Sage Mesa Water: Some history and thoughts

I was the Area F director from 2008 to 2018 and can perhaps provide some background on the Sage Mesa Water system and how we got here. I can also identify some possible paths forward.

I only know the history prior to 2008 second-hand and imperfectly, so others can fill in the gaps with corrections and additions. Sadly, Ron Perrie (my long-serving predecessor as Area F director) passed away in March and knew more about all this than anyone.

Ancient History

Here is a sketch of the early history of the system:

1. Dick Chapman, and perhaps others, built, paid for, and operated the Sage Mesa water system in order to enable development of the Sage Mesa subdivision. This kind of developer-provided infrastructure was common in rural areas during the heavy growth following the Second World War.
2. The system was subsequently modified to service Husula Highlands. This required the construction of an upper reservoir and a connection to the lower reservoir on the property of the Pine Hills golf course.
3. At some point in the 1990s, the disagreements between the Chapman family and the Office of the Water Comptroller came to a head and the province seized operation (but not ownership) of the Sage Mesa system. Some context: all private water systems in British Columbia are accountable to the provincial Water Comptroller (for operations) and the local Health Authority (for water quality). The Comptroller monitors the core operation of the systems and the financial operation of the utility. For example, the Comptroller ensures that the owner’s rate of return is appropriate. This prevents private utilities from exploiting their extraordinary monopoly power. A bureaucrat in Victoria was appointed to operate the system, although in practice, a local water operator was hired to monitor and maintain the many moving pieces. Billing was also contracted to a local accounting firm (HLW).
4. In the 1990s Dave Kampe made a deal to connect the Westwood Properties subdivision, again from the upper reservoir. The province was in control of the system, so it was not a simple negotiation process between Mr. Chapman and Mr. Kampe.
5. Soon after I joined the RDOS board, Frank Lamberty, the local water operator appointed by the province retired. The Water Comptroller needed someone on the ground to swing wrenches, so the RDOS—which had semi-recently acquired the Naramata water system—bid on and won the contract to operate the Sage Mesa system. The RDOS water operations team became decision-makers for the system, but only at the most operational level (chlorine levels, pump pressures, and occasionally suggested repairs).
6. When we executed the "bulk water" agreement for the West Bench with the City of Penticton in 2012, we included an option for the Sage Mesa system to join on exactly the same terms (adjusted for inflation) as the West Bench.

Seizure of private water systems is uncommon in BC, but Sage Mesa is hardly the only example. The plan is, and always has been, for the provincial Water Management Branch to find an alternative arrangement. As Al Aderichin pointed out in his recent presentation, his office is not really equipped to manage a water system for the long haul. System seizure should normally be followed by transfer of the utility to a more locally-responsive entity, such as an irrigation district or a local government.

This leads to the following question: why has the transfer to a locally-responsive entity not yet occurred?  It is not like people have not been working on it. When I came on as Area F director in 2008, Ron Perrie handed it to me as one of the top priorities. To answer this, we need to stray from verifiable facts and consider the complex dynamic that has existed for many years around Sage Mesa and its water system. I came to this dynamic late, and there are many who must know more about it than me, so I will just sketch it in the simplest terms: Dick Chapman, who passed away in 2015, did not like or trust the RDOS. And since his family owns and still owns the water system, this is not a bit of gossip or trivia. It is a fundamental constraint.

My Involvement 2008-2018

I never met Dick Chapman or his wife Mary. However, I had many conversations with their son John between 2008 and 2018. I do not want to speak out of turn on what is clearly a sensitive topic or tell a story that is not mine to tell. But if you walk down to the end of Sage Mesa Drive, to the paved cul-de-sac with no houses, you get a sense of the scale of the issue. There is also a good-sized scar on the hill adjacent to the Pine Hill golf course entrance. These are clues that Mr. Chapman’s development ambitions were thwarted by the RDOS and others. And there was secondary beef, such as perceived mistreatment surrounding the Westwood Properties expansion. The Chapmans had put a lot of their money and effort into building a water system so that they could develop land but felt that others, especially the RDOS, had reneged on the deal.

