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Westchester County (NYC Water Rate) - Decision, November 9, 1995

Decision, November 9, 1995

STATE OF NEW YORK
DEPARTMENT OF ENVIRONMENTAL CONSERVATION
50 Wolf Road
Albany, New York 12233-1010

In the Matter

- of the -

Petition from
WESTCHESTER COUNTY
for the Fixation of Water Rates Water Supply

Application No. 8865

DECISION

November 9, 1995

Decision of the Commissioner

Upon review of the record and the Hearing Report (copy attached) of Administrative Law Judge ("ALJ") Daniel P. O'Connell, I concur with its Findings of Fact, Conclusions and Recommendations, subject to my comments below.

The Water Supply Act of 1905 (the "Act") and amendments (Administrative Code of the City of New York 24-360) authorize various upstate communities to take a determinable quantity of water from the New York City ("City") water supply system. For this water the communities must pay the City "such fair and reasonable water charges or rates as may be agreed upon between the [parties]" (24-360(b)). Alternatively, either the City or the upstate communities may make application to the Department of Environmental Conservation to set a fair and reasonable rate after hearing all interested parties (Id.).

Since January 1973 (following a previous rate determination by this Department) the City has charged $76.87 per million gallons ("/MG") to communities which take water from the Croton system and $103.72/MG to those which use the Catskill/Delaware system. In July 1991, the Board notified the upstate communities that it was imposing an increase in the rate to $165.23/MG for each system (effective July 1, 1993). Westchester County countered that the fair and reasonable rate should be $153.71/MG. When no agreement was reached by June 8, 1992, Westchester applied to this Department for a hearing to fix the rates. The requested hearing was convened by ALJ O'Connell on October 11 and 13, 1994 at the Westchester County Office Building in the City of White Plains.

Based on the rationale and calculations set forth in the Hearing Report, I conclude that the rate of $158.31/MG arrived at by the ALJ is fair and reasonable, consistent with 24-360.

Conservation

The ALJ recommends that with the Department Staff's assistance, the upstate municipalities should develop and implement water conservation plans. The upstate municipal consumers are urged to develop conservation plans, and to seek appropriate assistance from both the City and the Department Staff. All parties accept the importance of and necessity for conservation planning and some of the affected municipalities have well developed conservation programs. Staff is instructed to assist the parties in this endeavor, to help to institute and improve conservation programs where necessary, to monitor conservation programs of the affected municipalities, and to keep the Commissioner informed of potential policy adjustments that may be believed to be necessary or desirable concerning the Department's responsibilities concerning water conservation.

NOW, THEREFORE, having considered this matter and being duly advised it is DECIDED that:

The rate to be charged by the New York City Water Board to upstate communities which take water from the NYC water supply system shall be $137.73/MG effective July 1, 1992 and $158.31/MG effective July 1, 1993.

Ror the New York State Department
of Environmental Conservation
/s/
By: Michael D. Zagata, Commissioner

Albany, New York
November 9, 1995

SUMMARY

Westchester County petitioned the NYS Department of Environmental Conservation for a hearing to fix the rate that the New York City Water Board can charge upstate communities who take water from the NYC water supply system. This Hearing Report recommends a rate of $137.73 per million gallons (/MG) effective July 1, 1992, and a rate of $158.31/MG effective July 1, 1993.

BACKGROUND AND PROCEEDINGS

The Water Supply Act of 1905 (the Act) and later amendments, now identified as Section 24-360 of the Administrative Code of the City of New York, authorizes upstate communities to take water from the NYC water supply system. For this water, the New York City Water Board (the Board) may charge a rate based on the actual total cost of the water to the City less all costs associated with distributing the water within the City's limits. If there is a dispute about whether the water rate is fair and reasonable, the Act and the ECL authorize the Commissioner of the Department of Environmental Conservation to conduct a hearing to determine the rate.

Historically, the City charged one rate to upstate communities who took water from the Croton system and another rate to those who used water from the Catskill/Delaware system. Since January 1973, the rate for the Croton System has been $76.87/MG and the rate for the Catskill/Delaware system has been $103.72/MG.

In July 1991, the Board retained Ernst & Young (New York, NY) as consultants to prepare a report on the cost of supplying water to upstate customers. The rate proposed in the Ernst & Young Report was a single rate of $168.13/MG for all upstate users. After the Board conducted its public hearings, the Board lowered the proposed rate and decided to phase in the rate over two years. For Phase I (effective July 1, 1992) the proposed rate was $143.84/MG. For Phase II (effective July 1, 1993) the proposed rate was $165.23/MG.

Westchester County (the County) retained Guastella Associates, Inc. (Weymouth, MA) as its consultants to review the Ernst & rate of $153.71/MG to be phased in over four years.

By letter dated June 8, 1992, the County petitioned the Commissioner for a hearing to fix a fair and reasonable rate. The County filed its petition pursuant to 24-360 of the Administrative Code, ECL Article 15, Title 9 (Water Resources - Administrative Procedures for Article 15), and 6 NYCRR Part 603 (Applications for Fixation of Water Rates). The procedures provided in 6 NYCRR Part 624 (Permit Hearing Procedures) were used as a guide for the administrative rate making hearing.

