Introduction to Water and Sewer Fund Needs August 11, 2017

Introduction to Water and Sewer Fund Needs August 11, 2017 A lot of good things are happening in Buffalo and we hope to make some exciting announcements in the months to come, especially about possible downtown re-development. While we work on these exciting endeavors and opportunities for the future, the Council must also ensure that the infrastructure of the community is maintained and prepared for current and future needs. As a matter of good business practices, the City regularly reviews costs for maintenance and operations of our infrastructure against the funding mechanisms available to support those costs. In 2017, the City Council commissioned a study of the community s water and sewer funds. This review took into account expenditures necessary now as well as important repairs that need to be made in the near future. This review showed that there is need for increases to the user fees for these utilities in order to pay for the services. The City s financial consultants have projected increases in user fees that will eventually pay for the services and a three-month reserve fund will be established, by the year 2027. The recommendation for rate increases that you will read in the attached rate study report follows two reports from the city engineer: one report addresses the city s wastewater treatment plant (link); another addresses the wastewater collection system (link), specifically the lift stations which pump wastewater to the plant. Both the treatment plant and lift stations need very costly maintenance and improvement. It is not unusual for a water/wastewater utility to lose money for a year or two, but we can t allow that situation to continue. Our bond covenants state that we will charge a rate sufficient to repay the bonds sold to finance the systems. Each of our utility funds needs to be selfsustaining. By adequately funding our utility systems, banks will look more positively on the City in the future when we borrow money for projects, which will save the community by allowing for us to receive better interest rates and terms. If utility funds are not funded properly, the community may face higher costs for borrowing in the future. The City Council only increases rates after careful consideration and study. The Council has reviewed the information provided by our engineers, staff and financial consultants and are confident that increased rates are needed to make necessary investments in water and wastewater maintenance. If we don t make the investment, we face unacceptable results. There have already been two breaks of a sewer main line. We also need to do everything we

reasonably can to make sure our sewer lift stations keep up with demand nobody wants a sewer back-up in a home or business. It would also be detrimental to our community to face state-ordered action because our treatment plant is violating permit requirements. Another factor entering into funding of the water and sewer utilities is access charges at the time a new building connects to our system. The City of Buffalo has not been immune to the effects of the recession and the impact the overall economy has had on new housing starts. Permit numbers are increasing and we have come a long way from the drastic drop in permits during the recession, but the effects of that drop remain and funds need to be generated to pay debt service for the systems we all use every day. We need to face up to this challenge now, not be forced into it later. There will be a public hearing on the pending rate increases. In the meantime, we urge you to look over the documents linked to here, the same documents on which we base our decisions. If you have thoughts, questions or concerns, please contact any of your council people. That is part of our duty, and we seek your understanding of the needs of the community as we move forward. Thank you. Teri Lachermeier Mayor

August 9, 2017 Water and Sanitary Sewer Utility Rate Study for the Ehlers Advisors: Nick Anhut Municipal Advisor nanhut@ehlers-inc.com Jessica Cook Financial Specialist jcook@ehlers-inc.com

Introduction In February of 2017, the City of Buffalo engaged Ehlers to conduct a Water and Sewer Utility Rate Study. This report provides the key findings and recommendations of the study as presented to the City Council in a work session on July 31, 2017. The goals of the rate study were to design and compute user rates for 2018 and subsequent years that will meet all financial obligations of the water and sewer utilities. Background The City of Buffalo owns and operates pumping, treatment, storage and distribution systems that convey drinking water to the homes and businesses in the City. It also owns and operates a sewer collection system and sewer treatment facility that transports and treats waste from residents and businesses. The City undertook this rate study in advance of issuing bonds to restructure existing debt issued for utility capital improvements and has plans to finance additional capital improvements this fall related to the treatment of biosolids. This rate study recommends rates and other revenue that will support continued operations, the 2017 debt issuances, and planned future capital improvements as described later within this report. The utilities financial activity is accounted for in the City s combined Water and Sewer Fund. By looking at the fund as a whole, we can see key features of the utility operations. First, infrastructure costs are the single biggest expense of the Water and Sewer utilities. Today, operating costs account for only 18% of the total utility expenses. Principal and interest on outstanding debt issued to finance capital projects accounts for 77%, and new capital expenditures for 5% of total expenditures. Consistent with most Minnesota communities, the City does not fully fund depreciation. The break-down of costs is shown in Figure 1. Figure 1. 2016 Expenditures in the Water and Sewer Fund Capital 5% 2016 Expenditures Operations 18% Operations Debt Service 77% Debt Service Capital Utility Rate Study for the Page 1 August 2017

