On May 18, 2004, the Board of Supervisors adopted a motion directing the Budget Analyst to perform a management audit of the Public Utilities Commission (Motion No. M04-57). As explained below, this report is the result of the third phase of a four-phase management audit. Our first and second phase management audit reports on the Clean Water and Hetch Hetchy Enterprises were issued on September 27, 2004 and December 21, 2004, respectively.

Purpose and Scope

The purpose of this management audit is to evaluate the economy, efficiency, and effectiveness of the Public Utilities Commission's programs, activities, and functions, and the Public Utilities Commission's compliance with applicable State and Federal laws, local ordinances, and City policies and procedures. This management audit is conducted in four phases:

• The Phase I Management Audit of the Public Utilities Commission - Clean Water Enterprise Fund is a review of the Clean Water Enterprise's programs, activities and functions.
• The Phase II Management Audit of the Public Utilities Commission - Hetch Hetchy Enterprise Fund is a review of the Hetch Hetchy Enterprise's programs, activities and functions.
• Phase III, which is the subject of this report, is a review of the Water Enterprise Fund's programs, activities, and functions, including water supply, treatment, and distribution for regional and City customers.
• Phase IV is a review of the programs, activities, and functions of the Public Utilities Commission as a whole, including the Water System Capital Improvement Program,¹ administrative functions, and enterprise-wide functions, such as asset management, that affect all three enterprise funds.

This Phase III report reviews the Water Enterprise in terms of:

• Business planning and risk management processes.
• Regulatory compliance and management.
• Laboratory management.
• Suburban wholesale water rates.
• The billing and collection of water and sewer accounts.
• Real estate services and land management.

Audit Methodology

The management audit was conducted in accordance with Governmental Auditing Standards, 2003 Revision, issued by the Comptroller General of the United States, U.S. General Accountability Office. The management audit staff presented a draft report to the Public Utilities Commission General Manager on February 28, 2005. The management audit staff held an exit conference with the General Manager and key members of the Public Utilities Commission's management staff on March 16, 2005, to discuss the draft report. After careful consideration of the additional information provided after submission of the draft report and at the exit conference, the management audit staff prepared a final report. The Public Utilities Commission has provided a written response to the Budget Analyst's Phase III Water Enterprise management audit report, which is appended to this report.

Overview of the Water Enterprise

The Water Enterprise provides water to almost 2.4 million people either directly to customers within the City of San Francisco (City) and to a small number of customers outside the City or indirectly through wholesale water sales to 29 municipal water agencies in Alameda, Santa Clara, and San Mateo counties. The Water Enterprise separates its function into two distinct geographic areas. The Regional Water System brings the water from Yosemite and the Sierra Nevada to the Bay Area and to 29 wholesale customers. This system includes five reservoirs in Alameda and San Mateo counties and two water treatment plants, one in Alameda County and one in San Mateo County. The Local Water System distributes and delivers water from the regional system to customers in the City as well as to the City itself for municipal use. The objectives of both the Regional and Local Water Systems are to maintain water quality and to ensure water supply reliability, even during catastrophic events or periods of drought.

Organization of the Water Enterprise within the Public Utilities Commission

Exhibit I below shows the Water Enterprise's placement in the organizational structure under the previous General Manager. Management accountabilities over the Water Enterprise were combined with both the Hetch Hetchy and Clean Water Enterprises. Exhibit II below shows the proposed organizational structure for the Public Utilities Commission under the current General Manager who took office on August 23, 2004. Management accountabilities have changed in that the Water Enterprise activities are proposed to be consolidated under one Assistant General Manager and to include the short-term planning function. However, this organizational structure is still being revised by the current General Manager and is not yet final.

EXHIBIT I
PUBLIC UTILITIES COMMISSION FUNCTIONAL ORGANIZATION
UNDER PREVIOUS GENERAL MANAGER

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Planning Bureau	Power, Policy and Resource Planning	Operations	Infrastructure	Communications and Government Relations	Business Services
Environmental Regulatory Compliance Clean Water Planning Water Resources and Planning Regional Water Project Planning	Power Planning and Administration Energy Efficiency Renewable Energy Technologies Regulatory Public Affairs	Bureau of Environmental and Regulatory Management City Distribution Division Water Supply and Treatment Division Water Quality Bureau Infrastructure Development Water Construction and Maintenance Support Hetch Hetchy Water Hetch Hetchy Power Water Pollution Control Fleet Management Security and Emergency Planning	Infrastructure Resources Management Bureau Project Management Bureau Engineering Design Bureau Construction Design Bureau Program Development and Support Bureau	Communications Government Relations	Human Resources Information Technology Services Financial Services Customer Services Real Estate Services

Note: Water Enterprise-related functions are highlighted in bold.