Since I was then the elected representative of the mendacious and mean-spirited RDOS, I walked directly into a hornets’ nest of blame and recrimination. However, I was new and most of the people at the RDOS had turned over many times over the years. A personal grudge against the RDOS seemed misplaced. John and I made a lot of progress, I think. I had no history in this battle and could see legitimacy in many of the Chapmans’ claims. On the other hand, many of the Bad Things that occurred were ultimately the consequence of changing standards regarding, for example, rural development, and were outside of the direct control of the RDOS. Moreover, the change reflected accumulated experience. Some development practices, such as putting septic fields on the edge of silt cliffs, turned out to be poor long-term decisions. Mr. Chapman’s recipe for developing land no longer fit the evolving regulatory environment.

So we started talking about compromise and placating the family so that they would be willing to sell the utility to the RDOS. There was no other real option. Irrigation districts had fallen out of favor by this point. The City of Penticton had zero interest in taking over the system outside its municipal boundary. So, unfortunately for Mr. Chapman pere, the RDOS was the only feasible exit. I think John recognized this, but Dick was the decision-maker. 

So we did not make much progress on the Sage Mesa water project despite plans and consultant reports and many meetings. During the same time frame, however, we transferred ownership and upgraded the West Bench system and upgraded the Faulder system, so it is not like everything the RDOS touched ground to a halt. Mr. Chapman’s death in 2015 was, of course, a significant turning point. And although his widow (and system owner) seemed to remain loyal to her late husband’s aversion to an RDOS transfer, it was becoming increasingly obvious that the transfer was inevitable. When I left the RDOS directorship in 2018 the deal seemed done. We had agreements in principle and all we needed was the paperwork. But paperwork takes time, then Covid, significant personnel changes at the RDOS, and so on.

A question that might arise at this point is: Why did the provincial government not simply seize complete ownership system against the wishes of the owner and hand it to the RDOS to own and operate on behalf of its ratepayers? If you think about this a bit, I believe you will agree that governments in Canada should avoid seizing private property as a matter or principle. The small number of exceptions mostly involve grave dangers to public safety. But the Sage Mesa water system has never come anywhere close to this trigger point. The water system was, and is, just about as good as any other small water system in BC. For many decades we have turned on the taps in our houses and water has come out. And even with the many water quality advisories (which my family, for one, routinely ignores), I have heard of no illness due to our water. Lastly, the water has remained cheap—cheaper than West Bench and Faulder for sure. Ironically, this cheapness has now become a focal point for outcry. More on this later.

So here we are. We are now at the point where we, as a community, decide whether to authorize the RDOS to initiate a voluntary transfer of the Sage Mesa water utility from private ownership to local government ownership. There is no question that this ownership structure, with the built-in democratic accountability of local government, and removal of the Water Comptroller from day-to-day operational decisions is better. Moreover, water systems benefit from economies of scale and the RDOS has an established track record of running multiple systems using shared resources. This vote should be a no-brainer, right?

Transfer

Here is the issue: much of the system is past its useful life and needs to be replaced. In addition, standards for water treatment processes have changed dramatically in the last 20 years. So some fundamental changes to the core supply system are also required. The policy of the RDOS, which seems sensible to me, is to bring any water system it acquires up to standard. So transferring ownership of the Sage Mesa water utility to the RDOS for $1 isn’t so simple. A vote in favor of transfer is also a vote in favor of the RDOS borrowing a whole bunch of money to pay for the upgrades. My own calculations, which are shown below, suggest that in initial rounds of upgrades (necessary fixes and supply upgrades) will cost each household an additional $500/month.*  This is just for phases A & B in the McElhanney report. The engineers also anticipate a third phase C starting in 2036-ish. But that seems a long way off to me, so I am ignoring it for now. Thus, just for starters, transfer of the Sage Mesa water system to the RDOS will require an additional $6K per year per household on our water bills. Yikes!

So what are the alternatives?

Grants

The best alternative is to get huge grants from the federal and provincial governments that cover two-thirds of the capital cost of the upgrade. The remaining one-third is still a significant burden for ratepayers, but no one says no to free money. The fundamental problem with grants is that there is zero obligation for other levels of government to give us anything. Water systems are meant to be user-pay. Not only is there no guarantee of getting a grant, the new rules around grants mean that the RDOS has to own the utility before even making an application. As noted above, transfer entails a borrowing authorization bylaw. So we have to commit to paying the full costs of upgrading the system before finding out whether we get a nickel of grant relief. 

