{00486727.2} 1

Memorandum

To: Village President and Trustees

CC: Village Administrator

From: Village Counsel

Date: 9/22/2014

Re: Recommendation for alternate water source

Introduction

As the Trustees know, the contract with the East Orange Water Commission

(“EOWC”) expires on December 31, 2016. Due to the unacceptable performance by

EOWC, both in the quality of the water delivered and in the operation and

maintenance of the system, a decision was made to explore options. A committee

formed for that purpose (consisting of Trustees Levison and Clarke, the Village

Administrator, and Village Counsel, the “Committee”) has explored options both in

the way of providers and legal structure.

Options for alternate water providers are limited. Although water can be delivered

from many miles distant, the cost to construct and operate lengthy mains for the

relatively small South Orange customer base kept the search close to South Orange.

The following owners of water resources were considered as they had existing

interconnections in or near South Orange.

1. EOWC

2. The City of Orange

3. The City of Newark

4. New Jersey American Water Company (“NJAW”)

September 22, 2014

{00486727.2} 2

Legal structures for water systems are equally limited, the authority for which

must be found in New Jersey statutes. The following were carefully considered.

1. A concession agreement coupled with an operation and maintenance

agreement (“O&M” agreement).

2. Sale of the system to a BPU-regulated public utility

3. A Commodity-Demand Agreement coupled with an O&M agreement

For reasons discussed below, the Committee recommends that the Trustees

approve a Commodity-Demand Agreement with NJAW in the form annexed and an

O&M contract to be let to the lowest responsible bidder after prequalification and

public bidding.

Water Source Options

Before engaging in a discussion of the four providers listed above, it is

important to make several points regarding the transmission/regulation of potable

water. Unlike electricity, which can be “wheeled” around the country with relative

ease, water is not so transmissible. Today, electric power can be generated, introduced

into the grid, and purchased by a distributor/consumer at some distant location. The

electrons introduced into the grid from countless sources are fungible and as long as

the source and use are metered, electricity becomes a commodity, to a great extent,

freed of geographic limitations. For numerous reasons, the locations of potable water

sources and consumers are dependent. The following are just a few reasons for such

dependency:

Unlike the electric grid, water systems are far more locally based, each system

designed primarily for distribution and only occasionally designed around

long distance mains with excess capacity.

September 22, 2014

{00486727.2} 3

Water flow is dependent upon pipe size and system pressure. Assuming that

intervening systems were willing to permit the wheeling of water to South

Orange, the relative sizes of mains and pressure differentials make through-

connections problematic.

The NJDEP requires redundancies at every interconnection (valves, pumps,

emergency electric generation and the like), a costly undertaking even if

technically possible.

Water systems in this part of New Jersey are relatively old, often with

significant water loss due to leaks. Such water loss would make the accounting

for wheeled water difficult.

Water treated for potability degrades when delivered over long distances.

Depending upon the distance, additional costly treatment facilities would have

to be constructed at the consuming destination.

Mindful of these constraints, the Committee explored existing interconnections

with the South Orange system and providers with nearby mains large enough to

service all of South Orange. The universe of possible providers was limited to the

four listed in the Introduction above.

EOWC

Absent the performance issues experienced with EOWC, the Village would

likely have exercised the option to renew the agreement for an additional 10 years, as

provided for in the current agreement. In addition to performance issues, as long as

contaminated wells remain off-line, EOWC has insufficient capacity and there is little

doubt that the Commission would substantially increase its rates post December 31,

2016. Given these concerns, the only benefit the Committee sees in the existing

EOWC interconnection is water in the event of an emergency and possibly for

supplemental needs.

September 22, 2014

{00486727.2} 4

City of Orange

There is an existing interconnection with the Orange water system. However,

that interconnection is very old, rarely used and lacks the redundancies required by

NJDEP. Moreover, the interconnection is at the northern edge of the low service area,

some distance from the point where water must be introduced into the South Orange

system (the reservoir on South Orange Avenue, West). Most importantly, Orange

lacks sufficient water reserves to fully supply South Orange.

