San Francisco Public Utilities Commission

San Francisco Public Utilities Commission Water & Wastewater Rate Study Report March 6, 2009 Prepared by:

Table of Contents I. EXECUTIVE SUMMARY...1 A. Pricing Objectives...2 B. Review of Findings Water...2 Water System...2 Capital Financing Plan Summary...3 Review of Water Revenue Requirements...3 Reserve Funds...5 Current Water Rate Structure...5 Cost of Service - Water...6 Rate Design - Water...7 C. Recommendations and Proposed Changes - Water...7 User Classifications...7 Proposed Water Rate Structure...7 Customer Impacts - Water...9 D. Review of Findings Wastewater...11 Wastewater System...11 Wastewater Capital Financing Plan Summary...11 Review of Wastewater Revenue Requirements...12 Reserve Funds...14 Current Wastewater Rate Structure...14 Cost of Service - Wastewater...15 E. Recommendations and Proposed Changes Wastewater...15 User Classifications...15 Proposed Wastewater Rate Structure...15 Customer Impacts...18 Comparison with Other Utilities...20 Raftelis Financial Consultants, Inc. i

II. INTRODUCTION...23 A. Current Environment...23 B. Study and Pricing Objectives...24 C. Scope of the Study...25 III. WATER SYSTEM AND CURRENT WATER RATE STRUCTURE...27 A. Water System...27 B. Existing Rate Structure...27 C. Growth...30 D. Usage Characteristics...30 IV. WATER REVENUE REQUIREMENTS...32 A. Annual Operating Revenues Under Existing Rates...32 B. Operating and Capital Expenses...33 D. Proposed Revenue Adjustments...37 E. Debt Coverage...40 F. Reserve Fund...41 V. PROPOSED WATER RATES AND CUSTOMER IMPACTS...46 A. Overview of Rate Setting...46 B. Cost of Service Analysis...46 C. Unit Costs of Service...50 D. Proposed Water Rate Structure and Rates...56 E. Customer Impacts...62 F. Comparisons with Other Local Utilities...64 VI. WASTEWATER SYSTEM AND CURRENT RATE STRUCTURE...67 A. Wastewater System...67 B. Current Rate Structure...67 C. Growth...70 Raftelis Financial Consultants, Inc. ii

D. Wastewater Customer Accounts...70 E. Wastewater Discharge Characteristics...70 VII. WASTEWATER REVENUE REQUIREMENTS...72 A. Revenues Under Existing Retail Rates...72 B. Operating and Capital Expenses...73 B. Wastewater Capital Financing Plan...74 C. Proposed Revenue Adjustments...76 D. Debt Coverage...79 C. Reserve Funds...80 VIII. PROPOSED WASTEWATER RATES AND CUSTOMER IMPACTS...82 A. Overview of Rate Setting...82 B. Cost of Service Analysis...82 C. Unit Cost of Service...83 D. Proposed Wastewater Rate Structure and Rates...86 E. Customer Impacts...90 F. Comparisons with Other Local Utilities...97 Raftelis Financial Consultants, Inc. iii

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I. EXECUTIVE SUMMARY In July 2008, the San Francisco Public Utilities Commission ( SFPUC ) engaged Raftelis Financial Consultants, Inc. ( RFC ) to provide utility rate consulting services and complete a water and wastewater rate study ( Study ). The objectives of the Study was to evaluate the financial impacts of the SFPUC s ten-year financial plan from fiscal year ( FY ) 2009 through FY 2018 and provide water and wastewater rate structure and revenue adjustment recommendations for the next five years. To address these objectives, RFC developed separate ten-year water and wastewater rate and financial planning models (referred to collectively as Models or separately as Water Model and Wastewater Model ) to serve as planning tools in evaluating alternative rate structures and providing more detailed forecasts to assist in updating rates in future years. The Study recommendations and resulting rate structures need to be in compliance with the City of San Francisco ( City ) Charter based on the following objectives: Provide sufficient revenues for the operations, maintenance, and repair of the enterprise consistent with good utility practice; Provide sufficient revenues to improve or maintain financial condition and bond ratings at or above levels equivalent to highly rated utilities of each enterprise; Meet requirements and covenants under all bond indentures; Rates based on cost of service; Investigate and develop capacity fees for new development; Investigate and develop rate-based conservation incentives; and Investigate and develop affordability programs for low-income customers. This executive summary ( ES ) documents the results of the Study and identifies the recommended changes to cost allocations and rate structures that are more appropriate in addressing the SFPUC s utility pricing objectives in FY 2010 and beyond. This ES discusses the SFPUC s rate pricing objectives, the findings of our analysis of the water and wastewater systems, and the cost of service and rate recommendations for water and wastewater enterprises. All years referenced in this ES and water and wastewater rate report ( Report ) should be assumed to be fiscal years, unless stated otherwise. The conceptual design memorandum and the results of our benchmarking survey are included as appendices to this report, while our recommendations related to the water and wastewater capacity fees, miscellaneous fees, and stormwater issues evaluated as part of this Study are documented in separate reports. Raftelis Financial Consultants, Inc. 1

A. Pricing Objectives The Study began with a kick-off meeting and a conceptual design workshop to assist RFC in understanding and prioritizing the SFPUC s rate pricing objectives. Following the August 2008 kick-off meeting, RFC developed a list of utility pricing objectives based on initial discussions with the SFPUC management team and our preliminary understanding of the important issues facing the SFPUC. As part of this process, these pricing objectives were confirmed with the SFPUC management team and serve as the basis for evaluating the rate structure alternatives recommended in the report. As part of the conceptual design workshop, RFC analyzed the existing water and wastewater rate structures, performed a water usage analysis, and examined alternative rate structures to ensure proposed rates would be consistent with the SFPUC pricing objectives and financial planning goals. This conceptual design process resulted in the identification of rate structures, and/or modifications to existing rates, suitable for further evaluation. B. Review of Findings Water This section of the ES provides a brief description of the water system, a review of the revenue requirements, the capital financing plan, an analysis of cost of service, the current rate structure, the design of water rates, and customer impacts for two alternative water rate structures. Water System The SFPUC currently provides water to retail customers in the City and County of San Francisco ( retail area ) and 28 wholesale ( regional ) water customers in Santa Clara, Alameda, and San Mateo counties. The population of the retail area is estimated to be about 825,000 with approximately 173,000 water accounts that includes customers located both inside and outside the City s corporate boundaries. Water sales to retail customers currently represent about 31% of the total water sales and approximately 44% of the total water revenue. The SFPUC water system extends from Hetch Hetchy Valley in Yosemite National Park to the Bay Area. The transmission system operates primarily through gravity lines and traverses three major fault lines. SFPUC is currently in the process of implementing a $4.4 billion Water System Improvement Program ( WSIP ) to improve system reliability and enhance quality of the water it delivers to its customers. 1 WSIP includes seismic improvements to reservoirs as well as 1 Although the total estimated cost of the WSIP is approximately $4.4 billion (including financing costs), the SFPUC already began and/or secured financing for certain project components of the WSIP. As a result, the total costs funded during the ten-year financial planning period for this Study are approximately $3.9 billion. Raftelis Financial Consultants, Inc. 2

