Combined Utility System Cost of Service Rate Study Presentation April 6, 2010

1. Combined Utility System Cost of Service Rate StudyPresentation April 6, 2010

2. Combined Utility System (CUS) • The CUS is an enterprise fund • All funds used in the CUS are generated from water & sewer rates and fees • Does not receive any general fund money • Closed system – Under CUS master bond ordinance, cannot fund anything but water and sewer services • One exception – may fund a limited amount of drainage out of fund balance, per Ord. 2004-299 • Cannot send funds to the general fund

3. Recent History of CUS Rising prices for FY04 through FY10 • TCEQ Unfunded Mandate -Annual Fees 228% • Chemicals 167% • Electricity 136% • Sludge Disposal 99% • Infrastructure Maintenance (O&M) 76% • Insurance 60% • Health Insurance/Pension 52% • Overall O&M 32% • Annual Debt Service – First/Junior Liens 53% ($233M in FY04, $356M in FY10)

4. Recent History of CUS Residential Water Use per account Fiscal Year 2004 - 2010 • Residential consumption in gallons per month has declined as more low flow appliances and fixtures are installed. • As townhouses/condominiums replace single family homes, also see lower consumption per account. • From FY04 to FY09 the range has been from a high of 6,736 in FY06 (drought year) to a low of 5,971 in FY07. The average from FY04 to FY09 is 6,276. • In the last 3 years average is 6,006 gallons/month. This trend continues into FY10 given the colder fall, winter and spring. • Even though lower usage recently, must have capacity for drought demand

5. CUS Historical Charts Total Revenues Average Residential Customer Gallons/Month Billed O&M Expenditures * FY10 is current projection prj = projection

6. CUS Financial Position FY07 through FY11 * February 2010 PWE MFOR Submission

7. Recent Steps Taken to Decrease CUS O&M • PWE has adopted less expensive ways to treat water and buy chemicals • Cost savings in chemicals alone for FY10 will exceed $4M • Implementing McKinsey & Company recommendations for an estimated $7 million in savings in FY11 • Continuing to review/re-negotiate contracts for savings • Bio-solids contract change – savings of $7.0 million over next 5 years • Sludge removal contract – savings of $800k over 5 years • Began energy conservation study for major wastewater facilities • Significant capital costs that will be paid for out of energy savings • Long term benefits only

8. FY10 Rate Study Objectives of Rate Study • Understand the System’s “cost of service” rates for each customer class for water and wastewater • Propose rates that ensure revenues fully cover the CUS’s costs and that meet all bond covenants – debt coverage and sound business practices • Propose rates that provide for the long term health and sustainability of the system • Consider new rate structure that moves rates in the direction of covering actual cost of service for each rate class over time • Restructure program by replacing “lifeline” rate (over time) with service charge waiver or discount for qualified single family customers • Structure single family rates to encourage conservation • Ensure that contract/non-City of Houston customers’ rates are set at the “cost of service” rate – not subsidized by Houston citizens

9. Options for Rate Study The Rate Study created three financial scenarios *HSR plus other selected investments ** Provide for the long term health and sustainability of the system – best practices History of CUS Water and Wastewater CIP

10. CUS Annual Debt Coverage Ratio History Annual Debt Coverage Ratio – Threshold 1.2 Net revenues to first lien debt service Prior to FY10, NO use of fund balance was required for this bond covenant. FY10 requires an estimated $40M use of fund balance to meet this covenant.

11. Consequences of Doing Nothing • The CUS must at least implement the Minimum Health, Safety & Regulatory CIP to meet regulatory requirements.

12. Consequences of Doing Nothing • The system will continue to lose money • Likely downgrades from Rating Agencies • Moody’s assigned a NEGATIVE outlook to the CUS on March 2nd, 2010. If the CUS issues new debt without a significant rate adjustment, the System risks a ratings downgrade. • Downgrades will result in higher costs • Higher interest cost over the bonds life per $100M Par. Estimates: A1 to A2 $2.3M, A1 to A3 $3.45M & A1 to BAA1 $5.75M • Letters of Credit fees increase for every ratings downgrade, per notch: A1 to A2 $3.2M higher fees, at A2 to A3 add $0.7M plus A3 to BAA1 add $1.1M • If insured, higher insurance fees on new issues will cost more • Downgrades may impact future LOC availability

13. Proposed 2011 Residential Monthly Water & Wastewater Bill This rate class three year average gallons per month is 6,000

14. Proposed 2011 Multi-Family Monthly Water & Wastewater Bill

15. Proposed 2011 Commercial Monthly Water & Wastewater Bill

16. Water & Wastewater Rate Comparison Single Family 3,000 Gallons 5/8 & 3/4 Inch Meters

17. Water & Wastewater Rate Comparison Single Family 6,000 Gallons 5/8 & 3/4 Inch Meters

18. Water & Wastewater Rate Comparison Single Family 10,000 Gallons 5/8 & 3/4 Inch Meters

19. Water & Wastewater Rate Comparison Multi-Family 10,000 Gallons

20. Water & Wastewater Rate Comparison Commercial 10,000 Gallons

21. Recommendations • Set rates at Best Practices CIP rates to ensure long term health and sustainability of the system • Set all non-city rates at cost of service • Implement Water & Wastewater rate adjustment June 1st • Change annual automatic rate increase to be based on PPI, not to exceed annual CPI plus population index,in compliance with Proposition 1

22. Comparison of Regional CPI vs. PPI Houston Regional CPI & PPI In Percentages Annual Percentage Abbreviations: “PPI” - Producer Price Index all commodities

23. Addendum – Other Rates