Brian Browne

Pinocchio - Noses are getting longer

In the September 2016 issue the Westside Observer (WSO), I expressed my concerns as to the ability of the SFPUC's Finance Dept. to manage vast sums of revenue bond-generated funds, their acquisition and use of a costly incoherent and undocumented ratemaking model, plus their continuing role as the lead department in actual rate design. The consulting model cost the SFPUC approximately $450,000.

Its brilliance, as expressed in its two sage reports (2001 and 2002), was ignored and business as usual has since prevailed.”

After that report, I received an invitation to meet with the SFPUC-GM and his two top financial executives. It was a very good meeting. The GM, unlike the chairs of the Revenue Bond Oversight Committee (RBOC), allowed the discussion to go forward uninterrupted. My questions and comments were neither rephrased nor diverted, as was the case while a member on the RBOC. Very little was said by these two financial executives to divest me of my negative take on their current deliverables (rate and financial models). The GM recommended to these executives that they stay in touch with me.

After the meeting concluded, I asked the CFO as to the status of his current ratemaking efforts. He said it would not start for another couple of months. Through Sunshine I have now learned that the SFPUC had issued, at the time of the SFPUC meeting, a Request for Proposal (RFP) to help in their rate efforts, and that the same consultants that produced the previously muffed model had been rehired with a $350,000 time and materials contract. Shades of the Pentagon's failed all-purpose F35 fighter plane program? Good money after bad? A big difference is that the F35 can fly and this rate-model cannot withstand a proper cross-check by truly skilled and competent experts.

Obfuscation and half-truths must not be tolerated in our government. San Francisco has been more than generous with its bureaucratic remuneration. Market-based wage theory is based on the marginal value in use of an employee. Just like any normal supply and demand generated piece of information as to value. Governments who operate by fiat (administered prices and hiring) are outside of the "law of supply and demand." This phenomenon has led to the cult of resume misfits with bloated salaries and considerable expertise in the superficiality of unending and banal PowerPoint presentations.

It is time to reassess all SFPUC salaries. A Taskforce led by a strong and impartial leader can work. Willie Brown's Infrastructure Taskforce worked (2000-2002). Westsider Rich Bodisco, as Chair, allowed this multidisciplinary group to have their say, unimpaired by any hidden agenda or pre-determined parliamentary shenanigans to suppress and deflect ideas. Rich believed the First Amendment was applicable, even in San Francisco. Its brilliance, as expressed in its two sage reports (2001 and 2002), was ignored and business as usual has since prevailed. Hopefully a wave of voter unrest will reach into the dark cobwebs of City Hall, and that government as a career will again attract our brightest and best, whose contributory value to society will actually justify their wages and benefits. Let's get started.

Merry Christmas

Brian Browne was coauthor of 2002 Prop P and former member of the Revenue Bond Oversight Committee it created.

December 2016 / January 2017

Is the SFPUC a bank with a side business in water, wastewater, and power?

Irecently met with District 3 Supervisor, Aaron Peskin, to discuss SFPUC financing and infrastructure issues. Supervisor Peskin's return to the Board is welcomed by all concerned about the SFPUC and prudent financial review. Let me go over some of the input I provided.

Using SFPUC's data I developed the above Table to summarize my concerns as to its financial stewardship. For the period 2016 – 2025 it forecast a modest annual increase in O&M of 2.01%. Debt service is forecast to increase annually by 9.01 percent. Currently it is stating debt service is 41.7 percent of total costs. By 2025 it predicts debt service will be 53.6 percent of total costs. This large increase in debt service to repay revenue bonds will drive total costs up by an annualized rate of 6.01 percent.

Serious thought must be given to adjust the marginal cost (supply) of resource use, especially during drought cycles. It is not obvious that the SFPUC has seriously considered this in its complex and implosive rate algorithm. There is no mention of "identification" as to supply vs. demand shifts. ”

During this period the SFPUC forecast that total water volumes sold will remain steady or fall slightly. An accurate forecast of volumetric sales is important. The general equation for setting a rate is to divide total costs (numerator) by total volumes (denominator). This is a benchmark coefficient used in the revenue requirement approach to ratemaking. Revenues = O&M + Debt + Other = Establishes Rates.

The SFPUC's rate model (algorithm) assumes that the elasticity of demand will remain at -0.25 (for every one percent increase in price quantity demanded will only decrease by .25 [hence the minus sign]) for the entire forecast period (2016-2025), and that the service area population growth will increase by 0.5 percent annually to offset decreasing customer demand by these large rate hikes. This estimation of -0.25 is a misuse of the concept of demand elasticity. Its validity as a policy tool and for decision making by the SFPUC (or by its consultants) must be seriously questioned.

