MOVING WATER FORWARD NATIONAL ASSOCIATION OF WATER COMPANIES. Water Policy Forum FOR STATE PUBLIC UTILITY COMMISSIONERS

Transcription

1 MOVING WATER FORWARD NATIONAL ASSOCIATION OF WATER COMPANIES Water Policy Forum FOR STATE PUBLIC UTILITY COMMISSIONERS Summary Report APRIL 2014

2 National Association of Water Companies 2014 Water Policy Forum SUMMARY REPORT April 2014 National Association of Water Companies 2001 L Street NW Suite 850 Washington, DC Tel: Fax: Prepared by Lila A. Jaber, Shareholder Gunster, Yoakley & Stewart, P.A. Page 1

3 TABLE OF CONTENTS I. ACKNOWLEDGEMENTS... 3 II. PREFACE... 4 III. FORUM PARTICIPANTS... 5 IV. THE FUNDAMENTALS OF THE PRIVATE WATER INDUSTRY... 6 A. The Regulatory Compact... 6 B. The Industry is Fragmented... 6 C. A Capital Intensive Industry... 7 D. Common Myths and Misperceptions in the Water Industry... 9 V. THE REGULATORY TOOLS TO ENSURE SERVICE: EXTENDING THE NATIONAL DIALOGUE TO THE STATE LEVEL...11 A. The Regulatory Compact is Alive and Well State Examples of Effective Ratemaking Processes New York Pennsylvania Florida The Logical Conclusion Alabama s Rate Stabilization and Equalization Program B. A Consumer Advocate s Perspective Statutory Deadlines for Commission Orders Stipulations and/or Settlements Regionalization and/or Consolidation Combined Water and Wastewater Revenues DSIC/Adjustment Clauses Fully Projected Future Test Year C. An Economic Regulator s Perspective VI. Tennessee H.B VII. ACCESS TO CAPITAL IN A COMPETITIVE MARKET...20 VIII. SMALL COMPANY CHALLENGES AND COMMUNICATING BEST PRACTICES...22 A. Issues and Arrangements Relating to Rates Simplified Rate Proceedings Single Tariff Pricing Alternatives to Rate Base/Rate of Return Regulation Use of Future Prospectively Relevant Test Years and Expedited Rate Proceedings B. Issues and Arrangements Relating to Return on Investment C. Issues and Arrangements Relating to Compliance Use of Infrastructure System Replacement Charge to Bring Nonviable Systems into Compliance Relief from Fines and Penalties Insulating Purchaser from Former Owner Violations D. Issues and Arrangements Relating to Purchase Price Reducing Purchase Price of a Small Utility for Penalties Acquisition Adjustments E. NARUC Best Practices for Small Systems Resolution A. Climate Change is Impacting Water Systems B. System Resiliency and Network Planning Drought in California California s Human Right to Water Bill Rulemaking on Water-Energy Nexus A. NAWC and the Value of Water Campaign XV. NARUC WATER COMMITTEE RESOLUTIONS PROMOTING BEST PRACTICES...41 A. NARUC Resolution Supporting the Consideration of Regulatory Policies Identified as Best Practices B. WA-1 Resolution Endorsing Consideration of Alternative Regulation that Supports Capital Investment in the 21st Century for Water and Wastewater Utilities C. WA-2 Resolution Supporting the Consideration of Regulatory Mechanisms and Policies Deemed Best Practices for the Regulation of Small Water Systems D. WA-3 Resolution Addressing Gap Between Authorized Versus Actual Returns on Equity in Regulation of Water and Wastewater Utilities E. Resolution Supporting the Value of Water Campai Page 2

4 I. ACKNOWLEDGEMENTS The National Association of Water Companies (NAWC) extends its sincere appreciation to all of the participants and presenters at the NAWC 2014 Water Policy Forum. NAWC wishes to thank NARUC leadership for their support and engagement at the Water Policy Forum. Page 3

5 II. PREFACE The 2014 NAWC Water Policy Forum was held April 13-15, 2014, in Nashville, Tennessee. Participants in this Forum represent the water industry, state economic and environmental regulators, consumer advocates, and the capital markets industry. The purpose of the Forum is not to reach consensus amongst the participants, but rather to share thoughts, information, and ideas in the form of effective regulatory practices that can be used to build a common understanding of the issues that impact water companies, the customers they serve, and their respective regulatory agencies. The ultimate goal is that each state adopts or promotes these effective regulatory practices. Therefore, this report provides a summary of the topics discussed at the Water Policy Forum in hopes that it will facilitate additional discussion on these issues, a greater understanding of the importance of effective regulatory practices, and action by states to implement and apply effective regulatory practices. By all counts, the NAWC Water Policy Forum is very useful in promoting education and dialogue amongst the industry stakeholders. The Forum provides the industry participants an opportunity to gain perspective from regulators and consumer advocates about a number of issues including the role of consumer education, challenges in regulation, and potential for collaboration. Over the years, it has become abundantly clear that more needs to be done in assisting state commissioners with navigating the process of implementing regulatory practices required to facilitate capital attraction at cost effective rates. Stakeholders that have participated in past opportunities with NAWC and have implemented these regulatory practices have benefitted from a more constructive regulatory environment for infrastructure improvements and quality service. Page 4

6 III. FORUM PARTICIPANTS The Honorable Julie Imanuel Brown Commissioner Florida Public Service Commission The Honorable Alaina C. Burtenshaw Co-Vice Chair, NARUC Committee on Water Chairman Nevada Public Utilities Commission Ms. Debra Coy Principal Svanda & Coy Consulting Mr. Dennis Doll President & CEO Middlesex Water Company The Honorable Edward S. Finley, Jr. Chairman North Carolina Utilities Commission Mr. Chris Franklin Executive Vice President & COO of Regulated Operations Aqua America, Inc. Mr. Joe Gysel President EPCOR Water USA The Honorable Kenneth Hill Chairman Tennessee Regulatory Authority Mr. Walton Hill Sr. Vice President, Regulatory Relations United Water The Honorable Mary-Anna Holden Commissioner New Jersey Board of Public Utilities Ms. Christine Hoover Senior Assistant Consumer Advocate Pennsylvania Office of Consumer Advocate The Honorable John E. Butch Howard Commissioner South Carolina Public Service Commission Mr. David Monie President GPM Associates The Honorable T.W. Patch Chairman Regulatory Commission of Alaska The Honorable Catherine J.K. Sandoval Commissioner California Public Utilities Commission Mr. Christopher Schilling President & CEO Park Water Company The Honorable Susan Bitter Smith Commissioner Arizona Corporation Commission Mr. Robert Sprowls President & CEO Golden State Water Company Mr. Tim Winter Vice President-Utility Research Gabelli & Company The Honorable Pamela A. Witmer Commissioner Pennsylvania Utility Commission Moderator Ms. Lila A. Jaber Shareholder Practice Leader Government Affairs Gunster, Yoakley and Stewart, P.A. Ms. Nicki Garcia Office Manager & Assistant to Lila Jaber Gunster, Yoakley and Stewart, P.A. NAWC Staff Mr. Michael Deane Executive Director Mr. Matthew McCaffree Director of State Regulatory Relations Mr. Walter Lynch President & CEO, Regulated Operations American Water The Honorable Sherina Maye Commissioner Illinois Commerce Commission Page 5