pipeline replacement, and new facilities. The primary mechanism to fund WSIP will be debt, and the financial impacts from implementation of the WSIP will be significant. Capital Financing Plan Summary WSIP includes regional capital projects that address capital needs that benefit wholesale and retail customers and local capital projects that solely benefit retail customers. In addition to WSIP, the Water ten-year capital plan evaluated as part of this Study also includes smaller renewal and replacement ( R&R ) projects. The WSIP projects, totaling approximately $3.3 billion, will be funded through the issuance of long term debt. R&R projects, totaling approximately $398 million, will be funded through current revenues. Figure ES-1 displays all capital spending. FIGURE ES-1 WATER CAPITAL SPENDING Millions $900 $800 WSIP R&R $700 $600 $500 $400 $300 $200 $100 $- 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Based on the WSIP spending plan, the SFPUC anticipates issuing $3.9 billion of Water Revenue Bonds. In additional to the $3.3 billion for project funding, the bonds will include funding for issuance costs, funding reserves, and capitalized interest. The SFPUC plans to fund the $398 million of R&R projects using annual rate revenues during the ten-year financial planning period. As Figure ES-1 demonstrates, the majority of the water capital spending is required for the WSIP from FY 2009 through FY 2014. The annual R&R project spending is less substantial and more consistent annually as these expenditures remain within a range of approximately $40 to $70 million during the forecast period. Review of Water Revenue Requirements Figure ES-2 shows the water system s estimated total revenue requirements of approximately $279 million in FY 2010, which consist of operating & maintenance ( O&M ) expenses, debt Raftelis Financial Consultants, Inc. 3

service, and revenue funded capital. Water revenue requirements will escalate considerably after FY 2010 primarily due to the additional debt service on bonds used to fund the WSIP. For example, total debt service increase from approximately $70 million in FY 2010 to approximately $321 million in FY 2018. Millions $700 $600 $500 $400 $300 $200 $100 $- $(100) FIGURE ES-2 WATER REVENUE REQUIREMENTS 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 O&M Debt Service Net Revenues Revenue Under Proposed Rates 060 - Capital Outlay Revenue Funded Capital Revenue Under Existing Rates The water system s principal source of operating revenue is from rates and charges on water sales to both retail and wholesale customers. Revenues from retail customers under the existing rates are expected to increase from $122.4 million in FY 2009 to $127.3 million by FY 2018. The wholesale customer revenues are expected to increase from $126.5 million in FY 2009 to $342.3 million by FY 2018, assuming wholesale rate adjustments based on the terms of existing contract. As the red line in Figure ES-2 demonstrates, anticipated revenues to be generated through the existing rates will not sufficient to recover the annual revenue requirements, fund operating reserves, and debt service coverage requirements during the ten-year financial planning period. To address this shortfall, revenue adjustments will be needed. The green line reflects the revenue stream under RFC s proposed rate adjustments, which results in sufficient revenues to meet both operating and capital funding needs. Both the red and green lines include wholesale revenue forecasts under the existing contract. With approximately $3.9 billion in new bonds issued to fund WSIP, additional revenues must increase significantly to meet bond covenant requirements (i.e. net revenues plus operating reserves must be at least 1.25 times annual debt service). Meeting this coverage test is crucial as Raftelis Financial Consultants, Inc. 4

a failure to maintain indenture requirements would result in a default of the bond covenant. Should the SFPUC fail to remedy a default, the bondholders could demand full payment of all outstanding bonds. To sustain operations, adequately fund reserves, and continue to meet bond indenture requirements over the planning period, RFC forecasts in Table ES-1 the following annual retail rate adjustments over the next five years. TABLE ES-1 WATER REVENUE ADJUSTMENTS (FY 2010 THROUGH FY 2014) FY 2010 15% FY 2011 15% FY 2012 10% FY 2013 10% FY 2014 3% Following FY 2014, we forecast annual revenue adjustments of 3% for the remainder of the forecast period. Given the inelastic nature of the SFPUC usage, these annual retail revenue adjustments do not consider nor assume any reductions in water demands due to price elasticity. A discussion of proposed rates in Section V provides more information on the potential effects of price elasticity. Reserve Funds The Water Enterprise s unappropriated fund balance functions as an operating reserve. This reserve is used for working capital requirements to meet the ongoing expenses of the water system operations. In addition, the SFPUC bond indentures allow these funds to be counted toward calculating the debt service coverage. Generally, practice in the utility business is to target a balance of 10 to 40% of annual O&M expenses. The SFPUC s current goal is approximately 25% of annual O&M expenses. Because water consumption does not vary much during the year and revenue is stable, we feel that 25% of annual O&M is a reasonable target for the operating reserve. As part of this Study, RFC conducted a benchmark survey of eleven water and/or wastewater utilities in large cities throughout the country and the majority of the respondents identified operating reserve policies that were below the SFPUC s current 25% of annual O&M expenses. However, many of these utilities also indicated having other types of reserves that provide additional levels of unappropriated cash balances. The result of the survey is presented in Table ES-8. Current Water Rate Structure The SFPUC s existing rate structure consists of two parts: a variable portion and a fixed monthly/bi-monthly charge. For single-family residential ( SFR ) customers, the variable Raftelis Financial Consultants, Inc. 5