The substitution effect (2nd Law of Demand) acting on consumer preferences (artificial lawns for real lawns) will, over time, increase this negative coefficient and require even higher prices to keep revenues equal to escalating costs. Should this dog chasing its tail phenomenon continue, there is a strong possibility that future price increases will result in lower total revenues after rate increases, with a disastrous impact on SFPUC's O&M and capital budgets. For the 101A Economic types this is where demand is or becomes elastic.

Serious thought must be given to adjust the marginal cost (supply) of resource use, especially during drought cycles. It is not obvious that the SFPUC has seriously considered this in its complex and implosive rate algorithm. There is no mention of "identification" as to supply vs. demand shifts.

The financial-gaming approach used by the SFPUC to utility debt issuance, use of funds, and debt service must be questioned. The hijacking of the Revenue Bond Oversight Committee (RBOC) by politicians, bureaucrats, along with their willing committee-collaborators, must now be challenged under a large legal microscope. The Mayor's Taskforce established this Committee as an independent watchdog, not a compliant lapdog.

I provided Supervisor Peskin with two important documents provided by the SFPUC via a Sunshine (FOI) request: 1) The SFPUC's computer model that supposedly sets your water and sewer rates and supposedly explains the economics behind the SFPUC's ascending block tariffs and 2) A copy of SFPUC's Excel bond issuances (see summary below). I made an explanatory video of the latter document, which I uploaded to YouTube, calling it; "Kicking the Debt into the Future." https://www.youtube.com/watch?v=QhHgZssLdhY.

I explained to Supervisor Peskin that the SFPUC rate model was delivered to me with only half its content obviously accessible (Excel worksheets) and without any explanatory documentation to understand relational links. It was confusing and near-impossible to decipher coherent paths of programming logic. This model is estimated to have cost ratepayers between $400,000 and $500,000 and was developed by outside consultants. This model cost will be "blended" (SFPUC jargon) into your water rates.

A well-organized and systematic utility system in expending external capital has a clear path to follow. It issues short-term debt to fund properly planned capital improvements. At the completion of the plan and build cycle (work-in-progress) the capitalized value of these short term loans are retired through the issuance of revenue bonds. All bond issues should be accompanied by a detailed prospectus delineating precisely what the funds will be used for, and how these expenditures will be monitored. As a member of the RBOC I always had a good chuckle when I saw this hijacked committee as being named a major guardian of the purse.

The coupon rate (percent – say, 4.5%) required to sell these bonds represents the market's confidence in the issuer. The repayment period (term) should correlate with the life of the project and be repaid in the rate structure by those customers who will benefit (Proposition 218) from its development. From these two variables (coupon and term) a future stream of payments is calculated that equals the present value of the summed elements (escalated) making up the total cost of the project. These level annual payments (same as a like mortgage) are embedded in the rate structure.

Below is an abbreviated table of the SFPUC's Water Enterprise debt structure. Adding in the debt for Sewer, Hetch Hetchy Power, and Golden Gate HQ brings the debt issued by the SFPUC to $6.8 Billion with $5.6 Billion outstanding. I have subjected these numbers to my own model and find many areas of concern. Why so much refinancing of bond debt with another bond issuance? Is this consistent with the correlative issuance prospectus? Interest only payments mean pushing the debt forward to future generations. Why so much liquidity (average of $1.25 Billion) in the Treasurer's Pool that earns less than 1 percent while the average debt cost 4.5 percent. There are many issues – one that is too egregious to overlook is calculating their average cost of capital by adding all issuances and creating an average. I did the same calculation, but weighted the interest by the bond-volume, and came up with a significantly higher average cost of capital. Their averaging method gives equal weight to a small bond issuance with a low coupon rate, to a large bond issuance with a higher coupon rate

Some of these bonds have been used to refund other bond issues, others only the interest on the debt is being paid, and some are amortized. Total debt issued by the SFPUC in Water revenue bond debt is $4.4 billion. Of this $4.4 billion $4.1 billion remains outstanding. Using my own calculations and assuming a normal approach to capitalization and amortization for debts service, I calculate the outstanding should be approximately $3.7 Billion.

Adding in the "approved" commercial paper (CP) program of $.5 Billion, total debt issued is $4.9 Billion. Total CP outstanding is $0.236 Billion, which makes the total debt outstanding for water at $4.4 Billion. Of some consequence to rate estimation and being in sync with Proposition 218 is that of the 24 debt instruments listed by the SFPUC, nine (9) have a note stating some or all of these funds have been used for refinancing other debt. This greatly clouds up the analytical waters as to stated objectives vs. achieved objectives. The SFPUC is a system begging for Proposition 218 scrutiny.

