Report 2012-104 Summary - January 2013

Southeastern Los Angeles County:

Various Reasons Affect the Rates Water Suppliers Charge and the Rate Increases They Have Imposed

HIGHLIGHTS

Our audit of water suppliers in southeastern Los Angeles County highlighted the following:

  • Water suppliers attributed rate increases to the increasing cost of purchasing water, improving water conservation, and no longer relying on reserves to help cover annual costs.
  • We questioned the legality of almost $1 million in fee revenues that the city of Downey transferred from its Water Fund because it could not sufficiently substantiate that the funds were used for water-related purposes.
  • Because a consumer's physical location determines the retailer that will provide water, there is a lack of competition and consumers cannot select among retailers to obtain the lowest rate.
  • We found that spending at each of the seven water suppliers was generally consistent with their respective policies and procedures and seemed reasonable.

RESULTS IN BRIEF

In July 2008 a family of four living in southeastern Los Angeles County1 could have purchased 20 units of water2—about a month's supply—from the City of Downey Department of Public Works (Downey) for $23.48. As of July 1, 2012, that same family of four would pay $38.57, or 64 percent more than it did in 2008. If the same family lived elsewhere, it could have purchased an equal amount of water from the City of Los Angeles Department of Water and Power (LADWP) for $60.64 in 2008 but $84.05—or 39 percent more—as of July 1, 2012. The purpose of our audit was, in part, to examine why water rate increases have occurred since 2008 and why the price for buying the same quantity of water from different suppliers can vary significantly.

As part of our audit of water suppliers in southeastern Los Angeles County, we identified the different types of agencies involved in supplying water to consumers (for example, the regional wholesaler, local wholesalers, and retailers), and we examined the rates suppliers charged and the reasons for any significant year-to-year rate increases. We also identified the processes suppliers used to approve proposed rate increases, the mechanisms in place to help ensure that consumers are protected from unreasonable rate increases, and the impact on water rates attributable to specific categories of expenses, such as litigation and administration.

Several reasons contributed to increases in water suppliers' rates in effect on July 1 of each year from 2008 through 2012. Chief among these is that the suppliers' costs increased. Because suppliers base the rates they charge on the amount of annual revenue they believe is necessary to cover their annual water-related costs, when costs increase, so do rates. For instance, one retailer—LADWP—budgeted a cost increase of $47.7 million, or 26 percent, from fiscal years 2008-09 to 2012-13 for the cost of purchased water. According to LADWP's water executive managing engineer, the increase in the cost of purchased water was caused by increases in the water rates charged by the Metropolitan Water District of Southern California, the regional wholesaler. Other reasons suppliers cited for rate increases include improving water conservation by implementing tiered rate structures in which customers pay higher per-unit rates when their water usage exceeds certain levels, and no longer relying on reserves to help cover the annual costs of providing water.

When examining water rates, we observed that portions of Downey's water rates may not be allowable under the California Constitution. Because Downey could not substantiate that almost $1 million in revenues that it transferred from its Water Fund to other funds were actually for specific water-related purposes, we question whether these transfers comply with the provisions of Article XIII D of the California Constitution, added by Proposition 218 in 1996. Under these provisions, revenues derived from a fee or charge cannot exceed the funds required to provide the service, revenues cannot be used for purposes other than those for which the fee or charge was imposed, and the local agency imposing the fee bears the burden of proving the fee complies with the article. We found that during fiscal years 2007-08 through 2010-11, Downey transferred almost $1 million from its Water Fund to other funds. Although Downey staff told us that the transfers to the Sewer and Storm Drain Fund paid for costs incurred by the stormwater engineering division, they were unable to provide sufficiently detailed evidence to convince us that the transfers were for water-related purposes. Our legal counsel advised us that court decisions interpreting Article XIII D have not prohibited local governments from charging its customer water fees that would recoup the costs of the government's water department on other departments, as long as these fees reasonably represent such costs. Because Downey did not provide evidence sufficient to make such a conclusion, we questioned the legality of these transfers.

We also identified several mechanisms that exist to help ensure that consumers are protected from unreasonable rate increases. Because a consumer's physical location determines the one retailer that will provide water, the lack of competition means that the consumer cannot choose among retailers to obtain the lowest rate. The mechanisms protecting against unjustifiable rates include transparency, the electoral process, and the use of consumer advocates. To provide transparency, government-operated suppliers consider water rates and proposed rate increases at public hearings or meetings held by their governing boards. The public has the right to attend and participate in these meetings or hearings and can voice opinions about proposed rate increases. Also if consumers do not like the decisions made by public water agencies, they can use the electoral process to replace members of their governing boards. Finally, two entities—the California Public Utilities Commission (CPUC) and LADWP—use consumer advocate positions to independently analyze proposed rate increases.

When faced with increasing water rates, some customers may blame poor spending decisions by water suppliers—for instance, spending on litigation involving other water suppliers, administrative overhead, or other factors—or more direct costs, such as maintenance or the treatment necessary to make water drinkable. Our review of 141 transactions at the seven water suppliers we examined revealed that spending was generally consistent with the water suppliers' policies and procedures and seemed reasonable. We also found that legal and administrative expenses constituted relatively modest proportions of the overall costs for the seven water suppliers, and that the suppliers typically maintained approximately six months' to a year's worth of operating costs in reserves.

RECOMMENDATIONS

To ensure that it can meet the burden of proof that its water fees comply with Article XIII D of the California Constitution, Downey should be able to provide, upon request, documentation that all transfers out of the Water Fund are for water-related purposes. Such documentation should be sufficiently detailed and understandable to the layperson.

If it believes that the mechanisms available to consumers in southeastern Los Angeles County to protect against unreasonable rates or rate increases are not sufficient, the Legislature should consider enacting additional consumer protection mechanisms. Mechanisms to consider include ratepayer advocacy positions similar to those used by the CPUC and LADWP.

AGENCY COMMENTS

Downey did not agree with our finding and its response did not address how it would implement the recommendation we made to it.


1 We defined southeastern Los Angeles County as the area roughly bounded by Highway 72 on the north, the Orange County line on the southeast, the Pacific Ocean on the south, and Highway 110 on the west.

2 A unit of water is 100 cubic feet, or approximately 748 gallons.


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