At the County's request, its petition was held in abeyance while the County and the Board tried to settle the rate dispute without an adjudicatory hearing. Subsequently, Administrative Law Judge Daniel P. O'Connell held an Issues Conference in White Plans, NY on March 30, 1993. In addition to the County, the Board, and the Department Staff, the following filed requests for party status and appeared at the Issues Conference: the Town and Village of Scarsdale (Scarsdale), the Town and Village of New Paltz (New Paltz), the Westchester Joint Water Works (WJWW), the City of White Plains (White Plains), and Scenic Hudson. The record of the Issues Conference closed on June 18, 1993.

In a ruling dated August 9, 1993, ALJ O'Connell identified issues for adjudication and granted all requests for Party Status. After reviewing appeals from the ALJ's rulings, the Commissioner issued an Interim Decision on November 22, 1993. The administrative hearing, however, was held in abeyance while Scarsdale and the Board petitioned the Courts to review the Commissioner's Interim Decision.

Pursuant to CPLR Article 78, the Village of Scarsdale filed a Petition dated January 20, 1994 with the Supreme Court in Westchester County. The Board filed a Petition pursuant to CPLR Article 78 with the Supreme Court in Albany County on June 1, 1994. At issue in these court proceedings was the Commissioner's determination in the November 22, 1993 Interim Decision to exclude issues concerning: (1) excess water consumption by the upstate communities, and (2) the rate the Board should charge upstate communities for excess water.

As part of the disposition of these court proceedings, the Commissioner agreed to reconsider the November 22, 1993 Interim Decision about excluding issues concerning excess water consumption. Accordingly, the Commissioner set a schedule for the Parties to file briefs and replies. In an Interim Decision dated December 14, 1994, the Commissioner decided not to expand the scope of the administrative hearing with respect to the excess consumption issues.

Meanwhile, ALJ O'Connell set a schedule for the Parties to prefile their direct cases regarding the issues identified in the Commissioner's November 22, 1993 Interim Decision. The adjudicatory hearing convened on October 11 and 13, 1994 at the Westchester County Office Building in White Plains, NY. During the adjudicatory hearing, the prefiled documents were received into evidence and the Parties had an opportunity to cross examine the opposing Parties' prefiled cases.

The following Parties appeared at the adjudicatory hearing. Barbara Kukowski, Esq., Assistant County Attorney, appeared for the County. Florence Hutner, Esq., Assistant Corporation Counsel, and Gail Rubin, Esq., Assistant Corporation Counsel represented the Board. Joel Dichter, Esq., from the law firm of Klein, Zelman, Briton, Rothermel and Dichter, New York, NY appeared for Scarsdale. Deborah Christian, Esq., represented the Department Staff. For unexplained reasons, representatives from New Paltz, WJWW, White Plains, and Scenic Hudson did not appear at the adjudicatory hearing.

After the Commissioner issued the December 14, 1994 Interim Decision, ALJ O'Connell established a schedule for filing briefs and replies with respect to the issues litigated at the October 1994 hearing. Upon timely receipt of briefs and replies, the record of this proceeding closed on February 15, 1995. Effective July 1, 1994, the NYC Water Board changed the water rate charged to upstate communities from $165.23/MP to $174.18/MG. Consequently, by letter dated July 29, 1994, Westchester County filed a second petition with the Commissioner to fix the water rate charged to upstate communities. This petition is being held in abeyance until the County's consultants evaluate the Board's report concerning the July 1994 rate change.

OFFICIAL NOTICE

Official Notice was taken of American Water Works Association (AWWA) Manual-1 Water Rates and Manual-35 Revenue Requirements. No Party objected to the use of these documents or otherwise sought to limit their use in this proceeding.

