This subject should be used as a guide to address the need for basic but useful information on setting water rates. It is intended for small water systems to be used with proper consideration for higher methodology of procedures for bigger water systems.

1. FULL-COST PRICING

Full cost pricing means establishing a price per unit of water (per cu.m.) that covers all the costs involved in producing water and delivering it to the customer.

There are several reasons why full-cost pricing is used. First, it is the fairest way of charging for water. The price tells the customer what it costs to deliver the water to a house or place of business. Second, knowing that everyone must pay the full price, customers will have a tendency not to waste, and therefore, full-cost pricing acts as a conservation measure. Finally, water income will cover expenditures plus provide extra funds for emergencies and small additions or replacements of the system.

In all likelihood the accounting system may need to be updated to show true expenses, public meetings may be necessary to explain the rates and the system's operation, and meters may have to be installed.

To charge the total cost of water to the customers as fairly as possible, the system must be 100 percent metered. That means every service or customer must have a meter, and there must be a master meter on the outlet of each source of supply to show how much water was provided. If some customers are unmetered, a flat rate must be incorporated as part of the total rate schedule.

2. RATE STRUCTURE

A basic rate structure should be made up of two parts. The first part, the base rate, is a charge per customer to recover fixed expenses, including the cost of debt service, reserve requirements, and capital improvements. This charge guarantees enough income to meet the utility's basic costs during periods of low water sales due to drought or other reasons. The second part, called the unit rate, is a charge per unit of water sold to cover the cost of operation, maintenance, and administration. With this two-part structure, all customers share equally in the basic costs of the water system and each pays only for the water used.

It is important to note that a rate schedule that shares the fixed cost equally among all customers, regardless of how much water each uses, is fair only when the demand by all customers is relatively uniform (1/2 inch or 3/4 inch meters, for example). Customers with greater demand who require larger meters need to have an increased "base rate". The increase is calculated using an equivalent meter and service ratio.

a. Determining a base rate to cover fixed expenses. The base rate should cover debt service (repayment of all loan principal and interest payments, capital expenditures (capex), and a reserve. No matter how fair the rates are, sudden large increases upset customers and raise questions about the operations of the system. Income and expense needs may be projected for three to five years. Good practice calls for a yearly review of income and expenses to determine if the rate structure is still satisfactory or needs adjustment.

If there exists a 10 to 15 percent difference between water produced and water sold (as a result of leaks, unauthorized use, and so forth), there is the need to address the problem. That certainly is the case in the example (Figure 1), where the difference between water produced (238,000 cu.m.) and water sold (195,000 cu.m.) is 18 percent. Any reduction in unaccounted-for water will either produce savings (most likely in power, and chemicals) that will reduce the O & M costs or increase income. These savings should be included in the annual rate structure review.

To determine the base rate per month per meter (see Figure 2-1):

(1) Add all the fixed costs, such as the annual loan payment or debt service (P436,000.00), the capex (P261,000.00), and the reserve (P79,000.00), for a total of P776,000.00.

(2) Divide the annual cost of P776,000.00 by 12 to obtain the monthly cost of P64,667.00.

(3) To arrive at the base rate per month per customer, divide the P64,667.00 by the number of customers (865) for a price of P74.75.

b. Determining water unit cost (per thousand cu.m.).The O & M costs listed in Figure 1 form the basis for water unit cost. For most small systems, the unit rate will be the same for all users. In the example, provisions for inflation of 15 percent per year, which amounts to 30 percent the second year and 45 percent the third year, based on current expenses, has been included. This averages to an increase of 30 percent per year.

To determine the cost of water (per thousand cu.m.):

(1) Multiply the total O & M costs (P1,488,000.00) by 15 percent and add the result (P223,200.00) to the P1,488,000.00 for a total of P1,711,200.00.

(2) Divide this figure by the amount of water expected to be sold in thousands of cu.m. on average over the next three years (no expected increase in sales in the example) to determine the cost per thousand cu.m.

The calculations are P1,711,200.00 divided by 195 for a cost of P8,775.00 per thousand cu.m. For the purpose, this figure may be broken down further into 10-cu.m. segments or P87.75 per ten cu.m.