How likely is it then that we will get a significant grant? I don’t think anyone knows, but keep in mind that another name for “grants” is “other people’s taxes”. The question you have to ask yourself is whether other people should be paying for your water system (or roof or driveway, or whatever)? And do you agree, in turn, to pay for theirs? I am not saying that a grant won’t happen. We may get lucky, or maybe this whole thing will become such a corrosive mess that the government will throw us a grant just to keep us from tearing each other’s heads off. This is roughly what happened on the West Bench. But the West Bench was different for many other reasons: coming out of an economic downturn meant that all governments were looking to pump money into communities. And we had (effectively) two MLAs then (one in cabinet, one speaker of the leg)**. Things are different today. Governments are more interested in fighting inflation by slowing the economy than stimulating it with infrastructure spending. The province is cutting costs on all fronts. Things may change quickly, of course, thanks to a certain amount of chaos to our south. All we know at this point is that if we don’t allow the RDOS to acquire the system, the probability of a grant is exactly zero. Not much to go on, so let’s consider other alternatives.

Reserves

The second-best alternative is to tap into the large replacement reserves that have been collected over the years to offset the capital cost of the upgrades. The hitch here is that the Sage Mesa system has accumulated no meaningful replacement reserves. Oops. Not that this should be much of a surprise. The push to better capital asset management is relatively new, and is not without its critics. The issue is who pays for system upgrades? I have seen this issue debated many times, so let’s take a moment to walk through it. 

When my wife and I bought our house in Westwood Properties, the developer (Dave Kampe) had paid for all the infrastructure (including the connections to the Sage Mesa water system) and, to make a profit, he had to pass those costs along to us as homebuyers. So we effectively paid for our share of the new system when we bought the lot. Now, if we had also paid over the years into replacement reserves, we would have been paying twice: once for the new system and a second time for the future replacement system. The key to the reserve-funding approach is that, when we sell our house, the new buyer recognizes that the aging water system comes with a large replacement reserve fund (making it functionally equivalent to a new water system). The new buyer should therefore be willing to pay more for our house. We pay twice for the water system but get compensated when we sell our house by getting a higher price than if no reserves were in place.

The problem in practice is that it seldom works this way. Future buyers are clueless about whether the water utility has adequate reserves. When it comes time for them to make an offer, they are more likely to be looking at prices of similar homes in Wiltse than the balance sheet of our water utility. It is therefore unrealistic for us to expect them to pay us a higher price (and thereby pay back our reserve contributions). Instead, we have strong incentives to skimp on reserves and furtively pass our under-funded utility along to the next buyer. This is precisely why the most democratically responsive governance structure for water systems (irrigation districts with elected boards) typically have notoriously inadequate reserves: the reserve-skimpers give people what they want and get elected. No one votes for a reserve-building buzzkill.

These same incentives are, of course, at work whenever there is common property, elected decision-makers, and information asymmetry between buyers and sellers. We can look to the much larger strata corporation ecosystem to see the forces play out. The province has had to introduce massive changes to the Strata Property Act to increase the transparency of every strata corporation’s reserve positions relative to the conditions of its assets. Stratas are now required to commission and pay for detailed depreciation reports and make minimum annual contributions to contingency reserve funds. The province has not yet taken the step of requiring strata corporations to match their reserve contributions to the depreciation report (thus creating the fully-funded reserve situation described above) because it would be political suicide. People generally do not want to pay huge strata fees so that the person who buys their unit can benefit from fully-funded upgrades.

The government has also mandated something similar for local governments. But again, they have opted for a nudge instead of a shove. Since 2009 local governments have been required—at considerable taxpayer cost—to have tangible capital asset (TCA) plans that are similar in spirit to the much-hated depreciation reports for strata corps. The idea is transparency. For example, when West Bench water users check to ensure that the regional district is putting enough money away to cover the theoretical depreciation of their pumping and distribution assets, they can compare the annual depreciation (or amortization) expense for the water system to the contributions to capital reserves. Who am I kidding? I know no West Bench water system has ever done this. In fact, it is impossible. Although the ledger entries are (I assume) made in accordance with the law, none of this is exposed to the public in budgets or financial statements. So when I say the next buyer of your house is clueless, it is not entirely their fault. The provincial government's efforts to increase financial transparency are having no practical impact.