FINDINGS OF FACT

  1. The Board's consultants, Ernst and Young, used audited expenditure and revenue data from Fiscal Year (FY) 1988 and FY 1989 as the basis for the proposed rate. These expenditures were the most recent sources of audited information.
  2. The New York City Office of Management and Budget (OMB) reviews all budgets for each City agency for reasonableness before submitting the budgets for approval. In addition, the NYC Department of Environmental Protection (DEP) certifies the water supply system costs to the Board after the DEP has reviewed and controlled the water supply costs.
  3. The Board's consultants, Ernst and Young, reviewed the historical cost data and determined that the costs incurred during FY 1989 and FY 1990 were generally representative of the costs that would be expected for FY 1992.
  4. Total fluoride costs for FY 1988 were $905,061. The unit cost for FY 1988 was $329/ton. The total amount of fluoride purchased in FY 1988 was about 2,751 tons.
  5. The total fluoride costs in FY 1989 were $2,150,343. The unit cost for FY 1989 was $824/ton. For FY 1989, the total amount of fluoride purchased was about 2,610 tons. From FY 1988 to FY 1989, the unit cost of fluoride increased 150% while the total amount purchased during that period decreased about 5%.
  6. Total chloride costs for FY 1988 were $933,981. The unit cost for FY 1988 was $431.40/ton. The total amount of chloride purchased in FY 1988 was 2,165 tons.
  7. For FY 1989, total chloride costs were $1,240,738. The unit cost for FY 1989 was $481.40/ton. The total amount of chloride purchased in FY 1989 was about 2,577 tons. From FY 1988 to FY 1989, the unit cost of chloride increased 12% and the total amount purchased during that period increased 16%.
  8. The record offers no explanation for the 150% increase in the unit cost of fluoride from FY 1988 to FY 1989, or the 12% increase in the unit cost of chloride for the same period.
  9. It is not known whether all, or part, of the chemicals purchased during fiscal years 1988 or 1989 were used within that particular fiscal year.
  10. The Hillview Reservoir is in southern Westchester County just north of the Bronx-Westchester County line. It functions primarily as a receiving and balancing reservoir to meet variations in the City's hourly demands.
  11. The Hillview Reservoir serves as an occasional source of water for Yonkers, New Rochelle, Mt. Vernon, Greenburgh and the Westchester Joint Water Works depending on their demand. The frequency and the amount of water these upstate communities take from the Hillview Reservoir is not known.
  12. Personnel expenses for the Hillview Reservoir are counted under the cost center for the Jerome Park Facility which is within the City limits.
  13. Total OTPS costs at facilities north of New York City for FY 1989 include, telephone service at Valhalla ($13,755), automotive repairs ($20,811), and laboratory costs ($269,500). The OTPS costs for the Hillview Reservoir are not itemized separately. It is impossible, therefore, simply to subtract all or a portion of the OTPS costs for the Hillview Facility from the total OTPS costs for all facilities north of NYC.
  14. The US Department of Health and Human Services annually reviews and approves the fringe benefit rate used by New York City. Historically, the rate has varied from 26% to 31%. For FY 1989, the approved fringe benefit rate was 30.0%. For FY 1990, the rate was 27.5%. For FY 1991, it was 27%. For FY 1992, the approved fringe benefit rate was 30%, and it was 28% for FY 1993.
  15. Since 1976, the average annual increase in the Consumer Price Index (CPI) has been about 5.6%.
  16. From 1972-1989, the real estate taxes paid by the City on water shed properties in upstate communities increased at an average annual rate of 6.7%. From FY 1987 to FY 1988, the rate of increase was 5.8%; from FY 1988 to FY 1989, real estate taxes increased 7.3%. Real estate taxes rose from $39,189,839 in FY 1989 to $41,200,317 in FY 1990 which was an increase of 5.1%.
  17. The adjusted total for the anticipated costs of service to upstate communities for FY 1990 is $83,617,060.
  18. There is no information in the record about population trends in upstate communities, and the per capita consumption of water both in and outside New York City. In addition, there is no qualitative information in the record about the integrity of the NYC water system or any quantitative estimate of the amount of leakage that occurs to the entire distribution system.
  19. Using the County's regression analysis, For FY 1990, the total consumption by upstate communities and city-residents for FY 1990 was 558,731 million gallons.
  20. For FY 1990, the ratio of the costs associated with facilities located north of NYC to total system-wide consumption is $158.31/MG ($88,451,508 558,731 MG = $158.31/MG).

DISCUSSION

The water rate is a unit cost expressed as dollars per million gallons ($/MG). The rate charged to upstate communities is the ratio of the costs associated with facilities located north of NYC, to the total system-wide consumption.

The Board developed a water rate for FY 1992 (the rate year) using historical data from FY 1989 and FY 1990 as test years. When the Board's consultants initially began to develop the upstate water rate in July 1991, expenditures and revenue data from FY 1989 were the most recent sources of audited information. The actual costs for debt service for FY 1990 had been audited by July 1991, however, and Ernst & Young used this information. The Board's consultants estimated the operating expenses and offsetting revenues for FY 1990 by increasing the operating expenses and revenue information for FY 1989 with a 5% inflation factor.

Scarsdale, the County and the Board presented expert testimony and argument about what should be the appropriate or normal costs for chemicals, Other Than Personal Services Costs (OTPS) at the Hillview Reservoir, and fringe benefits. The Parties also presented expert testimony and argument about how to estimate total water consumption for the purposes of determining the upstate water rate.

The last topic discussed below concerns the content, development, review and implementation of water conservation plans by the upstate communities. In the November 22, 1993 Interim Decision, the Commissioner required a consideration of this topic as part of these proceedings.

I. Normalization or Pro Forma Adjustments

Normalization, which is also referred to as pro-forma adjustments, is the process of adjusting historical costs from a particular test year when those costs do not represent the on-going level of expenses. When the test year costs are not representative of future expenses for the rate year, the Parties agreed that the actual costs for the test year must be normalized, or adjusted, to reflect a reasonable prospective level.

The only dispute concerning normalization is how the historical costs for the test years should be adjusted so that those costs represent the on-going level of expenses. Based on the reliable information presented in the American Water Works Association (AWWA) manual series on water supply practices, the test year data offered by the Board reflects a reasonable prospective level of future expenses for the rate year except with respect to chemical costs. These costs are addressed in detail below.

According to AWWA M1 - Water Rates, historical operating and maintenance expenses should be normalized by using all "known and measurable changes to expense levels or by using well-considered estimates of future expenses" (pp. 1-2). In addition, AWWA M35 - Revenue Requirements states that "expense projections should recognize such factors as changes in the number of customers served, changes in water demand, inflation, and changes in operation conditions or maintenance needs that may be expected within a projection period" (p. 19). Therefore, a fair and reasonable water rate should be based on a test year that includes pro-forma adjustments grounded in either known and measurable changes, or well-considered estimates of future expenses.