portion is comprised of a two-tier, inclining block rate structure. Both multi-family residential ( MFR ) and non-residential customers pay uniform commodity rates specific to their customer class. The fixed monthly/bi-monthly charges are applicable to all customer classes and vary by meter size. 2 Private fire protection service rates are also assessed according to meter size. Customers located outside of the retail area have the same rate structures as the retail customers, but are charged a 25% outside-city differential. Affordability is important, especially in the current economic climate. By EPA guidelines, bills less than 2% of median housing income are deemed affordable. The median monthly household income in the City is $5,459 (annual income of $65,519) as of 2007. 3 An average water bill of $21.21 at existing rates represents less than 1% (0.39%) of monthly median household income. Despite recent rate increases, the monthly water bill for the typical SFR customer with consumption of 6.5 hundred cubic feet ( Ccf ) within the City of San Francisco compares reasonably with similar communities, as shown at the end of this ES in Figure ES-5. The findings of RFC s review of the City s existing water rate structure were mostly favorable. The existing fixed charges appear to be largely consistent with meter capacity ratios, cost of service principles, and accepted industry practices. The commodity charges are also largely consistent with cost of service principles but can be improved to comply more with the City Charter objective to provide rate-based conservation incentives. Cost of Service - Water The cost of service ( COS ) to be recovered from retail users through rates is estimated at approximately $141 million in FY 2010 and increases to $236 million by FY 2014. The COS allocations conducted for this study are based on the Base-Extra Capacity method endorsed by the American Water Works Association ( AWWA ). Under the Base-Extra Capacity method, revenue requirements are allocated to the different user classes proportionately to their use of the water system. Allocations are based on average day ( Base ) usage, maximum day peak ( Max Day ) usage, maximum hour peak ( Max Hour ) usage, meters and services, and billing and collection. 2 The non-residential customer class comprises various customer classifications including commercial, industrial, docks & ships, builders & contractors, municipal, non-paying, agriculture, and airport. 3 http://www.bayareacensus.ca.gov/counties/sanfranciscocounty.htm Raftelis Financial Consultants, Inc. 6

Rate Design - Water The rate alternatives presented as part of this Study incorporate AWWA recommended methodologies adapted to meet the SFPUC s specific characteristics and provides for a system of user charges that will enhance the proportionate recovery of costs from the various user classes. C. Recommendations and Proposed Changes - Water RFC s recommendations were designed to address the SFPUC s pricing objectives and enhance equity in the recovery of costs of the water utility to the benefit of the SFPUC s customers. These changes include adjustments to monthly service charges, an updated cost of service for all commodity rates, and modifications to the SFR rate structure. User Classifications At this time, we recommend retaining the existing customer classes. However, we have adjusted the class peaking factors provided by the SFPUC. These factors will help provide a more equitable distribution of costs among SFR, MFR, and non-residential classes. Proposed Water Rate Structure The following discussion outlines proposed alternatives to address rate findings described in the previous section. RFC recommends retaining a tiered SFR commodity rate structure with the two alternatives to consider, including 1) implementing an additional third tier; or 2) retaining the current two tiered structure. The additional tier under the first alternative will provide an additional incentive for water conservation, while enhancing customer equity by improving the cost justification for the tiered rates through the Base-Extra Capacity cost allocations. Under the three tier structure, the first block usage cut-off will remain at 3 Ccf (approximately 2,200 gallons) per month, which is roughly one half of the 6.5 Ccf (approximately 4,900 gallons) per month average usage for the SFR customer class. The second block usage cut-off will be set at a monthly usage of 10 Ccf (approximately 7,500 gallons). The first and second tier cutoffs encompass 84% of the consumption and 88% of the customer bills. The proposed rates are shown in Table ES-2. Should the SFPUC decide the recommended three tier rate structure for SFR customers is not appropriately aligned with community values, and opt to continue with the two tiered structure, the SFPUC should implement cost of service based two tiered commodity rates. Under the revised two-tiered rate structure, the block cutoff would Raftelis Financial Consultants, Inc. 7

remain at 3 units and the tier one and tier two rates would be $2.45 and $3.94, respectively. Under both options the other customer classifications will retain uniform commodity rates that reflect their peaking characteristics. The cost of providing private fire protection was also updated as part of our analysis. The existing private rates were set many years ago and have not been updated since 1996. The rates were updated to be more consistent with the COS principles outlined in the AWWA M-1 manual chapter on Rates for Fire Protection Services. Table ES-2 reflects the SFPUC s existing rates and recommended changes for FY 2010. Rates for outside-city customers will include a 25% premium. Rate adjustments for the forecast period beyond FY 2010 will be across-the-board increases. TABLE ES-2 EXISTING AND PROPOSED WATER RATES Fixed Monthly Charge Potable Fire Service Existing Proposed Existing Proposed Meter Size FY 09 FY10 FY 09 FY10 5/8" $ 4.70 $ 5.70 3/4" $ 5.70 $ 6.60 N/A 1" $ 7.60 $ 8.40 $ 9.30 $ 0.40 1-1/2" $ 12.30 $ 12.90 $ 13.90 $ 1.20 2" $ 18.00 $ 18.30 $ 25.30 $ 2.40 3" $ 31.30 $ 31.00 $ 44.10 $ 7.00 4" $ 50.20 $ 49.10 $ 58.90 $ 14.90 6" $ 97.60 $ 94.30 $ 88.10 $ 43.10 8" $ 154.50 $ 148.60 $ 118.10 $ 91.70 10" $ 220.90 $ 211.90 $ 128.90 $ 164.80 12" $ 410.40 $ 392.90 $ 176.10 $ 266.20 16" $ 713.80 $ 682.30 N/A Commodity Rates Customer Existing Proposed Class Block FY 09 Block FY10 CPRS (Single Family) 0-3 $ 2.28 0-3 $ 2.45 4+ $ 2.89 4-10 $ 3.72 11+ $ 4.82 CPRM (Multi Family) $ 2.87 - $ 3.32 CPCM (Commercial) $ 2.92 - $ 3.45 CPIN (Industrial) $ 2.92 - $ 3.45 CPDS (Docks & Ships) $ 2.92 - $ 3.45 CPBC (Builders & Contractors) $ 2.92 - $ 3.45 CPMU (Municipal) $ 2.92 - $ 3.45 AG/AP $ 2.92 - $ 3.45 Raftelis Financial Consultants, Inc. 8