7 IV. THE FUNDAMENTALS OF THE PRIVATE WATER INDUSTRY A necessity of life, water is the only utility service that is physically ingested. There is no substitute. Regardless of cost, water service provided by a utility company must be safe to consume. Not only is water subject to increasingly stringent standards of quality by regulators, but customers demand a high level of reliability. In this overview, Dennis Doll provides insight into the fundamentals of the private water industry. The essential nature of water service is intrinsically related to quality and reliability. Of course, he also reminds us that water is critical for fire protection. The discussion that follows outlines the fundamentals of water from the importance of quality of service to the requirement of cost recovery. In that regard, the discussion must begin with the fundamentals of regulation still applicable and relevant today. A. The Regulatory Compact The need to reconcile the competing interests of the consuming public and investorowned utilities is The Regulatory Compact, policy that is well-articulated in case law and state commission regulations. Customers and regulated industries benefit from the application and adherence to the Regulatory Compact. Utilities rely on consistent, effective ratemaking to achieve adequate capital and consumers are protected by regulators who ensure essential services are provided at just, fair, and reasonable rates. The Regulatory Compact remains in place today. Simply stated by Forum Participant Doll, a fair return should be allowed and earned so the industry has the ability to attract capital. By the same token, the industry should ensure a long-term quality water supply to existing and new customers by maintaining and replacing aging infrastructure. The industry should comply with quality water standards, extend water service to those who need it, and have the opportunity to earn a fair return on its investment. 1 the return to the equity owner should be commensurate with returns on investments in other enterprises having corresponding risks. That return, moreover, should be sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and attract capital. 2 B. The Industry is Fragmented The private water industry is a fragmented industry. With more than 52,000 community water systems in operation and 83% of the water systems serving less than 3,300 people each, Forum Participant Doll notes that there are too many water systems, that they are 1 See, Federal Power Commission et al v. Hope Natural Gas Co., 320 U.S. 591 (1944) and Bluefield Waterworks & Improvement Co. v. Public Service Commission of the State of West Virginia et al, 262 U.S. 679 (1923). 2 Hope at 591. Page 6

8 too small, and too inefficient. As further demonstration of fragmentation, less than 1% of the water systems serve more than 100,000 people and over 80% of the market share is controlled by the government. Compared to other regulated utility industries, the water industry is the only utility that has not been deregulated. In fact, the water industry is heavily regulated by environmental and economic regulators. Contrary to the belief that water is free or not expensive to provide, the water industry is a rising cost industry with high capital needs, the longest capital recovery period, and declining per capita revenue. These factors contribute to the industry s negative cash flow making the industry less attractive to investors. Yet, as indicated below, compared to electric, telephone, and natural gas, water continues to be the least amount of consumer expenditure for a four-person household. 7 C. A Capital Intensive Industry The EPA estimates that $384.2 billion will be needed over the next 20 years for water infrastructure-related expenses. 3 This cost does not include dollars associated with wastewater improvements. The cost drivers and risk considerations include infrastructure replacement needs (supply, treatment, and distribution), increasingly stringent Safe Drinking Water Act (SDWA) requirements, increasing testing sensitivity, tort liability, rising costs of production, declining per capita revenue (conservation efforts are working), 3 EPA Drinking Water Infrastructure Needs Survey and Assessment, Fifth Report to Congress, April 2013 Page 7

9 growth-related needs, pressure on critical water supplies, rising security concerns, and regulatory lag. While the cost drivers and risk considerations will be discussed in greater detail later, the charts below demonstrate the differences between the regulated industries as it relates to capital investment and recovery. Regardless of water being a rising cost and essential service industry, it was noted that returns on equity (ROEs) tend to be higher in the electric and gas industries. 8 Page 8

10 Capital Intensive Industry Water utilities require more capital invested per dollar of revenue than any other regulated industries. To complicate the economics further, thus making it more difficult to attract capital, the water industry has the lowest depreciation rates. These characteristics negatively influence the industry s ability to attract capital because low depreciation rates and long recovery periods are viewed negatively by capital market analysts. Lowest Depreciation Rates 9 D. Common Myths and Misperceptions in the Water Industry Throughout the Water Policy Forum, the Forum Participants stressed the importance of communicating the value of water to consumers, and all Policy stakeholders. This is a critical point to the water industry as there are many myths and misperceptions about what the industry does or does not do. Forum Participant Doll addressed some of those misperceptions. For example, government does not pay for infrastructure costs. Infrastructure improvements and replacements are made after an assessment of demand growth and age of facilities that are required to provide service to customers. Utilities Page 9

11 have an obligation to serve and utility commissions should provide cost recovery for prudently incurred costs. Another myth is that municipal rates are lower than those of private utility rates. Forum Participant Doll notes that the rates comparisons are not appropriate as there are different considerations between municipal and private companies. For example, differences in tax structure and in subsidies between and among other municipal services create a difference in rates. Participant Reaction Industry Forum Participants note that major capital investment and rising costs of water will lead to more rate cases and greater need for efficiency. Participants recognized that communicating the value of water will continue to be critical, yet challenging. Meeting the challenge will involve all stakeholders including state commissions and consumer advocates. The Forum Participants discussed a greater need for a grassroots effort to communicate the value of water. In this regard, some Forum Participants offered the following effective practices: Participate in editorial board interviews to educate on issues or proceedings; Coordinate with local and state government officials on issues of mutual concern; Offer plant tours to community, schools, and colleges; Participate in Earth Week and other similar events; Communicate with customers and consumer advocates outside of rate cases and have pre-filing meetings with public counsel; Improve customer service centers (spending more time and money to improve training) as a recognition that customer service representatives are first responder to customer; Form citizens advisory boards and committees with leaders in the community and homeowners associations; Expand information on websites, social media to increase communication; and Increase communication with the Legislature and other public officials to minimize politics. Finally, Forum Participant 10 Doll notes that the water industry is an economic development partner to states as well as an active partner in the community. As a job creator and a facilitator to development, the Forum Participants emphasized that more should be done collaboratively to communicate this message. Page 10

12 V. THE REGULATORY TOOLS TO ENSURE SERVICE: EXTENDING THE NATIONAL DIALOGUE TO THE STATE LEVEL While the water industry has worked diligently to meet the ever increasing challenges of the Safe Drinking Water Act and Clean Water Act compliance, there are other challenges. On behalf of the water industry, Forum Participant Hill discussed these challenges: 1) Increased tort liability with a growing number of class action suits; 2) Rising costs of operation and production (labor, power, chemicals, and taxes); 3) Declining per capita revenue because conservation efforts are working; 4) Increased pressure on critical water supplies; 5) Rising security concerns and regulations; and 6) Increased regulatory lag. If these challenges are to be met in a cost effective manner, it is incumbent upon utilities and their regulators to identify and implement, as appropriate, regulatory practices designed to facilitate capital attraction, economies of scale, and efficient operations. As will be discussed later in greater detail, NARUC has also had a leadership role in facilitating and promoting effective regulatory practices. A. The Regulatory Compact is Alive and Well State Examples of Effective Ratemaking Processes A fair return that is allowed and earned will afford the industry access to capital. Correspondingly, the industry is able to ensure long term quality water supply to existing and new customers by maintaining and replacing aging infrastructure and extending water service to those who need it. However, Mr. Hill questions the feasibility of the current rate case model and how effective that really is in addressing regulatory lag and poor rates of return. From a consumer perspective, large rate increases every months result in rate shock. State commissions are facing workload issues, smaller staffs, and that creates longer processes. Lengthier and more political rate case processes make it difficult 11 for the industry to plan in the long term and adequately budget their operations. Forum Participant Hill notes the examples of regulatory lag and erosion of allowed returns and how that has created regulatory uncertainty. 4 With that said, some state commissions are beginning to address these issues by allowing and implementing alternative forms of ratemaking. 5 In 2013, the Tennessee Legislature passed House Bill 191 allowing alternative rate making in lieu of lengthy rate cases. 6 Forum Participant Hill provided examples of states that have taken positive steps to reduce regulatory lag. They include: 4 WeiserMazars, August 2012: 83% of respondents agreed the rate process should be simplified. 5 Connecticut has implemented revenue adjustment mechanisms; Ohio and Indiana have passed legislation to allow future test years; and Nevada s legislature has allowed repression adjustments and decoupling. 6 H.B. 191 is discussed in greater detail in Part VI of the Forum Report. Page 11

