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Sewer Rate Structure Alternatives for Utilities


October 11, 2017 by FCS GROUP
Category: Finance Advisor , Utilities - Billing and Collection

Sewer Rate Structure Alternatives for Utilities

Recognizing the predominantly fixed nature of a sewer utility’s annual operating and capital costs, most sewer rate structures include a base rate that applies to customers regardless of the amount of water that they use.

Base rates can include a charge per account to recognize that some costs (e.g. utility billing) are attributable to all customers equally, regardless of their demand or service characteristics. However, a charge per equivalent residential unit (ERU) typically comprises the majority of the base rate.

ERU Assignments per Customer

Conceptually, the ERU standardizes the customer base by equating a customer’s demands to those of a typical, single-family home.

Single-Family Unit: This is typically 1 ERU per home, by definition, though some utilities have adopted tiered ERU definitions to differentiate low water users from high water users. Some utilities have also established policies for assigning a greater number of ERUs to homes with accessory dwelling units (ADU).

Commercial Unit: ERU assignments for “normal” commercial customers are most commonly based on water meter size and fixture counts, though some utilities assign ERUs based on estimated demand defined by business type or a variety of other metrics (e.g. number of employees, number of seats, square footage). For large commercial or industrial customers, utilities often reserve the right to determine an appropriate assignment of ERUs based on expected demands.

Multifamily Unit: These can be treated like a commercial or a residential customer for the purpose of assigning ERUs. Some utilities assign ERUs based on water meter size or fixture counts, while others assign a fraction of an ERU to each dwelling unit. Comparative analyses of a multifamily structure’s demands relative to the winter-average demand of a single-family home typically justify an assignment of 0.6 – 0.8 ERUs per multifamily dwelling unit.

Some utilities include a certain amount of water usage in their base rates that would be scaled up in line with dwelling units or meter size. Base rates can also vary by customer class to reflect cost differentials associated with wastewater strength or billing frequency (For example, if residential customers are billed bimonthly and nonresidential customers are billed monthly).

Volumetric Rates for All Customers?

Volumetric rates have historically been more commonly used for commercial and multifamily customers (when treated similarly to commercial customers for ratemaking purposes). Volumetric rates are applied to usage over any amount built into the base rates.

Single-family customers are less likely to be separately metered for fire flow or irrigation water and, as a result, their water demand less accurately represents their sewer flows. For this reason, flat sewer rates have historically been most common for these customers. 

In recent years, an increasing number of utilities have been moving away from flat, single-family sewer rates and shifting to (or at least considering) volume-based rates. This shift is prompted by a number of reported upsides, including improved equity in cost recovery, reinforcement of conservation-oriented price signals embedded in water rates, and enhanced affordability for low users.

Volumetric Rate Options

Utilities have two primary options for instituting volume-based, single-family sewer rates: a Tailored Fixed Rate and a Volumetric Rate.

Tailored Fixed Rate: This is the most common approach. In it, a utility calculates winter-average usage for each customer on an annual basis and uses that calculated volume to determine the fixed rate to apply to the customer for the following year. The winter-average usage is usage that occurs during a defined “winter” period when a customer is unlikely to use irrigation. Utilities that use this approach typically update a customer’s winter-average volume on an annual basis and will use a system-average volume for new customers that have yet to establish a demand history. 

Volumetric Rate: Some utilities impose a volumetric rate for single-family residences based on actual water usage. Though not explicitly required, capping the amount of water usage subject to sewer charges helps to avoid charging for incremental irrigation water use. The cap could be customer-specific, using winter-average water use, or uniform for the entire single-family class. In lieu of a cap, some utilities apply a “sewer return flow factor” to a customer’s water usage based on the estimated percentage of water demand that enters into his/her sewer system.

Approaches taken in the tailored fixed rate and the volumetric rate are consistent with industry ratemaking practices and each approach has both pros and cons. The “tailored fixed rate approach” retains revenue stability but requires utilities with a significant number of “snowbird” customers to establish a policy for imposing charges on these customers (as their winter usage does not provide a representative basis for billing).

The volumetric rate approach does not rely on customers exhibiting representative demand patterns during a defined period, but instead, it comes with increased revenue volatility and seasonality, which can then be managed with an appropriate structure of reserves.

What are Your Policy Objectives?

In deciding whether or not to adopt a volume-based, sewer rate structure, it is worth considering your utility’s policy objectives in a broader sense. Equity is a relatively straightforward and desirable goal; however, the most equitable rate structures are often more complex to administer than those that have historically been the most popular alternatives in the industry.

The enhanced conservation incentives of a volume-based structure synergize well with affordability for low users but conflict directly with the need for revenue stability and reliability to cover what is primarily the fixed cost of providing service. Because there is no universally correct balance of these objectives, it would be prudent to engage your utility’s management staff and elected officials in a discussion to determine the balance that best reflects your utility’s conditions and values.

Questions? Comments?

If you have questions about this topic or other local government issues, please use our Ask MRSC form or call us at (206) 625-1300 or (800) 933-6772. If you have questions or comments about this blog post, please email the MRSC Insight Editors.

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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