So getting back to Sage Mesa Water: The Water Comptroller, on seizing the system, did not increase water fees to the level necessary to create a fully-funded replacement reserve fund. Doing so would have required exactly what is so controversial now: adding $275 per month to everyone’s water bills back in the 1990s (this is the inflation-adjusted equivalent of $500/month today). The situation was obvious to anyone paying attention at the time and I for one supported the reserve skimping. There are a couple of reasons for this:

1. As a matter of principle, an unelected bureaucrat hundreds of kms away in Victoria should be content to be a temporary caretaker and not go off making major decisions about a community’s core infrastructure. Conveniently, the unelected bureaucrat and his bosses saw it this way too.
2. I did not want to pay for upgrades that I might or might not be around to benefit from. I did not know we would still be in this house decades later. This is the rational reserve skimping strategy noted above.
3. Squeaky hinge gets the oil. Grants are a competitive process pitting communities against each other and it seemed to me that asking for grants when the system had fully-funded reserves was a losing strategy. Better to come to the table as a financial basket case on the verge of collapse. In short, the province’s granting practices created a strong disincentive for utilities to make themselves financially self-supporting.
4. Who knew what was going to happen? As always, there was talk of major expansions of Westwood Properties, the West Bench joining Penticton, PIB development, and other major changes. Wait and see seemed like a better approach.

This is not to say that the Water Comptroller did nothing to build reserves. As far as I can tell as a ratepayer, the system was run pretty well: our water rates have been low relative other systems, breaks and failures have been fixed when they have occurred, and I have so far not had to cough up any special levies. There are apparently adequate operating reserves; the issue is replacement reserves.

Pay as you go

The third alternative is the only one that is being formally presented to us: pay-as-you-go. As with the reserve case, the source of money is the ratepayer. The only difference is in the timing of the increased water fees: before or after the upgrade. In the pay-as-you approach, the local government borrows a bunch of money to pay for the upgrades, the work is done by contractors, and ratepayers are billed to cover the system’s operating and debt service costs over some term (say 20 or 30 years).

This is conceptually similar to the new construction case: the person who owns the house when the upgrade is done pays for it. But unlike the new construction case, in which all capital costs (including those attributable to utilities) are generally rolled into the homeowner’s mortgage, the established utility usually takes on the debt. Of course, if you want, you could commute your share of the utility’s upgrade costs (pay a lump sum) and add it to your mortgage. But this makes little sense given that the borrowing rate charged to the utility (though the local government and the Municipal Finance Authority) is invariably lower than anything you could get as a private citizen. And, according to the clueless buyer theory elaborated above, you would never get compensated for this outlay if you sold prior to the retirement of the debt.

The other major difference with the new construction case is that new construction involves the creation of large and obvious value. The difference in value between a plot of dirt with lumber stacked on it and a new house is large enough that paying for a portion of new utility infrastructure seems doable. On the other hand, paying to upgrade existing utility infrastructure seems much less doable. The additional value is there, but only in theory. It is invisible and creates no obvious benefit apart from risk reduction.  As discussed above, buyers are unlikely to notice the upgrade and hence unwilling to pay for it.

Growth

The fourth alternative is something that has apparently been explicitly ruled out by the RDOS, even though it was an important part of the 2018 Area F Official Community Plan (OCP): growth to fund infrastructure. As noted above, new development generally unlocks massive value. Here, value means the difference between the developer’s cost and the buyer’s willingness to pay. The negotiated selling price determines the distribution of value between the two parties. If the price is very close to the buyer’s maximum willingness to pay, and higher than the developer’s cost, then the value accrues to the developer (producer surplus in economics). If, on the other hand, the developer breaks even, all the value accrues to the buyer (consumer surplus). A third option is possible, however: if development creates a negative externality for neighbors (say traffic, noise, view impingement), then the neighbors have a theoretical claim to some of the value created by development to compensate them. It is not an actual claim in any legal sense—no law protects your view or promises you acceptable levels of traffic. However, in practice, incumbent residents can extract a piece of the development surplus by enacting and enforcing land use bylaws.

