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1 VILLAGE OF BUFFALO GROVE TO: Dane C. Bragg, Village Manager FROM: Scott D. Anderson, Finance Director DATE: September 14, 2011 RE: Water Fund 20 Year Pro Forma / Rate Recommendations History of Water and Sewer Rate Adjustments The Village has had a long history of being a community with consistently low user rates; in fact, the Village maintained a combined water and sewer rate of $1.80/1,000 gallons for a period of twenty three years ( ). One significant reason leading too this period of rate stability was due to the age of the water and sewer infrastructure. During the peak growth decades of the 1980 s and 1990 s, developers paid for, and donated, approximately 53% of the water and sewer system assets. Through a combination of minimal capital expenses coupled with a period of growing water consumption, the Water Fund was able to generate healthy cash reserves to allow for a strategy of pay-as-you-go financing for future infrastructure repair. In FY 2003, a pattern of declining water usage began. In 2002, 1.63 billion gallons of water metered with the average monthly consumption at 7,9066 gallons. In 2010, 1.3 billion gallons metered with an average monthly consumption of 6,140 gallons. The following chart shows the average monthly water consumption since were were 10,000 Average Monthly Usage Residential 9,000 8,000 Gallons 7,000 6,000 5,000 4, The outlier in FY 2005 was drought induced. Absent thatt year, a fairly linear decline began after FY Even with the decline, the Water Fund was able to cover its operating expenses and generate a small surplus each year until A rate recommendation was made to increase the rate by 33% to $2.40/ /1,000. The increase stabilized the fund from an operating standpoint but did not address future Page 1 of 6

2 capital needs. A second rate increase (25% to $3.00/$ $1,000) was proposed for Again the increase helped to ensure that water sales would offsett operating expenditures. The extent of the declinee in consumption was expected to bottom out during but a confluence of factors including, economic, meteorological, and ecologic have continued to put a strain on water sales. For future estimates, it is estimated that the current fiscal year will close at 1.31 billion gallons sold and will carry forward through the 20 year pro forma. Although theree will be an increase in total consumers over the next two decades, continued conservation effortss will likely counterbalancee that growth. One factor that has not been integrated into this analysis is any potential impact of replacing worn out meters in homes. As these devices start to fail and are replaced, there is the potential for more accurate (higher) reads. At this point I cannot quantify an improvement in metering efficiency. Current Financial Position of the Water and Sewer Fund The Village has been prudent about requesting water rate increases ass evident by a twenty-threee year rate freeze. During those years, the Water and Sewer Fund was able to amass a working cash balance that allowed for a reserve to address infrastructure maintenance and improvement. Due to the relative age of the system, over a fifteen year span ( ) the only capital expense was $229,527 for the St. Mary s Road water main replacement. Since 2007 the following capital expenses have occurred; Johnson Drive lift station Linden Avenue lift station Cambridge on the Lake lift station Buffalo Creek water main Arlington Heights water main Reservoir #7 Security Improvements Total $ 240, , ,049 86, ,631 1,777, ,000 $ 3,889,083 Until FY 2007, the Water and Sewer Fund maintained a cash and investment balance of approximately $10 million. That balance was accrued with the intention to cash finance capital projects in the future. As planned, those reserves are being used to pay for almost $4 million in infrastructure repairs and improvements. The additional challenge of managing the use of reserves is that as consumption began to plummet, working cash balances moved in tandem. The current rate structure is no longer funding operating expenses and therefore is not in a position to rebuild reserves. The following chart depicts both the trend of the Water Fund cash balance if no action is taken and a possible rate increase to stabilize the fund s working cash. 15,000,000 10,000,000 5,000,000 (5,000,000) (10,000,000) (15,000,000) (20,000,000) Water Fund Working Cashh Balance Working Cash Rate Increase Working Cash Noo rate increasee Page 2 of 6