EXHIBIT II
PUBLIC UTILITIES COMMISSION PROPOSED FUNCTIONAL ORGANIZATION
(Per the Public Utilities Commission General Manager's February 8, 2005 Draft Organizational Restructuring Proposal)

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Water Enterprise	Power Enterprise	Clean Water Enterprise2	Infrastructure	External Affairs	Business Services
City Distribution Division Hetch Hetchy water system Hetch Hetchy wholesale power up to Newark Natural resources Short-term water system policy and planning Water Quality Bureau Water Supply and Treatment Division	Energy services Retail power Power Policy Division Streetlight Management Program3	Bureau of Environmental Regulation and Monitoring Clean water master and short-term system planning Water Pollution Control Clean water regulatory compliance	Water System Capital Improvement Program Repair and replacement program Security Contracts	Strategic planning Communi-cations Legislative Affairs Real Estate	Human Resources Information Technology Financial Services Customer Services

Water Enterprise Fund Revenues and Expenditures

Between FY 1999-2000 and FY 2003-2004, the Water Enterprise Fund operating budget actual revenues increased by approximately $62.3 million, or 40.4 percent, from $154.4 million in FY 1999-2000 to $216.7 million in FY 2003-2004. As noted in Table 1, in FY 2003-2004, charges for services of $174.8 million comprised 80.6 percent of total Water Enterprise revenues of $216.7 million. Operating budget actual expenditures increased by $32.9 million, or 25.0 percent, from $131.6 million in FY 1999-2000 to $164.5 million in FY 2003-2004.

Table 1
Water Enterprise Fund Operating Budget
Actual Revenues and Expenditures
FY 1999-2000 through FY 2003-2004

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	FY 1999-2000	FY 2000-2001	FY 2001-2002	FY 2002-2003	FY 2003-2004
Revenues
Charges for Services	135,901,391	139,013,909	144,396,143	148,243,267	174,755,035
Rents and Concessions	7,880,767	8,077,467	8,302,928	8,611,317	8,451,001
Interest and Investment Income	4,923,525	9,707,830	7,781,358	4,942,810	7,420,182
Other Revenue	5,662,175	132,761,701	7,447,909	9,285,495	26,080,427
Total Revenues	154,367,858	289,560,907	167,928,338	171,082,889	216,706,645
Expenditures
Labor and Fringe	34,042,235	35,489,223	43,579,460	46,610,842	49,223,566
COWCAP	1,563,920	1,351,971	997,558	1,448,270	1,386,022
Non-Personnel Services	4,983,631	4,605,676	5,491,242	6,242,628	7,261,418
Materials and Supplies	6,151,253	5,648,283	6,451,533	6,481,894	7,828,621
Equipment	1,309,150	3,107,375	1,831,156	2,508,555	2,314,034
Services of Other Dept	5,972,143	6,386,439	6,140,985	7,664,190	7,865,470
Light Heat and Power	3,764,271	3,924,049	5,869,352	6,398,629	6,267,641
Services of PUC Bureaus	34,771,902	31,341,388	21,528,480	23,034,266	25,636,125
Debt Service	20,032,939	19,989,020	27,733,212	36,497,590	38,177,573
Hetch Hetchy	19,037,000	19,037,000	19,037,000	19,037,000	19,037,000
Recovery	-	-	-	-	(481,775)
Total Expenditures	131,628,444	130,880,424	138,659,978	155,923,864	164,515,695
Net Revenues	22,739,414	158,680,483	29,268,360	15,159,025	52,190,950

Source: Public Utilities Commission Financial Services Section

Water Enterprise actual revenues primarily increased due a $25.0 million increase in charges for services billed to suburban wholesale water customers in FY 2003-2004. Additionally, sales of property increased other revenues by $126.2 million in FY 2000-2001 and $16.5 million in FY 2003-2004. Water Enterprise actual expenditures increased due to an $18.1 million increase in debt service annual requirements and an increase in labor and fringe benefit costs of $15.2 million. Net revenues, which fluctuated significantly over the five year period due to significant variations in operating revenues, are available for appropriation. Pursuant to the Public Utilities Commission policies, these surplus revenues should be appropriated for revenue funded capital projects.