As previously stated, no Party objected to the use of the AWWA manuals or otherwise sought to limit their use in this proceeding. Moreover, expert testimony from the Board's witnesses supports the conclusion that the test year costs are representative of future expenses. As the Board's Treasurer for the past nine years, William Kusterbeck's unrefuted testimony established that the New York City Office of Management and Budget (the OMB) has a practice of reviewing all the budgets for each City agency for reasonableness before submitting the budgets for approval. The NYC Department of Environmental Protection (the DEP) then certifies the water supply system costs to the Board after the DEP has reviewed and controlled the water supply costs.

Furthermore, Edward Markus, the author of the Ernst & Young Report, testified that he had reviewed the historical cost data and determined that the costs incurred during FY 1989 and FY 1990 were generally representative of the costs that would be expected for FY 1992. Cross-examination by the County and Scarsdale did not undermine the testimony of the Board's experts.

II. Total Costs related to Facilities North of New York City for Fiscal Year 1989

Exhibit 2-rev b, The Cost of Water Supply: Summary of the Cost of Service and Unit Rates (Revised Ernst & Young Report dated June 1992), summarizes the total costs related to water supply facilities located north of NYC for FY 1989 (Attachment A to this Hearing Report). The costs at issue in the hearing were expenses associated with the direct costs of the Bureau of Water Supply and Wastewater Collection (BWSWC) for facilities located north of NYC (Section A of Attachment A). There were no disputes about any costs identified in Sections B and C of Attachment A.

On Attachment A, Section A, Line 1, the costs for Other Than Personal Services (OTPS) represent direct expenses related to the operating and maintenance of the water supply system. These expenses include, general supplies and materials, office equipment, telephone service, chemical costs, electric service and real estate taxes. With regard to the costs for OTPS, the Parties disputed: (1) the cost of chemicals, and (2) whether upstate communities should be responsible for any OTPS expenses for the Hillview Reservoir.

On Attachment A, Section A, Line 5, the costs for Personal Services represent the salaries and fringe benefits of all personnel working at water supply facilities located north of NYC. Concerning the costs for Personal Services, the Parties disputed the fringe benefit rate.

Based on the explanation that follows, chemical costs which are part of OTPS costs should be adjusted down from $3,391,081 to $1,839,040. No other adjustments to OTPS costs or Personal Service costs on Attachment A, Section A are recommended. As previously stated, there were no disputes about the costs presented in Sections B and C of Attachment A. Therefore, the total costs related to facilities north of NYC should be adjusted down from $85,169,101 2 On Attachment A, the total costs related to facilities north of NYC is presented as $85,169,102. However, $82,020,756 + $2,606,098 + $542,247 = $85,169,101, rather than $85,169,102. to $83,617,060.

A. Chemical Costs

The dispute over chemical expenditures centered on the increase in the unit costs of fluoride and chloride between FY 1988 and FY 1989. Also, at issue is whether the water rate should be based on the cost of the chemicals used during a particular fiscal year, or the cost of the chemicals purchased for that period.

According to the County, the FY 1989 chemical costs should be adjusted downward because the Board did not show that the increase in chemical costs from the first year to the second was the typical, ongoing level of expense. The County's expert, Stephen Alcott from Guastella Associates, recommended averaging the chemical costs for FY 1988 and FY 1989. The County argued further that the rate should be based on the cost of the chemicals used during a particular fiscal year rather than on the cost of the chemicals purchased for that period.

The Board argued that a fair and reasonable rate should recover the full costs of the chemicals purchased for FY 1989 regardless of whether the increase in chemical costs was temporary or permanent. The Board opposed the County's recommendation to average chemical costs because it would significantly underestimate the actual chemical costs for FY 1989.

From FY 1988 to FY 1989, the unit cost of fluoride increased 150% while the total amount purchased during the same period decreased about 5%. Total fluoride costs for FY 1988 were $905,061. The unit cost for FY 1988 was $329/ton. The total amount of fluoride purchased in FY 1988 was about 2,751 tons. For FY 1989, total fluoride costs were $2,150,343. The unit cost for FY 1989 was $824/ton, and the total amount of fluoride purchased in FY 1989 was about 2,610 tons.

From FY 1988 to FY 1989, the unit cost of chloride increased 12% and the total amount purchased during that period increased 16%. Total chloride costs for FY 1988 were $933,981. The unit cost for FY 1988 was $431.40/ton. The total amount of chloride purchased in FY 1988 was 2,165 tons. For FY 1989, total chloride costs were $1,240,738. The unit cost for FY 1989 was $481.4/ton. The total amount of chloride purchased in FY 1989 was about 2,577 tons. It is not known whether all the chemicals purchased during any particular fiscal year were used exclusively within that fiscal year.

Pursuant to 24-360 of the Administrative Code, the water rate charged by the Board must be fair and reasonable. As explained above, the American Water Works Association (AWWA) manual series provides insight into the meaning of the fair and reasonable standard. According to AWWA M-1 and M-35, water rates should be based on known and measurable changes, or well-considered estimates of future expenses.

