The City wants to raise water rates by 30%
Common Council approves
[Note: This will be the only newsletter this week due to some other obligations I have today.]
I. Natural Monopolies
If you want to start a business, the best type to start would be one that provides a product everyone wants and that no one else is allowed to supply. This can take a few forms. McDonald’s franchises can be lucrative not just because everyone knows what McDonald’s is and lots of people like it, but also because the McDonald’s Corporation controls who and where their franchise businesses go, and they tend to prevent other McDonald’s franchise owners from putting up a new store across the street from one that already exists. You have a corporate-enforced monopoly for your geographic area. Obviously this doesn’t prevent, you know, Arby’s from opening up across the street but who eats there?
Another good business, at least financially if not morally, are tobacco companies. Partly this is because nicotine is addictive so even as there are fewer new smokers, tobacco companies can continue raising prices to compensate because addicted people tend to be insensitive to the cost of the things they’re addicted to. But also, one result of the Tobacco Master Settlement in 1998 was that companies were prohibited from advertising in the ways they had previously. This hurt already existing tobacco companies—like RJ Reynolds or Altria (then known as Philip Morris)—but it hurt potential new tobacoo companies even more since they couldn’t really market their brand to people that had never heard of them before. A government-enforced monopoly1 is even better than a corporate-enforced one. Incidentally, Altria—owners of Marlboro—is one of the best performing stocks of all time.
Technically, a monopoly exists when a single business is the only supplier of a particular product or service. This is great for the monpolist because they can charge more without a competitor undercutting them on price, but it’s generally considered bad for the customer because they pay more or get a worse product than they otherwise would. The government will often prevent such monopolies from developing by, e.g., preventing competing businesses from merging or suing companies that engage in anti-competitive practices.
But sometimes monopolies are the only things that make sense. For instance, it could be pretty painful and disruptive if there were multiple electricity companies trying to string their own powerlines through your neighborhood and because of the huge fixed costs involved, only one would probably come out alive anyway.2
So, in industries where a natural monopoly would exist anyway—like generating electricity or supplying water—a state will usually allow it but they’ll impose a number of restrictions. Like limiting the amount of profit the utility company is allowed to earn and making them request approval from a board of uncorruptible, altruistic overseers before it can raise prices.
Wauwatosa’s water utility wants to raise rates by 29.49% in 2023. And so as the City’s Finance Director, John Ruggini, explains:
Unlike the sanitary and storm utility, the water utility is regulated by the Public Service Commission [PSC] just like We Energies. And so, in order to increase rates, we have two options. We have what’s called a Simplified Rate Increase which is 3.0% and it requires minimal application or information provided to the Public Service Commission. Or a Conventional Rate Case. This is a Conventional Rate Case. For a Conventional Rate Case you have to go through a pretty lengthy application process and review. In both cases approval by the Common Council is required.
The City of Wauwatosa must submit a Conventional Rate Case partly because the PSC requires one at least every 5 years and partly because of how large the proposed rate increase is.
II. Why so high?
The hour-long discussion seemed to touch on about 5 different reasons although they’re all interrelated to some extent:
1. Catch-up
The PSC describes the Standard Rate Case as “an inflationary type increase that helps utilities maintain rate continuity so that customers benefit from smaller, more frequent rate increases.” But the City has had only one standard rate increase in the last 5 years. So, while the 30% increase seems large, it’s partly to make up for a lack of smaller hikes in previous years. In 2018 and 2019 there were no rate increases because the City wanted to give everyone a reprieve after the rate increase of 20% in 2017. And there was no rate increase in 2020, because everyone was already kind of beaten up and worried about this whole pandemic thing. Rates only increased once, by 3.0%, in 2021.
2. Lower demand
Some businesses require almost no money to start. Think of anything where you have a skillset that someone can hire you for—consulting, copywriting, web design. Other businesses require huge investments up-front to build factories, forges, or foundries before they ever make their first dollar. Think of computer chip manufacturers or…water utilities.
During the Financial Affairs meeting, City Administrator Jim Archambo noted that as water consumption within the City has declined over many years, mainly due to less intensive use by industrial customers, the City has had to increase prices to compensate for the reduced volume. The water towers, after all, need to be painted whether there’s water inside them or not.