In writing the Economic Report for the Mayor's Infrastructure Taskforce in 2002 I advised the City to divest the SFPUC of most banking functions. To be continued…

Brian Browne was coauthor of 2002 Prop P and former member of the Revenue Bond Oversight Committee it created.

September 2016

Responding to the SFPUC

Apparently in response to my Westside Observer articles, Mr. Eric Sandler, CFO and AGM, SFPUC, wrote (6/13/2016) to assure me that the SFPUC is in compliance with the legal cost-of-service requirements in setting rates for water and wastewater services. Mr. Sandler specifically cited Article XIII D of the State Constitution.

There are many laws, legislated procedures, and judicial findings that direct Mr. Sandler and the SFPUC on what they can and cannot do in regard to charging for water and wastewater services. One imperative is that they stop calling the charges for these services "rates" and refer to them as special "taxes." A special tax may only be used for very specific purposes. This makes it very different from a general tax or assessment.

The Supreme Court in the 2006 Big-Horn case voided a 2000 decision (Howard Jarvis v. City of Los Angeles) that noticing, public hearing, and a majority vote were not Proposition 218 requirements; they definitely are law. This 2006 Decision also invalidates all utility rate increases since 1997 that did not comply with all procedural requirements of 1996 Proposition 218.”

 

Some notable benchmarks (but by no means all) on the thorny road to constraining local government taxing power in California are as follows:

1978 Proposition 13 added Article XIII A to the California Constitution and sought to set tax limits, mainly on property taxes. The model created by Proposition 13 spread quickly beyond the borders of California.

1979 voters approved Proposition 4. This imposed limits on the spending proceeds derived from taxes (Article XIII B California Constitution, Government Code 7900-7914).

1986 California Proposition 62 amended part of the California Government Code and imposed substantive, procedural requirements on new and increased taxes.

1996 Proposition 218 added articles XIII C and XIII D. The intent of this Proposition is clearly signaled in its official name "Right to Vote on Taxes." This Proposition, considered a judicial progeny of Proposition 13, added additional and substantive requirements for new and increased taxes, assessments, and property related charges. One analyst noted that Proposition 218 was needed to stop local government end-around-end runs on avoiding Proposition 13.

2006 The Bighorn- Desert Water Agency v. Verjil the California Supreme Court held that metered water rates charged by public agencies are subject to Proposition 218. This means public agencies (SFPUC) must comply with public noticing, public hearings, and majority protest requirements. This Decision extended Proposition 218's reach to cover sewer and garbage services provided by these entities. These charges are special taxes and may not be increased or changed without a vote.

The Supreme Court in the 2006 Big-Horn case voided a 2000 decision (Howard Jarvis v. City of Los Angeles) that noticing, public hearing, and a majority vote were not Proposition 218 requirements; they definitely are law. This 2006 Decision also invalidates all utility rate increases since 1997 that did not comply with all procedural requirements of 1996 Proposition 218

2007 The SFPUC introduced tier pricing for water and wastewater taxes.

2015 The Court of Appeals 4th Appellate District, Division 3 Case No. G048969 decided that San Juan Capistrano must dismantle its ascending tier pricing structure for water and repay $4.1 million in overcharges. Any ratepayer who was charged under the top three of the four tiers: $4.24, $6.37, and $11.67 per unit (748 gallons or 100 cubic feet), will be reimbursed based on the base rate of $3.18. The Court made it abundantly clear that tier pricing is not illegal per se, but to be legal it must follow all mandated procedural requirements and mirror costs that are reasonable and allowable in providing current services.

Mr. Sandler further noted that the City Attorney's office was involved in ensuring full compliance. I had always hoped that the City Attorney would have been more proactive in responding to my numerous complaints of committee nullification during my term (2003-2012) on the Revenue Bond Oversight Committee (RBOC).

Mr. Sandler states that their electronic cost-of-service calculations are accompanied with a readily understandable narrative. I replied to Mr. Sandler that I disagreed with him. When I asked the SFPUC to produce such a document (similar to a detailed road map – giving explicit directions from A to B) they said they could not.

Two possibilities for this situation: 1) there is no such document and/or 2) information is not effectively shared at the SFPUC. The theory of the firm is that organizations, such as the SFPUC, exist to lower information and transaction costs.