Customer Impacts - Water COS principles serve as the basis of the rate calculations throughout the process. Because the SFPUC is facing multiple years of rate increases, the impact on various customers was considered during the entire rate design process. Raftelis Financial Consultants, Inc. 9

Single-family Residential All SFR customers will experience bill increases in FY 2010 as a result of increases to both the fixed service charge and the commodity rates. Table ES-3 summarizes impacts for various SFR customers in FY 2010. TABLE ES-3 BI-MONTHLY BILL IMPACTS FOR SFR 5/8 METERS FY 2010 Alternative 1 Alternative 2 Total Bill Change Change Usage Existing Proposed % $ Proposed % $ 6 $ 23.08 $ 26.10 13% $ 3.02 $ 26.10 13% $ 3.02 8 $ 28.86 $ 33.54 16% $ 4.68 $ 33.98 18% $ 5.12 10 $ 34.64 $ 40.98 18% $ 6.34 $ 41.86 21% $ 7.22 12 $ 40.42 $ 48.42 20% $ 8.00 $ 49.74 23% $ 9.32 13 $ 43.31 $ 52.14 20% $ 8.83 $ 53.68 24% $ 10.37 15 $ 49.09 $ 59.58 21% $ 10.49 $ 61.56 25% $ 12.47 18 $ 57.76 $ 70.74 22% $ 12.98 $ 73.38 27% $ 15.62 24 $ 75.10 $ 97.46 30% $ 22.36 $ 97.02 29% $ 21.92 30 $ 92.44 $ 126.38 37% $ 33.94 $ 120.66 31% $ 28.22 13 CCF is the average bi-monthly usage Multi-Family Residential All MFR customers will also be impacted as a result of increases to both the fixed charge and the commodity charge. Table ES-4 presents FY 2010 impacts to certain MFR customers; the impacts are the same under both alternatives. TABLE ES-4 BILL IMPACTS FOR MULTI-FAMILY 5/8 METERS FY 2010 Non-Residential/Commercial Total Bill Change Usage Existing Proposed % $ 2 $ 15.14 $ 18.04 19% $ 2.90 3 $ 18.01 $ 21.36 19% $ 3.35 4 $ 20.88 $ 24.68 18% $ 3.80 5 $ 23.75 $ 28.00 18% $ 4.25 6 $ 26.62 $ 31.32 18% $ 4.70 8 $ 32.36 $ 37.96 17% $ 5.60 10 $ 38.10 $ 44.60 17% $ 6.50 12 $ 43.84 $ 51.24 17% $ 7.40 14 $ 49.58 $ 57.88 17% $ 8.30 Most non-residential customers will be impacted by increases to both the fixed charge and the commodity rate. Table ES-5 displays impacts to the certain non-residential customers in FY 2010; the impacts are the same under both alternatives. Raftelis Financial Consultants, Inc. 10

TABLE ES-5 BILL IMPACTS FOR COMMERCIAL 5/8 METERS FY 2010 Total Bill Change Usage Existing Proposed % $ 6 $ 20.22 $ 24.40 21% $ 4.18 12 $ 37.74 $ 45.10 20% $ 7.36 18 $ 55.26 $ 65.80 19% $ 10.54 24 $ 72.78 $ 86.50 19% $ 13.72 30 $ 90.30 $ 107.20 19% $ 16.90 36 $ 107.82 $ 127.90 19% $ 20.08 42 $ 125.34 $ 148.60 19% $ 23.26 48 $ 142.86 $ 169.30 19% $ 26.44 D. Review of Findings Wastewater This section of the ES provides a brief description of the wastewater system, a review of the revenue requirements, the capital financing plan, an analysis of COS, the design of wastewater rates, and customer impacts. Wastewater System The wastewater system serves the City and County of San Francisco and adjacent areas. The system provides service to approximately 173,000 accounts, the vast majority of which are residential. The wastewater system is a combined sewer and stormwater system which is divided into zones. The wastewater system consists of two wastewater treatment plants, a wet weather facility, and 898 miles of wastewater lines. To meet regulatory requirements, large transportation sewers maintain underground storage structures to limit the number and volume of combined sewer overflows. The SFPUC is addressing neighborhood flooding and odor issues through a five-year interim capital improvement program ( CIP ) and has a long-term vision and strategy for the management of the SFPUC s wastewater and stormwater infrastructure as part of a long-term master plan. Wastewater Capital Financing Plan Summary Similar to the water enterprise, the wastewater system has a significant amount of capital projects planned. The wastewater CIP is segregated into three categories of projects: 1) wastewater master plan projects totaling $3.4 billion that will be funded primarily through new debt issues; 2) R&R projects totaling $230 million that will be funded through annual rate revenues; and 3) the five-year interim CIP projects, totaling $215 million. The CIP includes projects to address odor control, sewer collection system replacements, and treatment facilities and pump stations upgrades. Figure ES-3 reflects the total capital expenditures during the forecast period. Raftelis Financial Consultants, Inc. 11

FIGURE ES-3 WASTERWATER CAPITAL SPENDING Millions $800 $700 $600 $500 $400 $300 $200 $100 $0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Master Plan R&R 5 year CIP As Figure ES-3 demonstrates, the majority of the wastewater capital spending relates to master plan projects that are anticipated to occur from FY 2014 through FY 2018, with the peak year of $642 million in capital expenditures occurring in FY 2016. Review of Wastewater Revenue Requirements Estimates show the wastewater system s total revenue requirements is approximately $216 million in FY 2010, which consist of O&M expenses, debt service and annual revenue funded capital. Annual revenue requirements escalate thereafter due to anticipated inflation in O&M expenses and on-going R&R spending. The majority of the annual increases result from new debt service associated with anticipated bonds required to fund the wastewater master plan projects. For example, total debt service requirements increase from approximately $67 million in FY 2009 to approximately $179 million in FY 2018. Figure ES-4 represents the projected revenue requirements over the ten-year forecast period. Raftelis Financial Consultants, Inc. 12

