BOARD OF SUPERVISORS

BUDGET ANALYST
1390 Market Street, Suite 1025, SanFrancisco, CA 94102 (415) 554-7642
FAX (415) 252-0461

March 23, 2005

Honorable Aaron Peskin, Chair of the Government Audits and Oversight Committee
and Members of the Board of Supervisors
City and County of San Francisco
Room 244, City Hall
1 Dr. Carlton B. Goodlett Place
San Francisco, CA 94102-4689

Dear President Peskin and Members of the Board of Supervisors:

The Budget Analyst is pleased to submit this Phase III Management Audit of the Public Utilities Commission, Water Enterprise Fund. On May 18, 2004, the Board of Supervisors adopted a motion directing the Budget Analyst to conduct a management audit of the San Francisco Public Utilities Commission, pursuant to its powers of inquiry defined in Charter Section 16.114 (Motion No. M04-57). The purpose of the management audit has been to (i) 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; and (ii) assess the appropriateness of established goals and objectives, strategies and plans to accomplish such goals and objectives, the degree to which such goals and objectives are being accomplished, and the appropriateness of controls established to provide reasonable assurance that such goals and objectives will be accomplished. The scope of the management audit includes all of the Public Utilities Commission's programs, activities, and functions.

The results of the management audit are being presented in four phases:

• The Phase I Management Audit of the Public Utilities Commission - Clean Water Enterprise Fund report was submitted to the Board of Supervisors on September 27, 2004.
• The Phase II Management Audit of the Public Utilities Commission - Hetch Hetchy Enterprise Fund report was submitted to the Board of Supervisors on December 21, 2004.
• The Phase III Management Audit of the Public Utilities Commission - Water Enterprise Fund is the subject of this report.
• Phase IV will be a review of the programs, activities, and functions of the Public Utilities Commission as a whole, including the Water System Capital Improvement Program, administrative functions, and enterprise functions, such as asset management, that affect all three enterprise funds.

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

• Setting suburban wholesale water rates.
• Capital planning and long range financial planning.
• Billing and collections for retail water and sewer customers.
• Water Quality Bureau Laboratories management and cost allocation.
• Regulatory risks for the Water Enterprise as a whole and Treasure Island in particular.
• Land and Real Estate management.
• Water Enterprise strategic and business planning and organization.
• Planning for programmatic environmental impact reports for the Water System Capital Improvement Program.

This management audit has been conducted in accordance with Government Auditing Standards, 2003 Revision, issued by the Comptroller General of the United States, U.S. General Accountability Office. As part of the management audit, the Budget Analyst interviewed the senior management and other Public Utilities Commission staff and representatives from other City and County departments. Additionally, the management audit staff reviewed various State statutes and local codes; examined various documents, reports and work products prepared by the Public Utilities Commission; reviewed the Water Enterprise Fund's audited financial statements and reports prepared by various consultants; obtained and analyzed various data and financial reports; and evaluated the effectiveness of the various tools used by Public Utilities Commission management to oversee the activities of the Water Enterprise program.

This management audit report of the Water Enterprise program includes 15 findings and 91 related recommendations prepared by the Budget Analyst, that encompass major areas of the Water Enterprise's operations. A list of the management audit recommendations are shown in the Attachment to this transmittal letter. Implementation of the Budget Analyst's recommendations would result in (a) estimated revenue increases of approximately $1.35 million annually from improved billing of retail water and sewer customers, increased Water Quality Bureau Laboratories revenues from external clients, and increased property rents; and (b) estimated expenditure decreases of approximately $500,000 annually from the deletion of unnecessary positions.

The following sections summarize our findings and recommendations.

Section 1. Suburban Wholesale Water Rates, Long Range Financial Planning, and Revenue Funded Repair and Replacement Projects

In FY 2003-2004, suburban wholesale water customers paid the Public Utilities Commission (PUC) $15 million more than necessary because water rates were based in part on the projected cost of several large capital projects that were not completed within the year. Between July 1, 2000, and June 30, 2005, suburban wholesale customers will have overpaid an estimated $27 million to the Public Utilities Commission, resulting in the need to decrease the suburban wholesale customers' water rates by 30 percent in FY 2005-2006, followed by a proposed increase in suburban wholesale customers' water rates of 40 percent in FY 2006-2007 to meet FY 2006-2007 revenue requirements.

Because the Public Utilities Commission has failed to accurately plan and time the completion of capital projects, contributing to volatile suburban wholesale customer rates and revenues, the Public Utilities Commission can not adequately plan for the Water Enterprise's finances, causing difficulties for both wholesale and retail customers. For example, in the five month period between August, 2004, and January, 2005, the Financial Services Section significantly revised its long range financial projections and estimates of annual retail rate increases for City customers from FY 2005-2006 through FY 2008-2009, from the August, 2004, estimated retail rate increase of 11 percent per year to the January, 2005, estimated retail rate increase of 15 percent per year.

Also, the January, 2005, Water Enterprise long range financial projections suggest that the Public Utilities Commission will be unable to meet its eleven year goal of allocating $506 million in operating revenues to fund capital repair and replacement projects that are necessary but are not part of the Water System Capital Improvement Program. To complete critical projects, such as the replacement of aging water pipelines, the Public Utilities Commission will need to develop an effective asset management program to determine its most critical capital repair and replacement needs.

