28 9.23 5.82 17.12 Impact(96)4.7% 7.7% 10.0% 22.6% 7.5% 4.2% 11.5% In Option 2c, the lowest volume users still see a reduced impact when compared to the city's current wastewater structure which helps increase affordability. Almost all users in the middle usage areas see decreased impacts from either Option 2a or 2b while high volume users see more of a reduction in impact. As discussed earlier, for high volume users this is driven by the new cap in usage to recognize water beyond 24 units is more likely than not to be related to outdoor water usage which does not impact the wastewater system. When looking at the impacts to rate payers across all wastewater options, a fixed charge recapturing 30 percent of wastewater's fixed costs helps provide an equitable balance between revenue stability, which helps support financial sustainability, and affordability. Wastewater Financial Plan Similar to the discussion for water, the financial plan for providing wastewater services is an important component of the COSS process. It looks at the financial policies for providing wastewater service, such as how reserve levels are determined or when debt issuance is appropriate. The financial plan also looks at the current and projected level of expenses and examines the amount of revenue required to meet the operational goals of providing wastewater service. The amount of revenue required influences the proposed revenue, or rate, adjustments needed over time. Wastewater Collection Method: Staff looked at how wastewater revenue could be collected for residential rate payers. This analysis was done given upcoming legislation relating to the discontinuation of residential water service titled Senate Bill No. 998 (SB 998). It was contemplated that collecting residential wastewater bills on the property tax rolls could help reduce the impact to a rate payer's monthly 26 of 30 October 15, 2019, Item #5.1 bill. The idea was an individual may be more likely to pay their water bill and avoid discontinuation of service if their bill did not include the wastewater portion (i.e. it was lower). There are several challenges associated with collecting wastewater bills via the tax rolls. It would be administratively challenging because a full year's worth of bills must be calculated and submitted to the County Auditor Controller by August 10th of each year. This would increase the staff resources needed to administer such a collection method increasing costs to rate payers. It would be financially challenging because residential wastewater revenue represents 77 percent of total wastewater revenue and the cash received is generally in two large installments, after the December 10 and April 10 property tax delinquency dates. Higher reserve levels would need to be maintained to deal with the cash flow timing issues under this collection method increasing costs to rate payers. Upon completion of this analysis, staff does not recommend collecting residential wastewater bills via the property tax roll. Financial Policies: Similar to water, the current reserve policy for wastewater is to maintain a minimum working capital balance equal to 20 percent of operating expenditures. Consistent with the newly proposed water operating reserve levels, and for the same reasons, the recommended minimum operating reserves are 90 days of operating costs with a target reserve of 180 days. As discussed in the financial policies section for water, capital reserve levels generally vary based on conditions specific to each utility. In the case of wastewater, a minimum reserve based on the 5-year average capital improvement program (CIP) is recommended because it more closely matches the estimated debt service payments for the San Diego Pure Water program, a large portion of wastewater's overall CIP. San Diego's Pure Water project is a multi-year project that is projected to supply one-third of San Diego's water supply locally by 2035. The following chart shows the estimated operating and capital reserves over the next 5 years. Operating&Capital Reserves(Wastewater) 51L 0 512 510 58 55 52 S0 FYE 2020 FYE 2021 FYE 2022 FYE 2023 ctai Reserves — — M numum Reserve —Target Reserve Reserve levels are well in excess of the newly established targets. This was a strategic financial management decision in preparation for San Diego Pure Water. Funds to help cover Poway's estimated share of this regional project have slowly been set aside to mitigate impacts to rate payers. As the chart shows, the reserves are going to be drawn down over the near-term to help pay Poway's share of the Pure Water project. 