March 2014, Issue 81: Editors’ Notes

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CAP customers should prepare for two budgetary time bombs that could trigger significant rate increases.

Over the next few months, CAP will complete its formal rate-setting process for the next 2 years. Although the terms of the federal repayment contract have always loomed in the background, CAP has managed them well and protected its customers from volatile rate increases. Looking ahead, however, we see two time bombs — budget reconciliation and shortage declaration — that may significantly impact customer budgeting cycles in the next few years.

The first time bomb is related to a “truing-up” clause in the federal repayment contract. This clause requires CAP to refund unspent, budgeted costs or to recover unbudgeted costs, which include excess fixed OM&R costs. Because CAP operates on a calendar year, the possibility of debt reconciliation presents a real problem to governmental customers with fiscal years ending on June 30 or September 30; these customers could receive a bill at the end of the calendar year for water delivered during a previous fiscal year. Fortunately, in the past, the reconciliation process has most often been triggered by budget surpluses, resulting in customer refunds. Additionally, CAP and its customers developed buffer mechanisms to prevent after-the-fact rate increases in the mid 1990s, as the risk of fixed OM&R excesses escalated in response to tightening budgets and aging infrastructure. However, these rate-adjustment mechanisms (such as the sale of SO2 credits) will quickly become exhausted or inadequate in the face of a supply shortage or infrastructure failure.

The second time bomb is the impact of a shortage declaration on the Colorado River. As we’ve discussed in previous editorials, any reduction in the total amount of CAP deliveries will proportionally increase the total fixed OM&R rate for the year of shortage. Recent modeling indicates that a shortage could potentially be declared during the 2015–2016 rate cycle. If this occurs, CAP’s rate-buffering strategies could probably cover a substantial portion of the fixed OM&R increase for 1 year — but not much longer. Although CAP’s highest-priority customers (M&I and tribes) will not be shorted in the near future, their water costs would increase under shortage conditions, impacting their budgets.

After decades of relatively uneventful rate-setting cycles, CAP customers may be unaware of the possible fiscal impacts associated with the federal repayment contract. Given the potential for unpredictable and unprecedented rate increases in the near future, it may be wise for them to adopt their own budgetary policies to buffer against increasing water-rate volatility.

Juliet M. McKenna, MS, PG | Mark Myers, MBA