Section 2. Calculation of the Suburban Wholesale Water Rates

Weaknesses in accounting methodologies and unreasonable delays in the timing of Water Enterprise financial audits of suburban wholesale revenue requirements make the Public Utilities Commission's annual revenue requirement analysis and reporting of questionable accuracy and contributes to unanticipated variances in available resources. As a result, both the Public Utilities Commission's and the suburban water customers' budgets and finances are significantly impacted. For example, in the most recent settlement agreement between the Public Utilities Commission and its suburban water customers, adjustments totaling $3,735,674 were determined to be owed by the Public Utilities Commission to suburban water customers for FY 1999-2000 and prior years. Potential additional adjustments to be made by the Public Utilities Commission for the period FY 2001-2002 forward are still pending because of delays in the completion of the Public Utilities Commission's annual financial statements.

The reasons for these adjustments are varied, but are generally due to the Public Utilities Commission having an inadequate accounting structure to capture, record, and report Water Enterprise activities - especially its capital activities - in a manner that is necessary for calculating suburban water customer rates. To compensate, the Public Utilities Commission has developed highly labor intensive processes for capturing costs. These processes are prone to error. Most significantly, the Public Utilities Commission commingles capital expenses with other expenses - such as repair and maintenance - which are typically not capitalized. Because of the different treatment which capitalized and non-capitalized expenses receive for purposes of calculating the Water Enterprise's suburban revenue requirements, these errors can affect the Public Utilities Commission's rate calculations.

For example, in a review of FY 2003-2004 activity, the Reservoir Roofs Seismic Upgrades project (CUW624) expensed $3,479,644 for cleaning and repair work in a project phase that also had capitalized expenses, requiring the project manager to track project details outside of the accounting system for purposes of expensing or capitalizing the project costs. Further, at least $2,694,272 of these expenses were incurred in prior years and, therefore, were not expensed timely. Another $154,174 in funds used for a comprehensive inspection and evaluation of water storage tanks were also expensed. To the extent that such project funds are related to the suburban wholesale customers, activities that are not expensed timely result in not recovering the costs from suburban customers in the period incurred.

Additionally, the process by which suburban wholesale water rates and the suburban revenue requirement are calculated and audited delays the finalization of the suburban revenue requirement. Although the Settlement Agreement and Master Water Sales Contract requires that the independent audit of revenue requirements be completed within six months of the year being audited, the FY 2002-2003 and FY 2003-2004 independent audits have still not been completed. Further, the Bay Area Water Supply and Conservation Agency transmits to the Public Utilities Commission extensive letters identifying potential problems in calculating the suburban revenue requirements, which extend the time for finalizing revenue requirements for an indefinite period. Most recently, the Bay Area Water Supply and Conservation Agency has transmitted these letters for problems relating to the FY 2001-2002 suburban wholesale water rates.

Section 3. Coordinating the Timing and the Financing of the Water System Capital Improvement Program

By not spending capital project funding in an expeditious manner, the Public Utilities Commission incurs significant interest expense and loses buying power through inflation. For example, approximately five to seven years after initial appropriation by the Board of Supervisors in FY 1997-1998 through FY 1999-2000, totaling $77.7 million, $5.2 million of the $77.7 million in 1996 revenue bond proceeds remain unspent, amounting to 6.7 percent of the total amount of the appropriation. Because of debt interest expense together with inflation, the unspent funds of $5.2 million have declined in value by an estimated 4 percent¹ per year, or approximately $208,000 per year or approximately $1.04 million over five years.

These circumstances occur because the Public Utilities Commission does not effectively manage the timing of financing and construction of capital projects. In other examples, capital projects totaling $2.8 million had unencumbered balances equal to 65 percent to 100 percent of the original appropriation two to five years subsequent to when the funds were originally appropriated.

The Public Utilities Commission is planning the largest issuance of revenue bonds in the Commission's history to finance the Water System Capital Improvement Program. The Water Enterprise will issue up to approximately $3.6 billion in revenue bonds to finance the Water System Capital Improvement Program, which is ten times the amount of revenue bonds issued by the Water Enterprise in the twelve year period from 1991 through 2002. Without well-coordinated information on the planning and timing of the Capital Improvement Program projects, the Financial Services Section staff cannot efficiently time cash flow requirements for constructing the Water System Capital Improvement Program projects with the issuance of revenue bonds.

If the Public Utilities Commission does not efficiently manage the planning and timing of issuance of revenue bonds and appropriation and expenditure of the revenue bond proceeds for the $3.6 billion Water System Capital Improvement Program, the additional costs which would be imposed on ratepayers resulting from interest payments on unencumbered and unexpended balances could be significant.

Section 4. Undercharging for Components of Water and Sewer Service

The Public Utilities Commission loses an estimated $910,000 annually in retail water and sewer rate revenues, including $620,000 due to aging water meters and $290,000 due to billings based on sewer flow factors that have been set too low.

The Public Utilities Commission loses $620,000 annually in water and sewer revenues due to 5/8-inch water meters that are more than 25 years old and measure water flow by an estimated 2 percent less than the actual water flow. Based on a random sample of Customer Services retail water and sewer accounts, 24 percent of 5/8-inch meters for multi-family residences and 45 percent of 5/8-inch meters for single family residences are more than 25 years old.