The Water System Capital Improvement Program

The Public Utilities Commission approved a $3.6 billion Water System Capital Improvement Program in May of 2002, to repair, replace, and seismically upgrade the regional and local water system's infrastructure over a twelve-year period, from 2002 through 2014. The City's estimated share of the Water System Capital Improvement Program costs are approximately $1.7 billion and the suburban customers' estimated share of the costs are approximately $1.9 billion.

Three propositions approved by City voters in November of 2002 affect the Public Utilities Commission's ability to issue new revenue bonds to finance the Water System Capital Improvement Program:

• Proposition A granted the Public Utilities Commission the authority to issue up to $1.628 in revenue bonds to fund the City's share of costs for the Water System Capital Improvement Program.
• Proposition E granted the Public Utilities Commission the authority to issue revenue bonds without further voter approval.
• Proposition P created a revenue bond oversight committee to review the management and administration of bonds issued for the Capital Improvement Program.

The Water System Capital Improvement Program and its total cost are currently under review by the Public Utilities Commission which anticipates (a) total program costs growing by $717 million, to a revised total of $4.3 billion, (b) the deletion of five of the Water System Capital Improvement Program's existing 77 capital improvement projects, and (c) the addition of new projects. The earliest that the Public Utilities Commission will make a final decision on the proposed changes to the Water System Capital Improvement Program is April of 2005.

Suburban Wholesale Water Rate Agreement

In 1984, the City and County of San Francisco entered into an agreement, the Settlement Agreement and Master Water Sales Contract, with its suburban wholesale water customers which established a detailed methodology for determining water rates to be charged to those customers. The agreement resulted from a settlement of a civil action filed against the City in 1974 by the City of Palo Alto regarding the method in which rates were established. The Settlement Agreement and Master Water Sales Contract expires June 30, 2009.

Since 1984, there have been disputes between the Public Utilities Commission and the suburban customers related to the suburban wholesale rate calculation in almost every year. These disputes have been resolved through informal negotiations, settlement agreements, and arbitration. In addition to these annual disputes, State legislation supported by the suburban customers and signed into law in September of 2002 increases independent oversight of the Public Utilities Commission and requires that the Public Utilities Commission work in coordination with the suburban customers.

• Assembly Bill 2058 enabled the creation of the Bay Area Water Supply and Conservation Agency, which represents the 29 suburban customers. Under Assembly Bill 2058, the Bay Area Water Supply and Conservation Agency holds the authority of a regional water agency. Thus, the suburban customers are united as one group with respect to issues concerning the Water Enterprise.
• Senate Bill 1870 created the San Francisco Bay Area Regional Water System Financing Authority, which would allow the Bay Area Water Supply and Conservation Agency to issue revenue bonds to finance the suburban share of costs of the Water System Capital Improvement Program. This would enable the Bay Area Water Supply and Conservation Agency to have financial control over the implementation of significant components of the Water System Capital Improvement Program.
• Assembly Bill 1823 required the State Department of Finance to conduct an audit of the Water Enterprise's program of maintenance of the regional water system prior to July 1, 2004. The audit included a review of the adequacy of the Public Utilities Commission's procedures and resources for identifying needed maintenance; planning, budgeting, scheduling, and completing maintenance; and record keeping of maintenance activities. The audit was completed and found that "the Commission is taking adequate steps to develop and implement maintenance procedures." However, the report also notes that the report conclusions were preliminary as the Public Utilities Commission was still in the process of developing and implementing maintenance procedures.

Clearly, the relationship between the two agencies is contentious. The significant annual fluctuations in the suburban revenue requirement discussed in Section 1, coupled with accounting process weaknesses discussed in Section 2, do not instill confidence in the suburban customers that the Public Utilities Commission is able to effectively manage and account for its existing capital program, let alone implement the tools necessary for the Water System Capital Improvement Program.