3 On the current course, the Water and Sewer Fund will be in a deficitt position in FY With the proposed rate increase, the fund will maintain a positive balance until FY While both scenarios sound ominous there are several assumptionss that factor into the analysis. The finance department has prepared a twenty year proo forma of the Water and Sewer Fund that factors for not only anticipated revenues and operating expenses but also capital expenditures that go beyond the revolving five-year Capital Improvement Plan. Water and Sewer System Assets The first step in the process was to determine the replacement cost of the water main system. The system consists of 181 linear miles of main. The valuee of the main system in today s dollars is approximately $2000 million. The service life of the infrastructure ranges from 50 years for cast iron main to 75 years for ductile iron. The replacement cost off the entire system, inflated at 3% per year, is $773 million. The assumption used for replacing any future water mains is that on any given year where sections of the system have reached the end of their useful life 25% of the system will be replaced. For instance, water main constructed in 1962 has a replacement cost of about $372,000, we will forecast that $94,000 in repairs should be anticipated. This cost estimate is trying to compensate for the improbability that the entire section will be replaced. The estimated reflect rolling replacements where in certain instances only sections are repaired. Another component is that the replacement cost includes a curb-to-curb Projects Street Fund or the Motor Fuel Tax Fund. street reconstruction n. A percentage of that expense will be charged to the Capital Within the straight line depreciation calculation beginningg with the oldest main constructed in 1929, the first replacement should have occurred in Approximately $ 10 million in water mains have expired but have not needed to be repaired. Trying to predict the actual asset life at times is more abstract than qualitative. Pipe that is ensconced in stable soil and subjected to consistent water pressure may have a service life that may double an engineering estimate, and conversely, shifting soils may reduce the life by many years. The following chart shows the pattern of construction of water main since ,,000 70,,000 60,,000 50,,000 40,,000 30,,000 20,,000 10,,000 0 Water Main Construction in linear feet During the thirteen years spanning , almost 50% of the water system was constructed. Fortunately during those years, the more resilient ductile iron was used. The age distribution of the water main leads to the cost estimates to replace the system noted in the graph presented below, Page 3 of 6

4 Infrastructure Replacement $90,000, $80,000, $70,000, $60,000, $50,000, $40,000, $30,000, $20,000, $10,000, $ Decade for Replacement Replacement costs begin to ramp up in the 2060s andd 2070s as main installed during the construction years reaches seventy years of age. peak Water main is only one component of the delivery system. Other assets include the sanitary sewer main, lift stations, and booster stations. The sanitary sewer mainss have roughly the same total mileage as the water main. Since the village does not treat waste there are no treatment facilities to fund. For the purpose of the pro forma, the FY Capital Improvement Plan was added to the calculation. Beyond 2016, a flat amount is budgeted each year to address sanitary sewer system and lift station repairs. Pro Forma and Rate Recommendations The pro forma was developed around an annual consumption base off 1.31 billion gallons. Operating expenses were built upon the FY 2011 and 2012 budgets and indexed for inflation. As part of the analysis, a working cash threshold was established at 25% of the operating budget of the water and sewer fund net of expenses related to Lake County Publicc Works as there are passs though revenues that offset those expenses. At minimum, the fund must strive to always have threee months worth of expenses in the bank. It is estimated that the Water Fund will have nearly $3.9 million at the end of this year. The threshold is $1.2 million. The difference between the two represents cash available for infrastructure. It is anticipated the much of the $2.7 million difference will be used to complete the deep well construction at reservoir #7 and improvements to lift stations. Although this analysis attempts to identify the financiall condition of the fund over the next two decades, the rate recommendat tion focuses on the next three years. Staff is recommending a 56% rate increase phased in over the next three years. The first year would be 25% (3.76/1,000), year two would be 16% (4.35/1,000), and the final year 15% (5.00/1,000). For the outlying years, I factored a CPI adjustment of 3% per year. Below is a graph that sets as a baseline the Village s water rate in A data Village s actual rate set against a CPI adjustedd rate. set represents the Page 4 of 6

5 Water Rates Actual vs CPI Inflation Actual Rate Indexed Rate With the recommended increases, the rate will surpasss inflationary growth in What is not measured on the chart is the value of the variance between the two data sets. Had the village charged a rate based solely on inflation during those yearss the cost to customers would have been an additional $42 million in user charges. The effect of the rate increase on the revenuee and expense profile is noted below. $30,000,000 Revenue vs. Expense $25,000,000 $20,000,000 $15,000,000 $10,000,000 $5,000,000 $0 Total Revenue Total Expense As you can see, the rate increase allows revenues to move in lockstep with expenses. What it doesn t do is start to rebuild the capital reserves (surplus over working cash threshold see chart below) and as discussed previously will not avoid the fund going into a negative cash position into FY Page 5 of 6

6 Ten Year Revenue Adequacy Revenue Operating Expenses Capital Expenses 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000, Staff recognizes the challenges associated with what is a significantt series of rate increases. That being said, these recommended increasess do not address infrastructure improvements in any meaningful manner. The water rate increasess are structured to stabilize operating losses, maintain for the next several years the working cash threshold, and allow time to revisit infrastructure to determine if pay-as-you go financing is still preferred, prudent, and attainable. On a more positive note, the current and past board should be commended on maintaining a water and sewer utility system with an engineeringg value of about a half a billion dollars that is debt free. Going forward, funding solutions in the future may needd to incorporate the issuance of revenue or general obligation bonds. This report, similar to the Corporate Fund Five Year Forecast, will be updated to reflect the fund s most current position. reviewed at least annually and It is recommendedd that an infrastructure reserve funding formula be developed years as part of a comprehensivee water/sewer utility strategy. over the next two Page 6 of 6