In FY 2003-2004, the Water Enterprise only replaced 2,270 5/8-inch meters, which is a 49.4 percent decrease from the 4,486 5/8-inch meters that were replaced in FY 2002-2003. Over the past three fiscal years, annual funding for meter replacement has decreased by 31.4 percent from approximately $700,000 in FY 2002-2003, to $580,000 in FY 2003-2004, and $480,000 in FY 2004-2005. Because the Water Enterprise does not track the labor and material costs for replacing 5/8-inch water meters, the Budget Analyst was unable to determine the costs of replacing 5/8-inch meters.

The Public Utilities Commission should direct its General Manager to present a cost-benefit analysis of meter replacement costs and revenue loss from aging meters. If the Water Enterprise were to replace 4,200 5/8-inch meters per year instead of the 2,270 meters replaced in FY 2003-2004, the Water Enterprise's revenues would increase incrementally in each year, resulting in estimated cumulative increased revenues over a ten-year period of $1.8 million.

The Public Utilities Commission loses $290,000 annually in commercial and residential revenues from sewer flow factors that have been set too low. Sewer rates are based on 90 to 95 percent of water consumption, or "flow factor," but commercial and residential customers can request reduced flow factors of less than 90 to 95 percent if water is used for irrigation or other purposes, and therefore, not discharged to the sewer.

The Public Utilities Commission Customer Services Section assigns reduced flow factors for residential customers based on two methods of calculation: (a) calculation of maximum irrigation potential and (b) comparison of water consumption during wet and dry months. According to Public Utilities Commission policy, Customer Services staff should assign reduced flow factors based on the calculation method that results in average daily consumption between 40 gallons per occupant per day if ultra low flush toilets are installed and 80 gallons per occupant per day if no ultra low flush toilets are installed.

Based on a random sample, the Budget Analyst found that Customer Services failed to document the number of occupants and use of low flush toilets and uniformly assigned the lowest flow factor derived from the two methods of calculation regardless of other factors, resulting in an estimated revenue loss to the Public Utilities Commission of $220,000 annually.

The Bureau of Environmental Regulation and Management has not re-inspected most commercial accounts that were assigned reduced flow factors more than four years ago, resulting in an estimated loss to the Public Utilities Commission in sewer rate revenues of approximately $70,000 annually.

The City's policies to provide water free of charge to City General Fund departments and City neighborhood associations that plant and maintain vegetation on median strips and public spaces have resulted in poor water conservation. Over the past four years, City General Fund departments have increased water usage by 2 percent on average, although commercial accounts, which pay for water use, have decreased water usage by 4 percent on average. Also, many homeowners' associations have significantly increased their water use over the past five years. For example, the Forest Hill Homeowners' Association has increased annual water use by 115 percent over the past four years.

The Public Utilities Commission's water conservation affidavit program, in which City retail customers pay one-third less per unit of water if they have signed an affidavit stating that they have installed low-flow fixtures, has no demonstrable direct impact on water conservation. Average water use by customers who sign such affidavits is comparable to average water use by City customers who have not signed such affidavits. The Public Utilities Commission should eliminate the water conservation affidavit program and evaluate implementation of water conservation rates when the current water rate freeze expires on June 30, 2005.

Section 5. Accounting for the Costs of Water Quality Bureau Laboratory Services.

The Water Quality Bureau Laboratories, which provide chemistry and microbiology analyses of the Public Utilities Commission's wastewater and drinking water systems, neither track nor allocate the costs of laboratory services provided to the laboratories' clients, and therefore, cannot ensure that the charges for laboratory services are recovering all costs. For example, although revenues from external clients, which include the San Francisco International Airport, various cities, and other public entities, make up 4 percent of the Water Quality Bureau Laboratories revenues, external client workload makes up 8 percent of the workload, resulting in an estimated $281,512 annually in lost revenues to the Public Utilities Commission from external clients.

Because the Water Quality Bureau Laboratories external clients pay for laboratory services based upon negotiated prices rather than cost-based prices, the costs of services differ among different clients. For example, for one type of analysis, known as "present/absence analysis of coliform", the City of Burlingame in San Mateo County pays $25 per analysis and the City of Hayward in Alameda County pays $15 per analysis.

The Water Quality Bureau Laboratories are funded by a direct transfer of Water and Clean Water Enterprise funds in the Public Utilities Commission budget each year. The Water Quality Bureau Laboratories have no internal cost-based price list and do not charge the Enterprises for specific laboratory analyses. More than 25 percent of the laboratory analyses performed by the Water Quality Bureau Laboratories for the Water and Clean Water Enterprises are discretionary to some extent, and are determined by operational considerations rather than regulatory requirements, such as monitoring a special process. Because the Water and Clean Water Enterprises are not charged for specific laboratory analyses, the Enterprises have no cost incentive to request the level of service that most cost-efficiently achieves the analytical goal.

The Public Utilities Commission should require its General Manager to direct the Water Quality Bureau Laboratories to negotiate cost-based fees with internal and external clients. Although the Public Utilities Commission can choose to negotiate fees with specific clients as a policy option, negotiated fees should be an exception rather than a standard practice.

The Water Quality Bureau Manager should enhance the client services job description to serve as (a) the project manager for developing cost-based fees and (b) the gatekeeper for internal and external clients to ensure that the appropriate level of laboratory services are provided to achieve clients' analytical goals.

Section 6. The Laboratories' Management Structure

Structural integration of the laboratories has improved organizational effectiveness and allowed the Public Utilities Commission to reduce the number of laboratory positions. Now that these benefits have been achieved, the Director of Laboratories position is no longer required and could be eliminated at a cost savings of up to $147,103 in salaries and mandatory fringe benefits annually.

