Ed Osann, Senior Policy Analyst, Santa Monica

Today they’re short of water.  Tomorrow they’ll be short of cash.  As water supplies dwindle in the face of the driest year in California’s history, most of the state’s urban water utilities face 2014 financially flatfooted.  Drought Sign re-size.jpg       CalTrans Highway Sign 2014 -- photo: Eric Beteille, pedestrianphotographer.com

Customers have been asked to conserve water, but when they do, water utility revenues will decline.  Eventually this zinger will be sent – “Thank you for conserving.  Now your bill has to go up to make up for our revenue shortfall.”  The perception will be that consumers who conserve are being punished, and the adoption of a general rate increase to make up for the drought’s revenue shortfall means that this perception is probably true.

This recurring scenario undercuts the public cooperation needed when water supplies drop to critical levels; it can and should be broken.  Local drought contingency plans are supposed to account for declines in revenue and protect consumers from such financial whiplash.

Every urban water supplier in California is required to prepare and adopt a drought contingency plan that includes proposed measures to counteract the revenue drop-off from water use curtailment.  But NRDC just completed a quick review of plans from 20 large water suppliers from around the state and found only one that has drought contingency rates already approved and ready to put in place without having to begin a new and time-consuming rate-making proceeding from scratch.  

Without the ability to make rate adjustments on the fly and appropriately match rate changes with each stage of drought severity, water suppliers are digging themselves -- and their customers -- deeper into a financial hole with each new call to curtail water use.  Rather than planning in advance for declining sales volumes, they’ll have to make up the shortfalls much later, typically with a general rate increase on all customers.

What’s the plan?

California law requires urban water utilities to have an Urban Water Management Plan that includes an “urban water shortage contingency analysis.”  The plan must be adopted locally, submitted to the state every five years, and include these six components at a minimum:

  • A description of the stages of action an agency will take in response to water shortages;
  • An estimate of supply for three consecutive dry years;
  • A plan for dealing with a catastrophic supply interruption;
  • A list of the prohibitions, penalties, and consumption reduction methods to be used;
  • An analysis of expected revenue effects of reduced sales during shortages and proposed measures to overcome those effects (emphasis added), and
  • How it will monitor and document water cutbacks.

As can be seen, water suppliers are already required to anticipate the revenue impacts of reduced water sales to customers who are conserving during a drought, and to determine how those effects will be addressed.  But, as noted earlier, relatively few water suppliers actually have drought contingency rates included in their drought contingency plan and included in their currently approved rate structure.   

Pricing is a tool for drought management

Water industry professionals have long known what to do when there’s a drought.  Writing 15 years ago in a journal article entitled "Conservation Rates in the Real World," Drs. Thomas Chesnutt and Janice Beecher noted that “Pricing is a tool for drought management,” adding:

When water becomes scarce during periodic droughts, forward-looking water agencies can use rates to send a signal about the increasing value of water during the shortage.  Ideally, the water agency will design shortage rates well in advance of a crisis, clearly communicate the purpose of the rates to customers, and secure support from the community for a comprehensive emergency management plan that includes pricing and other water use management measures. (emphasis added) --  Journal of the American Water Works Association, February 1998, p 66.

The water industry’s own manual of rate-making offers additional guidance to keep water bills steady:

Ideally, a well-designed drought surcharge should hold customers harmless if they comply with the desired and targeted savings levels.  In other words, a customer that has a targeted Stage 1 reduction of 10 percent and reduces their consumption accordingly may pay roughly the same bill as before the drought and produce the same level of revenue because the pricing of the surcharge has been structured to recover the same level of revenue, assuming a 10 percent reduction in consumption. (emphasis added) – American Water Works Association, Principles of Water Rates, Fees, and Charges, Manual M1, Sixth Edition, 2012.

In other words, drought contingency rates are not a ploy to “jack up” what consumers pay for water service.  In fact, some of a utility’s costs will actually decline as less water is sold, particularly for the chemicals and electricity used in the treatment process.  But other water service costs, including big ones such as personnel and debt service, remain the same no matter how much water is sold.  So the utility’s near-term priority is on maintaining revenues, not increasing them.

Rate structures should encourage conservation

Some utility managers have suggested that the best way to protect their finances from falling sales is by sharply increasing the “fixed” portion of a customer’s bill, perhaps to 75 or 80% of the total bill, and correspondingly reducing the volume-based portion of the bill.  However, by purposefully reducing the impact of water consumption on a customer’s total bill, this approach would severely undercut the conservation signal that a well-designed rate structure should be sending to customers.  As a changing climate takes its toll on the distribution and predictability of our water resources, customers need more encouragement to use water efficiently, not less.

Drought contingency rates can fill this need, serving as a rapid response mechanism to a utility’s financial stress brought on by sharp reductions in water use.  And when implemented in sync with each stage of drought severity, rather than afterwards, such rate modifications will plainly reinforce the message to consumers to curtail water use.  In Los Angeles, for example, the volume of water priced at the lowest tier has been reduced, so that customers who respond to calls to conserve will see little difference in their water bill. With this kind of tiered system, customers get the message, those who cut back on water use are not seriously disadvantaged, and the utility maintains needed levels of revenue.   And as conditions allow for a drought emergency to be lifted, rates can reset to their pre-drought levels.

So when should drought contingency rates be adopted?  Well, “yesterday” would be the best answer.  But even though the public appeals for curtailed use have already begun, it’s still prudent for utilities to act on rates.  We simply don’t know how long this drought will last, nor do we know its ultimate level of severity. Utilities without approved drought rates should begin the rate adjustment process promptly, rather than try to wait out the drought and contemplate the next general rate increase that will be needed to make up the inevitable revenue shortfall.  And apparently the Department of Water Resources agrees -- a webinar to assist urban water suppliers develop their drought water pricing structure has been scheduled for March 4.  Utilities starting the process now will be lucky to get drought rates in place by mid-summer, but better late than never. 

And the state can do more than provide technical assistance.  A change in the law to ensure that all utilities include drought contingency rates in both their drought plans and their adopted water rate schedules would be prudent as well.  This would help ensure that consumer interests, conservation objectives, and the financial health of water utilities are better aligned during the remainder of this drought -- and at the outset of future droughts -- than they were at the beginning of 2014.