Second, utility revenues have declined. During the development boom of the early 2000 s, which drove the need for expanding the utilities, the City received $1 million to $2 million annually from connection fees and hook-up charges. These development related fees accumulated in the fund and helped make debt payments through 2014. These reserves are now depleted and additional revenue will be needed to meet the City s future obligations. Third, water consumption has declined while the costs for delivering the water are relatively fixed. In 2009, the City sold over 544 million gallons of water.. By comparison, in 2016 the City sold only 442 milliongallons of water. While water consumption is weather dependent and so one cannot simply compare two isolated years of consumption data, a review of the City s Department of Natural Resources reports also indicate a longer-term trend of declining water consumption, which matches national trends. All of these factors have contributed to a weakened financial position for the City s Water and Sewer Fund, which is projected to have a negative cash position of $1.6 million at the end of 2017, and growing deficits in future years. Ehlers is recommending that the City of Buffalo implement a new rate structure in 2018 that will increase and stabilize revenues to immediately address structural deficits, followed by moderate annual rate increases in 2019 and beyond. Assumptions and Methodology Ehlers prepared a 10-year cashflow projection for both the water and sewer utilities. Although both utilities are accounted for in one fund, we separated the financial activity in each utility to allow us to determine what water and sewer rates would need to be to support their respective utility activities. Billing data from 2016 was obtained and sorted to develop a rate structure that would stabilize revenues and minimize impacts on low volume water users. A long-range cash flow analysis was also prepared through the year 2028 to examine projected cash flows in future years and estimate the user rate increases necessary to meet all financial obligations of the utilities while building modest cash reserves. In the cashflow projections we included the following conservative assumptions: 3% annual inflation on operating and capital expenses Water consumption declines 5% in 2018 and remains steady thereafter Sewer consumption declines 2% in 2018 and remains steady thereafter No new users assumed for future operating revenues. Approximately 40 new units per year for future connection fee revenue Utility Rate Study for the Page 2 August 2017

In preparing this utility rate study Ehlers relied on estimates of future capital costs from the City s consulting engineers and staff. A summary of these capital costs are in Table 1. Table 1. Planned Capital Improvements for Water and Sewer Utiltiies The major sewer project in 2017 is to improve the treatment of biosolids and the major sewer projects in 2021 and 2022 are the rehabilitation of key lift stations. Other capital items include vehicles, well and water tower rehab, spot water and sewer line repairs, and the maintenance of the treatment plants. The costs listed above are best estimates available at the time of this analysis. Additional items or refined cost estimates may be necessary for future analyses. The city is currently undergoing long-range studies of its street and utility infrastructure repair and replacement costs. Proposed Water Rates and Structure Modifying the Increasing Block Rate Structure for Water The City has an increasing block rate structure for its water rates. This means that as consumption increases, the rate per thousand gallons also increases. However, because the City s three water rate tiers are relatively broad, very few residential customers consume water in the third tier, which is designed to capture water used for irrigation. In fact, in 2016, approximately 89% of all water consumption was within the first two tiers (up to 8,000 gallons per month). The following graph shows the single-family residential water consumption in July of 2016. The blue bars represent the number of accounts at each level of consumption. The two black lines represent the current tier breaks. One can see that even in the peak irrigation month of July, very little consumption occurs and is billed in the third tier. Utility Rate Study for the Page 3 August 2017