Millions $450 $400 $350 $300 $250 $200 $150 $100 $50 $0 -$50 FIGURE ES-4 WASTEWATER REVENUE REQUIREMENTS 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 O&M Debt Service 060 - Capital Outlay Revenue Funded Capital Transfer to Capital Fund Net Revenues Revenue Under Existing Rates Revenue Under Proposed Rates The wastewater system s principal source of operating revenue is from user charges to both retail customers and three special districts served under separate Joint Powers Agreements. The retail customer revenues under the current rates are expected to increase from $206.0 million in FY 2009 to $215.5 million by FY 2018 while the revenues received from special districts are shown to remain at $6.0 million throughout the ten-year forecast period. As a result, the total user charge revenues under the current rates are expected to increase from $212.0 million in FY 2009 to $221.50 million by FY 2018. As the red line in Figure ES-4 demonstrates, anticipated revenues to be generated through the existing rates are not sufficient to recover the annual revenue requirements including funding operating reserve and meet debt service requirements during the ten-year financial planning period. To address this shortfall, revenue adjustments will be needed. The green line reflects the revenue stream under the proposed annual adjustments, which results in sufficient revenues to meet both operating and capital funding needs. With approximately $3.8 billion in new bonds issued over the forecast period to fund the significant capital plan, additional revenues needed to meet debt coverage requirements will be needed.. Specifically, in order to meet revenue requirements we forecast revenue adjustments for the next five years as presented in Table ES-7. Raftelis Financial Consultants, Inc. 13

TABLE ES-7 WASTEWATER REVENUE ADJUSTMENTS (FY 2010 THROUGH FY 2014) FY 2010 7% FY 2011 7% FY 2012 6% FY 2013 6% FY 2014 6% Subsequent to FY 2014, additional wastewater revenue adjustments will range from 5 to 9%. Reserve Funds Similar to the Water Enterprise, the Wastewater Enterprise s unappropriated fund balance functions as an operating reserve. This reserve is used for working capital requirements to meet the ongoing expenses of the wastewater system operations. In addition, the SFPUC bond indentures allow these funds to be counted toward calculating the debt service coverage. Generally, practice in the utility business is to target a balance of 10 to 40% of annual O&M expenses. The SFPUC s current goal is approximately 25% of annual O&M expenses. Because wastewater billings do not vary much during the year and revenue is stable, we feel that 25% of annual O&M is a reasonable target for the operating reserve. Again, the majority of the respondents in our benchmark group of large utilities identified operating reserve policies that were at or below the SFPUC s current 25% of annual O&M expenses. Table ES-8 identifies the eleven respondents and summarizes the various types of reserves the respondents indicated utilizing as either policy or practice. TABLE ES-8 OPERATING RESERVE BENCHMARKING Benchmark Utility Operating Stabilization Capital Debt Other Replace Assistance San Antonio Water System X X Phoenix Water Services Department X X Seattle Public Utilities X X Portland Water Bureau X X X San Diego Water Department X X X X San Diego Metropolitan Wastewater X X X X Los Angeles LADWP X X Los Angeles (LABS) X Denver Water X Sacramento (SCRSD) X X X XX XX XX New York City X X Note: More than one x indicates more than one fund in that category Current Wastewater Rate Structure Residential wastewater customers (Schedule A), consisting of single-family and multi-family, and are charged a three-tiered rate structure. The rate for the first three units of wastewater flow is $3.42, followed by a rate of $8.55 for the next two discharge units, and $9.77 for any Raftelis Financial Consultants, Inc. 14

additional discharge units. 4 No additional charges are assessed to these residential customers for wastewater strength, as these costs are recovered through the flow rates based on domestic strength levels. Non-residential customers (Schedule B) pay a uniform rate of $6.5548 per unit, which is based on 90% of metered water usage. Unlike residential customers, non-residential customers are charged separatel wastewater strength charges. For chemical oxygen demand ( COD ) the strength charge is $0.216 per ( lb ), while the strength charges for suspended solids ( SS ) and grease and oil ( G/O ) are $0.8819 and $1.1035 per lb, respectively. Again, with a median monthly household income in the City of $5,650, an average $40.06 wastewater bill represents less than 1% (0.7%) of monthly median household income. According to EPA guidelines, bills of less than 2% of median housing income are deemed affordable. Despite recent rate increases, the monthly wastewater bills for the typical SFR customer with consumption of 6.5 hundred cubic feet ( Ccf ) within the City of San Francisco compares reasonably with similar communities, as shown at the end of this ES in Figure ES-5. Cost of Service - Wastewater The COS to be recovered from retail users through rates is estimated at approximately $221.5 million in FY 2010 and increases to $288 million by FY 2014. E. Recommendations and Proposed Changes Wastewater Based on our understanding of the SFPUC s wastewater financial and pricing objectives, RFC developed rate structure modifications designed to enhance the equitable recovery of wastewater costs from various SFPUC wastewater customers based on COS principles and accepted industry practices. User Classifications At this time, we recommend retaining the existing customer classes. This includes residential (single-family and multi-family) wastewater customers and non-residential customers. Proposed Wastewater Rate Structure To reflect full COS, we recommend recovering the appropriate amount of capital costs assigned to each customer class through the rates assessed to those customers. In the case of the 4 A discharge unit represents 100 cubic feet of metered water usage multiplied by the SFR return factor of 90% and MFR return factor of 95%. Raftelis Financial Consultants, Inc. 15