This change in the management structure could be accomplished by (a) transferring executive management for the Southeast and Oceanside Water Pollution Control Plant Laboratories from the Director of Laboratory to the new Assistant General Manager, Clean Water position, as recommended by the Budget Analyst, and (b) balancing workload and sharing laboratory specialization by establishing formal contracts or work order agreements between the laboratories.

The deletion of the Director of Laboratory position would eliminate an unnecessary and excessive level of management between the Water Quality Bureau Manager and the two Laboratory Services Managers in the Millbrae Laboratory.

Section 7. Managing Regulatory Compliance

The Public Utilities Commission faces significant potential risks for Federal and State regulatory compliance violations, including violations resulting from operating or construction activities, and incurs liability for regulatory violations as well as for damage or destruction of property, natural resources, or public health. For example, the Sea Cliff sink hole incident, which occurred in 1995 prior to the transfer of the Clean Water Enterprise from the Department of Public Works to the Public Utilities Commission and had numerous causes, including inadequate construction management, resulted in regulatory violations. The City paid $300,000 in regulatory fines and $12 million in property loss claims. Despite these risks, the Clean Water and Water Enterprises do not report regularly to the General Manager or the Public Utilities Commission on regulatory compliance, regulatory risks, and how such risks are mitigated.

The Public Utilities Commission General Manager should consolidate regulatory planning and management functions, which are dispersed throughout the Public Utilities Commission, under the new Assistant General Manager, Clean Water and the new Assistant General Manager, Water and Power, as recommended by the Budget Analyst, to ensure management oversight. Without consolidated regulatory planning and management, the Public Utilities Commission risks implementing operating and capital programs that do not comply with regulatory requirements, project delays, and unnecessary costs. For example, the Public Utilities Commission planned inadequately for regulatory requirements in the Pulgas Dechlorination Plant project design, which was designed prior to 2000 and constructed in FY 2002-2003. The Pulgas Dechlorination Plant, which is located in San Mateo County, does not comply with current discharge regulations regarding chlorinated water, and will require additional negotiations with State regulatory agencies and estimated costs of up to $10 million to retrofit the plant in order to meet current regulations.

The Public Utilities Commission needs to ensure that regulatory planning and management are part of the Clean Water and Water Enterprises' business plans, the Public Utilities Commission's strategic plan, and the Water System Capital Improvement Program's project planning and design process.

Section 8. The Public Utilities Commission's Risks for Managing Treasure Island Utilities

The Public Utilities Commission faces significant financial and regulatory risks for operation of the Treasure Island and Yerba Buena Island utilities since 1997, including electricity, natural gas, water, and sewer, but has not planned adequately for the Public Utilities Commission's financial and regulatory risks once the Navy conveys full ownership of Treasure Island and Yerba Buena Island to the Treasure Island Development Authority, anticipated to occur in 2005 or 2006. Consequently, the Public Utilities Commission could incur significant costs with inadequate revenues to cover the expenditures.

For example, the Public Utilities Commission could incur up to $5.7 million in capital improvement and preventive maintenance costs for existing utilities during the approximately four year interim period, after the Navy conveys ownership of Treasure Island and Yerba Buena Island to the City and before construction of new utility infrastructure is completed, but has not yet identified a funding source for these costs.

The Public Utilities Commission will incur new operating and maintenance costs for the existing Treasure Island and Yerba Buena Island utilities during the four year interim period to meet State and Federal regulatory requirements, but has not developed cost projections for Treasure Island and Yerba Buena Island operating and maintenance costs during the interim period.

A March 2004 report, Utility Vulnerability and Risk Assessment for Treasure Island and Yerba Buena Island - Final Report, prepared by a consultant under contract to the Public Utilities Commission recommended that (a) the Public Utilities Commission should not take ownership of the existing utilities during the interim period; (b) the Treasure Island Development Authority should contract out operation of the existing utilities during the interim period; and (c) if the Public Utilities Commission does operate the existing utilities during the interim period, the Public Utilities Commission should negotiate a private industry standard agreement with the Treasure Island Development Authority to mitigate its risks and liabilities. However, neither the Public Utilities Commission nor the Treasure Island Development Authority have planned to contract out operation of the existing utilities during the interim period, and as of the writing of this report, the Public Utilities Commission will most likely operate the utilities during the interim period.

Also, as of June 30, 2004 the Public Utilities Commission had $1.6 million in outstanding unpaid bills for operating the utilities, of which $1.3 million was owed by the Treasure Island Development Authority and $300,000 was owed by other tenants. The outstanding unpaid balance will increase in FY 2004-2005 because the Treasure Island Development Authority does not include monies in its budget to pay utility costs. The Mayor should include funds in the FY 2005-2006 Treasure Island Development Authority recommended budget to pay utility costs and develop a schedule for payment of the past due balance.

Currently, the Public Utilities Commission has no written agreement with the Treasure Island Development Authority to operate the Treasure Island and Yerba Buena Island utilities. Because of the turnover of high level managers at the Public Utilities Commission since 1997, and the lack of a written agreement and other formal planning and financial analysis documents, the Public Utilities Commission lacks both informal and formal information for decision making.

The Public Utilities Commission should enter into a written agreement with the Treasure Island Development Authority for the operation of the Treasure Island and Yerba Buena Island utilities. Further, the Public Utilities Commission and the Treasure Island Development Authority should present a joint financial analysis to the Board of Supervisors in December, 2006, evaluating how the proposed development of the Treasure Island and Yerba Buena Island utilities system will best meet the financial interests of the City and the City's utility ratepayers.