Figure 2. Pattern of Residential Water Use in July 2016 with Existing Rate Tiers 700 Tier 1 Residential Water Use July, 2016 600 500 Tier 2 400 Tier 3 300 200 100 0 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 The 2017 tier structure and rates for residential customers are as follows: Tier 1: 0-5,000 gallons charged at $3.09 per thousand gallons Tier 2: 5,001 to 25,000 gallons charged at $3.84 per thousand gallons Tier 3: Over 25,000 gallons charged at $5.36 per thousand gallons The rationale for higher rates for higher consumption is to assign the costs of the system to the customers driving those costs. The City has constructed its water system to serve its residents and businesses on the hottest, driest days of summer that produce peak water demand. In the summer of 2016 water demand was 1.9 times higher than winter water demand, largely due to irrigation. By charging more for peak demand the City is allocating more of the costs of building the system large enough to serve those using the most water. The proposed residential water rate structure would have the following tiers 2018: Tier 1: 0-4,000 gallons Tier 2: 4,001 to 8,000 gallons Tier 3: Over 8,000 gallons These tiers are represented by the red bars in the following graph showing the same July, 2016 water consumption. Utility Rate Study for the Page 4 August 2017

Figure 3. Pattern of Residential Water Use in July 2016 with Proposed Rate Tiers 700 Tier 1 Residential Water Use July 2016 Proposed Tiers 600 Tier 2 500 400 Tier 3 300 200 100 0 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 As the tiers narrow more revenue is generated from high-volume users, addressing the cost driver. However, water revenues also become more volatile from year to year as weather patterns change. The water utility does have some fixed expenses that do not vary from one customer to the next, such as the cost of reading water meters, billing, and other fixed overhead. To pay for these fixed charges and stabilize revenues, Ehlers is recommending a new fixed monthly charge for water regardless of the volume used. This charge would apply to all customers year-round and would replace the existing minimum charge. The proposed fixed charge is $7.50 per month. We are proposing that multifamily water rates eliminate the tiers and go to a flat, perthousand gallons. This is to comply with state law which requires a City that has tiered rates for multi-family property to implement tiers for each unit within a multifamily property. This becomes labor-intensive and problematic with the billing system when there are multiple dwelling units on one meter. Transitioning to a flat rate for multifamily eliminates the administrative burden the state law would impose. Proposed Water Rates The proposed 2018 water rates for the various classes of customers are shown in Table 2 with the current 2017 rates shown for reference. Utility Rate Study for the Page 5 August 2017

Table 2. Proposed 2018 Monthly Water Rates Percentage Increase Monthly Water Rates Existing Proposed 2017 2018 Fixed Rates Minimum Charge (includes almost 3,000 gallons) 9.15 Base Fee (no usage included) 7.50 Usage Rates Residential 2017 0-5,000 3.09 5,001-25,000 3.84 >25,000 5.36 Residential 2018 0-4,000 3.57 4,000-8,000 5.00 >8,000 7.00 Commercial 2017 0-100,000 2.99 100,001-300,000 3.61 >300,000 5.17 Commercial 2018 Base Fee 7.50 0-25,000 3.57 25,001-75,000 5.00 >75,000 7.00 Mobile Homes 3.35 5.00 Multifamily 2017 0-5,000 3.09 5,001-25,000 3.84 >25,000 5.36 Multifamily 2018 5.00 Irrigation 4.48 7.75 Utility Rate Study for the Page 6 August 2017

Proposed Sewer Rates The City s current sewer rate is charged on a customer s winter average water consumption so that customers are not charged sewer disposal fees for outdoor water use. The City s rate structure is comprised of a minimum charge of $14 per month which includes almost 2,000 gallons of usage. While having a minimum usage for water is discouraged by the Minnesota Department of Natural Resources, it is common practice in Minnesota for sewer utilities to have a minimum. Therefore, Ehlers is not recommending any changes to the sewer rate structure, but but is proposing that the minimum charge be established at $23.36 per month and include the first 2,000 gallons of metered use.. These increases are designed primarily to address the existing debt carrying cost and future capital needs of the sewer system. The proposed 2018 sewer rate for all classes of customers is shown in the following table, with the 2017 rates shown for reference. Table 3. Proposed 2018 Sewer Rates Percentage Increase Monthly Sewer Rates Existing Proposed 2017 2018 Fixed Rates Minimum Charge 14.00 Minimum Charge (2 Units) 23.36 Usage Rates All Users per 1,000 gallons 7.84 11.68 Future Rate Increases In addition to the 2018 changes recommended above, Ehlers 10-year cashflow projection indicates that the following future rate increases will be needed to address future capital costs and slowly recover the financial health of the Water and Sewer Fund. Utility Rate Study for the Page 7 August 2017