Under this rate structure, the bill for a customer using 30 cu.m. during a billing period would be calculated as follows:

Base charge = P 74.75
Water cost: (3.0 x 87.75) = 263.25
Total due = P338.00

Now that the rate has been established it should be tested to make sure it will produce the required revenues. Table 1 shows the estimated annual funds needed for operation of the sample system.

The expected annual revenues under the established rate of P74.75 for base cost and P8,775.00 per thousand cu.m. sold would be:

Base rate: P74.75 x 865 x 12 mos = P 775,905.00
Water sales:ÿP8,775.00 x 195 (thousand cu.m.) = 1,711,125.00
Total Income = P2,487,030.00

Referring to Table 1, note that the total funds needed amount to P2,487,200.00. The water rate very slightly underfunds the system the first year. At this point there is the need to make a rate chart based on the systems needs. The rate chart should include the base rate and the unit rate. For this example, the chart would look like this:

Note that in the example are not included income from other sources which for most small systems this additional revenue would be very small and can be ignored. In cases in which this added income becomes significant, however, it should be subtracted from the O & M costs before the calculating the cost of water per thousand cu.m.

3. EQUIVALENT METER AND SERVICE RATIO

When there are a number of customers that require considerably more water than residential customers, but still do not use a major portion of the system capacity, it may be necessary to use an equivalent meter and service ratio in establishing the water cost charge.

Assume that all 865 customers in the example are metered. That total includes 710 with 1/2-in. meters, 145 with 3/4-in. meters, and 10 with 1-in. meters. Recognizing that meter and service costs vary (depending on service pipe size, meter size, and materials used), the base cost will vary and can be distributed by an equivalent meter and service ratio. For this example (Table 2), a ratio of 1.0 for 1/2-in. meters, 1.6 for 3/4-in. meters, and 3.2 for 1-in. meters should be used. Table 2 shows how to calculate the charge compared to 1/2-in. meters. The table shows that the smallest meters pay a little less of the base rate and the larger meters pay a little more. The rest of the calculations (cost per thousand cu.m.) remains the same.

If the 974 equivalent 1/2-in. meters are to recover the monthly base charge of P64,667.00, divide P64,667.00 by 974, giving a monthly charge of P66.39. That figure compares to P74.75 in the original example. The monthly base charge would be P66.39 x 1.6 or P106.22, for the 3/4-in. meters, and P66.39 x 3.2, or P212.45, for the 1-in. meters.

4. UNMETERED RATE

If the water system has metered and unmetered customers, the utility must have a rate for both types of customers. In calculating unmetered rates, consider that:

a. Unmetered rates should reflect the fact that these customers generally use more water and, therefore, the use estimate can be adjusted upward. Waste can be a major cost problem.

b. Customers on unmetered rates do not require meter maintenance and meter reading costs and this can be a savings.

After determining the revenue requirements for unmetered customers, it is necessary to design the rates to produce this revenue (number of homes x average use in cu.m.).

One method of designing unmetered rates involves the use of family units or equivalent family units. Using metered customer records, determine the amount of water used by the average family and adjust that figure upward (10 - 20 percent should be adequate) to account for potential waste because the service is not metered. For non-metered, multifamily buildings, multiply the single-family rate by the number of families living in the building. Industrial or commercial customers can be billed on the basis of equivalent family units. These can be determined by comparing water use by the various nonresidential services with single-family residential services. An alternate method uses the number of water fixtures in the building to determine billing.

5. PUBLIC FIRE PROTECTION RATES

The cost of fire protection can be distributed to all customers benefiting from such protection or through a separate charge. In the first case, the charge is usually the same for each customer and is added to the base charge. The second, and preferred method, is to make a separate charge directly to the municipality or fire district. The simplest method for recovering fire protection costs is on a per-hydrant basis. Determine the total fire protection expenses by adding the cost of all hydrants (including appurtenances) and all water used. The total cost is then divided by the number of hydrants to yield the cost per hydrant per year.