City of Newark

The City of Newark appears to have sufficient reserves to fully supply the water

needs of South Orange. However, the only interconnection with Newark (at Holland

Road) was designed for emergent use to supply the low service area. The water

introduced into South Orange through Holland Road cannot reach the High or

Mountain Service Areas under normal operating conditions. Furthermore, excessive

pumping at Holland Road can, and has in the past, reduced water pressure to

unacceptable levels at and above the third floor in Vailsburg.

An interconnecting main could be constructed to Newark mains on the far side

of East Orange. However the cost and time necessary a connection over such a long

distance rendered this option infeasible. (For the same reasons connection to the

systems of other surrounding communities was found not to be feasible). Finally,

municipal water providers like Newark and EOWC are not rate regulated by the BPU,

a distinct disadvantage for South Orange consumers.

NJAW

NJAW is a BPU-regulated public utility which currently provides water in

Essex County to Irvington, Millburn, Maplewood, and parts of West Orange. NJAW

has sufficient capacity at its Canoe Brook reservoir and treatment plant to supply all

of South Orange’s current and future water needs.

NJAW currently has several emergency interconnections with the South

Orange system and, through an interconnection owned by South Orange (underground

September 22, 2014

{00486727.2} 5

in Farrell Field), has previously provided supplemental water in the amount of one

million gallons per day. In addition, NJAW has a main in the bed of South Ridgewood

Road, just over the Maplewood line, from which it can supply all of the water needs

of the Village. As a result of negotiation with the Committee, NJAW has offered, in

exchange for a long-term contract, to construct and pay for interconnecting mains and

a pumping station, with required redundancies, to replace the present EOWC

interconnection at the South Orange Avenue reservoir.

The pumping station would be built on land owned by the Village, West of the

DPW yard. NJAW would bring water to the pumping station via a new main

beginning at the head of St. Lawrence Avenue in Maplewood, and then travelling East

to Kendal Avenue, North to Audley Street, East to Walton Avenue and North to the

entrance to the DPW yard. Water would then be pumped West up Lenox Avenue to

South Orange Avenue and the reservoir. The pumping station would be equipped with

three pumps, any two capable of pumping the daily needs of the Village, and an

emergency electric generator. NJAW would pay for, own, and maintain all of the

improvements.

Legal Structure Options

Given the limited option for water, it was fortunate that NJAW is a rate-

regulated provider. However, as such a provider, there are just a few legal structures

the parties can utilize.

Concession Agreement and O&M Contract

One of those structures is a concession agreement coupled with an O&M

contract. The committee analyzed one such transaction, recently entered into by the

Bayonne Municipal Utilities Authority with a joint venture composed of United Water

Company and a Wall Street investment firm. Bayonne entered into the concession

agreement, essentially a long-term lease, with the joint venture and he O&M contract

with United Water. The Committee was not impressed with that structure as the lease

September 22, 2014

{00486727.2} 6

was of such long duration that it was tantamount to a sale, and because the concession

agreement was with the joint venture, rates were not BPU regulated. Moreover, the

extremely complex structure was pursued by Bayonne primarily as a means to retire

an inordinate amount of debt, a problem South Orange does not face. The Committee

met with United Water and learned that it did not have water resources close enough

to service South Orange.

Sale of the System

The sale of a municipally owned water system is a lengthy, uncertain process.

That process, inter alia, includes the valuation of the system, a public referendum,

and approvals by both the NJDEP and the BPU. (NJDEP to assure that there is

sufficient water and BPU to assure that the utility is not overpaying for the system.)

The process is uncertain because the outcome is unknown until the referendum is held.

Depending upon the timeliness of the intermediate steps, the referendum, which must

be held at the general election, can make the process nearly 3 years long. That length

of time does not include the time to construct the needed interconnection. Should the

Trustees pursue that option, and lose the referendum, there would be insufficient time

to arrange for an alternative source of water.