Table 4. Proposed Rate Increases 2019-2028 Impact on Customers Across the nation utility rates are increasing faster than the rate of inflation on other goods and services such as electricity and cable television. Buffalo is not immune to the forces driving up the cost of delivering utilities. These costs include replacing pipes under road reconstruction projects and capital projects undertaken to improve the quality of sewer effluent into our streams and rivers. We have compared a sample residential customer s bill with what a customer would pay in surrounding communities. Currently, Buffalo customers are paying less than most of the peer communities. With the proposed increases, the City s customers bills will still be comparable to neighboring communities 2017 rates. Figure 4. Comparison of Water Rates $80 $70 $60 $50 $40 $30 $20 $10 $0 Comparison of Buffalo Proposed 2018 Rates to 2017 Water and Sewer Charges per Month for Sample Residential User (6,000 gallons water/3,500 gallons sewer) Sewer Water Utility Rate Study for the Page 8 August 2017

The following tables show the monthly impact of the proposed 2018 water and sewer rates on various hypothetical customers. Table 5. Sample Residential Bills Impact Analysis on Residential Monthly Existing Proposed Dollar 2017 2018 Increase Sample Summer Bill Low User - Residential Water (2,000 gallons/month) $ 9.15 $ 14.64 $ 5.49 Sewer (2,000 gallons/month) 15.68 23.36 $ 7.68 Total Monthly Utility Bill $ 24.83 $ 38.00 $ 13.17 Moderate User - Residential Water (6,000 gallons/month) $ 19.29 $ 31.78 $ 12.49 Sewer (3,500 gallons/month) 27.44 40.88 $ 13.44 Total Monthly Utility Bill $ 46.73 $ 72.66 $ 25.93 High User - Residential Water (30,000 gallons/month) $ 119.05 $ 195.71 $ 76.66 Sewer (4,000 gallons/month) 31.36 46.72 $ 15.36 Total Monthly Utility Bill $ 150.41 $ 242.43 $ 92.02 Table 6. Sample Commercial Bills Impact Analysis on Commercial Monthly Existing Proposed Dollar 2017 2018 Increase Sample Summer Bill Low User - Commercial Water (3,000 gallons/month) $ 9.15 $ 18.21 $ 9.06 Sewer (3,000 gallons/month) 23.52 35.04 $ 11.52 Total Monthly Utility Bill $ 32.67 $ 53.25 $ 20.58 Moderate User - Commercial Water (33,000 gallons/month) $ 98.67 $ 125.31 $ 26.64 Sewer (25,000 gallons/month) 196.00 292.00 $ 96.00 Total Monthly Utility Bill $ 294.67 $ 417.31 $ 122.64 High User - Commercial Water (175,000 gallons/month) $ 569.75 $ 1,046.37 $ 476.62 Sewer (182,000 gallons/month) 1,426.88 2,149.12 $ 722.24 Total Monthly Utility Bill $ 1,996.63 $ 3,195.49 $ 1,198.86 Utility Rate Study for the Page 9 August 2017

