Why is Conservation Driving Water Rates Up?

The fixed costs in most water utilities (depreciation, labor, amortization, maintenance, taxes, regulatory compliance, overheads, etc.) are far greater than the fixed charge on a customer’s bills. The commodity charge in theory should cover the variable costs of production only (power, chemicals, and residuals) but that creates a high base bill that neither municipalities nor state regulators often find palatable. The lightening rod is often the economically challenged customer, on a fixed income that uses almost no water. If they were billed based on true cost of service, their base bill would be much higher than their bill; kept artificially low because they used almost no water. In the end high water users pay a disproportionate share of the costs, but these customers are typically seen as that kind of user that is better able to pay the higher cost. This model may be true to an extent where the high use is due to irrigation, but falls apart for low income large families that are no better able to afford a high bill then a single person home.

Because of this artificial imbalance between fixed costs and the fixed fee portion of billed revenues, when conservation reduces water sales, the utility loses the commodity charge billed revenue for every gallon no longer sold. With much of the fixed costs embedded in the commodity (usage based) revenue, the utility loses revenue that goes to covering their fixed costs. If fixed and variable costs were balanced with fixed and variable revenue then the loss of consumption would be directly offset with the loss in expense. The imbalance creates a scenario where conservation will drive rate increases often far in excess of the costs saved by pumping less water. This has been demonstrated in areas like California where some utilities are increasing rates or adding surcharges solely due to the mandated consumption restrictions.

To mitigate these increases, it is imperative for utilities to move forward; driving efficiency and effectiveness deep into their operations to reduce costs has taken on greater significance. These efficiencies can be achieved by leveraging the technology now available in the industry, along with improving processes and aligning organizations. Only so much can be gained with so many small local water suppliers and large efficiency gains can also be achieved through consolidation of the incredibly fragmented industry via privation and public / private partnerships. Regional water supplies that serve large areas, like those typical of electric and gas utilities, can leverage economies of scale and have better access to the capital needed to invest in the technology required to create long term expense savings and mitigate rate increases.

There can be long-term positive impact of conservation on rates in some cases. In the long run, conservation can delay increased fixed costs by deferring investment in additional sources of supply needed to meet demand or in reducing or deferring the acquisition of high priced alternate water supply or rights from other entities.

This imbalance in fixed and variable costs is far more pronounced in the water industry than gas and electric utilities. Gas utilities have relatively low fixed costs with much of their expense being the cost of purchasing the product, natural gas. So a low fixed charge and high commodity rate is a better match; most gas utilities have tariffs that allow fuel cost adjustments as pass thru’s to their customers.

Electric utilities tend to be in between because they have high fixed costs but also the cost of generating / acquiring a kwh is high. They also in many cases to have fuel adjustment pass thru’s.

Historically, water has been undervalued and delivered to the customer at an extremely low cost. Those days are coming to an end as cities and private utilities alike fully understand the true cost of providing safe and reliable water to their customers.

Phone: 312-602-4000
Email: marketing@westmonroepartners.com
222 W. Adams
Chicago, IL 60606
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