Commodity-Demand Agreement

The Committee first explored legal structures with NJAW at a meeting on

February 15, 2012. At that time it learned the particulars of the NJAW tariff that,

together with the uncertainties of sale, led to the conclusion that pursuit of the sale

option should be postponed until the Village had the opportunity to realize the

potential benefits of a Commodity-Demand contract. In doing so, the Trustees would

be giving residents a fair choice at a referendum - the threat of a loss of all water

would be taken off the table.

What the Committee learned is that NJAW is subject to two BPU bulk water

rates. One such rate is based upon fluctuating consumption. At a rate of $6.10 per

1,000 gallons, NJAW would deliver all of the water required at any time. The second

September 22, 2014

{00486727.2} 7

or Commodity-Demand rate (often called “take or pay”), anticipates a fairly constant

flow. The Village would have to determine the maximum daily need (the “Initial

Nominated Demand”), and pay for such whether used or not. Should the Initial

Nominated Demand be exceeded, subject to certain exceptions, the Nominated

Demand would be increased to that level and payment recalculated for the entire year.

The Commodity-Demand rate is a much lower rate of approximately $3.00 per 1,000

gallons. (The Commodity-Demand rate can vary slightly depending on the size of the

interconnection.)

The Committee calculated that if the Village were to specify an Initial

Nominated Demand based on the historic maximum daily diversion of water, adjusted

downward for water pumped from Well #17, the Village would realize a surplus of

some $2,000,000, while maintaining rates currently paid by South Orange consumers

to EOWC. It is believed that an O&M contract and debt service for needed capital

repairs can be covered by such surplus.

Further support for the Commodity-Demand option was found by comparing

the rates that would apply should the system be sold. Although the BPU would act to

keep the rate paid by South Orange consumers fairly stable as the NJAW rate came

into equilibrium with the EOWC rate, one component of the NJAW rate would take

effect immediately. That component is an annual charge of $480 per fire hydrant. With

some 600 hydrants, this component of NJAW’s rate structure would impose a

disproportionate $288,000 burden on the taxpayers (consumers such as SHU would

remain unaffected).

The attached form of Commodity-Demand Agreement has been vetted by the

BPU for rate-setting purposes and hence is not subject to substantive revision.

However, counsel has been able to secure some revision for clarification purposes;

most significantly a schedule showing the calculation of the rate provided for in

Paragraph 4A will be attached to the document.

Two provisions of the attached agreement are of particular importance. The first

of these is the provision which permits assignment of the Agreement. That provision

gives the Village the flexibility it needs in order to be able to offer the system for sale.

September 22, 2014

{00486727.2} 8

Although the Commodity-Demand Agreement is of long duration, any potential

purchaser of the system will benefit from the very low BPU-regulated rate.

The second significant element of the agreement is the Initial Nominated

Demand requirement. That number will be a function of historic use, and several

variables, which will be determined with the assistance of consultants for the Village.

There is an all-day meeting scheduled for Friday, September 26 with the consultants

to discuss, among other water system issues, an approach to the calculation of the

Initial Nominated Demand. Should the Village President or any of the Trustees, in

addition to Trustees Levison and Clarke, wish to attend, the Villlage Clerk should be

so advised as notice of an executive session meeting would be required.

O&M Agreement

Unlike contracts for water supply, O&M agreements must be competitively bid.

While the Commodity-Demand Agreement is being finalized, the Committee is

directing its attention to the preparation of bid specifications for an O&M agreement.

In an effort to secure the most competent firm, the process will be bifurcated into a

request for qualifications (so as to prequalify bidders), followed by public bidding

among those firms that prequalified.

Although the term of the O&M agreement has yet to be determined, it should

be of short enough duration to allow for a sale, should the Commodity-Demand

Agreement prove not to be advantageous. The Committee has learned that O&M

contracts of short duration are not viewed favorably by potential bidders. For that

reason, the Committee will be working closely with potential bidders and Village

consultants so as to design a bid specification that will attract interest.

Conclusion

Based upon the foregoing it is requested that the Trustees consider approving

the attached Commodity-Demand Agreement as to form. Once the Initial Nominated

September 22, 2014

{00486727.2} 9

Demand has been resolved, the final agreement will be submitted to the Trustees for

approval and execution.