Section 9. Streamline Former Bureau of Environmental Regulation and Management Functions

The Environmental Compliance Program, which was part of the former Bureau of Environmental Regulation and Management, is not a comprehensive central advisor on environmental regulation compliance for all Public Utilities Commission enterprises as it was intended to be. That program's 3.00 FTE Classification 5620 Regulatory Specialist positions would be more useful if transferred to water and clean water system operations according to assessed need. Such transfers would ensure focused support for operations staff with their environmental regulation compliance obligations, particularly as the Water System Capital Improvement Program progresses.

Further, elimination of three unnecessary and expensive former Bureau of Environmental Regulation and Management positions would result in salary savings of up to $336,545, inclusive of mandatory fringe benefits, with no diminution of programmatic services. These salary savings would result from the elimination of an Administrative Engineer position, a Program Manager I position, and a Secretary II position.

Section 10. Establish an Assistant General Manager, Water and Power Position

The scope of the Public Utilities Commission's recently eliminated Assistant General Manager, Operations position was too broad and made it difficult for the incumbent to be a simultaneously strong manager of the water, clean water, and power systems' policies, planning, operations, and capital investments. As outlined in the Budget Analyst's Phase I Management Audit of the Public Utilities Commission - Clean Water Enterprise Fund, clean water functions particularly suffered from the resulting lack of focus.

The Public Utilities Commission General Manager replaced the Assistant General Manager, Operations position with three new Assistant General Manager positions for Water, Clean Water, and Retail Power. The creation of a new Assistant General Manager, Clean Water position is in line with our Phase I management audit recommendation.

The creation of the new Assistant General Manager, Retail Power position has merit but is insufficiently justified at this time. The Public Utilities Commission first needs to make key policy decisions and determine if it is going to proceed with community choice aggregation, which would allow the City (or a larger regional consortium) to procure electricity from a portfolio of power providers on behalf of citizens currently served by the Pacific Gas and Electric Company, and become a public provider of retail power to San Francisco residents.

Until that determination is made, there should be a single Assistant General Manager, Water and Power position with integrated management responsibility for the water and power systems, including the sale of retail power. This would be the most managerially effective and least expensive way of ensuring concentrated management oversight of both systems, and ensuring resolution of the tensions that exist between the water and power systems, most notably the generation of power within the confines of the "Water First" policy. This recommendation will save between $23,170 and $31,324 in incremental salary and mandatory fringe benefit costs annually. It would also prevent further expansion of the Department's executive management ranks.

The Assistant General Manager, External Affairs should continue to manage the strategic policy staff working on power policy issues related to community choice aggregation and renewable and alternative energy sources.

Section 11. Land Management

The Public Utilities Commission lacks comprehensive management of City-owned land and real property under the jurisdiction of the Public Utilities Commission. This has resulted in inadequate property inventories and the failure to define properties that are either essential or surplus to the water, power, and clean water utilities' requirements. Currently, the Public Utilities Commission Real Estate Services Bureau is unable to determine if all real properties are rented or in optimal use, resulting in the loss of potential rental revenue. The Real Estate Services Bureau should develop and maintain a comprehensive property inventory. A one percent increase in rental revenues would result in $100,000 in additional Public Utilities Commission rental revenues annually.

Although the Real Estate Services Bureau has identified up to 29 properties that are potentially eligible to be declared surplus to the Public Utilities Commission's needs, with estimated sales values exceeding $120 million, only four of the 29 properties have been presented to and been declared surplus by the Public Utilities Commission for potential sale at public auction. If the Public Utilities Commission identified and offered for sale all properties that are surplus to the water utilities requirements, the Public Utilities Commission would receive at least an estimated $120 million in one-time revenues that, in accordance with Public Utilities Commission policy, would be allocated to capital repair and replacement or Capital Improvement Program projects. By using an estimated $120 million in land sales proceeds rather than revenue bond debt to finance a portion of the Water System Capital Improvement Program, the Public Utilities Commission could save an estimated $4.8 million annually in interest expenses.

The Public Utilities Commission lacks a formal process of coordinating the sale of surplus properties among its Real Estate Services Bureau, and its enterprise departments, risking the sale or use of land that is inconsistent with the requirements of the water utility. For example, the Water Supply and Treatment Division and the Real Estate Services Bureau failed to communicate effectively regarding the option agreement for the sale to MasterDevo, a private developer, of Public Utilities Commission property in Mountain View, which includes a portion of the water system pipeline right-of-way. Organizations under the Water Supply and Treatment Division also failed to communicate and coordinate effectively, resulting in the failure to notify the Public Utilities Commission's Manager of Land and Resource Management, who is responsible for managing right-of-way properties, of the potential sale of right-of-way property.

Further, the Public Utilities Commission risks significant legal and other costs from encroachment by adjacent property owners on the Public Utilities Commission's water system rights-of-way. The Public Utilities Commission is engaged in five legal disputes to remove right-of-way encroachments and, according to the City Attorney's Office, may face up to an additional 15 legal disputes regarding private property owners or tenants encroaching on the water system rights-of-way, resulting in unknown legal and settlement costs to the City.

The Public Utilities Commission General Manager should ensure that the rights-of-way adopted management plan, presented to the Public Utilities Commission in June, 2004, is implemented effectively and should report to the Board of Supervisors on the existing and projected costs to the City to abate water system rights-of-way encroachments within the next six months.

