"Fair Market Value": An Example from Egg Harbor City

Fourteen states have passed laws permitting “fair market value” in the sale of water systems. These laws allow a utility purchase price to be higher than book-value, i.e., original cost less depreciation and amortization. Private utilities that purchase a water system at this higher price can then finance the purchase with subsequent rate increases. Thus, “fair market” valuations are paradoxical. Both the seller and the buyer prefer a higher price. In the end, utility customers are left paying the higher cost.

New Jersey is among the 14 states with fair market value (FMV) laws -- the Water Infrastructure Protection Act or WIPA. Prior to adoption, the Division of the Rate Counsel, an independent New Jersey state agency that acts as a consumer advocate for utility ratepayers, cautioned that WIPA would make transactions less transparent, limit the public’s role given the elimination of a public referendum requirement, inflate selling prices, and burden ratepayers. Nonetheless, the WIPA went into effect in 2015, and the first transaction under the new rule took place in 2021 in Egg Harbor City when New Jersey American Water, a subsidiary of American Water Works Company, Inc., bought Egg Harbor City, New Jersey’s water and sewer systems, which serves about 3,000 people, for $21.8 million.

As required by the WIPA, Egg Harbor City and New Jersey American Water submitted financial and technical reports to the New Jersey Board of Public Utilities, which reviews and, if appropriate, approves, FMV transactions. While the Board initially approved the Egg Harbor City FMV sale, input from the State Comptroller (provided through a separate review process) prompted the Board to reconsider for two reasons. First, the Comptroller found that the technical analysis the parties submitted to demonstrate that the FMV sale meet the statutory conditions were based on unsupported assumptions about the state of the water system that painted a much more negative picture than prior analyses showed. Second, the Comptroller found that the financial analysis submitted was not conducted by an independent, qualified party, as the analysis submitted was done by the same engineering firm that completed the technical analysis. As of February 2022, the Egg Harbor City sale is awaiting final approval from the New Jersey Board of Public Utilities.

This transaction provides at least two helpful insights:

1. The WIPA rules that require parties to a sale to demonstrate certain "emerging conditions" exist before an FMV transaction will be approved by the NJ Department of Environment can be helpful backstops to inappropriate FMV sales; and
2. Interested stakeholders should carefully review FMV submissions to ensure the technical and financial analyses are done by qualified, independent parties and are based on reasonable assumptions.

With approval pending it does, however, remain to be seen how the costs of the purchase will be applied to the rate base. In particular, the question is: will the purchase price, including all transaction costs, be applied to Egg Harbor City customers only or will the costs be imposed on all New Jersey American customers? The answer to this question is relevant to individual ratepayers and wholesale water customers who buy water from the Egg Harbor City system alike.

Source: Why Ratepayers Protections are Needed in the U. S. Water Utility Privatization Push