13 1. New York Through a progressive publicly articulated policy statement process begun in 1977, New York established a regulatory framework for support and implementation of future test years. The basic framework, as articulated by the New York Commission, is that the historic base year should be the bridge period to a fully forecasted rate year. The goal of ratemaking, therefore, is to ascertain as much as possible, the revenue, expenses, and conditions in the year the new rates will be in effect. The chart below demonstrates a typical New York PSC rate case timeline. NYPSC RATE CASE TIMELINE Forum Participant Hill observed that the New York process is so sophisticated and aggressive that the projections must be accurate. Notably, most of the rate cases in New York settle. 2. Pennsylvania Pennsylvania has long been touted as a state with effective regulatory practices. Most believe that regulation 12 in Pennsylvania is historically solid and conducive to meeting today s industry challenges. State legislation has given the Pennsylvania PUC the authority to approve ratemaking methods that will better address the challenges the utility industry faces today. 7 As already mentioned, those methods include the allowance of: 1) DSIC; 2) a fully-projected future test year; and 3) combined revenue requirements for water and wastewater. The Pennsylvania Legislature has now extended the use of the DSIC mechanism to wastewater, gas, and electric companies. The Pennsylvania Commission supported this legislation as they believe it will encourage investment in the state, accelerate aging infrastructure replacement, and result in greater rate stability for customers. Similar DSIC 7 Act 11 of 2012, Pennsylvania Statutes. Page 12

14 programs for water companies have now been implemented in at least eight other states Florida Florida s legal framework requires that file and suspend rate cases be completed within 8 months of the official date of filing. In addition, the standard by which cost recovery is allowed is established by law. By statute, Florida allows the prudent cost of providing service during the period of time the rates will be in effect 9 Florida also allows annual cost recovery through the form of pass-throughs as a way to streamline the cost recovery process. That streamlined cost recovery is for specific items like the cost of purchased water, power, taxes, and regulatory fees. 10 Some limitations apply. The pass throughs do not occur more than twice a year, and the company cannot be in an overearnings position. Florida s Proposed Agency Action (PAA) process is another effective regulatory process. If this process is selected by a company, a rate case can be completed within 5 months without a hearing. 11 The resulting order is issued as a PAA Order allowing substantially affected persons 21 days to protest. If no protest is received, the order is deemed final and effective. This procedure is in lieu of the lengthier rate case hearing process and can mitigate the costs to the company and therefore, to the ratepayers. Forum Participant Hill notes that Florida also uses an effective regulatory process as it relates to cost of capital testimony and the establishment of ROEs. In lieu of lengthy cost of capital testimony and hearings, the Florida Commission establishes, by order, an annual leverage formula for return on equity. The leverage formula is then applied in rate cases in lieu of requiring a company to present lengthy cost of capital evidence The Logical Conclusion Alabama s Rate Stabilization and Equalization Program After years of negative 13 political implications, negative press, multiple appeals of rate cases, and regulatory lag, Alabama implemented its Rate Stabilization and Equalization Program. The Rate Stabilization and Equalization Program has reduced the number of rate cases in Alabama and replaced the rate case process with rate reviews and greater communication amongst stakeholders. The removal of the once controversial rate case process has brought many benefits. Forum Participant Hill notes that the ongoing regulatory review as opposed to a lengthy rate case process has created more trust and fostered a more cooperative process in Alabama. All involved are able to budget efficiently and the regulatory certainty allows for greater planning and investment which results in greater economic development. The reduced regulatory lag creates a real 8 Illinois, St. Louis County in Missouri, Ohio, Delaware, Indiana, New Hampshire, New York, and Connecticut. 9 Section (3), Florida Statutes 10 Section (4), Florida Statutes 11 Section (8), Florida Statutes 12 Section (4)(f), Florida Statutes Page 13

15 opportunity for a utility to actually earn the approved ROE. This program has resulted in improved credit ratings, greater access to capital, and lower cost for the companies that do utility business in Alabama. From a quality of service perspective, customer satisfaction has increased because the companies are able to make the appropriate improvements to improve service reliability. The Rate Stabilization and Equalization Program is initiated in December of each year when the utility companies provide to Commission Staff the expected utility rate of return on equity for the next 12 months. Relying on the budgets provided by the company as a foundation, the Alabama staff conducts an audit. Meetings are then held to analyze and discuss projections. If necessary, rates are adjusted to bring expected ROE into the approved range. In March, the utility company must provide the actual ROE for the previous year so that an adjustment can be made to ROE. A refund to ratepayers is made if the utility has exceeded its approved range or ROE. This process holds the company responsible to make accurate projections and to operate to them. Accountability is ensured through ongoing monthly reporting and Staff monitoring. In addition, Staff can submit data requests and have quarterly full day meetings. Finally, annual increases are capped at 5% and the average of two consecutive annual increases is capped at 4%. Forum Participant Hill notes the many benefits of this model: The ongoing regulatory review instead of lengthy formal rate cases produces more trust and cooperation; Improved and more efficient budgeting and resource planning; Rate smoothing, reduced rate shock and political distraction; Reduced regulatory lag and therefore, a real opportunity to earn the allowed ROE; Improved credit ratings and lower cost of capital; Customer satisfaction and fewer customer complaints on rates or service; Improved service reliability; and Improved economic development. B. A Consumer Advocate s Perspective 14 Forum Participant Christine Hoover provided insight into the positions and concerns of consumer advocates on a number of regulatory practices. Ultimately, Ms. Hoover s position is that traditional ratebase/rate of return regulation works and that it balances utility and consumer interests adequately. For example, utilities are afforded the opportunity to demonstrate that cost recovery is necessary and hearings allow for a testing of the evidence and participation by all stakeholders. She opined that departures from the traditional ratemaking process will disassemble the ratemaking process and result in ineffective, single issue ratemaking. In addition, she believes that because alternative ratemaking does not involve the same level of review, it could create less accountability for the utility and therefore, a greater risk for consumers. She also noticed that rate cases will involve more stakeholder participation which creates a better record in her opinion. Page 14

16 As it relates to industry concerns about regulatory lag, Ms. Hoover offers some potential solutions: Statutory deadlines for Commission orders; Emphasis on stipulations and settlements; Regionalization and consolidation; Combined water and wastewater revenues; Adjustment clauses and DSIC; and The use of a fully projected future test year. 1. Statutory Deadlines for Commission Orders Some states have statutory deadlines of 7, 9 or 11 months for completion of a rate case. These statutory deadlines provide a known end point for the case and starting point for new rates. In most cases, this also means that companies and customers do not need to deal with multiple rate changes. Existing rates stay in effect during the rate case, which must be completed within an established period of time. 2. Stipulations and/or Settlements Forum Participant Hoover notes that while stipulations and settlements often take a lot of effort and time, the process can provide more certainty than litigation. She notes that legal or policy issues may need to be litigated. In addition, there is always a risk that the Commission may not accept the settlement. 3. Regionalization and/or Consolidation In some cases, consolidation can resolve problems with troubled systems. A new owner can address quality of service issues, managerial issues, and financial issues. Consolidated systems can lend themselves to the implementation of single tariff pricing as well. Forum Participant Hoover notes that the use of single tariff pricing in Pennsylvania has allowed that state to address a number of troubled system issues. 15 While it is not a view supported by all, there have been some clear benefits in that state from surge tariff pricing. 4. Combined Water and Wastewater Revenues Finally, Forum Participant Hoover addressed her concerns about the Legislature s approval to combine water and wastewater revenues in order to calculate rates for those utilities that serve both water and wastewater customers. She believes that the combination of these revenues could create a subsidy program whereby the water customers subsidize wastewater customers. While proponents believe that this regulatory approach benefits all customers in the long-run, Ms. Hoover believes this practice is flawed on a number of levels. It will be confusing to the customer, and care needs to be given to what adequate notice looks like. Second, no one can deny that there are subsidies between customers; and finally, no one can completely identify the primary Page 15