SFPUC still has serious concerns about the drought continuing. With a market based pricing system, as mandated by Proposition 218 et al, supply and demand pricing would produce a market clearing price. It would adjust automatically to shifts in supply and demand and send clear signals regarding resource use and investment priorities. This dynamic-type pricing would arguably be legal under Proposition 218. Proposition 218 has objections to administered pricing not rooted in economic theory, as is currently used by the SFPUC.

Brian Browne was coauthor of 2002 Prop P and former member of the Revenue Bond Oversight Committee it created. Feedback: browne@westsideobserver.com

July 2016

Unveiling a Flawed and
Enigmatic Tax System

San Francisco regularly ignores or morphs federal, state, and local laws that might impinge on the self-serving wishes and dictates of the ruling elite. They are now trying to ignore the laws of supply and demand (S&D). The latest and most dangerous assumption (embedded in the SFPUC rate model) is that water rates may be increased near indefinitely (at least through 2023) and that SFPUC retail customers will not significantly decrease demand. Consumers do react to price increases, especially large rate increases as San Francisco retail water customers are experiencing. This is not the first time, and I suspect will not be the last time, that combined Team Controller & SFPUC have invoked and misused a spurious elasticity coefficient to justify misguided public policies and associated expenditures.

This may give comfort to the bond markets as to the ability of the SFPUC to adequately service debt from present and future enterprise revenues, but such an assumption is highly debatable, and unreasonable based on economic theory. It must be revisited.”

 

The SFPUC has a somewhat enigmatic three-part charge for residential water customers.

1. Fixed or meter charge (service) based on the meter size. There are 12 different meter sizes range from 5/8 inch to 16 inch. The charge for a 5/8 inch meter, effective July 1, 2016 is $10.86. The charge for a 16 inch meter $1.215.46 effective the same date is $2,116.11. Meter sizes represent the potential volumetric demand on the system and are a proxy for recovering fixed costs.

2. Variable or commodity charges are divided into two-ascending tiers. As of July 1, 2016 a retail water customer pays $6.00 for the first 4 units (748 gallons) of water used per dwelling unit and then $8.05 per unit of water thereafter. All single-family dwelling units have one dwelling unit.

Ascending tier pricing may cut off demand, but is it legal and is it economically efficient. It is only legal if the ascending tiers exactly mirror the cost of producing the services. The probability of these fiat- developed steps mirroring real marginal costs is close to zero. Therefore its legality must be questioned and proved. If the SFPUC cannot do this they must cease and go to a marginal cost approach to ratemaking. The high priced tiers do decrease demand. This approach is analogous to slamming on the brakes on I-280 at 100 MPH. The vehicle will stop, but the potential damage to the vehicle, its occupants, and other travelers on the freeway is greatly increased and the outcomes are uncertain. This is analogous to the panic approach of fiat-developed tier pricing to ration water during droughts.

Marginal cost pricing, when applied properly, is effective in rationing water, and optimizing social welfare during both drought and non-drought cycles. A special "feel good" theory starring increasing tier-developing bureaucrats is not required.

The SFPUC's overly complex, confusing, and seat-of-the-pants approach only achieves bureaucratic make-work outcomes. A simple dollar per unit ($/unit x use) charge based on revenues required (numerator) divided by volumetric output (denominator) would be less confusing and more consistent with state law (1996 Proposition 218 amending the state constitution). Joint products with common costs are best valued by equating marginal costs with marginal revenues. Using a normative intertemporal approach to ratemaking (revenue requirements approach) will be less gimmicky, more transparent, less costly, complement macroeconomic growth, and be in conformity with the state constitution, none of which may be attributed to the current ascending block tariff system. The SFPUC approach to allocating costs is similar to an accountant arbitrarily allocating costs to different parts of a sheep producing both mutton and wool. Impossible, but bureaucrats proceed undaunted.

The SFPUC under Brown Act/Sunshine (FOI) provided its Excel model. It has no explanatory text (like a cake recipe) explaining the steps and assumptions used. These type explanations are required to fully understand how they calculate your utility rates. Most independent regulators call for transparent and concisely written "model specifications" to accompany any such public algorithm. A model specification is the same as having a recipe for a cake. In this case the public owns the cake and deserves to know what is in this very expensive cake. Water, wastewater, and garbage services are taxes when provided by local governments in California, and this heightens the need to know why you are being taxed and where your tax monies are going.

Since 2000, as a member of the Mayor's Infrastructure Taskforce (2000-2002) and then as a member of the hijacked Revenue Bond Oversight Committee (RBOC 0003-2012), I have sought access to this recipe, so I might understand what is embedded in these taxes to better understand their correlation with state laws and economic efficiency. The worksheet (multiple spreadsheets) housing their rate model was confusing and less organized than I suspected. The Excel code was relatively sophisticated.

