It has become increasingly common to note, under the general law that no good deed goes unpunished, that successful implementation of water conservation measures by utilities and their customers generally leads to higher commodity rates for water. This phenomenon occurs because water utilities have significant fixed costs, and as the amount of water decreases, those costs must be collected by increasing water commodity rates. The concept is simple, but it causes consternation among some who feel that water conservation is a moral good that should be rewarded rather than punished. While I am more inclined to view water conservation in economic rather than moral terms, undoubtedly the phenomenon has an impact on customer attitudes toward conservation and thus water resource management under conditions of scarcity.

An example of this phenomenon was recently addressed by the California Public Utilities Commission (CPUC) for the Penngrove Water Company (PWC) in Sonoma County, California. PWC is a small water company that serves approximately 600 metered connections with water purchased from the Sonoma County Water Agency (SCWA). In 2007, the SCWA mandated that its wholesale water customers, such as PWC, reduce their consumption by 15 percent, and in turn PWC adopted increasing tiered water rates to discourage high-volume water use by its retail customers. During the period July through October 2009, PWC customers reduced their water purchases so that the company collected $56,653 less than authorized by the CPUC to meet its expenses. The company requested to recover the deficiency by collecting a surcharge of $1.85 per hundred cubic feet (ccf) of water purchased during March through June 2010, and the CPUC granted that request in Resolution W-4825 (2010).

This example demonstrates that the CPUC understands the problem posed by water conservation and has devised a mechanism for allowing utilities to recover lost revenues. That is necessary for maintenance of healthy water systems, and a positive development of the past few years. It also shows how difficult it can be for a water company and its regulator to create the proper economic incentives for water conservation. Although a company may attempt to predict the impact that tiered water rates or other incentives will have on customer consumption levels, such predictions will invariably be wrong to some extent because those incentives are set at a single point in time based on defined incentives, rather than being updated on a continuous basis to achieve certain defined impacts. This causes a timing problem, since the water conservation actions during one period of time (here, July through October 2009, the highest water usage season) have an economic impact during that period, but also during a later corrective period (here, March through June 2010, a moderate water usage season). Thus, the full economic cost of water conservation was not accounted for during the period that the incentives were in effect, and the incentives were distorted accordingly. To improve this program, in the short term the water company and regulator can use past performance to refine future predictions. In the long term, hopefully the water industry can develop and implement smart metering programs that allow continuously gathered water usage data to adjust water rates in near-real time to achieve defined conservation impacts.

6 comments

  1. Wes, I enjoyed your post. This other edge of the conservation “sword” often gets overlooked. When I worked for an Engineering Consulting firm many of our municipal clients saw significant drops in their revenue when Georgia was faced with increased water restrictions and greater conservation efforts.

    My opinion is that water is still just too cheap…and so we treat it that way. I think there needs to be conservation education and implementation coupled with across-the-board rate increases. To reduce consumption while keeping municipal revenues and consumer bill level. Let’s call it my pipe dream…for now.

    Tom

  2. Thanks, Tom. Yes, one of the issues is that water is generally underpriced, leading to underinvestment, a low level of innovation and overuse of the resource. A better pricing model could have many benefits, luckily a view that is becoming more popular in the industry. There also is a rising group that argues for free water, at least up to a certain subsistence level.

    Wes

  3. I don’t know if anyone is still monitoring this site as I notice the posts are some 18 months old, but this situation is very relevant to us in Boise, Idaho at the moment.

    We have a public hearing coming up on United Water’s proposal to raise water rates 20% due to decreased income based on successful ratepayer conservation efforts. This has created quite a stir, particularly in these difficult economic times.

    Perhaps you can comment on why Utility costs do not decrease in accordance with reduced demand for product, as is common in industry. A drop in consumer demand for water should be accompanied by a corresponding decrease in O&M costs (less pumping, less chemicals, less sludge for disposal, less maintenance, reduced fuel for vehicle fleet etc).

    It would also be interesting to know austerity measures Ultility Companies employ to reduce their costs in such situations, e.g. decreasing overtime costs, mothballing underused facilities (such as unit treatment processes), reduced travel and training costs etc.