Section 12. Real Estate Services

The Public Utilities Commission loses at least $150,000 annually in rental revenues by failing to adjust property rents under the terms of existing leases, conduct appraisals, and collect taxes. For example, the Public Utilities Commission loses an estimated $100,000 annually under the lease agreement with All Auto Dismantlers because the Public Utilities Commission has failed to adjust the monthly rent to fair market value under the terms of the lease. The Public Utilities Commission, which obtained jurisdiction over the subject property in 1997, when the Clean Water Enterprise was transferred from the Department of Public Works to the Public Utilities Commission, has lost an estimated $630,000 in rental revenues from 1998 through 2004.

The Public Utilities Commission also faces significant environmental risks and hazardous waste clean up costs under the lease with All Auto Dismantlers. Although the current lease agreement with All Auto Dismantlers, implemented in 1989, requires that All Auto Dismantlers (a) indemnify the City against losses from environmental hazards and (b) maintain insurance of $1 million, the estimated cost for clean up of existing oil contamination on the leased property in 1990 was more than $500,000, and could now exceed the $1 million insurance requirement. Further, the $1 million policy is for general liability and does not cover environmental clean up costs.

Although the Commercial Land Management Operating Manual, adopted by the Public Utilities Commission in 1999, requires the Public Utilities Commission Real Estate Services Bureau to maintain an inventory of all available Public Utilities Commission property considered to be suitable for leasing, the Real Estate Services Bureau does not have a complete inventory. Therefore, the Real Estate Services Bureau is unable to (a) determine if all real properties, that are currently leased, are leased for the optimal use, and (b) identify properties currently not rented with leasing or permit potential. Consequently, the Public Utilities Commission cannot determine if it receives maximum lease revenues for all properties that could be leased.

The Public Utilities Commission loses an unknown amount of rental revenue by failing to enter into competitive bids for the lease of various properties. Public Utilities Commission policies require competitive bids if there is more than one potential user. However, a review of eight lease files, which were not competitively bid, found that none of the files contained documentation on why the leases were not competitively bid nor on how the lease rates were set. For example, the Real Estate Services Bureau is negotiating a new lease agreement with Decorative Plant Services, Inc, for a 4.39 acre parcel with improvements including a greenhouse, offices and parking located near the Southeast Treatment Facility at 1150 Phelps in the Bayview neighborhood, which has not been competitively bid, although the property most likely has more than one potential user.

The Real Estate Services Bureau has not consistently enforced and implemented the Public Utilities Commission's policies in the Commercial Land Management Operating Manual, including ensuring competitive bids for properties where possible, maintaining current rental property inventories, and obtaining Public Utilities Commission approval prior to leasing properties that could be declared surplus to the Public Utilities Commission's needs. The Assistant General Manager, External Affairs, should ensure that the Real Estate Services Bureau consistently complies with the Public Utilities Commission's policies.

Section 13. Water Enterprise Planning and Reporting Deficiencies

Despite revenues of $239 million per year, the Water Enterprise does not have a business plan. While the Water Enterprise does have important strategic plans in place or in development, each one focuses only on a portion of the Water Enterprise's functions. Collectively the existing plans do not constitute a business plan for the enterprise as a whole.

The Water Enterprise does not have a business planning context for (a) renegotiating the 1984 Settlement Agreement and Master Water Sales Contract with the Bay Area Water Supply and Conservation Agency which expires in 2009, (b) making informed decisions about the merits of major policy, planning, and financing options, (c) determining future water rates, (d) measuring its performance, (e) determining its optimal personnel resources and organizational structure, (f) comprehensively planning for all of the Water Enterprise's capital needs, and (g) managing future business risks. The Department should develop a Water Enterprise business plan in FY 2005-2006 to address these business risks.

For those Water Enterprise plans currently in place, the monitoring and reporting frameworks to track implementation of required management actions are inconsistent. Plans with insufficient monitoring and reporting frameworks do not ensure sufficient accountability for implementation of management actions approved by the Public Utilities Commission and funded by the Board of Supervisors. The Department should ensure that there are adequate performance measures and reporting mechanisms to allow the Public Utilities Commission to know that approved management actions have been achieved.

Section 14. Programmatic Environmental Impact Report

In its planning for the Water System Capital Improvement Program, the Public Utilities Commission has failed to make a timely determination of the need for a programmatic environmental impact report under the California Environmental Quality Act. This is in spite of the Public Utilities Commission's considerable investment in expert consultant support, most notably the $45 million, greater than four years Program Management Services Contract which has environmental services subconsultants, one of whom is now being separately contracted to develop a programmatic environmental impact report. The Program Management Services Contract did not identify the need for a programmatic environmental impact report.

The Water System Capital Improvement Program's policy parameters are only now being determined, despite past representations to the Board of Supervisors and voters that such policy parameters had been determined and put in place. Nine critical projects, costing an estimated $1.2 billion or approximately two thirds of the estimated total $1.9 billion cost for the regional water system capital improvement program projects, are currently being delayed because of the need for the programmatic environmental impact report. Project-specific environmental impact reviews and design work cannot be completed until after the programmatic environmental impact report is approved. Establishing a firm project-sequencing schedule is necessary to determine the optimal and least costly timing for new revenue bond issuance.