The land use bylaw I am thinking of is Section 7.2.1.14 of the Area F OCP:

[The RDOS] may consider residential development proposals with a range of densities […] only on parcels shown in Figure 15 […]. If development is proposed for these areas, it is predicated on full sewer, storm water and water community infrastructure services being in place, all geotechnical risks being addressed […]

I do not know if anyone recalls the process we ran for the 2018 OCP, but it was a multi-round Delphi survey in which we presented the community with a series of scenarios. The important thing about the scenarios is that they were designed to elicit tradeoffs. The simple reality of rural land use is that you cannot have it all. For example, you can not have bucolic rural densities, low taxes, and high-quality amenities, such as water, sewer, vibrant retail, good schools, and so on. You can, however, give up one thing to achieve the other two. I have always illustrated this using the Rural Growth Triangle, which is shown below.  The Areas A, B, and C of the Venn diagram represent feasible combinations (overlapping objectives).  The shaded area in the middle denotes an unobtainable combination.

Traditionally, the West Bench (broadly defined in this section) has valued rural ambiance and low taxes and made do with barely adequate amenities (no sewer, woefully inadequate stormwater management, and so on)***. This is Area A of the Rural Growth Triangle. In contrast, the OCP surveys surfaced divergent options about the future. There was a large contingent that wanted the area to stay exactly as it was and another large contingent that wanted to shift away from rural ambiance and towards increased amenities (primarily storm, sewer, and water)—towards Area C.

Sometimes, it is possible to make tradeoffs that achieve a kind of compromise. In the case of the West Bench, the planners identified the large parcels referred to in the bylaw (specifically: the Peter Bros. pit, the Pine Hills golf course, and the Wow golf course as possible areas of pocket densification. The idea was that high-density development on these parcels would not unduly alter our rural ambiance and, in the case of the asphalt plant, might solve a whole different problem. The second part of the OCP section outlines the other side of the tradeoff: we may consider development on these parcels if and only if adequate water, storm, and sewer infrastructure is in place.  How does such infrastructure get paid for? From the value created by development, of course.

I am not advocating for massive pocket densification on these parcels. Indeed, I am getting old enough not to have any strong feelings about it one way or another. However, I am identifying alternatives. The reality is that the West Bench cannot afford to skimp on infrastructure and services much longer. Our traditional Area A in the diagram is increasingly untenable due to aging expensive infrastructure. That leaves Area B (which is pay-as-you-go), or Area C (which is growth). Naturally, since I was heavily involved, I think the Area C option with pocket densification is a reasonable compromise.

It is realistic? Well, in one sense, yes. When I look out my window and see Penticton’s Sendero Canyon, massive hillside development in Naramata (which, by the way, is no longer consistent with their OCP, which was developed in a similar way to our OCP), and Skaha Hills on PIB land, I conclude that the supply and demand for such projects exist. As long as sufficient money is up for grabs, everything else is a mere engineering challenge.

In another sense, however, meaningful and dramatic change is not possible on the Greater West Bench. The primary issue is not soil stability (at least not in the Peter Bros. pit or Pine Hills), but our governance structure. I was on the RDOS board for a decade and believe that regional districts in British Columbia exist to solve an important set of problems. But they are not designed to facilitate transformative growth or renewal. I think OK Falls has come to this realization the hard way.

So, to be candid, the only path forward I see for the Greater West Bench (other than pay-you-go) is to amalgamate with the City of Penticton. The advantage of this is not that it will be cheaper. There is zero chance that Penticton taxpayers will underwrite a penny of any of the infrastructure costs we are talking about. The primary advantage is that municipalities in British Columbia have powers and capabilities that regional districts are, by design, denied. Penticton can, for example, run infrastructure up to Sendaro before there are any residents there. A regional district cannot. If our only way forward is to grow our way out of infrastructure deficits and then develop a critical mass of ratepayers to make our community truly self-sufficent, we will need the flexibility and organizational capacity of a good-sized municipality.

Another possible benefit—and now I am in the world of dreamworld speculation—is that the province may look more favorably on a solution that permanently addresses a problem than one that just kicks the problem down the road. Bringing our community, the City of Penticton, owners of the large parcels, and developers together to address multifaceted infrastructure and governance problems will require a good amount of fire starter. Maybe senior governments are willing to help this along with some grant funding.

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