Infrastructure Replacement Programs

Cheryl Norton

President

Kentucky American Water

Lexington, Kentucky

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• Heritage dates back to 1886

• Largest U.S. water and wastewater services provider

• Serves more than 15 million people in more than 1,600 communities

• Operations in more than 30 states and parts of Canada

• More than 7,000 employees

American Water – History and Operations

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Distribution System Improvement Charge (DSIC)

• DSIC is a regulatory mechanism that allows for the recovery of

costs between general rate cases related to distribution system

improvement projects designed to enhance water quality, fire

protection reliability and long-term system viability.

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• DSIC-eligible additions are limited to revenue neutral projects,

consisting principally of replacement investments.

• The costs of extending facilities to serve new customers would not

be recoverable through DSIC.

DSIC Is Not A Revenue Increasing Mechanism

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Regulatory Lag and Negative Impact on Capital Attraction

• Regulatory Lag: The time between the investment or cost a utility incurs and when it can begin earning a return on the investment or recover the cost during the traditional regulatory process.

• Negative Impact of Regulatory Lag: Permanent impairment of the ability to earn a return on invested capital which the commission has determined is appropriate.

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The Challenge of Infrastructure Replacement and Capital Attraction - > $1 Trillion/20 Years for Water and Wastewater Systems

Aging systems discharge billions of gallons of untreated wastewater into U.S. surface waters each year. The Environmental Protection Agency estimates that the nation must invest $390 billion over the next 20 years to update or replace existing systems and build new ones to meet increasing demand.

American’s drinking water systems face an annual shortfall of at least $11 illion to replace aging facilities that are near the end of their useful lives and to comply with existing and future federal water regulations. This does not account for growth in the demand for drinking water over the next 20 years. Leaking pipes lose an estimated 7 billions of clean drinking water a day.

Wastewater: 2002 US EPA Gap Analysis - $331 Billion - $450 Billion/20 Years

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Old Pipes = Failing Pipes

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Infrastructure Replacement Surcharge Programs:Programs Can Differ But Contain Common Elements

• Identified as best practice by NARUC in 2005• Surcharges currently exist in 11 states (CA, CT, DE, IL, IN, MO, NH, NJ, NY,

OH, PA)• Included plant (all or some combination)

Replacement of mains, valves, services, meters and hydrants New facilities due to changes in law/regulations Main cleaning and relining Main extensions to eliminate dead ends Unreimbursed relocation expenditures Land or land rights associated with qualifying plant Wells Sewer: force to gravity collection mains, services, man holes, lift stations

Applicability Timed Frequency of Surcharge

Recovery Cap Reconciliations

Water

Water/Wastewater

- Quarterly

- Semi-Annually

- Annually

3% - 10%

Generally annually or at time of surcharge

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Pennsylvania American Water: Miles of Pipe Replaced

25

3640

47

38

4853

36

5155 54

83

74 7681

95

0

10

20

30

40

50

60

70

80

90

100

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Year

Miles

Source: Steve Klick, Executive Policy Manager, PA PUC

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Aqua PA - Miles of Pipe Replaced

0

10

20

30

40

50

60

70

80

90

100

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Mile

s

Notes:1) Miles of Pipe replaced taken from 7.5% DSIC Discovery response (1a)2) 2001 and 2002 were years Aqua focused on treatment plant upgrades (Ingrams and Bristol)

Source: Steve Klick, Executive Policy Manager, PA PUC

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DSIC Rate Gradualism – Smaller Rate Increases Over Time

Source: Steve Klick, Executive Policy Manager, PA PUC

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• Cap on the DSIC rate (3% to 10%) resulting in low impact to customer bills

• Annual reconciliation of costs and revenues associated with DSIC by the Commission

• Customer notification requirements of DSIC changes

• Commission audits ensure money is spent on DSIC-eligible projects

• Surcharge reset to zero if quarterly or annual earnings reports show company earnings exceeding the allowable rate of return used to calculate fixed costs under the DSIC

• Surcharge reset to zero as of the effective date of new base rates

A Number Of Consumer Protections Can Be Built Into System Improvement Charges

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• Water main replacement/rehabilitation increased substantially – from less

than 4 miles per year pre-DSIC to 23 miles per year – with the DSIC program in place.

• Infrastructure investment increased from $1.2 million per year pre-DSIC to $2.7 million per year under DSIC.

• Replacement/rehabilitation pace increased from replacing the entire system over a 900-year period to replacing the entire system over a 125-year period.

• Intervals between general rate cases increased more than a year (much more in some instances).

Jurisdictions With DSIC Programs Have Seen Numerous Benefits:

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Additional Benefits of a DSIC Program

• Accelerates the replacement of aging infrastructure, improving water quality and service.

• Proactively addresses main breaks, using cost and reliability measure to prioritize projects.

• Allows coordination and sharing of paving costs with DOTs, local government, and other utilities.

• Promotes acquisition of small and non-viable water systems.

• Other benefits: Promotes economic development Less property damage Less traffic disruption Facilitates street repaving projects

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• Significant capital needs for aging infrastructure nationally.

• Regulatory lag can result in investment delays, more frequent rate failings and impacts to credit ratings.

• DSIC encourages infrastructure renewal and operational efficiencies by reducing regulatory lag.

• DSIC programs incent capital investment.

• DSIC programs provide gradual rate impacts and do not guarantee a rate of return.

• Many ratepayer protections exist with DSIC programs.

Summary