Regardless of whether the chemical expenditures for FY 1989 have been verified as the actual expenses, there is no reasonable basis on which to conclude that FY 1989 chemical costs are well-considered estimates of future chemical expenses. The record offers no explanation for the 150% increase in the unit cost of fluoride from FY 1988 to FY 1989, or the 12% increase in the unit cost of chloride for the same period. Absent any explanation, it would be reasonable to conclude based on the historical information from FY 1988 concerning chemical costs that the significant cost increase in FY 1989, particularly for fluoride, was an isolated event. In other words, the chemical costs from the FY 1989 test year would not be expected to represent the on-going level of expenses for the FY 1992 rate year.

The County's proposal to average the actual cost of chemicals for FY 1988 and 1989 is not the appropriate pro-forma adjustment because averaging does not result in a well-considered estimate of future chemical costs either. Since there is no reasonable basis to accept the FY 1989 chemical expenses, these expenses should not be included either in whole, as proposed by the Board, or in part, as proposed by the County. Accordingly, I assign no weight to the County's proposal.

While the County argued that the water rate should be based on the cost of the chemicals used during a particular fiscal year rather than on the cost of the chemicals purchased for that period, it offered no information about the quantity of chemicals used for FY 1988 or 1989. Without more information, the County's argument cannot be considered further. Consequently, the total chemical costs cannot be adjusted further.

Therefore, the total chemical costs should be adjusted down from the FY 1989 costs of $3,391,081 to the FY 1988 costs of $1,839,040.

B. OTPS Expenses at the Hillview Reservoir

With respect to other OTPS costs, the Parties disputed whether upstate communities should be responsible for any OTPS expenses for the Hillview Reservoir. This dispute focused on two questions. The first is whether the Board has the legal authority to include any costs related to the Hillview Reservoir in the upstate water rate calculation. If the Board has this authority, the second question is what part of the costs for the Hillview Reservoir should be in the upstate water rate.

According to the County, the upstate water rate should not include any expenses associated with the Reservoir because upstate communities receive no benefit from the Hillview Reservoir. Since the Board chose to exclude the Personal Costs for the Hillview Reservoir from the proposed upstate water rate, the County argued the Board also should exclude the OTPS costs for the Hillview Reservoir.

The Board contended that the Hillview Reservoir is north of the City, and that some upstate communities occasionally take water from it. The Board argued that the water rate should include at least a portion of the OTPS costs for the Hillview Reservoir because Personal Service costs for the Hillview Facility are not included in the costs related to facilities north of NYC. Rather, Personal Service costs for the Hillview Reservoir are part of the cost center for the Jerome Park Facility which is within the City's limits.

The Hillview Reservoir is in southern Westchester County just north of the Bronx-Westchester County line. It functions primarily as a receiving and balancing reservoir to meet variations in the City's hourly demands. Based on Mr. Kusterbeck's unrefuted testimony, the Hillview Reservoir also serves as an occasional source of water for Yonkers, New Rochelle, Mt. Vernon, Greenburgh and the Westchester Joint Water Works. The frequency and the amount of water these upstate communities take from the Hillview Reservoir is unknown, however.

With respect to the first question, then, the Board has the authority to include some portion of the costs associated with the Hillview Reservoir in the rate charged to upstate communities. The Facility is north of the City and some upstate communities take water from the Hillview Reservoir. The limited use of the Hillview Facility by upstate communities, however, complicates the answer to the second question.

A reasonable approach to answering the second question would be to identify the OTPS costs for the Hillview Reservoir, and allocate that part of the OTPS costs for the Hillview Facility which is proportional to the benefit upstate communities receive from the Reservoir in the upstate water rate calculation.

The record does not provide enough information to identify the OTPS costs that are unique to the Hillview Facility, however. Exhibit 3 to the July 1991 Ernst & Young Report summarizes the total OTPS costs for all facilities north of the City and does not itemize the OTPS costs for each upstate facility separately.

The County attempted to estimate the OTPS costs for the Hillview Facility by using a multiplier. The County's multiplier is the ratio of Personal Service costs for the Hillview Reservoir to the total Personal Service costs for all facilities north of the City. The County estimated the OTPS costs for the Hillview Reservoir by multiplying the total OTPS costs for all facilities north of the City by the multiplier.

The method proposed by the County to estimate the OTPS costs for the Hillview reservoir, however, is unreliable. First, the County's expert, Mr. Alcott, did not explain how the multiplier, which is derived from Personal Service costs, relates to OTPS costs.

Second, the total OTPS costs for all facilities north of the City include expenditures that are not related specifically to the Hillview Facility. For example, total OTPS costs for FY 1989 include telephone service at Valhalla ($13,755), automotive repairs ($20,811), and laboratory costs ($269,500). The Hillview Facility is not in Valhalla, and there is no information in the record about whether any automotive repairs or laboratory analyses are done at the Hillview Facility. Therefore, the County's method of estimating the OTPS costs for the Hillview Reservoir would inappropriately include some OTPS costs associated with facilities other than the Hillview Reservoir.

Rather than attempt to prorate the OTPS costs for the Hillview Facility, the Board included the OTPS costs for the Reservoir in the upstate water rate calculation while excluding the costs for Personal Services for the Hillview Facility. Given the lack of any specific information in the record about the OTPS costs related to the Hillview Reservoir, and the unreliability of the method proposed by the County to estimate the OTPS costs for the Hillview Reservoir, the Board's method provides the most reasonable solution to the question of what part of the total costs for the Hillview Reservoir should be included in the upstate water rate. With respect to the Hillview Facility, therefore, the total OTPS costs should not be adjusted further.