The Public Utilities Commission will need to cultivate its relationship with the suburban customers as it moves forward with the Water System Capital Improvement Program and contract negotiations with the Bay Area Water Supply and Conservation Agency.

Water Enterprise Accomplishments

The management audit team invited the Public Utilities Commission to submit written statements on the Water Enterprise's accomplishments that it perceives have occurred in recent years. The Public Utilities Commission has provided the following list of accomplishments for the Water Enterprise and the Bureau of Environmental Regulation and Management.

• The Water Enterprise has improved the level of service provided to wholesale customers by meeting individually with wholesale customers and conducting bi-annual surveys of wholesale customer satisfaction with services provided. According to the Water Enterprise, results of the most recent survey have showed a relatively high level of customer satisfaction with services provided by the Water Supply and Treatment Division and the Water Quality Bureau.
• The Water Enterprise has developed procedures for inspections, condition assessment, and reporting for dams. These procedures have been included in the maintenance management system (MAXIMO) database so that the ongoing assessments will become part of the Water Enterprise's preventive maintenance program. Also, the Water Enterprise has inspected over 16 miles of water system transmission pipelines in FY 2004-2005 to perform condition assessments, including the Crystal Springs, Bay Division, and Pilarcitos pipelines.
• The Water Enterprise has implemented a program for providing supervised access to the Bay Area Ridge Trail for hikers, bicyclists, and equestrians, which provides public education and recreational opportunities and protects sensitive natural resources. Additionally, the Water Enterprise has produced a book on Woody Plants, Ground Covers, Shrubs and Trees of the Peninsula Watershed and has provided sensitive plant training for staff engaged in watershed operations.
• The Water Enterprise has implemented a Fuel Break Vegetation Management Log to track progress in performing fuel management consistent with the Watershed Management Plan.
• The Water Quality Bureau Laboratories have reported several performance achievements, including:

(i) receiving an overall combined score of 96.3 percent for all four laboratories - Millbrae, Southeast, Oceanside, and Treasure Island - as part of the State of California Environmental Laboratory Accreditation Program;

(ii) becoming one of the first tier of laboratories in the nation to be certified by the U.S. Environmental Protection Agency for performing parasite monitoring throughout the drinking water system, including scoring as number one in the nation in 2004 in performance assessment testing by the U.S. Environmental Protection Agency; and

(iii) scoring 100 percent in California State proficiency testing of trace metal testing performance in wastewater and drinking water.

• The Water Enterprise has completed five studies related to demand on the Public Utilities Commission water system, including the SFPUC Wholesale Customer Water Demand Projections Technical Report, the SFPUC Wholesale Customer Conservation Potential Technical Report, the City and County of San Francisco Retail Ware Demands and Conservation Potential, the SFPUC Wholesale Customer Recycled Water Potential Technical Memorandum, and the SFPUC 2030 Purchase Estimates Technical Memorandum.
• San Francisco is the first large municipality in the State to implement a permit program that involves the installation of amalgam separators in dental offices to remove mercury from the sewer system.
• The Bureau of Environmental Regulation and Management has successfully assessed and remediated mercury contamination in five Public Utilities Commission facilities.
• The Bureau of Environmental Regulation and Management has successfully prepared a Stormwater Management Plan that has been approved by the State, giving San Francisco coverage under the State's General Stormwater Permit, Phase II Stormwater Regulations.
• The Bureau of Environmental Regulation and Management has received several state and national awards for pretreatment and water pollution prevention.

Acknowledgements

We would like to thank the management and staff of the Public Utilities Commission for their cooperation during Phase III of this management audit. We hope the findings contained in this report provide a useful tool for the General Manager and her staff as they work to improve the operations of the Water Enterprise.

¹ Although the Public Utilities Commission has recently renamed the Water System Capital Improvement Program as the "Water System Improvement Program," this audit report retains the former name in order to be consistent with the Phase I and II management audit reports.

² This report refers to the "Clean Water Enterprise" and the "Assistant General Manager, Clean Water" to be consistent with the Phase I and II management audit reports. However, the Public Utilities Commission General Manager has recently changed the terminology from "clean water" to "wastewater."

³ The Phase II Management Audit of the Public Utilities Commission - Hetch Hetchy Enterprise Fund report recommended that the Streetlight Management Program be transferred to the Department of Public Works (Recommendations 7.1 - 7.3).