residential customer class, this can be accomplished by moving toward a uniform rate structure that incorporates all capital costs allocated to the class. This rate structure is outlined in the first of three rate structure alternatives (designated as A-1, A-2 and A-3) presented in this section. Ideally rates should be set in accordance with A-1. However, because of the significant impacts on residential customers, A-2 and A-3 are provided as additional alternatives that phase in the recommended rate structure. A-1 implements the uniform residential rate immediately and moves to the cost of service based rate structure in the first year. The existing rate structure and proposed rates for the five-year forecast period are shown in the following table. After the test year, FY 2010, the rates are increased across the board by the annual revenue adjustment. Table ES-9 outlines the existing and proposed A-1 rates. TABLE ES-9 EXISTING AND PROPOSED WASTEWATER RATES ALTERNATIVE 1 Existing Residential 2009 0-3 Discharge ($/CCF) $ 3.42 4-5 Discharge ($/CCF) $ 8.55 6+ Discharge ($/CCF) $ 9.77 Non-Residential Discharge ($/CCF) $ 6.5548 COD ($/lb) $ 0.2156 SS ($/lb) $ 0.8819 G/O ($/lb) $ 1.1035 Proposed - Alternative 1 2010 2011 2012 2013 2014 Residential Discharge ($/CCF) $ 7.484 $ 8.010 $ 8.500 $ 9.010 $ 9.560 Non-Residential Discharge ($/CCF) $ 5.3785 $ 5.7550 $ 6.1003 $ 6.4664 $ 6.8544 COD ($/lb) $ 0.2427 $ 0.2597 $ 0.2753 $ 0.2919 $ 0.3095 SS ($/lb) $ 0.6323 $ 0.6766 $ 0.7172 $ 0.7603 $ 0.8060 G/O ($/lb) $ 0.7135 $ 0.7635 $ 0.8094 $ 0.8580 $ 0.9095 A-2 and A-3 ultimately end up at the same place as A-1 the rates in FY 2014 are identical in each alternative. Table ES-10 outlines the existing and A-2 rates. This approach implements a uniform rate for residential customers right away, but it phases in the full cost of service rate over the five year period. Raftelis Financial Consultants, Inc. 16

TABLE ES-10 EXISTING AND PROPOSED WASTEWATER RATES ALTERNATIVE 2 Existing Residential 2009 0-3 Discharge ($/CCF) $ 3.42 4-5 Discharge ($/CCF) $ 8.55 6+ Discharge ($/CCF) $ 9.77 Non-Residential Discharge ($/CCF) $ 6.5548 COD ($/lb) $ 0.2156 SS ($/lb) $ 0.8819 G/O ($/lb) $ 1.1035 Proposed - Alternative 2 2010 2011 2012 2013 2014 Residential Discharge ($/CCF) $ 6.665 $ 7.458 $ 8.186 $ 8.958 $ 9.560 Non-Residential Discharge ($/CCF) $ 6.5548 $ 6.5548 $ 6.5548 $ 6.5548 $ 6.8544 COD ($/lb) $ 0.2156 $ 0.2156 $ 0.2156 $ 0.2156 $ 0.3095 SS ($/lb) $ 0.8819 $ 0.8819 $ 0.8819 $ 0.8819 $ 0.8060 G/O ($/lb) $ 1.1035 $ 1.1035 $ 1.1035 $ 1.1035 $ 0.9095 A-3, outlined in Table ES-11 on the following page, retains the current three tier rate structure and phases it out over several years, as shown below. This option would have more gradual impacts on customers. Raftelis Financial Consultants, Inc. 17

TABLE ES-11 EXISTING AND PROPOSED WASTEWATER RATES ALTERNATIVE 3 Existing Residential 2009 0-3 Discharge ($/CCF) $ 3.42 4-5 Discharge ($/CCF) $ 8.55 6+ Discharge ($/CCF) $ 9.77 Non-Residential Discharge ($/CCF) $ 6.5548 COD ($/lb) $ 0.2156 SS ($/lb) $ 0.8819 G/O ($/lb) $ 1.1035 Proposed - Alternative 3 2010 2011 2012 2013 2014 Residential 0-3 Discharge ($/CCF) $ 3.960 $ 5.000 $ 6.250 $ 8.000 $ 9.560 4-5 Discharge ($/CCF) $ 8.980 $ 9.330 $ 9.660 $ 9.990 $ 9.560 6+ Discharge ($/CCF) $ 11.360 $ 11.933 $ 11.710 $ 10.403 $ 9.560 Non-Residential Discharge ($/CCF) $ 6.5548 $ 6.5548 $ 6.5548 $ 6.5548 $ 6.8544 COD ($/lb) $ 0.2156 $ 0.2156 $ 0.2156 $ 0.2156 $ 0.3095 SS ($/lb) $ 0.8819 $ 0.8819 $ 0.8819 $ 0.8819 $ 0.8060 G/O ($/lb) $ 1.1035 $ 1.1035 $ 1.1035 $ 1.1035 $ 0.9095 Customer Impacts The tables in this section will cover bill impacts under the three wastewater rate structure alternatives. Because the proposed rate structure includes a re-allocation of costs between customer classes in addition to the revenue adjustments, the initial impacts for residential customers are more than the overall annual revenue adjustment required in the forecast period. However, this initial impact is necessary to correct to current cost recovery issues associated with the first tier residential rate and to move toward a uniform rate over five years. Table ES-12 presents impacts for residential customers in FY 2010 under A-1. All residential bill impacts will be calculated on a bi-monthly basis. Bill impacts for non-residential customers under A-1 are shown in Table ES-13. Since rate adjustments thereafter are applied across the board, the bill impacts will be equal to the overall annual revenue adjustment. Raftelis Financial Consultants, Inc. 18