17 driver of cost. Ms. Hoover noted there was not any information as of yet to address her concerns. At the time of the Forum, Pennsylvania had two cases before the PUC with combined water and wastewater revenues and both settled. 5. DSIC/Adjustment Clauses As it relates to DSIC, consumer advocates generally believe that infrastructure costs should be reviewed in a traditional full-blown rate case setting. Ms. Hoover does not necessarily believe that the DSIC mechanism results in a reduction in the frequency of rate cases. Moreover, she believes the DSIC does not result in adequate oversight of utility expenditures, but rather the review of expenditures is an after the fact less extensive sing issue review. Additionally, she believes that the Commission should reduce ROE to reflect the reduced risk that comes along with the DSIC implementation. 6. Fully Projected Future Test Year With regard to using a fully projected test year in the development of rates, Ms. Hoover believes that additional regulations are needed to provide guidance and fully establish the information that is needed for implementation and a better understanding of how the information will be relied upon. She believes that a fully projected future test year is too speculative and will not result in streamlining rate cases. C. An Economic Regulator s Perspective New Jersey s Commissioner Holden provided the regulator s perspective. Providing context to the importance of issues related to water, Forum Participant Holden reminds us that water is a critical infrastructure. Leadership in the industry among all stakeholders is required. Recent tragic events, like Super Storm Sandy, brought to focus the importance of water to the country and how resiliency became a key factor to getting so many customers back to the basic needs of each of their communities. The utility companies played a major role in clean-up and restoration of services. 16 As an example of collaboration, New Jersey has created a New Jersey Clean Water Council that is reviewing water policies more holistically (from protecting waters to storm water practices). These recent events in New Jersey should also serve to bring to light that policies and practices are outdated as it relates to cost recovery mechanisms. New investment must be encouraged and alternative regulation may be necessary. In another example of collaboration, New Jersey is working with its environmental counterpart to see a grant for the creation of an energy resiliency bank that would create a revolving fund to facilitate infrastructure improvements. Finally, Forum Participant Holden notes that water policies will be impacted in the future by energy required to meet future needs. The Water/Energy Nexus is something she would like to consider and review in the near future as New Jersey, for example, addresses the impact from distributed generation policies. Page 16

18 Participant Reaction The water industry faces enormous capital attraction challenges and is the most capital intensive of all the traditional utility industries. Regulatory lag poses a significant challenge in terms of attracting capital at rates that are cost effective. Forum Participants recognize that all of the regulatory tools when applied consistently and with the appropriate consumer protections do achieve the goals of capital attraction, cost effective rates, and industry investment. Regulatory policies such as infrastructure replacement programs, revenue stability mechanisms, and flexible test year rules can significantly mitigate the impacts of regulatory lag. Effective regulatory policies benefit both the utility and the consumers in assuring the long-term viability of the utility, as well as efficient quality customer service. Forum Participant Burtenshaw noted that Nevada has embarked on collaborative processes to implement effective regulatory practices in its regulation of water and wastewater companies. Nevada is home to many small water companies some with only 25 customers. To successfully address small company viability issues, Nevada s Commission has had to work collaboratively with all stakeholders, including the legislature. Working together with its Legislature and the water industry, Nevada was able to implement the DSIC, decoupling, non-rate case revenue adjustments, and surcharge mechanisms. While Forum Participant Burtenshaw noted the importance of communication and collaboration in this legislative effort, she also noted the importance of communicating with the customer on the value of water. In her state, scarcity of supply is a major issue, so the more the customer understands about pricing, availability, and value, the better the state can maintain the sustainability of the resource. Finally, the more consensus on legislative initiatives in advance amongst the stakeholders, the greater likelihood of success. 17 Page 17

19 VI. Tennessee H.B. 191 Tennessee Representative Pat Marsh addressed the Water Policy Forum about House Bill 191, legislation that he sponsored to promote alternative ratemaking designed to minimize regulatory lag and promote investment. Representative Marsh is the Chair of the Tennessee House Business and Utilities Committee. Representative Marsh believes H.B. 191 streamlines the rate case process so that common sense regulations can promote replacement of aging infrastructure and address adequate cost recovery. In his opinion, the streamline approach will reduce rate case expense and reduce risk by mitigating regulatory lag. H.B. 191, signed by Governor Bill Haslam in April 2013, gives the Tennessee Regulatory Authority (TRA) the authority to implement alternative regulatory methods to allow for public utility rate reviews and cost recovery in lieu of lengthy general rate case proceedings. In general, H.B. 191: 1. Authorizes the TRA to develop minimum filing requirements, and procedural schedules to expedite the decision-making to 120 days from the initial filing. If the TRA denies an alternative regulatory method, the public utility may refile an amended plan or amendment within 60 days of the issuance of a final order, and, thereafter, the TRA would have 60 days to approve or deny the amended plan or amendment; 2. Authorizes a public utility to request, and the TRA to authorize a mechanism to recover the operational, capital costs or both, if such expenses or costs are in the public interest and are: a. Related to safety requirements imposed by the state or federal government, insuring the reliability of the public utility plant in service, or weather-related natural disasters; b. Related to the expansion of infrastructure for the purpose of economic development; or c. Related 18 to other programs that are in the public interest. 3. Requires the TRA to grant recovery and authorize a separate recovery mechanism or to adjust rates to recover the operational expenses, capital costs or both, associated with the investment in facilities described above in (2)(A) or (B), including the return on such investments at the rate of return approved by the TRA at a public utility s most recent general rate case upon a finding that such mechanism or adjustment is in the public interest; 4. Requires the TRA to grant recovery and authorize a separate recovery mechanism or adjust rates to a mechanism to recover the operational expenses, capital costs or both, associated with the investment in programs described above in (2)(C), including the rate of return approved by the TRA at the public utility's most recent general rate case; Page 18

20 5. Authorizes a public utility to request, and the TRA to recognize, a mechanism to recover expenses associated with efforts to promote economic development in its service territory, if such expenses are in the public interest. 6. Authorizes a utility to request, and a utility to authorize a mechanism to allow for and permit a more timely adjustment of rates resulting from changes in essential, non-discretionary expenses, such as fuel and power and chemical expenses; 7. Authorizes a public utility to opt to file for an annual review of its rates based upon the methodology adopted in its most recent rate case, if the public utility has engaged in a general rate case within the last five years; and 8. In addition to the alternative regulatory methods described above, authorizes a public utility to opt to file for other alternative regulatory methods. Upon a filing by a public utility for an alternative method not prescribed, the TRA may adopt policies or procedures that would permit a more timely review and revisions of the rates, tolls, fares, charges, schedules, classifications or rate structures of public utilities, and that would further streamline the regulatory process and reduce the cost and time associated with the ratemaking processes. 19 Page 19

21 VII. ACCESS TO CAPITAL IN A COMPETITIVE MARKET Presenting to the Water Policy Forum, Timothy Winter, with Gabelli & Company, noted that water companies are not just competing with each other for capital but also compete across other industries as well. Therefore, what investors need to see for investment purposes should be of interest to all stakeholders. Investors are looking for low risk, revenue-producing opportunities and constructive regulatory environments. Investors have many investment choices. The global equity marketplace is over $60 trillion. The global utility market accounts for $2.3 trillion. Utility stocks compete with other income products as well. Mr. Winter notes that there are roughly 100 utility equities and many more fixed income investments for the investor to choose. Utility investments can be sub-divided into power merchants, electric, gas, and water utilities. There are many reasons to invest in water utility stocks. The water industry s risk business profile is good. As a regulated industry, water companies have strong balance sheets and good credit ratings. With constructive growth potential, water companies offer competitive dividend yields. There are also concerns with water utility stocks. For example, water is a capital-intensive industry and the economics are dependent on regulation. The earned ROEs in the water industry are well below ROEs for the electric and gas utilities. In addition, there is historically slow organic growth and lack of liquidity with only 10 to 12 publicly traded water utilities. Finally, declining per capita consumption from conservation creates additional challenge. Notwithstanding, it is Forum Participant Winter s belief that these challenges can be met by creating constructive regulatory models. All constituents, including investors, benefit from constructive rules. Constructive regulation equates to earned ROEs. Investors expect that utilities will earn reasonable ROEs. Simply stated, investment flows to better risk-reward opportunities. Stronger utilities are awarded premium multiples and higher credit ratings. It is also clear that multistate utilities pull capital from poor states and invest in constructive states. Speaking from his experience, Forum Participant Winter notes that investors need to see streamlined and predictable rate 20 cases, as well as modified best practices (or adoption of best practices) to include decoupling, infrastructure surcharges, pre-approval of large projects, and cost tracking mechanisms. Forum Participant Winter noted that the utility companies play a vital role in mitigating risk and ensuring a positive investor outlook. Utilities have to stay focused on core utility business and really make the necessary investment including investment in relationships with regulators, customers, and the public at large. They have to work with the community to create a win-win situation. This involves the communication with customers to provide information and improving service. Participant Reaction Page 20