    Since it appears a main driving force for higher rates is to maintain a high credit rating and an attractive rate of return for Utility bonds for funding capital-intensive projects, why don’t water companies take advantage of low-interest State Revolving Funds loan for capital projects?? and create attentuated capital replacement/repair accounts?

    Thank you for your consideration, and I look forward to hearing from you.

    Kevin

  4. Kevin,

    Yes, I still actively maintain the blog although the post you found is older.

    The issue of reduced utility revenues based on water conservation continues to cause rate increases across the country. The general reason is that water utility service is a very capital-intensive enterprise. In fact, it requires more capital expenditure per dollar of revenue than any other utility business, roughly $10 to $15 of capital expenditure per $1 of revenue. Thus, capital recovery is stretched out over long periods of time, fixed costs represent a significant percentage of total utility costs, and the revenue required for a utility to cover its capital costs does not vary by the amount of water used. For example, if a water utility needs to replace an aging pipe, the capital cost of that pipe will be the same regardless of the amount of water flowing through the pipe. While a utility will build the pipe based on projected water usage, it is impossible to be completely accurate, and it generally makes sense to build infrastructure with a view to future as well as current demands, to avoid having to dig up and replace the pipe a few years later at great expense. Water usage has generally declined across the US in the past 3-4 years based on the intersection of dry conditions and the stagnant economy.

    It is important to keep in mind that what is kept constant is the amount of revenue required by the utility for its operations. The utility can collect the same amount of revenue by charging a higher rate on less water, or a lower rate on more water. An increase in water rates under those circumstances will not necessarily result in an increase in overall utility bills. For example, assume that a water utility collects $25.00 from an average customer for 25 units of water, or $1.00 per unit. If customers on average reduce their usage to 20 units, then the utility would need to charge $1.25 to generate the same revenue as before. An average customer would still pay $25.00, however, so the financial burden would not have increased. What does happen is that customers who conserve more than average will pay less than before, while customers who conserve less than average will pay more. This is in line with the concept of using pricing to encourage conservation, but in practice it is difficult to accurately predict exactly how much water will be conserved at a given rate. Utilities try to make the pricing as close as possible, but adjustments are almost inevitably needed. It is, of course, understandable for customers to be frustrated by the adjustment process.

    In the current economic situation, many utilities (both investor- and government-owned) have attempted to undertake reasonable austerity measures, but there are limitations based on manpower needs, regulatory requirements for drinking water safety and environmental protection, and union contracts. In some cases, water utilities have sought to take austerity measures that were disapproved by the state public service commission. I do not know about the specifics of the United Water rates you reference so cannot comment there. One issue that investor-owned utilities face is that some states do not allow them to receive State Revolving Fund (SRF) loans or other financial assistance. That is unfortunate, since use of SRF funds directly benefits customers, and the customers of investor-owned utilities pay federal and state taxes that fund the SRF program on an equal basis with the customers of government-owned utilities. In addition, the federal government significantly subsidizes government-owned utilities through the tax exemption on local government debt. Ending these inequalities would go a long way to helping customers of investor-owned utilities such as United Water. In the long-term, I would not expect SRF or other federal subsidies to be available to any water utilities, as financial pressures increase on the federal budget related to the systemic deficit.

    Wes

    1. Wes, thanks for your timely reply. It appears that perhaps it is time to reconsider the benefits of privitization of public utilities, given the uncertainties of subjecting a basic service to market forces while attempting to conserve scarce resources, particularly when that industry does not have access to low-cost loans, and no ability to adapt practices to flucuating demand for its product.

  5. Kevin, the issues you raise don’t really go to the value of private water utilities. Government-owned utilities face the same lack of control over their costs versus the amount of water delivered. Customers of government-owned utilities across the country are complaining about the same thing.

    As far as low-cost loans or other tax subsidies, I think the best observation is about how the government creates rules to favor its own proprietary operations and disfavor competition from the private sector. It’s a cautionary tale about the perils of government power. In fact, despite the (sometimes) lower cost of capital for government-owned utilities, on average private utilities have rates that are comparable to government-owned utilities due to greater efficiencies in other, non-cost of capital aspects of their operations. Of course, every utility has different rates based of their varying costs and size efficiencies.

    Wes

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