His comment was interesting to me because it highlights a way in which conservation can be privately beneficial (you personally are spending less money) when relatively few people do it but where the incentive disappears once everybody starts doing it due to fixed infrastructure that must be maintained in either case. Kind of like a tragedy of the commons but in reverse.
3. Increased costs
Expenditures have grown by 28%, or $1.3M, while revenue has grown only 3% since 2017. Of that $1.3M increase, wage increases comprised 26%, operational expenditures comprised 24%—which John Ruggini attributed mostly to increased depreciation costs and the cost of water from City of Milwaukee—and 12% is from additional principal and interest payments on the City’s debt.
This has caused the rate of return (ROR, how much net income the water utility makes as a percentage of the value of its assets) to decline from 5.6% in 2017 to 1.7% in 2022. A 30% rate increase would bring ROR back to 6.0% which is near the limit of what the Public Service Commission allows.
4. Speed-up infrastructure improvements
Wauwatosa is an old, built-out city with no room to grow. It has a little over 1,000,000 lateral feet (LF) of water piping, 30% of which was installed before 19403. The life expectency of water pipes is about 100 years, and the city is currently replacing about 7,500 LF per year. At this rate, it would take 43 years just to replace the pre-1940 piping. The City would like to speed this process up, and so it is asking for a slightly larger rate hike to do that.
There was also a comment about how this “accelerated depreciation schedule” made it easier to match the rate of depreciation with the 20-year loans required to fund water main replacement. It wasn’t clear to me why exactly that is desirable.
5. Pay with cash
The City typically budgets $2.5M per year for water main replacement which it funds by issuing debt that it pays back over the following 20 years. However, the City would ultimately like to use less debt and more cash4 to pay for capital improvements. Because they are limited in their ability to raise property taxes, they can get this extra cash to fund infrastructure improvements by increasing water and other utility rates.
III. So what will my bill look like?
The City actually presented two potential scenarios for increasing water rates.
1.
The first didn’t include an accelerated depreciation schedule and there was no attempt to improve the City’s ability to cash-finance its capital improvement budget. In this case:
Water rates would increase by 24.25%. So if your quarterly water bill was $90.36 this year, it would be $112.95 the next.
A residential customer who used the average amount of water would then expect to see his total utility bill in 2023 (which includes not just water but sewer and sanitary service as well) increase by 11%.
2.
The second supported an accelerated depreciation schedule and increased cash-financing of capital improvements. In this case:
Water rates would increase by 29.49%. So if your quarterly water bill was $90.36 this year, it would be $117.48 the next.
A residential customer who used the average amount of water would then expect to see his total utility bill in 2023 (which includes not just water but sewer and sanitary service as well) increase by 13.25%.
While this rate hike will be more expensive in the short-term, it also helps reduce the City’s need to take on debt. Therefore, there will be fewer and smaller rate hikes in the future as interest expenses decline making it cheaper than (1) in the long-run.
Another advantage is that it provides some inflation protection as rising interest rates will continue to raise the cost of borrowing and make any debt the City takes on in the future more expensive.
City Staff recommended the 29.5% increase and the Financial Affairs committee agreed. For what it’s worth, the City is not planning for any rate increases on sanitary or sewer service in 2023.
IV. Final Comments
Overall, the increase mostly makes sense to me and seems reasonable. On the other hand:
→ Why has water become so much more expensive over the past 10 years? Based on Figure 1 all the way up in Part II, water rates increased by 57% from 2010 to 2020. This is much faster than the rate of inflation. Including the 30% increase next year and projections for future rate increases out to 2030, the price will increased by a total of 137% between 2010 and 2030.
The figure above compares Wauwatosa’s water rates to other nearby utilities. You can see today that Wauwatosa is about average. But after the price increase (“Tosa Bill w/ AD”), Wauwatosa’s water will be more expensive than almost 90% of other utilities.
Sure, water from Milwaukee has gotten more expensive and wages have increased and debt service has grown larger. But why are all those things happening?
From what I can tell this a nationwide problem. For instance, this Wall Street Journal article from 2018 says:
Bills started rising significantly faster than inflation in the mid-2000s as communities stepped up their repairs of aging water and sewer infrastructure. Over the past decade, the increases have averaged 5.5% a year, more than three times the rate of inflation, according to the Labor Department.