22 Forum Participant Doll noted that overall, risk for water utilities is greater than that for electric and gas utilities. Risk takes on many forms in water. In addition to regulatory risk, water companies are facing political risk more often. Also, operator risk and risk to system security are additional factors. Forum Participant Franklin noted Aqua s experience in Florida as an example of political risk. Florida politics led to Aqua s decision to sell its assets and exit Florida. Instead, the company will invest their capital in different states with constructive regulatory environments. Forum Participant Schilling noted that the utilities and their stakeholders have to follow the dollars in terms of investment. 21 Page 21

23 VIII. SMALL COMPANY CHALLENGES AND COMMUNICATING BEST PRACTICES Based upon his own experiences successfully operating a small water company, Forum Participant Monie, observed that a small water and wastewater utility is viable with: 1) an owner who cares; and 2) access to capital. If the owner does not care, the only solution is an acquisition by a responsible utility owner. With a caring owner, access to capital is a consequence of having adequate rates. A. Issues and Arrangements Relating to Rates 1. Simplified Rate Proceedings While small system rate application assistance programs have been adopted in many states, in most jurisdictions the cost of processing a rate increase for a small utility is extremely high on a per customer basis. For instance, if a water system serving 100 customers processes a rate increase at a cost of just $20,000, the per customer cost is $200. In many jurisdictions, it is not uncommon for a very small system to have rate case costs of over $300 per customer. Mr. Monie suggests that rate case costs of over $100 per customer do not benefit anyone as the likely savings to the customer by the careful review built into most rate case procedures are not likely to reduce the final rate by more than the rate case costs, even when amortized. As a comparison, if a company that served 50,000 customers were to have rate case expenses of $1,000,000, the rate case cost per customer would be $20. Mr. Monie notes that the high cost and complexity of rate case filings prevents many small systems from seeking the rates necessary to attract the required capital for the system to become or remain viable. Mr. Monie notes that truly simplified rate cases designed to significantly reduce the per customer cost and allow significant time between cases, would be a big benefit to the small utility s customers. He believes one possibility is a simplified rate case procedure with automatic cost of living increases for some period of time following the implementation of the new rates. The many benefits include keeping 22 subsequent rate increases small, avoiding rate shock, and allowing the utility to attract capital so it can become or remain viable. Given adequate rates and wider adoption of innovative best practices for small system regulation, Mr. Monie believes that even the smallest utilities can attract the necessary capital in order to remain viable. The Indiana Utilities Regulatory Commission has implemented a simplified rate case process. Pointing to this process as a best practice, Mr. Monie described Indiana s simplified process as an abbreviated application requiring balance sheet information, revenue requirement data, and a case summary. The form is filed online and is acted upon administratively by the Commission. Mr. Monie notes that even the e-filing process is an easier process that saves cost for the smaller utilities. This streamlined approach has assisted with timely recovery and efficiencies in regulation. Page 22

24 2. Single Tariff Pricing When a small, nonviable system is acquired by a larger system, the improvements necessary to bring the nonviable system into regulatory compliance or to provide reliable service often result in a rate increase that is prohibitive if applied against the small, nonviable system by itself. This can make acquisition by a larger water company difficult. Mr. Monie suggests that single tariff pricing could spread these costs over a wider customer base. This is effectively the way prices have been set for many years for the electric, natural gas, and telecommunications companies where large service territories can cover diverse geographic locations but all customers in the same class basically pay the same rates. Many jurisdictions currently allow single tariff pricing for commonly owned water systems (sometimes restricted to geographical areas in a state) and others are considering rate applications that would allow for single tariff rates. Mr. Monie notes that whatever rate structure is approved, it should provide sufficient revenue to the purchaser to cover the full cost of providing water service, including O&M, capital investments, and a competitive rate of return (i.e. full cost of service rates). 3. Alternatives to Rate Base/Rate of Return Regulation In the case of many small, nonviable systems, there may be little remaining original cost rate base as the result of accumulated depreciation or large amounts of contributed plant (CIAC). This could make viability difficult and acquisition of the system financially infeasible for an acquiring entity because there is little, or no, rate base left upon which a return can be earned. In such cases, alternate methodologies for setting rates may be necessary, such as the use of operating ratios, instead of rate base. Properly regulated operating ratios, in use in some jurisdictions, can allow the otherwise nonviable system to attract capital for needed capital expenditures. If single tariff pricing is not allowed in a jurisdiction, a larger company that may acquire the small system would not be able to recover capital improvements necessary to bring the system into compliance if there is a negative rate base without an alternative regulatory process like the use of operating ratios. Since in many small systems the amount of CIAC was arbitrarily set by the Commission to keep rates 23 down, the transfer of CIAC to Equity may be a simpler method to facilitate an acquisition without the need of an acquisition adjustment. 4. Use of Future Prospectively Relevant Test Years and Expedited Rate Proceedings The use of historic test years and the length and cost of rate proceedings can be a real deterrent to the ability of a small system to either remain viable or become viable. According to Mr. Monie, the use of a future test year, coupled with an expedited procedure, is an important small system viability tool. In addition, these mechanisms help an acquiring system make the capital investments necessary to bring a nonviable system into compliance. Basically, without a future test year, the acquiring company would need to wait to file for any rate relief until it had already made the capital investments necessary to bring the nonviable system into compliance, and then it would be faced with a rate- Page 23

25 setting process that could take up to a year or more. Likewise, without the use of a future test year the small utility, on its own, is not likely to be able to attract the capital needed for the capital improvement. The use of future test years and expedited rate proceedings could mitigate these disincentives. Another possibility for small systems facing a significant capital improvement would be to allow quarterly construction work in progress (CWIP) rate increases that would allow the small utility to earn on the investment shortly after it is made and would greatly help in its ability to attract the necessary capital for the project. Many small systems do not experience maintenance expenses at a constant level from year to year. Therefore, traditional ratemaking policies that require expenses to have occurred in the test year to be recognized in rates should be modified to assure that the small system will have enough funds to pay for required maintenance when needed. In that regard, the use of averaging methods and, in some cases, the allowance in rates for annual contributions to a maintenance/capital investment fund is a possible method to help small companies become, or remain, viable. B. Issues and Arrangements Relating to Return on Investment When the acquisition of a troubled utility is encouraged or ordered by a state commission, the overall acquisition must be structured to assure the purchaser has a good chance of earning a competitive return. For this to happen not only must the maximum allowable rate of return set by the state commission be competitive but also the rate structure that is approved must provide sufficient revenues so the purchaser has a good chance of realizing that maximum return. From a purely business perspective, there is little incentive for a successful utility to take over a troubled utility. While an emergency takeover of a troubled utility may be necessary in circumstances where the situation is so dire that public health is being jeopardized, ultimately the acquiring utility must be made whole on the takeover or its own financial health and potentially the public s health could be jeopardized. C. Issues and Arrangements Relating to Compliance Use of Infrastructure System Replacement Charge to Bring Nonviable Systems into Compliance Connecticut has adopted the Water Infrastructure and Conservation Adjustment (WICA), similar to legislation in California, Missouri, Pennsylvania, Illinois, Delaware, Indiana, New York, and Ohio, to provide for recovery of capital investments to replace aging infrastructure, outside of the confines of a general rate proceeding. In the case of many small, nonviable systems, there is an immediate need to make capital investments to bring the system into regulatory compliance. Mr. Monie believes that some form of the WICA concept for this purpose could facilitate the necessary capital investment by helping in the acquisition of capital by the small system, as well as by making acquisition of the nonviable system more feasible for the acquiring company. Page 24

