Report 2014-132 Summary - April 2015

Apple Valley Area Water Rates: Differences in Costs Affect Water Utilities' Rates, and One Utility May Have Spent Millions of Ratepayer Funds Inappropriately

HIGHLIGHTS

Our review of water rates charged by four water suppliers in the Apple Valley area—Apple Valley Ranchos Water Company (Apple Valley Ranchos), Golden State Water Company (Golden State), Hesperia Water District (Hesperia), and the Victorville Water District (Victorville) highlighted the following:

RESULTS IN BRIEF

Apple Valley is a rural community of 71,000 in the high desert north of San Bernardino and adjacent to the cities of Victorville and Hesperia. The water supplies of these three communities come from groundwater, which accumulates naturally in local aquifers beneath the land's surface and is obtained from wells that local water utilities own and operate. Most of Apple Valley's residents receive their water from two privately owned water utilities (private utilities): Apple Valley Ranchos Water Company (Apple Valley Ranchos) and Golden State Water Company (Golden State). Those residing in the adjoining cities of Victorville and Hesperia receive their water from publicly owned water utilities (public utilities) that those two local governments run.

A variety of cost factors and differences in costs among the utilities contributes to the variations in the four utilities' water rates. We compared the utilities' average annual costs per connection, or customer, to make comparisons between the differently sized water utilities. Overall, the two private water utilities had higher costs and therefore higher rates. Specifically, for the three-year period we reviewed, Apple Valley Ranchos and Golden State had average annual costs of $1,108 and $1,035 per connection, respectively. In comparison, the two public water utilities had lower average annual costs per connection, with the Hesperia Water District (Hesperia) at $702 per connection and the Victorville Water District (Victorville) at $829 per connection. Golden State had the highest costs per connection in several categories, such as personnel and operations costs, in part because Golden State's service area has a smaller number of connections to share the costs. Although the two public utilities had higher costs in other categories such as water purchases, their overall costs per connection were lower than those of the private utilities.

A key factor that contributes to the differences in costs among the water utilities is the inherent difference between private and public water utilities. For example, the two private water utilities, Apple Valley Ranchos and Golden State, incur costs that the public utilities do not, including income and property taxes. In 2011 through 2013, Apple Valley Ranchos' annual average costs for income and property taxes were $154 per connection. Although public utilities may receive revenues such as property taxes and connection fees paid by its customers, these amounts are not incorporated directly into customers' rates and do not appear on their bills. In addition, state law allows private utilities the opportunity to receive a reasonable return on their investment in the water utility, if the California Public Utilities Commission (commission) so approves. This return on investment is a component of the costs included in the water rates that customers pay. For example, in 2013 Apple Valley Ranchos received a return on its investment of $3.6 million, or $198 per connection.

Customers' bills from Apple Valley Ranchos and Golden State also include other charges not found on the bills of public utility customers. State law authorizes—and the commission encourages—private utilities to offer rate assistance programs. Both Apple Valley Ranchos and Golden State offer a low-income rate assistance program to certain demographics of their water customers. For example, Golden State's low-income customers can receive a monthly credit of $8, while customers who do not benefit from the program pay 92 cents per month to fund that program. The public utilities we reviewed do not currently offer rate assistance. In fact, state law prohibits public utilities from using revenues from water rates to offer rate assistance programs like those the private utilities offer. However, the public utilities are not prohibited from using revenues from other sources to offer these programs.

Public utilities also receive revenues from additional sources, such as taxes based on the assessed value of properties in their service area. These additional revenue sources help public utilities offset their costs and therefore can contribute to lower monthly water rates for their customers. For example, Victorville received $502,000 in property taxes in fiscal year 2012-13, offsetting 2 percent of its costs. Victorville also received an average of $1.4 million during fiscal years 2010-11 through 2012-13 in connection fees from new development, equating to 5 percent of its costs.

The four water utilities have taken measures to reduce their costs and to keep rates reasonable. Because higher costs can contribute to increases in water rates, we expected that the water utilities would be able to demonstrate the savings achieved by their efforts to reduce costs. Although each water utility we reviewed indicated that it had taken numerous steps to reduce costs to consumers, such as pumping at off-peak times, two of them had not determined the cost savings resulting from any of the measures. However, in response to our discussions, one of the two utilities subsequently determined amounts for some of its cost-saving efforts. When the water utilities do not quantify their efforts, they are missing an opportunity to demonstrate to customers that they are taking steps to keep costs down, especially in those instances where they are seeking rate increases.