As part of the Water System Capital Improvement Program budget, the Public Utilities Commission is currently proposing an additional $143 million for the programmatic environmental impact report, related environmental mitigation costs, and project-specific environmental mitigation costs. The Public Utilities Commission had previously only budgeted $10 million for environmental mitigation.

The Public Utilities Commission needs to ensure that the planning processes for all future capital improvement programs, which it undertakes, explicitly include consideration of the need for a programmatic environmental impact report from the outset to avoid the costs associated with planning, design, and construction delays.

The Public Utilities Commission and the Planning Department need a formal operating procedures memorandum of understanding, including a weekly reporting framework for all Planning Department staff funded by the Public Utilities Commission, to ensure that there is a full accounting of the Planning Department's expenditures of Water System Capital Improvement Program funds.

The Planning Department's Major Environmental Analysis Division needs to identify proactively when capital improvement programs require programmatic environmental impact reports so that the necessary planning can happen in a timely fashion.

Section 15. The Need for a Departmental Strategic Plan

Despite an annual Public Utilities Commission operating budget of approximately $585 million, management responsibility for the operation of critical public utilities used by up to 2.4 million San Francisco and suburban customers, and ownership responsibility for billions of dollars worth of capital assets and land holdings, the Public Utilities Commission does not have a broad strategic plan.

The Water, Hetch Hetchy, and Clean Water Enterprises each have significant planning needs because (a) strategic policy and planning is not regarded as a core function in the way that system operations has traditionally been, and (b) the Public Utilities Commission lacks a strategic plan which encompasses its water, power, and clean water responsibilities and how those functions will be coherently and consistently managed.

Absent a regularly updated departmental strategic plan developed through a consultative process with internal and external stakeholders, the Public Utilities Commission lacks on a department-wide basis: (a) a unified vision, mission, and policy goals which shows the linkages between the water, power, and clean water enterprises; (b) a regular forum, format, and process for the managers and the Public Utilities Commission to raise and discuss major policy issues with each other; (c) a strategic policy and planning orientation for the department as a whole; (d) planning consistency across the enterprises; (e) discussion about how business processes can optimally support the organization as a whole; and (f) a framework for consistent organizational policies and procedures.

The Public Utilities Commission requires a regularly updated strategic plan which is supported by a comprehensive policy, planning, implementation, and reporting system.

The Public Utilities Commission's Written Response

The Public Utilities Commission General Manager's written response is attached to this management audit report beginning on page 180. The Public Utilities Commission's written response agrees with 74, or approximately 81.3 percent, of our 91 recommendations, partially agrees with four of our 91 recommendations, or approximately 4.4. percent, and is considering two recommendations. The Public Utilities Commission disagrees with 11 of our 91 recommendations, or approximately 12.1 percent.

The Public Utilities Commission disagrees with the conclusions of the Budget Analyst in Section 2 with regard to the calculation of the suburban wholesale water rates stating that the Department does not believe the issue is an accounting structure or an accounting system problem. In the General Manager's response, the General Manager stated "We also disagree that the accounting system is inadequate..." The Budget Analyst never stated that "the accounting system is inadequate," but instead refers to "weaknesses in accounting methodologies." The Budget Analyst emphasizes here that the problem is not necessarily an accounting structure and system issue, but rather an issue of how the Department uses the accounting structure and system. Further, the Department does not believe that it inappropriately commingles capital and operating expenses. However, the Budget Analyst reviewed internal Public Utilities Commission workpapers that specifically identified capital appropriations that were systematically expensed as operating activities, such as cleaning and repair work. These expenses were audited by the Public Utilities Commission's independent auditor and, therefore, should be materially accurate. While the Department qualifies the findings by noting the variety of asset-driven activities that the Public Utilities Commission must account for, the Budget Analyst does not agree that the distinction between the activities is not "clear-cut". Due to the different accounting treatments for the various activities and the impact on the suburban wholesale water rates, it is the responsibility of the Department's financial management staff to ensure that the activities are clearly defined and accounted for in the accounting system.

As discussed in Section 2 of our report (pages 26 and 27), for the past six fiscal years, the Public Utilities Commission has not complied with the terms of the Settlement Agreement and Master Water Sales Contract with respect to the timing of the annual audit of the suburban wholesale revenue requirements. In the written response, the General Manager has stated that "we disagree with the claim that the agency is at fault for delays in the suburban compliance audit; it is the auditor who has delayed this process". In Section 2 of our report, the Budget Analyst finds that there are a number of parties and factors at fault and not just the Public Utilities Commission. The process, as it has evolved over the years, has become extremely cumbersome and must be revised to improve audit timeliness. However, the Public Utilities Commission is ultimately responsible for the suburban rate calculation and getting the audit completed.

Further, the General Manager disagrees with all recommendations which would result in the elimination of positions. The General Manager has disagreed with Recommendation 6.1 which recommends the transfer of executive management responsibility for the Southeast and Oceanside Water Pollution Control Plant Laboratories to the new Assistant General Manager, Clean Water. The General Manager argues that she is undertaking a reorganization, that "Any move now would be premature without our having more solid cost and staffing analyses," and "Until we complete an analysis of laboratory functions, services and associated cost recovery, we do not see the advantages of laboratory separation." The Budget Analyst is making these recommendations precisely because the Department is being restructured and it is timely to recommend cost efficient organizational structures. The advantages of laboratory separation are laid out in detail in the table in Section 6 of this report under the heading "Restructuring Advantages," (page 61) and in the following summary under "Recommended Actions," namely:

"The benefits of such a transfer include: (a) a unified business identity for clean water staff that is characterized by shared goals, shared long-term planning capacity, functional coordination, and efficiency; (b) improved decision-making among staff working on clean water issues, and clear accountability lines; and (c) implementation of the Commission's stated policy preference for the Public Utilities Commission to be structured organizationally into business enterprises."