26 2. Relief from Fines and Penalties Existence of outstanding fines and penalties against a system from either federal or state agencies poses significant obstacles to acquisition. This is especially true where local health authorities, primacy agencies, or enforcement authorities may have been holding off enforcement activities against the nonviable operator but then insist on immediate compliance by the acquiring entity. State legislation may be necessary to assure that responsible operators who acquire nonviable systems with outstanding fines and penalties will have such penalties waived and a reasonable compliance schedule established. 3. Insulating Purchaser from Former Owner Violations Past and current violations of standards or regulations should not be attributable to the purchasing utility unless it fails to correct the violations in a timely fashion. State and USEPA enforcement records should clearly identify that the utility s previous owner is responsible for the occurrence of any violations existing at the time of purchase. The new owner should be classified as being in compliance, provided he is correcting the violations in accordance with the terms agreed to by all the parties. The purchasing company should be given a grace period to correct the violations. The amount of the grace period should be a function of what must be done to correct the violations. Finally, according to Mr. Monie, USEPA and state officials should provide documentation to the purchasing company explaining the above circumstances so the company can provide it to anyone who questions its compliance record (such as a potential client). To accomplish the above measures, the state commission may need to enter into agreements with the state primacy agency and the relevant USEPA regional office that would establish a protocol for implementing the details, including how to document and oversee the commitments of all the parties. D. Issues and Arrangements Relating to Purchase Price 25 Mr. Monie notes that if a utility is ordered to purchase a troubled utility, the purchaser might have little leverage to get a fair price and may have to pay an inflated price with consequences to the rate of return. Therefore, he believes that if a state commission requires or encourages a utility to purchase a troubled utility and a premium price must be paid to acquire that utility, the state commission should provide an acquisition or some comparable adjustment so the purchasing utility is not financially penalized from what could be an excessive purchase cost. Transfer of CIAC to Equity may be a relatively simple way to increase the rate base for the acquiring system, especially if CIAC was arbitrarily set by the commission to keep the initial rates lower than they would need to be for a sustainable system. Mr. Monie noted that care should be taken to assure that well managed and financed small utilities are not penalized with policies favoring only troubled small systems. His point will be discussed in greater detail below. Page 25

27 1. Reducing Purchase Price of a Small Utility for Penalties The elimination of penalties against the system, if it is acquired by a larger system that agrees to a time schedule for upgrading the system to meet standards, is a very helpful way of reducing the purchase price and, therefore, the ultimate rates to ratepayers. 2. Acquisition Adjustments Granting acquisition adjustments with regard to small water systems can raise issues of concern. All things being equal, it would be appropriate not to provide incentives for unscrupulous operators of nonviable systems to profit from their failure to properly maintain them. On the other hand, a properly structured policy with regard to acquisition adjustments can play an important role in addressing not only the small company problem, but also issues of fragmentation and lack of economies of scale in general in the water industry. Not all small system owners are irresponsible. Even owners of nonviable systems may simply not be in a good position to meet the daunting challenges of quality compliance and infrastructure replacement. Their systems have value and any purchase price is likely to include some increment over depreciated book value. Recognizing an acquisition adjustment in these cases is appropriate. For example, Pennsylvania provides for possible recognition of premiums for systems with less than 3,300 service connections subject to certain conditions. In addition, premium recovery is possible for systems in excess of 3,300 service connections if they are nonviable. However, if acquisition adjustments are allowed into rate base for small systems, Mr. Monie believes it is clearly unfair to only allow acquisition adjustments for nonviable systems. This would punish the responsible owners of small, but viable systems that have kept their utilities in compliance with all applicable standards and could encourage owners to give poor service if they are contemplating a sale in order to have the acquiring company qualify for an acquisition adjustment and, therefore, be willing to pay a higher purchase price. When state commissions allow acquisition adjustments, even where systems are not small or nonviable, it 26 can be an effective tool in addressing the small company viability issues. For example, enlarging the footprint of a financially viable, competent system operator through acquisition of other competent systems could place the responsible operator in closer proximity to nonviable systems, thus making it more economically viable to acquire and operate them. Texas has explicit provisions and standards for recovery of positive acquisition adjustments. Likewise, California provides for valuing rate base at fair market value for rate setting purposes. When American Water acquired the water assets of Citizens Utilities in 2001, the company made a proposal in three states whereby the commissions would agree to consider some form of premium recognition if the company could demonstrate value to ratepayers. The basic principle is that if, and to the extent that a business combination produces identifiable savings, service improvements, or other benefits to customers, shareholders should have the opportunity to recover and earn a return on their investment Page 26

28 (i.e., the premium) required to produce those benefits. The principle is no different than what is involved when a utility invests in a more efficient pump that produces savings. Generally, that investment is allowed in rates. In California and Illinois, such proposals resulted in the ability of the company to partially retain quantifiable and proven savings resulting from the acquisition. In Arizona, it resulted in an acquisition order that recognizes the possibility of retaining certain quantifiable and proven synergy savings. E. NARUC Best Practices for Small Systems Resolution In the regulation of small water systems it is recognized that rate application processes and mechanisms that reduce or remove the need for use of outside counsel or consulting services, thus reducing rate application duration and costs, should be encouraged. To meet the challenges of environmental compliance and continued capital investment required to deliver safe and reliable service to the customers served by regulated small water systems, certain practices have been identified as means to improve sustainable and continued investment in small water system infrastructure at cost-effective rates. Consequently, NARUC captured some of these regulatory practices in the form of a Resolution to be shared with all state commissions. Passed July 2013, this resolution reflects the leadership role taken by NARUC to address challenges faced by the small water companies. Some of the best practices recognized by state commissions and therefore, in the Resolution include: Accepting simplified rate applications using electronic filing; Relying on Annual Reports for cost recovery; Implementing Staff Assisted Rate Cases; Using simplified rate of return calculation; Making periodic cost of living adjustments; 27 Establishing emergency fund mechanisms; and Limiting CIAC so rates are sustainable. A complete copy of the Resolution is attached to this Forum Report. F. Regulator Perspective and Participant Reaction Forum Participant Susan Bitter Smith noted the value of hearing the previous conversations about best practices in the water industry at both the NAWC Staff and Commission Water Policy Forums. She discussed the practices that the Arizona Page 27

29 Commission, a constitutionally-created entity, has been able to implement as a result of both her staff s participation in these forums as well as her own. For example, Arizona has now implemented a version of DSIC called SIB, or System Improvement Benefits Mechanism. The Arizona SIB can now be used in rate cases to address infrastructure costs. The Arizona PSC has worked diligently to educate the consumers on the benefits of SIB and to ensure that it continues to be a consumer-friendly initiative. The Arizona SIB includes a true-up of costs. In addition, her commission has modified its rate case application process for small companies (300 customers or less). David Monie reminds us that regardless of size of facility or number of customers served, all water companies are held to the same standard for quality service. In addition, all companies need access to capital. Financing for small water companies may be different than that for large utilities, but nevertheless, it is obtainable. The difference is that some small companies might have to rely on owner financing or small bank loans for their capital. But like the larger companies, the likelihood of achieving affordable access to capital is greater with adequate rates and regulatory stability. Therefore, the use of effective regulatory practices in the regulation of small water companies is critical. In addition to some of the best practices discussed above, Forum Participant Monie notes that states like Pennsylvania have designated experienced staff to work on small company issues. From a cost perspective, this is helpful to the small water companies as unnecessary discovery, due to inexperience, is avoided and costly litigation is mitigated. Other states like Missouri and Florida have staff assisted rate case processes. In California, the California Water Association will assist in processing 4 small water company rate cases annually. This industry to industry assistance comes from a recognition that it is in everyone s best interest that the systems remain viable. Some other examples of effective small system practices came from Forum Participant Burtenshaw who described Nevada s approach to ensuring small system viability. In Nevada, they have allowed surcharges for capital improvements. By expedited petition ruled upon in 30 to 60 days, companies may implement some rate increases without a lengthy hearing process. 28 Annual reports and surveillance processes are used to track these rates and expenditures. In addition, some states allow annual increase adjustments based upon a consumer price index (CPI) factor. Those states include Florida, Nevada, Indiana, and California. Forum Participant Hoover noted the importance of collaboration with the consumer advocates about the small system issues. It was noted that the informal sharing of information and could prevent protracted unnecessary litigation and facilitate negotiation. Page 28