Table 7. Sample Multifamily Bills Impact Analysis on Multi-Family Monthly Existing Proposed Dollar 2017 2018 Increase Sample Summer Bill Low User -Multi-Family (6 Units) Water (8,000 gallons/month) $ 26.97 $ 47.48 $ 20.51 Sewer (8,000 gallons/month) 62.72 93.44 $ 30.72 Total Monthly Utility Bill $ 89.69 $ 140.92 $ 51.23 Moderate User Multi-Family (16 Units) Water (37,000 gallons/month) $ 156.57 $ 192.43 $ 35.86 Sewer (30,000 gallons/month) 235.20 350.40 $ 115.20 Total Monthly Utility Bill $ 391.77 $ 542.83 $ 151.06 High User -Multi-Family (84 Units) Water (307,000 gallons/month) $ 1,603.77 $ 1,541.89 $ (61.88) Sewer (300,000 gallons/month) 2,352.00 3,504.00 $ 1,152.00 Total Monthly Utility Bill $ 3,955.77 $ 5,045.89 $ 1,090.12 Development Fees The City of Buffalo has made a significant investment in its utility infrastructure to serve both new and existing users. Ehlers recommends increasing developer fees as illustrated in Table 8 in order to recover costs associated with expanding the system to accommodate new development. Table 8. Proposed Future Development Fees Impact Analysis on Development Fees Existing 2017 2018 2019 2020 2021 2022 Residential Property Trunk Water Access Charge $ 750 $ 1,500 $ 1,590 $ 1,685 $ 1,787 $ 1,894 WAC $ 750 $ 1,500 $ 1,590 $ 1,685 $ 1,787 $ 1,894 Proposed Increase 100% 6% 6% 6% 6% Sewer Access Charge $ 1,500 $ 1,590 $ 1,685 $ 1,787 $ 1,894 $ 2,007 SAC $ 5,950 $ 6,307 $ 6,685 $ 7,087 $ 7,512 $ 7,962 Proposed Increase 6% 6% 6% 6% 6% Total Development Fees for Water and Sewer $ 8,950 $ 10,897 $ 11,551 $ 12,244 $ 12,979 $ 13,757 % Increase/(Decrease) 22% 6% 6% 6% 6% Utility Rate Study for the Page 10 August 2017

Achieving Financial Sustainability for Water and Sewer Utilities The Water and Sewer Fund is an enterprise fund, meaning it is intended to operate like a business and be financially self-supporting. In 2016, the City contributed $498,954 of property tax receipts to support the utilities. Even with the proposed rate increases, it will take some time for the Fund to become financially stable, and we are projecting the need to continue the property tax levy for the utilities through 2028. It is estimated that $500,000 per year of levy will be need in 2017 through 2022, and $300,000 per year will be needed in 2023 through 2028. After 2028, a significant portion of the utilityrelated debt will be retired and levy support will no longer be necessary. The decline in 2029 of projected debt payments is shown in Figure 5. Figure 5. Debt Service Payments on Outstanding Bonds With the proposed rate increases and sustained levy support, the Water and Sewer Fund will slowly build cash reserves and have capacity to pay cash for capital improvements beginning in 2029, as shown in Figure 6. The projected cash balances are compared to the City s target cash reserve for the combined fund, which is equal to 3 months of operating costs plus the next year s debt service. Utility Rate Study for the Page 11 August 2017

Figure 6. Cash Projection for Water and Sewer Fund 10,250,000 8,250,000 6,250,000 4,250,000 2,250,000 Combined Water and Sewer Fund Projected vs. Target Cash Balances 250,000 (1,750,000) 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 Target Cash Balance Ending Cash Recommendations Ehlers makes the following recommendations based on this utility rate study. 1. Adopt the water rates as shown in Table 2 and the sewer rates as shown in Table 3. 2. Adopt increases to the development related charges as shown in Table 8. 3. Continue the property tax levy for the utilities in the amount of $500,000, evaluating the need on an annual basis based on the revenue performance in the fund. 4. Evaluate the affordability of new capital projects by including the marginal cost in the rate study model and measuring the impact of the project on cash reserves and the sufficiency of user rates. 5. Periodically update the full rate study. It is important to note that a number of assumptions were used to develop the results shown in this study. It is therefore recommended that the City continuously monitor the financial health of its water and sewer utility as part of its annual budgeting process, and revise the study every three years or at the onset of designing significant capital improvements. Utility Rate Study for the Page 12 August 2017