Full Cost Pricing – How Do 2013 Rate Survey Respondents Measure Up?

The concept of full cost pricing is generally defined as the recovery of revenues sufficient to meeting operating expenses, maintenance expenses, debt service principal and interest payments, and contributions to reserves adequate to fund renewal of the system. Though somewhat difficult to pinpoint, appropriate funding of system renewal is often described as an annual investment in rate-funded capital, debt service principal, and contributions to reserves equal to at least annual depreciation of the system. Full cost pricing can be viewed at both a high level in terms of overall utility revenue requirements and revenues, as well as at the individual user type level, which is generally measured as the cost of service.

One assessment of a utility’s efforts to achieve full cost pricing can be measured using the Operating Ratio, calculated by dividing the operating revenues by operating expenses and capital reinvestment. An operating ratio of 1.0 would indicate that utility revenues are exactly equal to utility revenue requirements. An operating ratio larger than 1.0 would indicate a scenario where the utility generates revenue that exceeds its revenue requirements, and an operation ratio less than 1.0 would be indicative of a utility that does not fund depreciation and/or requires a subsidy outside of user revenues to meet total revenue requirements.

Figures 1 and 2 illustrate the calculations of 2012 operating ratios, based on data reported by water and wastewater utilities that participated in the 2013 North Central Utility Rate Survey. The average value calculated based on reported 2012 financial data from all water and wastewater respondents to the rate survey was 1.09, and the median was 1.06. These values have decreased from those reported in 2011 based on 2010 financial data, which indicated average and median operating ratios of 1.48 and 1.38, respectively.

Of the systems that reported financial data in the 2013 survey, the calculated operating ratio for 66 percent of water respondents and 59 percent of wastewater respondents was greater than 1.0. This also represents a decrease from 2010 data, which indicated that 90 percent of water systems and 86 percent of wastewater systems achieved operating ratios greater than 1.0. This is not necessarily cause for alarm, as it may be indicative of the degree to which some utilities rely on non-rate revenue sources. How those non-rate revenue sources figure into the discussion of full cost recovery varies based on financial philosophy of each utility.

Figure 1: Calculated Water Utility Operating Ratios for 2013 Respondents to the AE2S Utility Rate Survey Respondents

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Figure 2: Calculated Wastewater Utility Operating Ratios for 2013 Respondents to the AE2S Utility Rate Survey

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O&M and Revenue per Capita

Another trend that is commonly used to monitor the fiscal health of a utility is measurement of O&M and rate revenues per capita. While this indicator may not be meaningful for all communities, it is interesting to compare the average values for rate survey respondents in recent years. Figure 3 illustrates the calculated O&M and rate revenue values for fiscal years 2011 and 2012 as reported by respondents in the 2012 and 2013 rate surveys.  It should be noted that the 2011 values in Figure 3 represent responses from 67 systems, and the results for 2012 represent data from 123 water systems and 109 wastewater systems. In addition, not all utilities that responded in 2012 participated in 2013, so the illustration is purely a general illustration of changes in the average utility O&M and rate revenues based on the available data.

Figure 3: Average Reported Per Capita O&M and Rate Revenue Values from 2011 and 2012

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As shown in Figure 3, assuming that the rate survey participants are representative of systems in the region, it appears that while O&M expenses are increasing on a per capita basis, rate revenues are also increasing on the same basis. Data provided by survey participants indicate that both the average water O&M expense and rate revenue increased by approximately 28 percent from 2011 to 2012. For wastewater, the data indicates the average wastewater O&M expense per capita increased by 14 percent from 2011 to 2012 and the average wastewater rate revenue per capita increased by 22 percent.

It would generally be expected that the change in expenditures per capita would increase in accordance with inflation. The changes illustrated in Figure 3 greatly exceed inflation.  This is primarily due to the changing sample group. Similarly, the change in revenue per person is also higher than would be expected, again partially due to the changing sample set but also likely due to rate-setting efforts that have been undertaken by many systems striving to meet full cost recovery. We will continue to calculate this indicator in future years, and expect that as the number of participating systems increase, the results will become increasingly more reflective of conditions in the region.

Trend Toward Full Cost Recovery

The industry trend to encourage full cost recovery through utility rates is one that is expected to continue into the future. Generally, full cost recovery is not a goal that is readily achieved. Utilities usually strive to meet full cost recovery over a period of several years. Monitoring operating ratios and the changes in annual expenses and revenues on a per account or per capita basis are just a couple of the tools available to continually assess efforts to promote and maintain financial sustainability for your utility.