30 IX. PROTECTING WATER RESOURCES AND ADDRESSING THE NEW NORMAL On behalf of the water industry, Forum Participants Walter Lynch and Joe Gysel made presentations on this issue. Additionally, Commissioner Sandoval provided insight into California s resource challenges. In describing recent challenges the industry has faced as a result of weather-related events, Forum Participant Lynch believes the new normal reflects greater pressures to protect water resources, address supply issues, and water system reliability. Therefore, the new normal for water utilities necessitates a discussion about: Climate Change on Water Utilities (severe weather events); System Resiliency Integrated Water Resource Management (reuse, desalination, and conservation); Watershed Protection (early warning monitoring); and Rate Recovery Like many water companies, American Water can directly speak to these issues. American Water provides services to approximately 14 million people in more than 1,600 communities in more than 30 states and in Canada; and employs nearly 6,700 water professionals. The company owns or operates nearly 325 drinking water systems and 225 wastewater facilities. Treating over a billion gallons of water daily, the company conducts over one million water quality tests each year for over 100 regulated parameters, and up to 50 types of water-related tests each day. A. Climate Change is Impacting Water Systems Increased storm activity has challenged water systems. American Water, just like other water companies, must be aggressive in its disaster preparedness plans. Recent storm experience has tested those plans. A synopsis of recent extreme weather activity that 29 impacted American Water and other water companies includes the December 2010 Blizzard that caused New York City and parts of New Jersey to shut down for 5 days; the May 2011 Joplin, Missouri Tornado; and Superstorm Sandy in October The May 22, 2011, Joplin, Missouri tornado was the worst single tornado in United States history. It was rated an EF5 tornado with wind speeds in excess of 200 miles per hour. It was a six-mile long by 3/4 mile wide path of destruction. In addition, 8,000 structures were damaged or destroyed; and there were 4,000 leaking customer lines, a massive loss of pressure, and impairment of fire service lines. The total damage is estimated to be $3 billion dollars. Hurricane Sandy was an unprecedented storm event for the New Jersey water industry. New Jersey American serves 647,000 customers or 28% of the state. As a result of Hurricane Sandy, everything in the state was placed on backup generator power. The Page 29

31 hardest hit area, the Northern Ocean County/Barrier Island, had nearly 10,000 homes without water and many of them were destroyed. B. System Resiliency and Network Planning Forum Participant Lynch notes that the success of restoration of services after a major storm or disaster is a result of the industry s proactive approach to ensuring resiliency and network planning. He defines resiliency by a determination of how well a plant can withstand a severe event and how well it can recover. The diagram below indicates the process identified to secure resiliency in system planning. After the Joplin tornado, full pressure was restored in the entire system in two days. The boil water orders were lifted in less than six days after flushing and sampling was completed. Restoration efforts were made exceptionally difficult because of problems in locating service lines. In many of the circumstances, the landmarks were completely relocated or demolished. GPS systems were used to track service lines and landmarks. Missouri American transferred statewide employees to assist in the restoration efforts. With Hurricane Sandy, a great majority of the service area was isolated but there was a very short duration of low or no pressure. Transportation logistics were of some concern. There was limited damage to plants and buildings from wind and rain. However, as stated earlier, about 10,000 homes were without water in the Northern Ocean County/Barrier Island area. 30 In addition, redundant connectivity is critical to a restoration effort. Examples of new tools that support redundant connectivity and restoration efforts after a major storm or other Page 30

32 event include: (1) ANIRA (AT&T Network-Based IP VPN Remote Access); and (2) Telecommunications Service Priority System (TSP). C. Integrated Water Resource Management Forum Participant Lynch defines integrated water resource management as management of the whole hydrologic cycle to achieve a coherent set of water resource policies and uses that balance all reasonable social, environmental, and economic needs in a sustainable way. As it applies to American Water, it is a focus on understanding all of the water resources available to American Water-served communities and surrounding regions, actively caring for those resources and providing solutions that best match an area s water needs and constraints with proactive stakeholder engagement. Integrated Water Resource Management is often the integration of technologies and programs to provide sustainable, cost effective solutions to water resource issues. Some examples can be found in the chart below provided by American Water. Technologies Wastewater recycling and reuse Stormwater capture & recovery Sludge beneficial use Desalination Advanced treatment technologies Groundwater Recharge/Infiltration Advanced tools for demand management and leak detection Energy efficiency/recovery Programs Proactive stakeholder engagement Regionalization of water resources Interagency agreements Conjunctive Use Demand side management Supply side management Water quality optimization Communications & media outreach Community education and involvement EPCOR has operations in British Columbia, Canada, and in the United States. With its United States efforts in Arizona and New Mexico, EPCOR Water USA s water supply and total use is shown below. 31 EPCOR USA provides 74,816 active fee (AF) of potable water to homes and businesses, 3,541 AF to 18 turf-related facilities, 13,615 AF recharged, 11,357 AF of CAP water 2,258 AF of effluent, and 2,962 AF of direct reuse effluent delivered. Page 31

33 The ongoing challenges for EPCOR in its service areas relate to appropriate pricing for scarcity. Forum Participant Gysel challenged the Forum to start thinking about pricing for the future; i.e., looking forward towards cost and price models that allow cost recovery for what is needed in the future. With declining use and effective conservation, appropriate alternative ratemaking is an important factor. Increasing block structures conserve water, but they reduce revenue and impair utilities. Forum Participant Gysel notes that an effective rate structure that results in appropriate returns for the company and establishes the correct price signals for the consumer is required. The appropriate remedies must include decoupling rates, cost and revenue matching, and allowance of water revenue adjustment (WRAM) mechanisms. Looking ahead Mr. Gysel observes that his company will need additional ground water (wells) and alternative augmentation from groundwater leasing, developer projects, surface water treatment, recharge, and additional surface water supplies. For example, today, EPCOR Water has several agreements with farmers whereby the utility company leases groundwater from those farmers. This pay as you draw structure has been approved by the respective state commission and is an alternative mechanism for addressing supply issues. Mr. Gysel and Forum Participant Burtenshaw note that other similar concepts will be necessary to fully address supply issues in their states. D. Watershed Protection In January 2014, a different kind of event occurred for the water industry with the Freedom Industries spill in West Virginia. More than 7,000 gallons of MCHM spilled into drinking water and impacted drinking water supply 1.5 miles downstream. West Virginia has introduced legislation, Senate Bill 373, to address this issue prospectively. The legislation calls for source water protection plans, redundant intakes, and early warning monitoring. E. Rate Recovery To meet the ongoing challenges of the industry associated with greater EPA 32 requirements, as well as what we have referred to here as the new normal, the utilities must be able to achieve adequate rate recovery. The utility companies understand that this will involve raising customer awareness on the value of water with a greater dialogue on what companies need in terms of financing to meet infrastructure investment needs. Constructive regulatory models that recognize future test years and allow capital expenditure riders are necessary for effective cost recovery. By the same token, Mr. Lynch notes that water companies can do more to ensure continued affordability. Water companies can continue to address O&M expenses making sure that all efficiencies are captured. In addition, the water companies can be even more mindful of the capital expenditures, the associated impact on rates, and offer low income programs where appropriate. Page 32

34 The new normal poses multiple challenges to water utilities. The water companies consider a number of additional factors in their investment decisions, including risk management that incudes integrated resource management and rapid response to extreme weather. F. Regulator s Perspective: California Forum Participant Sandoval briefed the Forum Participants on the unique challenges California faces as it relates to water supply issues. 1. Drought in California On January 17, 2014, Governor Brown declared a drought emergency for California and asked Californians to voluntarily reduce water use by 20%. The US Drought Monitor classified 62% of California as under "extreme drought". The highest driver of California water demand is agriculture, not its population. Farmers use, on average, 80% of all water consumed from rivers, lakes, and groundwater. To provide further perspective, about one-half of all California precipitation is from December through February. California averages an annual rainfall of 21 inches, but this includes very wet areas in the northwest and the deserts. By contrast, the average rainfall of Morocco is inches and the average rainfall in Tucson, Arizona is inches. The average California rainfall as of April 2014 for San Diego is inches. According to Forum Participant Sandoval, the Governor has not ruled out mandatory conservation. Improving conservation in residential water use makes a difference. Residential conservation happens in simple steps, including reducing the frequency and duration of landscape irrigation, switching from lawns to more drought resistant plants, watering at night, installing low flow shower heads and toilets, and turning off the faucet when brushing your teeth. 2. California s Human Right to Water Bill 33 Existing California law establishes various state water policies, including the policy that the use of water for domestic purposes is the highest use of water. AB 685, California s Human Right to Water Bill, passed in 2012, declaring that every human being has the right to safe, clean, affordable, and accessible water adequate for human consumption, cooking, and sanitary purposes. The bill requires all relevant state agencies, including the Department of Water Resources, the State Water Resources Control Board, and the State Department of Public Health, to consider this state policy when revising, adopting, or establishing policies, regulations, and grant criteria when those policies, regulations, and grant criteria are pertinent to the uses of water described above The people of the State of California do enact as follows: (a) It is hereby declared to be the established policy of the state that every human being has the right to safe, clean, affordable, and accessible water adequate for human consumption, cooking, and sanitary purposes. Page 33