27 of 30 October 15, 2019, Item #5.1 Similar to water, wastewater reserves will also help mitigate potential risks, mitigate revenue fluctuations, and smooth rates. They are also important to mitigate emergencies such as emergency repairs, droughts, natural disasters, and unforeseen economic influences. Revenue Adjustments: As with water, the costs to operate a wastewater system increase over time. Part of the upward pressure on costs relate to general inflation and aging infrastructure, like water. However, the cost to treat wastewater is also increasing. A wastewater treatment plant is designed to treat certain types of waste. As people dispose of pharmaceuticals, food waste, cooking oil, industrial chemicals, etc. down the wastewater system, the treatment process gets extended which increases costs. It also increases the maintenance of the system driving operating costs higher. Revenue adjustments are needed to cover the increasing costs of providing safe and reliable wastewater services to rate payers. The chart below shows the current estimated increases over the next five fiscal years. Revenue Adjustments(Wastewater) 7.0% 140% 6.0% Emim 120% 5.0% 100% 111 a+ 3 4.0% 80% l a 3.0% 60% „ s 2.0% 40% 1.0% 20': 0.0% 0% FYE 2020 FYE 2021 FYE 2022 FYE 2023 FYE 2024 Revenue Adjustments(Wastewater)— — Debt Coverwe Peau,ed Cevera e CoverageA'ert These estimated increases are necessary to fund the costs of wastewater treatment, operational expenses, capital expenses, and appropriate reserve levels. Increases are being proposed even though reserves are being drawn down. This is a long-range financial management approach to mitigating impacts to rate payers of the Pure Water project. If reserves were used until they were below recommended minimum levels, multi-year double digit rate increases would be required to fund Poway's share of the Pure Water project and replenish reserves. Using a combination of reserves and rate increases reduces the overall rate increases needed to fund operations which reduces costs to rate payers. Similar to water, a two-year rate setting process is also being recommended for wastewater. This approach will help save wastewater rate payers money while still providing flexibility in the financial management of the utility. 28 of 30 October 15, 2019, Item #5.1 The chart below shows the projected expenses over the next five years, along with the current revenue and projected revenue based on the projected increases. Operating Financial Plan(Wastewater) 514 C 512 510 5s 56 54 52 SO 52 54 FYE 2020 FYE 2021 FYE 2022 FYE 2023 PIE 2024 Operatire Expenses mom Rae Funded Capital MIMI Debt Service Net Cashflow —Current Revenue — — Proposed Revenue As the chart shows, even with the recommended rate increases, revenues are not sufficient to fund operations and capital investment. As discussed previously, reserves are being drawn down to help cover the shortfalls shown in the chart. Several factors are currently driving the need for revenue increases over the near term. First, San Diego's Pure Water project is a multi-year project that is projected to supply one-third of San Diego's water supply locally by 2035. Based on projections from April 2019, Poway's estimated share of the project is over $4 million annually for the next five years. Second, rate funded capital is being proactively invested in the rehabilitation and repair of the wastewater infrastructure to ensure Poway continues to provide safe, reliable, and affordable wastewater services. A more detailed description of current infrastructure investment is discussed in the City's Fiscal Year 2019-20 Comprehensive Financial Plan. The chart below shows the anticipated capital expenditures over the next five years. Capital Funding Sources(Wastewater) Sl E S1.70 51.e 51.4 51.29 51.2 S1 CC 51.0 SO.8 50. 61 50.6 50.45 50.4 50. 211150.0 FYE 2020 PIE 2021 FYE 2022 FYE 2023 FYE 2024 Debt Funded I Raes/Reserves Funded •Total C IP Continued investment into operations and system rehabilitation and renewal, along with long- range prudent financial management, will help ensure the City of Poway continues to provide safe, reliable, and affordable wastewater services to its rate payers. 29 of 30 October 15, 2019, Item #5.1 Environmental Review: This action is not subject to review under the California Environmental Quality Act (CEQA). Fiscal Impact: There is no direct fiscal impact associated with this staff report because it only contains information related to the workshop. However, based on the information contained in this staff report, sufficient revenues to fund operations, investment in capital infrastructure, and appropriate reserve levels will be generated from the recommended water and wastewater revenue increases staff will present to the City Council on January 7, 2020 when it is anticipated the City Council will set the public hearing for rate adoption on March 3, 2020. The proposed revenue increases are independent of what rate design Council ultimately pursues. The revenue increases are determined by the costs to operate the water and wastewater systems while the rate designs deal with how those costs are allocated amongst rate payers. Over the next two-year period, it is estimated approximately $2 million in additional water revenues will be generated while approximately $900 thousand in additional wastewater revenues will be generated. Safe reliable water delivered on demand to an average residential rate payer costs less than nine- tenths of one penny per gallon. Treating the average residential rate payer's wastewater in a safe and reliable fashion also costs less than nine-tenths of one penny per gallon. Public Notification: None. Attachments: None. Reviewed/Approved By: Reviewed By: Approved By: l‘ff/4 Wend Kaserman Alan Fenstermacher Ch s H_'-Itine Assistant City Manager City Attorney City Manager 30 of 30 October 15, 2019, Item #5.1