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Is Your Utility Rate Study Talking to Your Asset Management Strategy?


August 13, 2018 by FCS GROUP
Category: Finance Advisor , Asset Management

Is Your Utility Rate Study Talking to Your Asset Management Strategy?

Written by Ben Hoffman

Asset management strategies serve to prioritize investments, optimize maintenance, and, more importantly, mitigate risk. Ultimately, asset management defines the level of investment required to effectively and sustainably operate your utility. These are also the very same elements that feed into and define your utility financial plan and corresponding rates.

However, your utility may be missing key intersections between asset management and rate setting — or you could be interpreting the same data differently in order to satisfy the requirements of each program. Missing these links could result in critical underinvestment in capital projects or inadequate planning for future operations and maintenance (O&M) needs. 

Here are three examples of areas where asset management and rate setting can interact: the fixed asset registry and depreciation, cost allocation and changing assumptions, and balancing capital and O&M requirements. 

Fixed Asset Registry and Depreciation

In a rate study, depreciation is used as a means to recover the cost of using assets. It helps you equitably plan for and invest in new capital infrastructure. More often than not, rate studies calculate depreciation from a fixed asset registry. Assets in this registry will likely take the form of the project or program where they originated, such as a pump station, well, conveyance system, and so on.

A good asset management program looks at assets by their maintainable components. For a pump station, that means having “assets” of pumps, electrical components, the building, and pipes. The difference in how one views a pump station in a fixed asset registry versus an assent management plan can be seen in the table below.

Useful Life According to Your Fixed Asset Registry Useful Life According to Your Asset Management Program
Asset Years Asset Years
Pump Station   Pump Station  
Pump Station Project 35 Pump 30
    Building 50
    Electrical 15
    Force Main 60

What does this mean for your rate structure? The individual components of an asset or group of assets degrade differently. Asset management recognizes this, but your fixed asset registry may not. Unless these systems are appropriately matched, the rate policy may be calculating depreciation expense in a way that does not accurately reflect the utilities investment needs.

Allocating Costs and Changing Assumptions

If a sewer system has excessive inflow and infiltration (I&I) or a water system has too much water loss, utilities can use the principles of asset management to help reign in these problems. Leak inspection programs, strategic sewer lining, and pipe inspection are some of the tools used in varying degrees by utilities.

Tackling these problems at the utility level has impacts on your rate design. But how? Rate studies estimate revenue requirements over functional categories such as I&I and flow. A full “ramping up” of asset management programs that impact flow, O&M needs, and more can have important implications on the assumptions going into your rate program. The snapshot used to calculate rates in year one may no longer be relevant three years later.

For example, say your asset management program has identified the primary issues contributing to infiltration in a neighborhood with old, cracked concrete pipe. A capital project that funds critical sewer lining and burst pipes in year one drastically addresses this issue. This is positive news for the utility. However, the assumptions used in your rate study to allocate I&I expenses are now off, and expenses, as they relate to I&I, are now lower. Understanding these implications in advance may help you adapt and more accurately set pricing.

Balancing Capital and O&M Requirements

Finally, the way you maintain your system has a direct impact on the necessary capital expenses incurred. Greater efforts in preventative maintenance may lower expectations for expenses on capital replacements. Meanwhile, increased inspection may increase expenditures on emergency and preventative repairs as problems are found. New capital projects could decrease historic O&M requirements by fixing prior problems or increase O&M requirements by adding new services. An asset management program understands these interactions, and your rate and financial plan should reflect these same assumptions.

Conclusion

Using asset management to inform your utility financial plan and rate strategy improves the accuracy of forecasts and facilitates better investment in infrastructure. From fixed asset registries to O&M, there are several ways to start aligning asset management and rate studies today. Missing out may result in improper allocations or an underinvestment in key programs.

Questions? Comments?

If you have questions about this blog post, contact Ben Hoffman BenH@fcsgroup.com at FCS Group or email the MRSC Insight editors. If you have questions about other local government issues, please use our Ask MRSC form or call us at (206) 625-1300 or (800) 933-6772

About FCS GROUP

FCS GROUP writes for MRSC as a Finance Advisor.

FCS GROUP, established in 1988, is an independent financial consulting firm that provides economic, public finance, management consulting, and financial (rates, charges, and fees) services to public sector clients inclusive of city and county governments, utilities, municipal corporations and ports, special purpose districts, and state agencies. Since the firm’s inception, FCS GROUP has delivered high-quality, cost-effective consulting services in over 2,300 engagements and served more than 525 clients. Their staff serves clients throughout the western United States and Canada from locations in Redmond, Washington and Lake Oswego, Oregon.

The views expressed in Advisor columns represent the opinions of the author and do not necessarily reflect those of MRSC.

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