35 3. Rulemaking on Water-Energy Nexus The California PUC began rulemaking in December, 2013, to promote a partnership framework between investor-owned utilities and the water sector to promote water-energy nexus programs. The goals are to: 1) examine the relationship between water and energy, especially in light of the drought; and 2) to gather and analyze data, consider policies, programs, and pilots to maximize effort. The rulemaking will include several workshops and a consultant calculator to determine how much energy and water are saved by each effort, and to determine funding and marketing. In California, approximately 19% of total electricity and about 33% of the non-power plant natural gas is used for conveyance, treatment, and use of water. The USGS estimates 48% of all U.S. freshwater and saline-water withdrawals were used for thermoelectric power, including cooling. Participant Reaction Forum Participant Finley provided the regulator response to some of the discussion above. In North Carolina, Aqua and Utilities Inc., are the largest water providers. As it relates to cost recovery, he notes that for the most part the water utilities have implemented single tariff pricing since those companies have multiple systems in one state. The companies can use a modified test year in the rate case applications. Additionally, the Legislature has approved the use of a rider to allow recovery of 5% of major capital additions or environmental costs. Storm related costs, however, are deferred to the next rate case. The most recent environmental issue in North Carolina involves electric company, Duke Energy. Duke has been accused of causing a coal ash spill into the Danube River. The spill has migrated downstream bringing with it arsenic and heavy metals. That situation continues to be a major issue for Duke Energy with ongoing investigation and litigation. Forum Participant Burtenshaw focused on the supply issue. In her state, scarcity of supply is a very big concern. 34 As Forum Participant Witmer noted, Pennsylvania has formed an operability working group to identify best practices in a number of areas involving coordination, restoration, or system resiliency as it relates to storm or other tragic events. The purpose is to identify these best practices and gather the appropriate processes before events happen. (b) (c) (d) (e) All relevant state agencies, including the department, the state board, and the State Department of Public Health, shall consider this state policy when revising, adopting, or establishing policies, regulations, and grant criteria when those policies, regulations, and criteria are pertinent to the uses of water described in this section. This section does not expand any obligation of the state to provide water or to require the expenditure of additional resources to develop water infrastructure beyond the obligations that may exist pursuant to subdivision (b). This section shall not apply to water supplies for new development. The implementation of this section shall not infringe on the rights or responsibilities of any public water system. Page 34

36 As it related to the West Virginia spill, both Forum Participants Lynch and Franklin noted that they immediately were able to put their safety procedures in place to assure regulators of the quality of the water. Mr. Lynch also observed that the company s social media efforts were crucial to effective communication with the customers. American Water added staff to call centers and to their website management so that they communicated in real time with the customers. Forum Participant Schilling noted that these are the kinds of events that underscore operating risk. Even though the water companies did not cause any of the tragic events discussed, utility companies must respond to the concern and be prepared for any subsequent litigation. Forum Participant Maye noted the increased calls to American Water during the West Virginia spill and how well American Water handled it all. The company mitigated panic and concern by their effective communication with all stakeholders. As it relates to Forum Participant s Gysel s idea to consider rate and price models that address future infrastructure needs, Forum Participant Hill suggested a future collaboration and presentation by NARUC and NAWC on those ideas. 35 Page 35

37 X. COMMUNICATING THE VALUE OF WATER AND STAKEHOLDER ENGAGEMENT A. NAWC and the Value of Water Campaign For several years, NAWC, its member companies, and other industry influencers have discussed the need for a powerful, collaborative effort leveraging utilities, associations and companies in the water and wastewater community to inform the broader public about the true value of water and the pressing need to increase investment in water resources, infrastructure, and operations. Recognizing a collaborative approach would have the greatest impact, the public and private sectors have joined forces to work together on this critical need. NAWC and several member companies have been working with organizations including the American Water Works Association (AWWA), Water Environmental Federation (WEF), U.S. Water Alliance, American Metropolitan Water Agencies (AMWA) and National Association of Clean Water Agencies (NACWA) to launch a joint campaign to promote awareness of and interest in the Value of Water. These groups have informally formed the Value of Water (VoW) Coalition to brand this shared initiative. Two promising opportunities have arisen as a result of finding this common ground. The first opportunity is a recently reached agreement between the VoW Coalition members to fund joint research that would result in a robust, substantive report on overall awareness and views on water issues, identifying broad message frames and themes. From that research, messaging architecture would be developed for all participating groups to use that would include key messaging, appropriate messaging vehicles and recommended media targets. The objective is to create an effective, long-term public education campaign with consistent, shared messaging and a variety of adaptable tools for VoW Coalition members to use in communicating with critical stakeholders. The second opportunity was brought to WEF by the Ad Council, a private, non-profit organization that recruits volunteer talent from advertising and communications 36 industries, the media, and other resources from business and non-profit communities to deliver specific messages to the American public. Some of their best known work includes Smokey Bear's "Only You Can Prevent Forest Fires," and "A Mind is a Terrible Thing to Waste." While the Ad Council does not aim to directly influence policy or legislative decisions, their campaigns have the power to put issues on the national stage and create a platform for other communications activities. A formal proposal will be submitted for review to the Ad Council board in the coming months. The VoW Coalition views both of these opportunities as independent but complimentary as the research and messaging architecture work will provide the necessary messaging platform for a national campaign if the Ad Council opportunity comes to fruition. If the Ad Council campaign does not occur, NAWC will still have made considerable progress toward this shared goal by having launched the VoW awareness campaign and in a position to expand that effort accordingly. Page 36

38 B. Industry Perspective In light of the many challenges facing the water industry and what we have previously identified as the new normal, Forum Participant Debra Coy provided valuable insight into the importance of communicating the value of water. For an irreplaceable commodity, the price/demand curve for water is a lot more elastic than we once thought. These issues have resulted in a tougher business case for companies because customer demand is declining but capital expenditures and operation expense costs remain high. Equally, there is a tougher value proposition for customers as usage is going down while prices have continued to increase Communicating Value Water utilities have long benefited from a monopoly position in that they are the only source of an essential service. Therefore, in the past, most utilities saw no significant need for marketing, branding, advertising, and public outreach. This is no longer the case. In fact, water rates have reached a level of public sensitivity in many areas. Given the facts about future challenges facing the industry, rates will have to rise further. Consequently, the industry has realized the less than a penny a gallon message isn t enough. As the Black & Veatch survey below demonstrates, the vast majority of water service providers (nearly 85%) feel their customers have little to no understanding of the gap between water costs and water prices Water service providers are facing new challenges in forecasting and preparing for future water demand, staying fiscally solvent while providing fair prices, incorporating conservation and efficiency, and communicating clearly to customers about rates and service. Pacific Institute, June 2013 Page 37

39 The need to increase customer understanding of the value of water is not unique to private water companies. Municipal water (and sewer) systems are facing the same challenges. For example, D.C. Water has a $4 billion capital program. Understanding the value of the projects will ensure recovery for capital costs. San Francisco Public Utilities has a $2.7 billion capital program. Innovatively, San Francisco has used humor to communicate the value of the project. 2. Must Engage a Broader Group of Stakeholders Forum Participant Coy uses the pyramid chart below as an example to emphasize her point that an effective campaign to communicate the value of water must involve a consistent message across multiple stakeholder groups. She notes that there are other stakeholders to add to the pyramid chart. Consistent messaging will have more impact than episodic, varied, and fragmented messages. Underground infrastructure is out of sight, out of mind Ways to Engage Customer education materials, community programs, and marketing campaigns are effective. Ongoing dialogue with multiple stakeholder groups is necessary. While these programs cost money and ratepayers ultimately will pay for them, the industry has to make the case that public education and marketing is a legitimate ratepayer expense. Ensuring public health and system reliability creates long-term cost savings and that benefits the companies and its customers. Page 38