C. Personal Services

For the upstate water rate calculation, Personal Services costs represent the salaries, and fringe benefits associated with all personnel working at water supply facilities located north of NYC. The dispute about Personal Services costs (Section A, Line 5 of Attachment A) centers on the fringe benefit rate.

In developing the proposed rate, the Board computed fringe benefits at 30.0% of direct salaries for the personnel who work at the upstate water facilities. The 30.0% fringe benefit rate was the standard rate in FY 1989 for all City employees. Since the test year costs were adjusted to estimate FY 1990 costs, the County argued that the fringe benefit rate should be 27.5% which was the actual rate for FY 1990. Consequently, the issue is whether to use the rate from FY 1989 or from FY 1990.

Historically, the fringe benefit rate has varied from 26% to 31%. The US Department of Health and Human Services annually reviews and approves the fringe benefit rate used by the City. There is no dispute among the Parties that for FY 1989, the fringe benefit rate was 30.0%, and for FY 1990, the rate was 27.5%.

The test year for purposes of calculating the rate with respect to expenditures and revenue is FY 1989. The 30.0% fringe benefit rate was the standard rate in FY 1989 for all City employees. The 30% fringe benefit rate for FY 1989 is within the historical range. Therefore, it is a reasonable estimate of what future fringe benefit rates will be. The County's argument that the proper fringe benefit rate should be 27.5% because the FY 1989 Personal Services costs were adjusted to estimate expenses in FY 1990 is not persuasive. It is also worth noting that the FY 1990 fringe benefit rate was unknown when Ernst & Young initially began the rate calculation.

As stated above, the Board has agreed to exclude all Personal Services costs related to the Hillview Reservoir from the proposed upstate rate. This includes the Personal Services costs associated with fringe benefits for the Hillview Reservoir. For FY 1989, fringe benefits for personnel at the Hillview Reservoir amounted to $14,617,162. These costs are itemized in Exhibits 7A and 8A from Appendix I of the Revised Ernst & Young Report dated June 1992 (Hearing Exhibit 5), and are not included in the Personal Service costs on Line 5 in Section A of Attachment A to this Hearing Report.

D. Total Adjusted Costs related to Facilities North of NYC With the adjustment to chemical costs described above, the total costs for the Bureau of Water Supply and Wastewater Collection directly related to facilities north of NYC (Section A of Attachment A) should be adjusted down from $82,020,756 to $80,468,715. There were no disputes about Section B, Upstate Share of NYC Department of Environmental Protection Costs, and Section C, Upstate Share of City of New York Central Service Costs. Consequently, there are no adjustments to these cost calculations, and they would remain at $2,606,098, and $542,247, respectively. Therefore, the total adjusted costs related to facilities north of NYC for FY 1989 should be adjusted down from $85,169,101 to $83,617,060.

III. The 5% Inflation Factor

The Board adjusted the total operating and maintenance costs related to facilities north of NYC for FY 1989 with a 5% inflation factor to estimate those expenses for FY 1990. The estimated operating and maintenance costs for FY 1990 were then added to the actual debt service costs for that fiscal year to arrive at the total expenses for FY 1990.

The 5% inflation factor was based on recent increases in the real estate taxes assessed by upstate communities on watershed properties owned by the City, and the Consumer Price Index (CPI). Generally, tax rates and the CPI have increased at an annual rate of between 5% and 6% according to the Board.

Scarsdale's expert, David E. Peterson, opined that any inflation factor is arbitrary and therefore inappropriate. The basis for Mr. Peterson's opinion is that inflation adjustments are not known and measurable changes in expenses.

The County's expert, Stephen Alcott, however, recognized that an inflation factor is appropriate. According to the Guastella Report (Hearing Exhibit 4), the annual rate of inflation from FY 1971 to FY 1989 was about 6%.

Since 1976, the average annual increase in the Consumer Price Index (CPI) has been about 5.6% (Exhibit 12). Based on Mr. Markus' unrefuted testimony, the real estate taxes paid by the City on its properties in the upstate water shed increased at an average annual rate of 6.7% from 1972 - 1989. From FY 1987 to FY 1988, the rate of increase was 5.8%; from FY 1988 to FY 1989, real estate taxes increased 7.3%. Real estate taxes rose from $39,189,839 in FY 1989 to $41,200,317 in FY 1990 which was an increase of 5.1%.

In addition to using known and measurable changes in expenses, the American Water Works Association guidelines also suggest using well-considered adjustments (See AWWA M1) and inflation (See AWWA M35). The guidance provided by the AWWA is recognized as the industry standard.

Although Mr. Peterson correctly stated that inflation adjustments are not known and measurable changes, his claim that inflation adjustments could not be well-considered estimates is unreasonable. If Mr. Peterson's claim about inflation were true, there would be no way to predict any future costs. Consequently, all rates would have to be set retrospectively rather than prospectively. Utilities must set rates prospectively, however, to avoid chronic revenue shortages. The AWWA has recognized that adequate revenues are the "lifeblood of a water utility" (AWWA M35, p. 8). Accordingly, I reject Mr. Peterson's testimony about the use of an inflation factor, and accept the guidance provided by the AWWA.