In general, many local communities have underinvested in their water infrastructure for decades. When infrastructure is new, it can be easy to put off saving the money to replace it. It may not always be obvious how much things will cost to replace or how quickly that will need to happen. But eventually, the bill comes due.
It could partly be an aging workforce. This American Water Works Association survey of water industry professionals from 2021 lists an aging workforce and retention of talent as the 8th and 14th most urgent problem the industry faces. The 14th most urgent concern is not exactly urgent—but maybe this explains the increased wage expenses that are driving up costs. Fewer people who want to work for water utilities means you have to pay more to the ones that do.
But if it’s a widespread problem that everyone is dealing with, why has Wauwatosa’s water gotten significantly more expensive not only in an absolute sense but relative to all the surrounding water utilities?
I don’t know. I mean, maybe there’s something in the 25 years of annual reports the municipal water utility has submitted to the PSC since 1997. While I admit it’s temping, I’ve not perused them.
One explanation could be that Wauwatosa alone, compared to surrounding communities, has underinvested in infrastructure for many years and catching up on repairs is much more expensive than if we had, like our neighbors, maintained adequate investment all along.
Another explanation is that, actually, we’ve gotten our act together sooner than most, and it’s everyone else in the area that’s continuing to underinvest. I like Wauwatosa and the people that run it seem pretty smart, so I’m inclined to think it’s the latter, but it’s hard to tell. And of course, many other explanations are possible.
However, our water utility does seem to be well-run. For instance, one way to judge a utility is based on its level of debt compared to its assets. The rate case documentation provided to the City doesn’t give a good benchmark for what a high debt-to-asset level would be, but some research by Brookings a few years ago did look at the debt levels of water utilities across the US and considered one less than 0.56 ($0.56 of debt for every $1.00 of assets) to be a good sign. It would be useful to know how they determined this benchmark, but Wauwatosa compares pretty well at 0.31.
Similarly, it has an operating ratio above 1.00—that is, it brings in more than $1.00 of revenue from customers for every $1.00 it spends on operating expenses and depreciation—which can’t be said for many utilities and which both the Brookings article above and the consultant who presented the rate case to the Financial Affairs committee the other week also considered noteworthy.
Overall, water in Wauwatosa seems to be getting more expensive for the same reasons water everywhere else in the country is getting more expensive. At the same time, that doesn’t explain why we’re getting more expensive relative to other regional water utilities. And none of the discussion during the Financial Affairs committee meeting really addressed this.
→ What about Schoonmaker Creek? During the meeting, City Finance Director John Ruggini made clear that none of these projected future rate increases will cover improvements to Schoonmaker Creek, a potentially $100M dollar capital project to improve drainage and reduce flooding that dwarfs any capital project the City has ever undertaken.
A very similar comment was made during the previous Financial Affairs committee meeting as they discussed projected gaps in the City’s budget over the next several years—not only will the City be operating in the red unless it finds some expenses to cut, the situation is likely even worse if you include the extra costs needed to pay for fixing Schoonmaker Creek. Which they didn’t.
While I think ethically and professionally it’s good to acknowledge that one’s model or projection excludes some critical uncertainty so at least alders are aware that the numbers might be worse than predicted, it would be even better not to exclude those uncertainties to begin with. Currently, it seems like there’s this very large future liability that everyone sort of vaguely understands will make things worse in potentially significant ways but which in practice everyone ignores since it’s not included in the models people use to actually make decisions.
This seems bad and wrong. To be clear, this doesn’t require anyone to be bad at their job. In fact, it’s probably the opposite. With respect to things like financial models and projections, it’s possible that professional norms (and maybe even requirements) keep people from explicitly accounting for such uncertainties because it’s hard to quantify and doesn’t really fit the standard format. But I’m not sure this is a great excuse, and it still seems bad to make decisions based on information everyone knows is literally false.
The Financial Affairs committee recommended the rate increase and the Common Council approved it unanimously on July 19. However, it still requires approval by the Public Service Commission which can take anywhere from 6-8 months. The new rates will not go into effect until 2023.
Or, I guess, technically an oligopoly.
As I mentioned previously, the City would like to finance at least 40% of its yearly capital improvement budget with cash rather than debt.