Because of their different cost structures, water rates for the two private utilities have increased in recent years, while rates for the public utilities have remained relatively stable. Specifically, rates for a unit of water for Apple Valley Ranchos and Golden State have increased between January 2011 and June 2014 by 16 percent and 18 percent, respectively, while rates for Hesperia and Victorville remained mostly unchanged. The public utilities' rates have stayed low not only because of lower costs. For example, the City of Hesperia has invested in water rights that it leases to the Hesperia Water District at costs lower than it could purchase or lease from others, and it has also reduced its administrative charges to the water district.

Although Victorville has kept its water rates low in part by deferring routine maintenance, it implemented a rate increase, initially approved for 2010 but deferred until 2014, and it is likely to increase its rates beginning in 2015. However, it might not have needed to raise rates if it had not undertaken some inappropriate transactions. Specifically, beginning in 2009, Victorville loaned $21.9 million in water customer revenues to an agency within the city of Victorville (city) in two loans, which resulted in harm to the customers, or ratepayers. Although it is not unlawful for a water district to loan ratepayer money or otherwise invest it in a prudent manner, it cannot do so if loaning that money impairs its ability to perform the functions for which the ratepayer revenue was collected. During the time that the two loans to the city were outstanding, Victorville borrowed $20 million from the Southern California Logistics Airport Authority (Airport Authority) at a higher interest rate. In March 2013 the city repaid the $21.9 million in loans it had received from Victorville in 2009 plus interest of nearly $400,000; in turn, Victorville paid off its $20 million loan from the Airport Authority plus $5 million in interest. As a result, Victorville incurred more than $4.6 million in unnecessary interest expense. During the same time that the loans were outstanding, Victorville postponed routine maintenance and repairs and scheduled asset replacement. In April 2014 the deferred maintenance resulted in an inspection letter by the California Department of Public Health for insufficient maintenance and inspections. Also in 2014, Victorville increased its water rates, in part because it stated that it needed to address the deferred maintenance; and it is likely to have an additional increase in rates that it might not otherwise have needed.

Victorville used the $20 million from the Airport Authority, along with $11 million in water district revenues, to construct an industrial wastewater treatment plant (wastewater plant), which was completed in December 2010 for a total of approximately $31 million. The wastewater plant has served primarily one commercial customer—a beverage manufacturing plant. An agreement between the city and the beverage manufacturer requires an annual minimum payment of $1.95 million from the beverage manufacturer for use of the wastewater plant, but none of the amount is contractually obligated to Victorville so it can recoup its costs for building the plant. However, the city is providing a portion of the funds it receives from the beverage manufacturer to Victorville. Specifically, as of June 2014, the city had allocated only $4.5 million to Victorville to repay its costs of building the wastewater plant, including $2.2 million from the beverage manufacturer. In addition, although Victorville contracted in 2010 with a power plant to sell its reclaimed water from the wastewater plant, it has not yet received any revenue from the sale of reclaimed water. Nonetheless, because it has received so little repayment to recover its costs in the years since the wastewater plant was built, we do not believe that Victorville's investment in the wastewater plant was a prudent use of water district funds. Further, the use of the $11 million in ratepayer revenues, which includes water delivery fees and connection fees, to construct the wastewater plant may have violated provisions of state law limiting the use of water delivery fee revenues to the purposes for which they were collected.

RECOMMENDATIONS

To assist low-income water customers, the two public utilities—Hesperia and Victorville—should work with their respective governing bodies to consider the feasibility of using revenues from sources other than water rates to implement rate assistance programs.

To show water customers that they are working to keep rates reasonable, water utilities should document any cost-saving efforts and quantify, to the extent possible, any specific cost savings achieved from their respective efforts.

To ensure that it does not use revenues from ratepayers for inappropriate purposes, by October 2015 Victorville should establish a policy to prohibit transfers or loans of water utility revenue for nonwater district purposes.

AGENCY COMMENTS

Apple Valley Ranchos agreed with our recommendation that it quantify its cost-saving efforts. Golden State believes that the recommendation to document and quantify future cost-saving efforts does not acknowledge the commission's rate-making process, in which costs and operations are reviewed. Hesperia disagreed with our recommendation that it implement a low-income assistance program, stating its rates are already lower than another utility in the area. It also disagreed with our recommendation that it quantify its cost-saving efforts, stating that it focused its limited resources on efficiently providing water. Victorville did not specifically address the recommendations we directed to it and instead expressed dissatisfaction with the audit process.