The 5% inflation factor used by the Board is within the historical range of the CPI and the annual increases in the real estate taxes that the City has paid for the properties it owns in upstate communities. Using the 5% inflation factor to estimate the operating and maintenance expenses for FY 1990 from FY 1989 costs is a reasonable and, therefore, an appropriate pro-forma adjustment.

IV. Estimated Cost of Service for FY 1990

According to the July 1991 Ernst & Young Report, the total anticipated cash basis cost of service to upstate communities for FY 1990 was $90,581,238 (Hearing Exhibit 4 pp. 15-16). This figure was derived as follows. The actual debt service costs for FY 1989 were subtracted from the actual total costs related to facilities north of the City for FY 1989. The miscellaneous revenue for FY 1989 was then added to the difference. The sum is the total cost of service for FY 1989 less debt service and offsetting revenues. Then, this sum was adjusted upward with a 5% inflation factor to estimate the total cost of service for FY 1990 less debt service and offsetting revenues. The actual debt service for the facilities north of the City for FY 1990 was added to the estimated total cost of service for FY 1990 while the miscellaneous revenues from FY 1988 3 See Footnote 6 at the bottom of Table 1 for an explanation about why the Board used miscellaneous revenues from FY 1988. were subtracted.

Using the method for estimating the FY 1990 costs of service to upstate communities described in the July 1991 Ernst & Young Report, Table 1 shows the total adjusted costs for FY 1990. After adjusting the OTPS costs for chemical expenditures, the total costs related to facilities north of NYC for FY 1989 are $83,617,060. Therefore, the adjusted total for the anticipated costs of service to upstate communities for FY 1990 is $88,451,508.

V. Consumption

The Parties disputed the method that should be used to estimate consumption. Estimating future consumption is a significant part of determining the rate. The water rate, or unit cost, is the ratio of the total cost of service to upstate communities to system-wide consumption.

An important consideration in evaluating methods to estimate consumption is the relationship between the water rate and consumption. The rate is inversely proportional to consumption. Therefore, underestimating consumption will increase the water rate while overestimating consumption will decrease the rate. Once the rate is set, actual consumption will determine the amount of revenue that the Board will collect during the period that the rate is in effect.

The dispute centered on two questions. The first question relates to the method that should be used to estimate consumption. The second question is what consumption year should be used to calculate the water rate.

The Board estimated system-wide consumption for FY 1990 by averaging actual consumption for ten years from FY 1980 to FY 1989. For FY 1990, the Board estimated system-wide consumption to be 538,770.7 million gallons (MG). Mr. Markus from Ernst & Young opined that the estimated consumption for FY 1990 should be used to calculate the rate rather than an estimate for some other year because the test year for the proposed rate is FY 1990.

The County's expert, Stephen Alcott from the Guastella Associates, criticized the averaging method used by the Board. He argued that averaging does not recognize increases in consumption over time and will underestimate water usage during drought years. Mr. Alcott maintained that the regression method was the better way to estimate consumption because it recognizes growth over time, and levels out fluctuations in consumption. Using a regression analysis, Mr. Alcott estimated the total consumption for FY 1992 to be 564,741 MG. Mr. Alcott estimated consumption for FY 1992 rather than for some other year because FY 1992 is the rate year.

Using the averaging method, the Board estimated system-wide consumption for FY 1990 to be 538,770.7 MG. Actual consumption, however, for all upstate communities and City residents for FY 1990 was 556,753 MG. The Board's averaging method, therefore, underestimates consumption by 3%. As a result, the Board's estimate unfairly inflates the water rate, and is rejected as unreasonable.

The regression analysis used by the County recognizes the trend toward increased consumption, and levels out fluctuations in consumption. This is the more favorable method for estimating consumption than the averaging method. Since the proposed rate is based on estimated costs for FY 1990 as the test year, the system-wide consumption for that period should be used. For FY 1990, the County's regression analysis estimates total system-wide consumption to be 558,731 MG.

VI. The Rate

The water rate or unit cost expressed as dollars per million gallons ($/MG) is the ratio of the costs associated with facilities located north of NYC to total system-wide consumption. For FY 1990, the anticipated costs for facilities located north of NYC are $88,451,508. The total estimated consumption for FY 1990 was 558,731 MG. Therefore, the rate is $158.31/MG ($88,451,508 558,731 MG = $158.31/MG).

The Board proposed to implement the increase over two years. During the first year, the Board proposed to implement 87% of the rate. For the second year, the rate would increase by 13% and would be fully implemented. Phasing in the $158.31/MG rate over two years results in a rate of $137.73/MG for FY 1992 with an increase beginning in FY 1993 to the full rate.

VII. Water Conservation

The Commissioner's November 22, 1993 Interim Decision required this proceeding to address water conservation. In a memorandum dated December 17, 1993, I outlined a schedule for the exchange of information about this topic. The Department Staff outlined the essential elements of an approvable water conservation plan for the Parties. The Parties to the administrative rate hearing had an opportunity to comment about Staff's outline and about the water conservation plan.

There are two parts associated with this topic. The first part centers on the content of the water conservation plan. The second part relates to questions about who should develop, review and implement the water conservation plan.