Through the smokescreen of poorly documented Excel sheets, I did immediately find two major weaknesses (I am still analyzing). 1. Their stated method for capitalizing major investments via revenue bond expenditures and amortization of these funds for blending into the rate structure, and 2) the misuse of the important economic concept of price elasticity of demand. I have spoken of the former in prior essays.

The SFPUC rate-model assumes for the period 2013 through 2023 that the price elasticity of price demand for retail water will remain at -0.25. This means that for every 1 percent increase in rates or prices consumers will only cut back physical demand by .25 percent. This will ensure SFPUC total-revenues will always increase at a like proportion after every rate increase, regardless of the amount of the price hike. This may give comfort to the bond markets as to the ability of the SFPUC to adequately service debt from present and future enterprise revenues, but such an assumption is highly debatable, and unreasonable based on economic theory. It must be revisited.

The derivation of the price elasticity of demand coefficient used for this analysis does not support this near-infinitum type extrapolation. Using this static elasticity number is also contrary to history experiences. San Francisco water users during the price increases and mandated restrictions of the 1970s and 1980s droughts made many permanent cutbacks in their water-use. Similar cutbacks will most probably occur as a result of the current drought with its rate hikes, and like moral and mandated rationing.

Postscript – Just in case the City folks take offense at my economics, let me quote from two outstanding economists - William R. Allen and Armen A. Alchian from their Exchange & Production…. Text book (3rd Ed.) "First law of demand: At any given price there is some higher price at which less of a good is demanded. & Second law of demand: In the long-run, demand is more elastic for any given good as substitutes for that good become more readily apparent."

Brian Browne was coauthor of 2002 Prop P and former member of the Revenue Bond Oversight Committee it created. Feedback: browne@westsideobserver.com

June 2016

The SFPUC's Illegal Tier Pricing

I have long lamented the lack of real oversight in San Francisco, but may indeed have a remedy in the form of the state constitution and the limits placed on the taxing power of local government agencies to tax without voter approval. Using this power for taxpayer wellbeing will require concerned citizens to step forward and ask the courts to constrain the current runaway taxing efforts (under the guise of utility charges) of the Administration and its enterprises.

The SFPUC must eventually repay the present value of its total issued debt, and as an enterprise entity, it only can do this through the rate/taxing mechanism. And as such, under state law, must be approved before the fact by the voters.”

It is time for the citizens of San Francisco and the SFPUC (they possibly will issue $15 billion in bond debt) to realize retail water, wastewater, and garbage services are taxes under the California Constitution (Articles XIII D, sect. 6 (a) 7 (b)) thanks to the passage in 1996 of Prop 218 (no vote, no taxes). The State Supreme Court in 2006 (Big Horn Decision) agreed with the proponents of Prop 218, that retail water, wastewater, and garbage charges by local government agencies are taxes. Tax increases or new tax funded purposes must be approved by the voters. The self-regulatory powers given to local government are significantly limited by this 1996 addition to the state constitution.

In 2006 the California Supreme Court (Bighorn-Desert View Water Agency v. Verjil [July 24, 2006, S127535]) affirmed that water, wastewater, and garbage services are taxes and are subject to the changes made to the state constitution by Prop 218. In April 2015, the California 4th Appellate court declared the San Juan Capistrano ascending tier structure for retail water sales was illegal and must be reworked to be consistent with actual costs. The Court did not say ascending tier pricing is illegal. The court stated ascending tier pricing must reflect actual costs. The expected probability of this happening is probably close to zero. I would guess even more unlikely with the SFPUC tinkerers who have this well paid assignment.

In 2007, one year after the Court affirmed that rates are taxes and must be put to a vote prior to an increase; the SFPUC instituted an ascending tier rate structure. It is difficult to see any way that SFPUC's ascending tier pricing can be compliant with Prop 218.

I have long argued that the ascending tier structure adversely effects conservation. This may not satisfy social engineers who ignore the fact that the intention of these taxes is to provide utility services, not finance welfare. These are specific taxes for specific purposes and should not be usurped elsewhere.

The SFPUC has issued $4.039 billion in revenue bonds for its Water Supply Improvement Program (WSIP). Of this amount only $1.6 billion (SF 2002 Prop A) in revenue bonds were approved by the voters. SF's Prop E in 2002 dispossessed the voters of the right to issue revenue bonds and gave it to Board of Supervisors. At that time a lot of Prop 218's inhibiting power over municipal taxing were yet undiscovered. These powers may need to be invoked as the SFPUC marches toward a possible revenue bond debt of $15