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The Economics of For‑Profit Versus Non‑Profit

 

If you have browsed very much of this website, you know that water or sewer service by a for‑profit utility is more expensive.  A key reason is that the financial management of a for‑profit utility is very different than for a non‑profit utility.  This section is going to compare the two options in some depth. 

 

This page focuses on Aqua Pennsylvania because that is the operation we have the most experience with.  The same will apply to PA American, they are like two peas in a pod.  Other states likely do pretty much the same things, but we do not have direct experience with them. 

 

The following charts illustrate the key differences.  This is not an apples to apples comparison, but read on and we will fix that. 

For-Profit Versus Non-Profit

A somewhat unfair comparison

The chart on the right shows the two major cost elements that would disappear if Aqua existed as a non‑profit.  It is obviously quite a stark contrast.  Profit and depreciation are a whopping amount of money that a non‑profit municipal system does not collect from its customers. 

The basic difference is that the for-profit utility operates on a full cost profit/loss basis.  However, a municipal non-profit essentially operates on a cash basis.  The difference is mostly in profit and depreciation.  A more detailed discussion of the differences can be found here (LINK). 

What about that element of unfairness?

If Aqua operated as a non‑profit, three changes would be needed:

 

#1 - It is likely that operating cost would be lower.  Aqua has major expenses dealing with the Public Utility Commission (PUC) that a non‑profit would not have. 

#2 - Debt Service is different than interest expense and likely will be higher. 

 

#3 - There will be a need for capital investments over and above that provided by Debt Service.  Any operation as large as Aqua’s will have significant on going capital construction costs. 

 

Applying the above changes results in the following:

IF Aqua Was A Non-Profit

IF...IF...IF

What this shows is that ratepayers would save over $340 million/yr – 55% of their current bills.  The assumptions behind this comparison are important:

 

#1 - Even though operating cost should be lower for the non‑profit, they are set equal in this example.  We really do not have a basis for estimating what the difference might be. 

 

#2 - Both companies have the same capital structure:  54% equity and 46% debt. 

 

#3 - A municipal non‑profit can finance their debt about 1% lower than a for‑profit.  This is because muni-bonds are income tax exempt.  Since Aqua’s interest cost was 4%/yr in their rate case, 3%/yr was used for the non‑profit. 

 

#4 - Capital spending for the non‑profit is set at 5% of rate base – just under $210 million/yr.  We believe this is a generous allowance.  Aqua’s capital spending as reported in their annual reports to the PUC has averaged $150 million/yr over the last five years. 

 

#5 - The capital spending for the non‑profit is funded by the annual turnover of debt (about 5%/yr or $96 million/yr) and issuing new debt for the balance (about $113 million).  This new debt means that Debt Service will gradually increase over time – about 2%/yr of revenue. 

The bottom line result would be a big savings for customers. 

Conclusions

The business management of a for-profit utility is very different than a municipal non-profit.  It is not hard to see why municipal utility service will almost always be the low cost option.  It is also easy to see why Big Water wants to gobble up municipal systems - it is a sure fire way to grow profits. 

Related Subjects

#1 - Financial Reporting - For a more detailed look at financial reporting for these two options, click here (LINK). 

 

#2 - Depreciation - As shown above, depreciation is a major cost for Big Water customers, but not for municipal ones.  For many people depreciation is not easy to understand.  Here is a page that tries to address these issues (LINK)

#3 - Interest - This is a major expense for Big Water.  It goes with the capital intensive nature of the business.  At least in Pennsylvania, utility companies report interest costs a bit strangely.  It shows up on their reporting as an after-tax cost.  It is not.  The issue is whether it is part of a three card monte game (see note below) being played in setting rates.  We would like help from knowledgeable people on this issue.  Click here for more information: (LINK)

Note:  Not sure what three card monte is?  Click here for a three minute fun and interesting video about this age old con game (LINK). 

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