TABLE ES-12 BILL IMPACTS FOR RESIDENTIAL WASTEWATER CUSTOMERS ALTERNATIVE 1 - FY 2010 Change Discharge Existing Proposed % $ 3 $ 10.26 $ 22.45 119% $ 12.19 6 $ 20.52 $ 44.91 119% $ 24.39 8 $ 37.62 $ 59.87 59% $ 22.25 10 $ 54.72 $ 74.84 37% $ 20.12 11 $ 64.49 $ 82.33 28% $ 17.84 12 $ 74.26 $ 89.81 21% $ 15.55 14 $ 93.80 $ 104.78 12% $ 10.98 16 $ 113.34 $ 119.75 6% $ 6.41 18 $ 132.88 $ 134.72 1% $ 1.84 10 CCF is the average MFR bi-monthly discharge 12 CCF is the average SFR bi-monthly dishcarge TABLE ES-13 BILL IMPACTS FOR NON-RESIDENTIAL WASTEWATER CUSTOMERS ALTERNATIVE 1 - FY 2010 Change Discharge Existing Proposed % $ 10 $ 65.55 $ 53.79-18% -$11.76 20 $ 131.10 $ 107.57-18% -$23.53 30 $ 196.64 $ 161.36-18% -$35.29 40 $ 262.19 $ 215.14-18% -$47.05 50 $ 327.74 $ 268.93-18% -$58.82 60 $ 393.29 $ 322.71-18% -$70.58 70 $ 458.84 $ 376.50-18% -$82.34 80 $ 524.38 $ 430.28-18% -$94.10 90 $ 589.93 $ 484.07-18% -$105.87 100 $ 655.48 $ 537.85-18% -$117.63 Table ES-14 and ES-15 outlines the bill impacts for residential customers in FY 2010 under A2 and A-3, respectively. Non-residential bills are unchanged until FY 2014. Bill impacts for the full five year period can be found in the main section of this report. Raftelis Financial Consultants, Inc. 19

TABLE ES-14 BILL IMPACTS FOR RESIDENTIAL WASTEWATER CUSTOMERS ALTERNATIVE 2 - FY 2010 Change Discharge Existing Proposed % $ 3 $ 10.26 $ 19.99 95% $ 9.73 6 $ 20.52 $ 39.99 95% $ 19.47 8 $ 37.62 $ 53.32 42% $ 15.70 10 $ 54.72 $ 66.65 22% $ 11.93 11 $ 64.49 $ 73.31 14% $ 8.82 12 $ 74.26 $ 79.98 8% $ 5.72 14 $ 93.80 $ 93.31-1% $ (0.49) 16 $ 113.34 $ 106.64-6% $ (6.70) 18 $ 132.88 $ 119.97-10% $ (12.91) 12 CCF is the average SFR bi-monthly dishcarge 10 CCF is the average MFR bi-monthly discharge TABLE ES-15 BILL IMPACTS FOR RESIDENTIAL WASTEWATER CUSTOMERS ALTERNATIVE 3 - FY 2010 Change Discharge Existing Proposed % $ 3 $ 10.26 $ 11.88 16% $ 1.62 6 $ 20.52 $ 23.76 16% $ 3.24 8 $ 37.62 $ 41.72 11% $ 4.10 10 $ 54.72 $ 59.68 9% $ 4.96 11 $ 64.49 $ 71.04 10% $ 6.55 12 $ 74.26 $ 82.40 11% $ 8.14 14 $ 93.80 $ 105.12 12% $ 11.32 16 $ 113.34 $ 127.84 13% $ 14.50 18 $ 132.88 $ 150.56 13% $ 17.68 12 CCF is the average SFR bi-monthly dishcarge 10 CCF is the average MFR bi-monthly discharge Comparison with Other Utilities An important aspect of evaluating the impacts of the recommended rate alternatives and anticipated rate adjustments is a comparison with other large utilities and utilities serving local communities. To develop this comparison, RFC gathered current utility rate schedules from the large utilities participating in our benchmark survey and from utilities serving other local communities. Since the 6.5 Ccf average monthly water use per SFR account in the SFPUC retail Raftelis Financial Consultants, Inc. 20

service area is less than half the national average, RFC calculated the monthly bills for each utility according to the monthly average single-family water use in each local area. 5 The chart in Figure ES-5 presents the average monthly residential utility bill for each of the benchmark utilities in comparison with the average SFR monthly utility bills for SFPUC customers under the existing rates and under alternative 1 (A-1) for both water and wastewater. Alternative 1 (water and wastewater) was selected for this comparison since this alternative results in the greatest combined impact for all the water and wastewater alternatives. (Since some utilities recover wet weather flows through separate stormwater charges, the average stormwater bills for those utilities are also included in the average monthly residential wastewater bills.) FIGURE ES-5 COMPARISON OF MONTHLY BILL WITH BENCHMARCK UTILITIES 6 Residential Combined Monthly Bill (Average Local Use) Water Sewer Stormwater $120 $110 $100 $100 $112 $90 $80 $70 $60 $50 $40 $36 $39 $44 $48 $50 $51 $55 $58 $58 $62 $63 $65 $72 $74 $75 $75 $82 $85 $30 $20 $10 $- San Antonio Santa Clara Hayward Houston Fremont (USD) San Jose Dallas *Phoenix Las Vegas Combined Average San Francisco Existing *Oakland (EBMUD) *Sacramento Seattle San Francisco A-1 (W&S) Walnut Creek (CCCSD) Palo Alto *Portland *San Diego *Los Angeles 5 According to the AWWA statistics, average daily household water use is 350 gallons per day (10,500 gallons and 13.4 Ccf per month). http://www.drinktap.org/consumerdnn/default.aspx?tabid=85 6 Although the SFPUC bills the majority of its retail residential customers on a bi-monthly basis, it publishes, compares, and assesses its rate structure based on a monthly usage levels. Raftelis Financial Consultants, Inc. 21

The SFR bill under the existing SFPUC water rates is below the average water bill for the benchmark group. Furthermore, the SFR water bill under each water option or alternative (A-1 and A-2) is also below the average water bill for the benchmark group. On the other hand, the SFR wastewater bill under the existing SFPUC wastewater rates, as well as the SFR wastewater bills for each wastewater option or alternative (A-1, A-2, & A-3), is above the average wastewater bill for the benchmark group. When combined, the water and wastewater SFR bills under the existing SFPUC rates and the combined water and wastewater bills for water and wastewater alternatives 1 are above the combined average utility bill for the benchmark group. Raftelis Financial Consultants, Inc. 22

