MEMORANDUM
Date: March 4, 2025
To: Mayor and City Council
From: Gerry Beaudin, City Manager
Siew-Chin Yeong, Director of Public Works
Re: City Council Workshop March 4, 2025, Item #2 Accept the Water Enterprise Financial Analysis and Approve the Enhance Scenario
Regarding the March 4 City Council Water Financial Plan Workshop, page 2 of the agenda report mentions the cost-of-service principles outlined by the American Water Works Association (AWWA).
A cost-of-service analysis is a critical technical process used to determine the cost of providing water service to the City’s customers based on their usage and impact on the water system.
This analysis establishes a direct correlation between the utility's costs and the water rates charged to customers, ensuring compliance with ratepayer notification requirements (Proposition 218).
Cost-of-Service Principles
The cost-of-service methodology follows the principles established by AWWA and is outlined in the M1 Principles of Water Rates, Fees, and Charges, Seventh Edition (M1 Manual). These principles provide a standardized approach to rate-setting, ensuring that water rates are fair and equitable and directly tied to the costs incurred in providing service. The AWWA framework emphasizes transparency and cost accountability, which helps utilities allocate costs in a manner that reflects customer usage patterns and system demands.
Cost-of-Service Methodology
Most rate studies follow the base-extra capacity method to determine appropriate water rates.
The primary objective of this analysis is to develop unit costs, which serve as the foundation for proposed rate structures. The analysis is conducted using a single representative “test year.” The key steps in conducting a water cost-of-service analysis are outlined below:
• Revenue requirement determination: The total rate revenue requirement for the test year is determined based on the results of the proposed financial plan and divided into primary sub-components (operating, capital, etc.).
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• Cost functionalization: Operating and capital costs are evaluated and assigned to “functional categories” in the water system (e.g., customer service, groundwater wells, distribution, etc.). This provides a proportional breakdown of system costs by functional category.
• Revenue requirement allocation to cost causation components: Functionalized costs are allocated to “cost causation components” (e.g., water supply, base delivery, max day delivery, etc.), which is used to attribute customers’ use of the system to the City’s incursion of costs.
• Unit cost development: The rate revenue requirement allocation for each individual cost causation component is divided by the appropriate units of service to establish unit costs for the test year. Unit costs provide the basis from which proposed rates are calculated.
By following the AWWA cost-of-service principles and methodology, the City ensures that water rates are equitably distributed based on actual service costs, promoting fairness and financial sustainability within the water utility system.