Current financial data on the impact of COVID-19 on community-owned utilities reveals several national trends and the need to factor in case-by-case issues during the analysis. Above all, the data makes clear that the best strategy for a strong recovery is following the fundamentals of utility financial management: develop key financial targets, make a plan to meet those targets, and stay true to the plan.
Revenues During COVID-19
Since the beginning of the COVID crisis, there has been a decrease in small commercial sales across the country while industrial sales are varying widely. In general, decreases in industrial and commercial sales are not being offset by increases in residential sales. Utilities that derive most of their revenues from residential customers are likely to weather the pandemic more easily.
A large number of utilities are experiencing an increase in customer delinquencies, reducing line extension fees, delaying capital investments, and postponing rate increases. To manage expenses, some utilities are alternating employee schedules, furloughing staff, and restricting travel and training.
The data is beginning to show that the ultimate financial impact of COVID-19 may not be as deep as it may have appeared during the first few months of the disruption. The chart below indicates the possible COVID effect on sales for one public power utility.
Electric Effect on Sales Case Study
For this utility, growth in the industrial and residential sectors mostly offset declines in the commercial, government, and school sectors, keeping the YTD revenue impact minimal.
However, for many community-owned utilities, there are utility policies and practices that are compounding the impact of COVID-19. Too many governing boards and city councils have avoided rate increases, even during strong economic periods. These utilities often operate at a loss, spend down cash, forego capital investments in infrastructure—for aging water and wastewater systems in particular, and remain unprepared for a pandemic or other emergency.
Yet, no matter the current financial condition of a utility, there is a methodical path to recovery available to all.
Slow and Steady Wins the Race
Utilities should set a plan for small, incremental rate increases over time and stick to the plan. Small incremental rate increases have a powerful, compounding financial affect for the utility; and allow customers to prepare for rate changes and avoid rate shock. Conversely, delaying rate increases can financially devastate utilities quickly and will require large future rate increases.
Governing boards and city officials often resist the prospect of announcing rate increases. Community-owned utilities are typically concerned about increasing rates for electric and water services, especially for low income customers. As a result, they keep rates artificially low and train customers to think the utility can continue to operate without rate adjustments. Then, when a crisis like COVID hits, the utility is strapped for cash and officials are even more concerned about raising rates during an economic downturn.
Furthermore, cities short on funds tend to lean on revenues from the electric department to finance shortfalls in the water or other departments. This places even more upward pressure on electric rates. Utilities must charge rates that will finance each enterprise fund individually and not use one to offset losses in another.
Even for utilities in the deepest financial hole, there is always a way out. First, it’s crucial to educate decision makers. Operating at a loss has short and long-term consequences. The best strategy is to spread out annual rate increases over multiple years. Utilities should make a plan, publish the plan, and stick to the plan.
One utility developed a plan to increase rates 6.5% a year for three years. This would cost each rate payer only about $2 more per month. It would stabilize a cash shortage situation. But the utility did nothing during those three years. Facing a negative cash balance today, the utility will need to turn to the bond market to finance a large capital improvement. In addition, the utility is now facing a 20% rate increase to restore their cash position and recover from the consequences of delaying rate increases.
Bring in Revenues to Meet Three Financial Targets
When determining revenue requirements, utilities should set their sights on three financial targets: debt coverage ratio, minimum cash reserves, and operating income.
Debt Coverage Ratio
Debt coverage ratio is a measurement of debt affordability that is mandated by covenants and established in the revenue bond ordinance. The general guideline is to generate sufficient cash to cover the utility’s debt payments 1.25 times per year. Utilities with insufficient debt coverage can be considered higher risk and face higher rates for future bonds.
When setting rates, it’s important to build in a safety factor when addressing debt coverage. Power supply prices can fluctuate, unexpected emergencies can arise, and the city may demand larger financial transfers from the electric department than anticipated. A good guideline is adding a safety factor of 0.2 to the bond coverage requirement.
Minimum Cash Reserves
Every utility needs sufficient cash to pay bills, make debt service payments, replace failed or damaged equipment, finance capital improvements, and pay for increases in power supply costs. Falling below a cash reserves minimum should trigger action from the decisions makers such as reduction in expenses, a rate increase or bond issue for extra-ordinary capital improvements.
As the COVID crisis is making clear, healthier utilities establish cash reserve policies and follow them. A cash policy does not reference a specific dollar amount. Instead, at least five factors determine minimum cash requirements:
- Operations & Maintenance Expenses
- cash to cover 45 to 90 days of operations
- Historical investment in Assets
- factoring in age of system; likelihood of ice, wind, or other damage
- Power costs
- sufficient funds to cover the month with maximum costs
- Annual Debt Payment
- Total Five-Year Capital Plan
- funds for current year’s construction costs
The utility’s cash reserve policy should follow a defendable methodology to give future decision makers guidance and accountability.
Operating Income Target—Fully Funding Revenue Requirements
It’s vital for community-owned utilities to establish an adequate operating income target to help ensure current customers are paying their fair share of the use of the infrastructure and not deferring the charge to future generations. If a utility has negative operating income, current rate payers are not paying their fair share and future rate increases will be much larger.
Power of Small Yearly Rate Increases—Stick to the Plan!
The need for rate increases to keep up with inflation and other costs is a persistent fact for utilities. But there is a methodical way to minimize the impact on customers. Small, incremental, increases of under 5% that are advertised well in advance and implemented on schedule are powerful and typically digestible for customers of all income levels. Double digit rate increases will generate complaints and ill will.
Utilities often research the rates of neighboring utilities, eager to charge less. A utility should not use a survey of local rates as a guide to setting their own. The utility may mimic the poor decision-making policies of a neighboring utility that doesn’t meet its core financial targets. Each utility has unique revenue requirements and rates should be set to meet or work toward proper funding.
Currently, the electric utility marketplace expects to see a return to more normal revenue levels this fall. Those utilities that work toward meeting their financial targets will bounce back more quickly and stay on track far into the future.
Utility Financial Solutions, LLC
UFS is an international consulting firm and a marketing partner of Hometown Connections, Inc., the utility services organization dedicated to serving the unique requirements of community-owned utilities. UFS is public power’s premier provider of cost of service studies, unbundling studies, competitive rate designs, financial projections, and special financial analysis. UFS officials serve as instructors for cost of service and financial planning courses for the American Public Power Association and other industry.