Improving Capacity Charges through Sound Philosophy and Modern Statistics

...SUMMARY This presentation summarizes a comprehensive Water System Capacity Charge (capacity charge) study conducted by the East Bay Municipal Utility District (EBMUD), which provides drinking water for 1.4 million customers in Alameda and Contra Costa counties. EBMUD's capacity charges recognize variations in costs associated with providing service to new customers in different geographic regions of the District, as well as the variability in water consumption patterns across each of the District's Regions. The presentation describes a comprehensive update to the capacity charge calculation methodology that implements shifts in the underlying philosophies supporting the valuation of existing system assets, the basis for fee administration, and the recognition of demand characteristics of the District's customers. The approaches used in this study represent a meaningful evolution in the calculation of capacity charges for EBMUD that brings fees in line with observed customer usage behavior and the District's long term water supply infrastructure planning. While the methodology and assumptions used in this study were customized for EBMUD, this approach could be readily adopted by other utilities looking to advance the calculation of their capacity charges to more closely capture the cost to serve their customers. ...ABSTRACT ...Background In publicly owned utilities, rate payers finance the construction, renewal, and replacement of system assets through user rates and fees, with occasional support from outside the utility. When new connections are added to the system, they receive services through infrastructure that has been funded by existing customers. It is common for utilities to impose charges or fees to fund the capital improvements required to serve growth and new or expanded development. East Bay Municipal Utility District (EBMUD) utilizes Water System Capacity Charges (capacity charges), often referred to as capacity fees, to recover proportional shares of the costs of water supply, treatment, and distribution system investments from new customers joining the water system or customers requiring increased system capacity. The capacity charges are designed to recover the proportionate capacity-related costs of new connections on the water system. EBMUD's capacity charge program recognizes differences in typical demand profiles and capacity costs across different service regions within the District's service area. As part of a recent study, Stantec worked with EBMUD to conduct a comprehensive evaluation of the capacity charge calculation methodology. Capacity charges are a very common financial mechanism used by utilities, and typical calculation procedures generally produce well-founded and implementable results. But utilities experiencing increasingly diverse customer demand profiles or shifts in cost structures might not recover the right amounts if special care is not given to these unique circumstances. This presentation introduces novel approaches to establishing the basis of the charge that may be more representative of the true cost to serve a new connection to a water utility's system and result in more equitable cost recovery across different customer types. At their most basic level, capacity charges are comprised of two components, a unit cost of system capacity and an estimate of customer use, which are multiplied together to determine the charge that is assessed to each new system connection. This study produced two significant updates to the way EBMUD calculates their capacity charges. First by updating the methodology used to assess the value of existing assets as part of the unit cost calculation, and second by updating the approach to determining the customer demand for new connections with smaller meter sizes. ...Unit Cost Calculation EBMUD's unit cost calculation is comprised of a buy-In component, which calculates the unit cost of capacity solely based on the value of existing utility system assets, and an incremental component, which estimates the cost of providing new system capacity to serve growth. When calculating the value of existing assets, a utility will typically select one of two main asset valuation approaches, replacement cost new (RCN) or replacement cost new less depreciation (RCNLD). RCN takes the original cost of the asset then inflates the value to current dollars using the ENR or another inflationary index. RCNLD uses the same approach, but accounts for the depreciation of the asset over time. One major recommendation of this study was to make use of both approaches. This is a major philosophical shift for most utilities that typically use a single approach for all assets. Under this new approach, the District will retain the RCN asset valuation approach for long lived assets that are not being actively replaced such as terminal reservoirs, reclamation facilities, water supply infrastructure, and land. This approach considers the estimated cost to reacquire these large assets that provide essential service, but will not be replaced. For infrastructure that is actively being replaced, such as pipelines, pumping plants, distribution reservoirs, and equipment, the District will now use the RCNLD approach to reflect the remaining useful life of these assets (based on age, existing condition and the typical useful life of the asset). This change better aligns the cost basis with the nature of these fundamental facilities, and results in a more moderated cost basis over time as compared to a utility that only uses RCN or RCNLD exclusively. ...Estimated Customer Use and Basis of Fee Administration Currently, the District uses a common industry approach by assessing capacity charges to new customers based on an assumed average water use for single family residential (SFR), multi-family residential (MFR), and non-residential customer classes, and then scales the projected demand on a water meter equivalence schedule. As part of this Study, recent water use data from 2005 to 2017 was analyzed to update typical water use characteristics for each customer class, both system-wide and in each region. This analysis included nearly 57 million data points that helped to characterize customer demands over time and across customer classes and service area regions. The District's billing data was merged with land use data, meter data, and GIS based property data. This compilation of account, usage, and property data allowed water use characteristics to be analyzed for each customer class with consideration of meter size, as well as alternative charge units including number of rooms per household, number of bedrooms, building square footage, dwelling size, and irrigation area. Water demands were analyzed relative to each of these parameters using a series of statistical tests to identify statistically significant relationships and representative billing units. Based on our evaluation of water usage characteristics we identified breakpoints for SFR and non-residential customers per meter size in each service area regions. Water use for MFR dwelling units did not vary across service area regions, but we did find a statistically significant breakpoint in usage based on a property's average dwelling unit size, enabling EBMUD to charge a lower fee per dwelling unit for dwelling units with areas of less than 500 square feet. Using these statistically derived billing units allowed EBMUD to assess capacity charges to customers in a manner that is more representative of the actual demand that a new connection will likely place on the water system than using meter size capacity scaling factors. ...Conclusion The resulting capacity charge methodology is still very recognizable to stakeholders but provides very meaningful evolution in the approach for calculating these charges. The nuanced approach to assessing asset values provides an arguably more equitable approach to determining the cost basis for charges than the standard industry approach. Depreciating short lived assets allows new connections to pay into a system based on its current condition, knowing that rate revenues will be used to pay for future replacements. Similarly, charging the escalated cost of long-lived assets allows the utility to recoup their investment in assets that continue to provide service even if they were built many decades ago. Additionally, the data driven approach to deriving typical water demands for new customers using EBMUD's extensive dataset of actual usage rather than generic meter capacity schedules transforms the District's fee structure from a generic 'cookbook' exercise into a customized, locally-relevant cost recovery system. These subtle yet meaningful changes in approach represent a nuanced but powerful next step in the development of fees and may prove valuable for other utilities.