II. INTRODUCTION In July 2008, The San Francisco Public Utilities Commission ( SFPUC ) engaged Raftelis Financial Consultants, Inc. ( RFC ) to provide utility consulting services with the purpose of developing equitable rate structures for water and wastewater services to recover costs of providing service to customer groups based on usage characteristics while addressing community values. The ( Study ) required recommendations related to cost justified customer class rate differentials, lifeline rates, conservation rates, public and private fire protection charges, and an evaluation of the recovery of costs for stormwater runoff. The Study included the following major deliverables: review of the existing water and wastewater system rate structure and underlying cost allocations; recommend changes to the rate structures as well as revenue adjustments for the next five years; develop a ten-year financial plan from fiscal year ( FY ) 2009 through FY 2018; determine capacity charge recommendations; and evaluate the feasibility of separate wet weather charges. The rates for water and wastewater were developed in separate financial planning and rate models ( Models ) that have been used to evaluate alternative rate structures and provide more detailed forecasts to assist in financial planning and updating rates in future years. Although our wastewater rate recommendations are designed to recover both dry and wet weather flows, we have included an evaluation of the operating and capital costs required to collect and treat stormwater runoff. Additionally, we have provided an evaluation of potential incentives to encourage Low Impact Development ( LID ) and our capacity charge recommendations in separately submitted reports. A. Current Environment The SFPUC currently provides water for a population of over 2.4 million people which includes both retail customers and wholesale customers. Retail water service to customers located in the City of San Francisco ( City ), the Town of Sunol in Alameda County, San Francisco International Airport, the San Francisco jail in San Bruno, and other customers immediately adjacent to major transmission. The majority of retail customers are provided service thorough the local water system. The SFPUC currently provides wholesale water services to 28 suburban wholesale customers in San Mateo, Santa Clara, and Alameda counties. The SFPUC water system extends from Hetch Hetchy Valley in Yosemite National Park to the Bay Area. The majority of water supplied, approximately 85%, originates from the Upper Tuolumne River watershed. The remainder comes from reservoirs in the Alameda and Peninsula watersheds. Water from the Alameda and Peninsula watersheds is treated at two SFPUC owned water treatment plants. Approximately two thirds of potable water produced is used by wholesale customers and the remaining third used by the retail customers. To enhance its ability to provide reliable, cost-effective, high-quality water in an environmentally responsible manner, in 2002 the Raftelis Financial Consultants, Inc. 23

SFPUC began a multi-year Water System Improvement Program ( WSIP ) that is currently estimated to total $4.4 billion. The SFPUC provides wastewater service to the City and County of San Francisco as well as parts of the surrounding areas. These surrounding areas include San Mateo County through Joint Power Agreements with the North San Mateo County Sanitary District No. 3, the Bayshore Sanitary District, and the City of Brisbane. The wastewater system has a collection and transport capacity of approximately 172.2 million gallons per day ( MGD ) and a wastewater treatment design hydraulic capacity providing primary treatment of 415 MGD. The wastewater system is a combined sewer and stormwater system which is divided into three zones. The SFPUC owns two treatment plants and one wet weather plant to treat all wastewater. The Southeast Water Pollution Control Plant treats wastewater discharges from the eastern portion of the City, while the Oceanside Water Pollution Control Plant treats wastewater discharges from western portion of the City. The SFPUC also operates the North Point Wet Weather Facility during wet weather events and maintains underground storage structures to limit the number and volume of combined sewer overflows in order to meet regulatory requirements. All costs associated with dry and wet weather flows are currently recovered through the SFPUC s wastewater rate structure. B. Study and Pricing Objectives The Study began with a kick-off meeting and a conceptual design workshop to assist RFC in understanding and prioritizing the SFPUC s rate pricing objectives. Following the August 2008 kick-off meeting, RFC developed a list of utility pricing objectives based on our discussions with the SFPUC management team and our preliminary understanding of the important issues facing the SFPUC. As part of this process and the conceptual design workshop, RFC analyzed the existing SFPUC water and wastewater rate structures, performed a water usage analysis, and examined alternative rate structures to ensure proposed rates are consistent with SFPUC pricing objectives and financial planning goals. The goal of the workshop was to gain a preliminary understanding of the important issues facing the SFPUC and discuss how any potential future rate structures would address those issues. Based on our discussions with the SFPUC management team and our understanding of the important issues facing the SFPUC, RFC developed, and the SFPUC management team confirmed, the following list of utility pricing objectives: Customer Equity: Rates should be designed such that the costs recovered from each customer class are directly related to the way in which class demand characteristics and usage patterns cause the utility to incur costs and no customer class should subsidize or be subsidized by another customer class. Raftelis Financial Consultants, Inc. 24

Revenue Sufficiency: Rates should generate revenues sufficient to meet revenue requirements despite fluctuations in demand. Conservation / Demand Management: Rates should promote the optimal use of available water resources while reducing peak demand levels and the average consumption per customer. Ease of Implementation: Rates should be easily implemented using existing staff and the existing billing and collection infrastructure with only minor modifications. Defensibility and Reasonableness: Rates should be designed according to standard industry practice and in accordance with applicable law to avoid disputes. Easy to Understand: Rates should be readily understandable by customers. Affordability for Economically Disadvantaged Customers: Rates should be designed with mechanisms in place that allow for economically disadvantaged customers to continue receiving water service. Public Acceptance / Communication: The rate and charge structures should address internal and external stakeholder concerns and be compatible with the SFPUC administrative system. In addition, the rate and charge structure should allow for the continuation of existing management and system reports. C. Scope of the Study The scope of this Study focuses on the development of cost-based water and wastewater user rates for the retail customers through a comprehensive cost of service ( COS ) and rate design study process. Figure 2-1 provides a graphical representation of the various steps involved in the comprehensive COS and rate design process. The steps involved are: Financial Vision: Prioritize pricing objectives and develop suitable alternative rate structures for further evaluation. Financial Planning: Revenue requirements are projected for FY 2009 through FY 2018. Financial planning involves estimation of annual operating & maintenance ( O&M ) and capital expenditures, reserve targets, and operating and capital revenue sources, and the determination of required annual user revenues from rates and charges. Cost of Service Analysis: Cost of service analysis involves identifying and apportioning annual revenue requirements to the different user classes proportionate to their demand on the water and wastewater systems. Raftelis Financial Consultants, Inc. 25

Rate Design: Rate design involves developing fixed and variable schedules of rates for different user classes to proportionately recover the costs attributable to them. The SFPUC pricing objectives, identified above, are considered at this stage. FIGURE 2-1 COST OF SERVICE/RATE DESIGN PROCESS Raftelis Financial Consultants, Inc. 26