The General Manager further argues that "Current utility practice when an agency provides both water and wastewater service is to have a single laboratory (i.e. East Bay MUD)." The Budget Analyst notes the Department itself advised that some large municipalities, such as Houston, TX, Miami, FL, and Tampa, FL, do in fact operate separate water and wastewater laboratories.

The General Manager disagrees with Recommendation 6.2 which would eliminate the 1.00 FTE Classification 5133 Program Manager II, Director of Laboratories position. This position, which is an additional management tier over the 3.00 FTE Classification 2498 Laboratory Services Managers, each of whom is paid up to $129,263 annually in salary and mandatory fringe benefits, would be unnecessary if the Southeast and Oceanside Water Pollution Control Plant Laboratories were transferred to the Clean Water Enterprise, and the Laboratory Services Managers for the Millbrae Laboratories became direct reports to the Manager of the Water Quality Bureau. Further, elimination of the Director of Laboratories position would save up to $147,103 annually in salary and mandatory fringe benefit costs.

The General Manager disagrees with Recommendation 6.3 which recommends the transfer of 2.00 FTE administrative support positions from the Water Quality Bureau to the Southeast and Oceanside Water Pollution Control Plant Laboratories. The intent of this recommendation is to ensure that the Southeast and Oceanside Water Pollution Control Plant Laboratories have sufficient administrative support within the Clean Water Enterprise.

The General Manager disagrees with Recommendation 6.4 which recommends the development of contracts or work orders between the laboratories to ensure the continued rationalization of technical and support services and prompt service reprioritization in emergencies. The intent of this recommendation is to ensure that the disaggregated laboratories continue to provide specialized technical services and centralize their support services while providing timely, high quality services to each other, the rest of the Department, and to external clients. The General Manager does not explain how such contracts or work orders would impede the laboratories' work.

The General Manager disagrees with Recommendations 9.2 - 9.4 which would eliminate 3.00 FTE positions which were formerly in the Bureau of Environmental Regulation and Management, before being transferred to the new Wastewater Collection System Bureau within the Clean Water Enterprise. Recommendation 9.2 recommends the elimination of a vacant 1.00 FTE Classification 5174 Administrative Engineer position because the Clean Water Enterprise already has sufficient administrative, finance, and budget support staff. The General Manager does not provide a justification explaining why this duplicative, vacant position is required. Elimination of this position would save up to $135,015 annually in salary and mandatory fringe benefit costs.

Despite agreeing with Recommendation 9.1 which recommends that the management responsibility for 3.00 FTE Classification 5620 Regulatory Specialists in the Environmental Compliance Program be transferred to water and clean water system operations according to assessed need, the General Manager objects to the elimination of that program's 1.00 FTE Classification 5138 Program Manager I, Environmental Compliance Program position (Recommendation 9.3) and 1.00 FTE Classification 1446 Secretary II position (Recommendation 9.4). The General Manager does not explain why these two positions, which cost up to $201,530 in salary and mandatory fringe benefits, would be required if there are no staff to manage.

As outlined in Section 9, in addition to the loss of management responsibility for the 3.00 FTE Classification 5620 Regulatory Specialists, our report states:

"The Program Manager has already lost responsibility for environmental regulation permits required for Water System Capital Improvement Program projects, will soon cease managing both pools of pre-qualified, as-needed contractors, and has not completed a department-wide database of all of the Department's environmental regulatory compliance permits, licenses, plan renewals, or contracts which could, in the future, be completed by the 3.00 FTE Classification 5620 Regulatory Specialists based on their work with water and clean water system operations staff. This management position and its secretarial support are no longer necessary."

Finally, the General Manager disagrees with Recommendations 10.1 - 10.4. These recommend the establishment of one Assistant General Manager, Water and Power position and the retention of the Director of Power Policy position reporting to the Assistant General Manager, External Relations. Instead, the General Manager has created two Assistant General Manager positions, one for Water and the other for Power. This increases the total number of Assistant General Managers to six. The Budget Analyst considers the sixth Assistant General Manager, for Retail Power, to be premature until the Public Utilities Commission determines if it is going to proceed with community choice aggregation. A single Assistant General Manager, Water and Power position would be the most managerially effective and least expensive way of ensuring concentrated management oversight of both systems, and of ensuring resolution of the tensions that exist between the water and power systems. Further, one Assistant General Manager position, rather than two, would save between $23,170 and $31,324 in incremental salary and mandatory fringe benefit costs annually. The General Manager does not explain why the sixth Assistant General Manager position is justified.

The cumulative value of the position cuts recommended in Sections 6, 9, and 10 is up to $514,972 in salary and mandatory fringe benefit costs. The General Manager does not explain the justification for these positions and the relative value of this investment.

We would like to thank the General Manager of the Public Utilities Commission, her staff, and the various representatives from other City departments whom we contacted, for their cooperation and assistance throughout this management audit.

Respectfully submitted,

Harvey M. Rose
Budget Analyst

1 The estimated 4 percent decline in value is based on estimated annual interest expense on debt service and annual inflation rate, less interest earnings on Treasury deposits.