With respect to the content, the Department Staff included guidelines for developing an approvable water conservation plan with a letter to the Parties dated January 21, 1994. This information included the January 1989 Draft Water Conservation Manual, and the Water Conservation Program Form dated June 29, 1989. The Parties did not object to these guidelines. Consequently, any approvable water conservation plan should be based on them.

There are disputes, however, about who should develop, review and implement the water conservation plan. The resolution of this dispute calls for an interpretation of the November 22, 1993 Interim Decision. Subject to confirmation by the Commissioner, each upstate community who takes water from the NYC water supply system should develop and implement a water conservation plan based on the outline provided by the Department Staff. Furthermore, the Department Staff should review and approve each upstate community's plan.

CONCLUSIONS

  1. Normalization, which is also referred to as pro-forma adjustments, is the process of adjusting historical costs from a particular test year when those costs do not represent the on-going level of expenses. Consequently, if the test year costs are not representative, the actual costs for that test year must be normalized, or adjusted, to reflect a reasonable prospective level of future expenses for the rate year.
  2. Based on the guidance provided by the American Water Works Association Manuals (M1 - Water Rates, and M35 - Revenue Requirements), calculating a fair and reasonable water rate must include pro-forma adjustments that are either known and measurable changes, or well-considered estimates of future expenses.
  3. The chemical costs from FY 1989 are not well-considered estimates of future chemical costs because those costs do not represent the on-going level of expenses. However, based on the historical data presented in the record, the FY 1988 chemical costs are a reasonable estimate of future chemical costs. Consequently, the total chemical costs should be adjusted down from $3,391,081 to $1,839,040.
  4. The Board has the authority to include at least part of the costs associated with the Hillview Reservoir in the rate charged to upstate communities because the Facility is located north of the City and some upstate communities occasionally use the Facility as a source of water.
  5. Based on the record, I conclude that incorporating the OTPS costs for the Hillview Reservoir in the upstate water rate calculation while excluding the costs for Personal Services for that Facility provides a reasonable solution to the question of what part of the total costs for the Hillview Reservoir should be included in the upstate water rate.
  6. With respect to expenditures and revenue, the test year for purposes of calculating the rate is FY 1989. For that period, the fringe benefit rate was 30%. Given the historical data, the Board's choice is reasonable, and the appropriate rate for calculating fringe benefits is 30.0%.
  7. Given that the average annual increase in the Consumer Price Index (CPI) has been about 5.6% since 1976, and that the real estate taxes paid by the City on water shed properties in upstate communities increased at an average annual rate of 6.7% for the same period, the 5% inflation factor used by the Board to estimate the FY 1990 costs from FY 1989 costs is an appropriate pro-forma adjustment.
  8. The averaging method proposed by the Board is rejected as unreasonable because it inappropriately underestimates consumption, and thereby unfairly inflates the water rate.
  9. The regression analysis used by the County recognizes the trend toward increased consumption, and levels out fluctuations in consumption. Given that the averaging method inappropriately underestimates consumption, the regression analysis is the more favorable method. Furthermore, since the proposed rate is based on estimated costs for FY 1990 as the test year, the system-wide consumption for that period should be used rather than the estimated consumption for the rate year. For FY 1990, the County's regression analysis estimates total system-wide consumption to be 558,731 MG.

RECOMMENDATIONS

  1. The fair and reasonable rate that the Board should charge upstate communities who take water from the NYC water supply system is $137.73/MG effective July 1, 1992, and $158.31/MG effective July 1, 1993.
  2. With the Department Staff's assistance, the upstate communities should develop and implement water conservation plans.

Attachments: Attachment A, The Cost of Water Supply: Summary of the Cost of Service and Unit rates.

Table 1, Total Anticipated Costs for FY 1990 (Adjusted).

Table 1: Total Anticipated Costs for FY 1990 (Adjusted)
Category Cost
Total Costs for FY 1989 related to Facilities North of NYC See Attachment A and footnote 2 of the Hearing Report $85,169,101
Total Chemical Costs for FY 1989 - $3,391,081
Adjusted Chemical Costs (from FY 1988) + $1,839,040
Adjusted Total Costs for related to Facilities North of NYC $83,617,060
Debt Service FY 1989 Section A, Line 2 of Attachment A - $25,335,534
Miscellaneous Revenue for FY 1989 (revised) Section A, Line 4 of Attachment A + $2,665,779
Total Adjusted FY 1989 Expenditures Less Debts Service and Offsetting Revenues $60,947,305
5% Inflation Factor 5% of $60,947,305 is about $3,047,365 + $3,047,365
Estimated Costs for FY 1990 $63,994,670
Actual Debt Service FY 1990 8 Exhibit 4-90 to the July 1991 Ernst & Young Report (Hearing Exhibit 4) + $27,556,217
Miscellaneous Revenue FY 1988 9 To estimate the costs for FY 1990, Ernst & Young used miscellaneous revenue from FY 1988 ($3,099,379) rather than miscellaneous revenue from FY 1989 ($2,227,325) because these revenues declined from 1988 to 1989 and the decline was not expected to continue. Using miscellaneous revenues from FY 1988, rather than the miscellanous revenues from FY 1989, to determine the total anticipated costs for FY 1990 was not at issue in hearing - $3,099,379
Total Anticipated Costs for FY 1990 (Adjusted) $88,451,508
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